Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, Standardized Approach for Risk-weighted Assets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital Rule, 62017-62291 [2013-21653]

Download as PDF Vol. 78 Friday, No. 198 October 11, 2013 Part II Department of the Treasury Office of the Comptroller of the Currency 12 CFR Parts 3, 5, 6, et al. Federal Reserve System wreier-aviles on DSK5TPTVN1PROD with RULES2 12 CFR Parts 208, 217, and 225 Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, Standardized Approach for Risk-weighted Assets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital Rule; Final Rule VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00001 Fmt 4717 Sfmt 4717 E:\FR\FM\11OCR2.SGM 11OCR2 62018 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations DEPARTMENT OF THE TREASURY Office of the Comptroller of the Currency 12 CFR Parts 3, 5, 6, 165, and 167 [Docket ID OCC–2012–0008] RIN 1557–AD46 FEDERAL RESERVE SYSTEM 12 CFR Parts 208, 217, and 225 [Docket No. R–1442; Regulations H, Q, and Y] RIN 7100–AD 87 Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, Standardized Approach for Riskweighted Assets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital Rule Office of the Comptroller of the Currency, Treasury; and the Board of Governors of the Federal Reserve System. ACTION: Final rule. AGENCY: The Office of the Comptroller of the Currency (OCC) and Board of Governors of the Federal Reserve System (Board), are adopting a final rule that revises their risk-based and leverage capital requirements for banking organizations. The final rule consolidates three separate notices of proposed rulemaking that the OCC, Board, and FDIC published in the Federal Register on August 30, 2012, with selected changes. The final rule implements a revised definition of regulatory capital, a new common equity tier 1 minimum capital requirement, a higher minimum tier 1 capital requirement, and, for banking organizations subject to the advanced approaches risk-based capital rules, a supplementary leverage ratio that incorporates a broader set of exposures in the denominator. The final rule incorporates these new requirements into the agencies’ prompt corrective action (PCA) framework. In addition, the final rule establishes limits on a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a specified amount of common equity tier 1 capital in addition to the amount necessary to meet its minimum risk-based capital wreier-aviles on DSK5TPTVN1PROD with RULES2 SUMMARY: VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 requirements. Further, the final rule amends the methodologies for determining risk-weighted assets for all banking organizations, and introduces disclosure requirements that would apply to top-tier banking organizations domiciled in the United States with $50 billion or more in total assets. The final rule also adopts changes to the agencies’ regulatory capital requirements that meet the requirements of section 171 and section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The final rule also codifies the agencies’ regulatory capital rules, which have previously resided in various appendices to their respective regulations, into a harmonized integrated regulatory framework. In addition, the OCC is amending the market risk capital rule (market risk rule) to apply to Federal savings associations, and the Board is amending the advanced approaches and market risk rules to apply to top-tier savings and loan holding companies domiciled in the United States, except for certain savings and loan holding companies that are substantially engaged in insurance underwriting or commercial activities, as described in this preamble. DATES: Effective date: January 1, 2014, except that the amendments to Appendixes A, B and E to 12 CFR Part 208, 12 CFR 225.1, and Appendixes D and E to Part 225 are effective January 1, 2015, and the amendment to Appendix A to 12 CFR Part 225 is effective January 1, 2019. Mandatory compliance date: January 1, 2014 for advanced approaches banking organizations that are not savings and loan holding companies; January 1, 2015 for all other covered banking organizations. FOR FURTHER INFORMATION CONTACT: OCC: Margot Schwadron, Senior Risk Expert, (202) 649–6982; David Elkes, Risk Expert, (202) 649–6984; Mark Ginsberg, Risk Expert, (202) 649–6983, Capital Policy; or Ron Shimabukuro, Senior Counsel; Patrick Tierney, Special Counsel; Carl Kaminski, Senior Attorney; or Kevin Korzeniewski, Attorney, Legislative and Regulatory Activities Division, (202) 649–5490, Office of the Comptroller of the Currency, 400 7th Street SW., Washington, DC 20219. Board: Anna Lee Hewko, Deputy Associate Director, (202) 530–6260; Thomas Boemio, Manager, (202) 452– 2982; Constance M. Horsley, Manager, (202) 452–5239; Juan C. Climent, Senior Supervisory Financial Analyst, (202) 872–7526; or Elizabeth MacDonald, Senior Supervisory Financial Analyst, PO 00000 Frm 00002 Fmt 4701 Sfmt 4700 (202) 475–6316, Capital and Regulatory Policy, Division of Banking Supervision and Regulation; or Benjamin McDonough, Senior Counsel, (202) 452– 2036; April C. Snyder, Senior Counsel, (202) 452–3099; Christine Graham, Senior Attorney, (202) 452–3005; or David Alexander, Senior Attorney, (202) 452–2877, Legal Division, Board of Governors of the Federal Reserve System, 20th and C Streets NW., Washington, DC 20551. For the hearing impaired only, Telecommunication Device for the Deaf (TDD), (202) 263– 4869. SUPPLEMENTARY INFORMATION: Table of Contents I. Introduction II. Summary of the Three Notices of Proposed Rulemaking A. The Basel III Notice of Proposed Rulemaking B. The Standardized Approach Notice of Proposed Rulemaking C. The Advanced Approaches Notice of Proposed Rulemaking III. Summary of General Comments on the Basel III Notice of Proposed Rulemaking and on the Standardized Approach Notice of Proposed Rulemaking; Overview of the Final Rule A. General Comments on the Basel III Notice of Proposed Rulemaking and on the Standardized Approach Notice of Proposed Rulemaking 1. Applicability and Scope 2. Aggregate Impact 3. Competitive Concerns 4. Costs B. Comments on Particular Aspects of the Basel III Notice of Proposed Rulemaking and on the Standardized Approach Notice of Proposed Rulemaking 1. Accumulated Other Comprehensive Income 2. Residential Mortgages 3. Trust Preferred Securities for Smaller Banking Organizations 4. Insurance Activities C. Overview of the Final Rule D. Timeframe for Implementation and Compliance IV. Minimum Regulatory Capital Ratios, Additional Capital Requirements, and Overall Capital Adequacy A. Minimum Risk-Based Capital Ratios and Other Regulatory Capital Provisions B. Leverage Ratio C. Supplementary Leverage Ratio for Advanced Approaches Banking Organizations D. Capital Conservation Buffer E. Countercyclical Capital Buffer F. Prompt Corrective Action Requirements G. Supervisory Assessment of Overall Capital Adequacy H. Tangible Capital Requirement for Federal Savings Associations V. Definition of Capital A. Capital Components and Eligibility Criteria for Regulatory Capital Instruments 1. Common Equity Tier 1 Capital E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 2. Additional Tier 1 Capital 3. Tier 2 Capital 4. Capital Instruments of Mutual Banking Organizations 5. Grandfathering of Certain Capital Instruments 6. Agency Approval of Capital Elements 7. Addressing the Point of Non-Viability Requirements Under Basel III 8. Qualifying Capital Instruments Issued by Consolidated Subsidiaries of a Banking Organization 9. Real Estate Investment Trust Preferred Capital B. Regulatory Adjustments and Deductions 1. Regulatory Deductions From Common Equity Tier 1 Capital a. Goodwill and Other Intangibles (Other Than Mortgage Servicing Assets) b. Gain-on-sale Associated With a Securitization Exposure c. Defined Benefit Pension Fund Net Assets d. Expected Credit Loss That Exceeds Eligible Credit Reserves e. Equity Investments in Financial Subsidiaries f. Deduction for Subsidiaries of Savings Associations That Engage in Activities That Are Not Permissible for National Banks 2. Regulatory Adjustments to Common Equity Tier 1 Capital a. Accumulated Net Gains and Losses on Certain Cash-Flow Hedges b. Changes in a Banking Organization’s Own Credit Risk c. Accumulated Other Comprehensive Income d. Investments in Own Regulatory Capital Instruments e. Definition of Financial Institution f. The Corresponding Deduction Approach g. Reciprocal Crossholdings in the Capital Instruments of Financial Institutions h. Investments in the Banking Organization’s Own Capital Instruments or in the Capital of Unconsolidated Financial Institutions i. Indirect Exposure Calculations j. Non-Significant Investments in the Capital of Unconsolidated Financial Institutions k. Significant Investments in the Capital of Unconsolidated Financial Institutions That Are Not in the Form of Common Stock l. Items Subject to the 10 and 15 Percent Common Equity Tier 1 Capital Threshold Deductions m. Netting of Deferred Tax Liabilities Against Deferred Tax Assets and Other Deductible Assets 3. Investments in Hedge Funds and Private Equity Funds Pursuant to Section 13 of the Bank Holding Company Act VI. Denominator Changes Related to the Regulatory Capital Changes VII. Transition Provisions A. Transitions Provisions for Minimum Regulatory Capital Ratios B. Transition Provisions for Capital Conservation and Countercyclical Capital Buffers C. Transition Provisions for Regulatory Capital Adjustments and Deductions 1. Deductions for Certain Items Under Section 22(a) of the Final Rule VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 2. Deductions for Intangibles Other Than Goodwill and Mortgage Servicing Assets 3. Regulatory Adjustments Under Section 22(b)(1) of the Final Rule 4. Phase-out of Current Accumulated Other Comprehensive Income Regulatory Capital Adjustments 5. Phase-out of Unrealized Gains on Available for Sale Equity Securities in Tier 2 Capital 6. Phase-in of Deductions Related to Investments in Capital Instruments and to the Items Subject to the 10 and 15 Percent Common Equity Tier 1 Capital Deduction Thresholds (Sections 22(c) and 22(d)) of the Final Rule D. Transition Provisions for Non-qualifying Capital Instruments 1. Depository Institution Holding Companies With Less Than $15 Billion in Total Consolidated Assets as of December 31, 2009 and 2010 Mutual Holding Companies 2. Depository Institutions 3. Depository Institution Holding Companies With $15 Billion or More in Total Consolidated Assets as of December 31, 2009 That Are Not 2010 Mutual Holding Companies 4. Merger and Acquisition Transition Provisions 5. Phase-out Schedule for Surplus and Non-Qualifying Minority Interest VIII. Standardized Approach for Riskweighted Assets A. Calculation of Standardized Total Riskweighted Assets B. Risk-weighted Assets for General Credit Risk 1. Exposures to Sovereigns 2. Exposures to Certain Supranational Entities and Multilateral Development Banks 3. Exposures to Government-sponsored Enterprises 4. Exposures to Depository Institutions, Foreign Banks, and Credit Unions 5. Exposures to Public-sector Entities 6. Corporate Exposures 7. Residential Mortgage Exposures 8. Pre-sold Construction Loans and Statutory Multifamily Mortgages 9. High-volatility Commercial Real Estate 10. Past-Due Exposures 11. Other Assets C. Off-balance Sheet Items 1. Credit Conversion Factors 2. Credit-Enhancing Representations and Warranties D. Over-the-Counter Derivative Contracts E. Cleared Transactions 1. Definition of Cleared Transaction 2. Exposure Amount Scalar for Calculating for Client Exposures 3. Risk Weighting for Cleared Transactions 4. Default Fund Contribution Exposures F. Credit Risk Mitigation 1. Guarantees and Credit Derivatives a. Eligibility Requirements b. Substitution Approach c. Maturity Mismatch Haircut d. Adjustment for Credit Derivatives Without Restructuring as a Credit Event e. Currency Mismatch Adjustment f. Multiple Credit Risk Mitigants 2. Collateralized Transactions PO 00000 Frm 00003 Fmt 4701 Sfmt 4700 62019 a. Eligible Collateral b. Risk-management Guidance for Recognizing Collateral c. Simple Approach d. Collateral Haircut Approach e. Standard Supervisory Haircuts f. Own Estimates of Haircuts g. Simple Value-at-Risk and Internal Models Methodology G. Unsettled Transactions H. Risk-weighted Assets for Securitization Exposures 1. Overview of the Securitization Framework and Definitions 2. Operational Requirements a. Due Diligence Requirements b. Operational Requirements for Traditional Securitizations c. Operational Requirements for Synthetic Securitizations d. Clean-up Calls 3. Risk-weighted Asset Amounts for Securitization Exposures a. Exposure Amount of a Securitization Exposure b. Gains-on-sale and Credit-enhancing Interest-only Strips c. Exceptions Under the Securitization Framework d. Overlapping Exposures e. Servicer Cash Advances f. Implicit Support 4. Simplified Supervisory Formula Approach 5. Gross-up Approach 6. Alternative Treatments for Certain Types of Securitization Exposures a. Eligible Asset-backed Commercial Paper Liquidity Facilities b. A Securitization Exposure in a Secondloss Position or Better to an AssetBacked Commercial Paper Program 7. Credit Risk Mitigation for Securitization Exposures 8. Nth-to-default Credit Derivatives IX. Equity Exposures A. Definition of Equity Exposure and Exposure Measurement B. Equity Exposure Risk Weights C. Non-significant Equity Exposures D. Hedged Transactions E. Measures of Hedge Effectiveness F. Equity Exposures to Investment Funds 1. Full Look-Through Approach 2. Simple Modified Look-Through Approach 3. Alternative Modified Look-Through Approach X. Insurance-related Activities A. Policy Loans B. Separate Accounts C. Additional Deductions—Insurance Underwriting Subsidiaries XI. Market Discipline and Disclosure Requirements A. Proposed Disclosure Requirements B. Frequency of Disclosures C. Location of Disclosures and Audit Requirements D. Proprietary and Confidential Information E. Specific Public Disclosure Requirements XII. Risk-Weighted Assets—Modifications to the Advanced Approaches A. Counterparty Credit Risk 1. Recognition of Financial Collateral E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62020 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations a. Financial Collateral b. Revised Supervisory Haircuts 2. Holding Periods and the Margin Period of Risk 3. Internal Models Methodology a. Recognition of Wrong-Way Risk b. Increased Asset Value Correlation Factor 4. Credit Valuation Adjustments a. Simple Credit Valuation Adjustment Approach b. Advanced Credit Valuation Adjustment Approach 5. Cleared Transactions (Central Counterparties) 6. Stress Period for Own Estimates B. Removal of Credit Ratings 1. Eligible Guarantor 2. Money Market Fund Approach 3. Modified Look-through Approaches for Equity Exposures to Investment Funds C. Revisions to the Treatment of Securitization Exposures 1. Definitions 2. Operational Criteria for Recognizing Risk Transference in Traditional Securitizations 3. The Hierarchy of Approaches 4. Guarantees and Credit Derivatives Referencing a Securitization Exposure 5. Due Diligence Requirements for Securitization Exposures 6. Nth-to-Default Credit Derivatives D. Treatment of Exposures Subject to Deduction E. Technical Amendments to the Advanced Approaches Rule 1. Eligible Guarantees and Contingent U.S. Government Guarantees 2. Calculation of Foreign Exposures for Applicability of the Advanced Approaches—Insurance Underwriting Subsidiaries 3. Calculation of Foreign Exposures for Applicability of the Advanced Approaches—Changes to Federal Financial Institutions Examination Council 009 4. Applicability of the Final Rule 5. Change to the Definition of Probability of Default Related to Seasoning 6. Cash Items in Process of Collection 7. Change to the Definition of Qualifying Revolving Exposure 8. Trade-related Letters of Credit 9. Defaulted Exposures That Are Guaranteed by the U.S. Government 10. Stable Value Wraps 11. Treatment of Pre-Sold Construction Loans and Multi-Family Residential Loans F. Pillar 3 Disclosures 1. Frequency and Timeliness of Disclosures 2. Enhanced Securitization Disclosure Requirements 3. Equity Holdings That Are Not Covered Positions XIII. Market Risk Rule XIV. Additional OCC Technical Amendments XV. Abbreviations XVI. Regulatory Flexibility Act XVII. Paperwork Reduction Act XVIII. Plain Language XIX. OCC Unfunded Mandates Reform Act of 1995 Determinations VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 I. Introduction On August 30, 2012, the Office of the Comptroller of the Currency (OCC) the Board of Governors of the Federal Reserve System (Board) (collectively, the agencies), and the Federal Deposit Insurance Corporation (FDIC) published in the Federal Register three joint notices of proposed rulemaking seeking public comment on revisions to their risk-based and leverage capital requirements and on methodologies for calculating risk-weighted assets under the standardized and advanced approaches (each, a proposal, and together, the NPRs, the proposed rules, or the proposals).1 The proposed rules, in part, reflected agreements reached by the Basel Committee on Banking Supervision (BCBS) in ‘‘Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems’’ (Basel III), including subsequent changes to the BCBS’s capital standards and recent BCBS consultative papers.2 Basel III is intended to improve both the quality and quantity of banking organizations’ capital, as well as to strengthen various aspects of the international capital standards for calculating regulatory capital. The proposed rules also reflect aspects of the Basel II Standardized Approach and other Basel Committee standards. The proposals also included changes consistent with the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act); 3 would apply the risk-based and leverage capital rules to top-tier savings and loan holding companies (SLHCs) domiciled in the United States; and would apply the market risk capital rule (the market risk rule) 4 to Federal and state savings associations (as appropriate based on trading activity). The NPR titled ‘‘Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Minimum Regulatory Capital Ratios, Capital Adequacy, Transition Provisions, and 1 77 FR 52792 (August 30, 2012); 77 FR 52888 (August 30, 2012); 77 FR 52978 (August 30, 2012). 2 Basel III was published in December 2010 and revised in June 2011. The text is available at https:// www.bis.org/publ/bcbs189.htm. The BCBS is a committee of banking supervisory authorities, which was established by the central bank governors of the G–10 countries in 1975. More information regarding the BCBS and its membership is available at https://www.bis.org/bcbs/ about.htm. Documents issued by the BCBS are available through the Bank for International Settlements Web site at https://www.bis.org. 3 Public Law 111–203, 124 Stat. 1376, 1435–38 (2010). 4 The agencies’ and the FDIC’s market risk rule is at 12 CFR part 3, appendix B (OCC); 12 CFR parts 208 and 225, appendix E (Board); and 12 CFR part 325, appendix C (FDIC). PO 00000 Frm 00004 Fmt 4701 Sfmt 4700 Prompt Corrective Action’’ 5 (the Basel III NPR), provided for the implementation of the Basel III revisions to international capital standards related to minimum capital requirements, regulatory capital, and additional capital ‘‘buffer’’ standards to enhance the resilience of banking organizations to withstand periods of financial stress. (Banking organizations include national banks, state member banks, Federal savings associations, and top-tier bank holding companies domiciled in the United States not subject to the Board’s Small Bank Holding Company Policy Statement (12 CFR part 225, appendix C)), as well as top-tier savings and loan holding companies domiciled in the United States, except certain savings and loan holding companies that are substantially engaged in insurance underwriting or commercial activities, as described in this preamble.) The proposal included transition periods for many of the requirements, consistent with Basel III and the Dodd-Frank Act. The NPR titled ‘‘Regulatory Capital Rules: Standardized Approach for Riskweighted Assets; Market Discipline and Disclosure Requirements’’ 6 (the Standardized Approach NPR), would revise the methodologies for calculating risk-weighted assets in the agencies’ and the FDIC’s general risk-based capital rules 7 (the general risk-based capital rules), incorporating aspects of the Basel II standardized approach,8 and establish alternative standards of creditworthiness in place of credit ratings, consistent with section 939A of the Dodd-Frank Act.9 The proposed minimum capital requirements in section 10(a) of the Basel III NPR, as determined using the standardized capital ratio calculations in section 10(b), would establish minimum capital requirements that would be the ‘‘generally applicable’’ capital requirements for purpose of section 171 of the Dodd-Frank Act.10 The NPR titled ‘‘Regulatory Capital Rules: Advanced Approaches RiskBased Capital Rule; Market Risk Capital 5 77 FR 52792 (August 30, 2012). FR 52888 (August 30, 2012). 7 The agencies’ and the FDIC’s general risk-based capital rules are at 12 CFR part 3, appendix A (national banks) and 12 CFR part 167 (Federal savings associations) (OCC); 12 CFR parts 208 and 225, appendix A (Board); and 12 CFR part 325, appendix A, and 12 CFR part 390, subpart Z (FDIC). The general risk-based capital rules are supplemented by the market risk rule. 8 See BCBS, ‘‘International Convergence of Capital Measurement and Capital Standards: A Revised Framework,’’ (June 2006), available at https://www.bis.org/publ/bcbs128.htm (Basel II). 9 See section 939A of the Dodd-Frank Act (15 U.S.C. 78o–7 note). 10 See 77 FR 52856 (August 30, 2012). 6 77 E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations Rule’’ 11 (the Advanced Approaches NPR) included proposed changes to the agencies’ and the FDIC’s current advanced approaches risk-based capital rules (the advanced approaches rule) 12 to incorporate applicable provisions of Basel III and the ‘‘Enhancements to the Basel II framework’’ (2009 Enhancements) published in July 2009 13 and subsequent consultative papers, to remove references to credit ratings, to apply the market risk rule to savings associations and SLHCs, and to apply the advanced approaches rule to SLHCs meeting the scope of application of those rules. Taken together, the three proposals also would have restructured the agencies’ and the FDIC’s regulatory capital rules (the general risk-based capital rules, leverage rules,14 market risk rule, and advanced approaches rule) into a harmonized, codified regulatory capital framework. The agencies are adopting the Basel III NPR, Standardized Approach NPR, and Advanced Approaches NPR in this final rule, with certain changes to the proposals, as described further below. (The Board approved this final rule on July 2, 2013, and the OCC approved this final rule on July 9, 2013. The FDIC approved a similar regulation as an interim final rule on July 9, 2013.) This final rule applies to all banking organizations currently subject to minimum capital requirements, including national banks, state member banks, state nonmember banks, state and Federal savings associations, toptier bank holding companies (BHCs) that are domiciled in the United States and are not subject to the Board’s Small Bank Holding Company Policy Statement, and top-tier SLHCs that are domiciled in the United States and that do not engage substantially in insurance underwriting or commercial activities, as discussed further below (together, banking organizations). Generally, BHCs with total consolidated assets of less than $500 million (small BHCs) remain 11 77 FR 52978 (August 30, 2012). agencies’ and the FDIC’s advanced approaches rules are at 12 CFR part 3, appendix C (national banks) and 12 CFR part 167, appendix C (Federal savings associations) (OCC); 12 CFR part 208, appendix F, and 12 CFR part 225, appendix G (Board); 12 CFR part 325, appendix D, and 12 CFR part 390, subpart Z, appendix A (FDIC). The advanced approaches rules are supplemented by the market risk rule. 13 See ‘‘Enhancements to the Basel II framework’’ (July 2009), available at https://www.bis.org/publ/ bcbs157.htm. 14 The agencies’ and the FDIC’s tier 1 leverage rules are at 12 CFR 3.6(b) and 3.6(c) (national banks) and 167.6 (Federal savings associations) (OCC); 12 CFR part 208, appendix B, and 12 CFR part 225, appendix D (Board); and 12 CFR 325.3, and 390.467 (FDIC). wreier-aviles on DSK5TPTVN1PROD with RULES2 12 The VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 subject to the Board’s Small Bank Holding Company Policy Statement.15 Certain aspects of this final rule apply only to banking organizations subject to the advanced approaches rule (advanced approaches banking organizations) or to banking organizations with significant trading activities, as further described below. Likewise, the enhanced disclosure requirements in the final rule apply only to banking organizations with $50 billion or more in total consolidated assets. Consistent with section 171 of the Dodd-Frank Act, a BHC subsidiary of a foreign banking organization that is currently relying on the Board’s Supervision and Regulation Letter (SR) 01–1 is not required to comply with the requirements of the final rule until July 21, 2015. Thereafter, all top-tier U.S.domiciled BHC subsidiaries of foreign banking organizations will be required to comply with the final rule, subject to applicable transition arrangements set forth in subpart G of the rule.16 The final rule reorganizes the agencies’ regulatory capital rules into a harmonized, codified regulatory capital framework. As under the proposal, the minimum capital requirements in section 10(a) of the final rule, as determined using the standardized capital ratio calculations in section 10(b), which apply to all banking organizations, establish the ‘‘generally applicable’’ capital requirements under section 171 of the Dodd-Frank Act.17 Under the final rule, as under the proposal, in order to determine its minimum risk-based capital requirements, an advanced approaches banking organization that has completed the parallel run process and that has received notification from its primary Federal supervisor pursuant to section 121(d) of subpart E must determine its minimum risk-based capital requirements by calculating the three risk-based capital ratios using total riskweighted assets under the standardized 15 See 12 CFR part 225, appendix C (Small Bank Holding Company Policy Statement). 16 See section 171(b)(4)(E) of the Dodd-Frank Act (12 U.S.C. 5371(b)(4)(E)); see also SR 01–1 (January 5, 2001), available at https://www.federalreserve.gov/ boarddocs/srletters/2001/sr0101.htm. In addition, the Board has proposed to apply specific enhanced capital standards to certain U.S. subsidiaries of foreign banking organizations beginning on July 1, 2015, under the proposed notice of rulemaking issued by the Board to implement sections 165 and 166 of the Dodd-Frank Act. See 77 FR 76628, 76640, 76681–82 (December 28, 2012). 17 See note 12, supra. Risk-weighted assets calculated under the market risk framework in subpart F of the final rule are included in calculations of risk-weighted assets both under the standardized approach and the advanced approaches. PO 00000 Frm 00005 Fmt 4701 Sfmt 4700 62021 approach and, separately, total riskweighted assets under the advanced approaches.18 The lower ratio for each risk-based capital requirement is the ratio the banking organization must use to determine its compliance with the minimum capital requirement.19 These enhanced prudential standards help ensure that advanced approaches banking organizations, which are among the largest and most complex banking organizations, have capital adequate to address their more complex operations and risks. II. Summary of the Three Notices of Proposed Rulemaking A. The Basel III Notice of Proposed Rulemaking As discussed in the proposals, the recent financial crisis demonstrated that the amount of high-quality capital held by banking organizations was insufficient to absorb the losses generated over that period. In addition, some non-common stock capital instruments included in tier 1 capital did not absorb losses to the extent previously expected. A lack of clear and easily understood disclosures regarding the characteristics of regulatory capital instruments, as well as inconsistencies in the definition of capital across jurisdictions, contributed to difficulties in evaluating a banking organization’s capital strength. Accordingly, the BCBS assessed the international capital framework and, in 2010, published Basel III, a comprehensive reform package designed to improve the quality and quantity of regulatory capital and build additional capacity into the banking system to absorb losses in times of market and economic stress. On August 30, 2012, the agencies and the FDIC published the NPRs in the Federal Register to revise regulatory capital requirements, as discussed above. As proposed, the Basel III NPR generally would have applied to all U.S. banking organizations. Consistent with Basel III, the Basel III NPR would have required banking organizations to comply with the following minimum capital ratios: (i) A new requirement for a ratio of common equity tier 1 capital to risk-weighted assets (common equity tier 1 capital ratio) of 4.5 percent; (ii) a ratio of tier 1 capital to risk-weighted assets (tier 1 capital ratio) of 6 percent, increased from 4 percent; (iii) a ratio of total capital to risk-weighted assets (total capital ratio) of 8 percent; (iv) a ratio of 18 The banking organization must also use its advanced-approaches-adjusted total to determine its total risk-based capital ratio. 19 See section 10(c) of the final rule. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62022 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations tier 1 capital to average total consolidated assets (leverage ratio) of 4 percent; and (v) for advanced approaches banking organizations only, an additional requirement that the ratio of tier 1 capital to total leverage exposure (supplementary leverage ratio) be at least 3 percent. The Basel III NPR also proposed implementation of a capital conservation buffer equal to 2.5 percent of risk-weighted assets above the minimum risk-based capital ratio requirements, which could be expanded by a countercyclical capital buffer for advanced approaches banking organizations under certain circumstances. If a banking organization failed to hold capital above the minimum capital ratios and proposed capital conservation buffer (as potentially expanded by the countercyclical capital buffer), it would be subject to certain restrictions on capital distributions and discretionary bonus payments. The proposed countercyclical capital buffer was designed to take into account the macrofinancial environment in which large, internationally active banking organizations function. The countercyclical capital buffer could be implemented if the agencies and the FDIC determined that credit growth in the economy became excessive. As proposed, the countercyclical capital buffer would initially be set at zero, and could expand to as much as 2.5 percent of risk-weighted assets. The Basel III NPR proposed to apply a 4 percent minimum leverage ratio requirement to all banking organizations (computed using the new definition of capital), and to eliminate the exceptions for banking organizations with strong supervisory ratings or subject to the market risk rule. The Basel III NPR also proposed to require advanced approaches banking organizations to satisfy a minimum supplementary leverage ratio requirement of 3 percent, measured in a manner consistent with the international leverage ratio set forth in Basel III. Unlike the agencies’ current leverage ratio requirement, the proposed supplementary leverage ratio incorporates certain off-balance sheet exposures in the denominator. To strengthen the quality of capital, the Basel III NPR proposed more conservative eligibility criteria for regulatory capital instruments. For example, the Basel III NPR proposed that trust preferred securities (TruPS) and cumulative perpetual preferred securities, which were tier-1-eligible instruments (subject to limits) at the BHC level, would no longer be includable in tier 1 capital under the VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 proposal and would be gradually phased out from tier 1 capital. The proposal also eliminated the existing limitations on the amount of tier 2 capital that could be recognized in total capital, as well as the limitations on the amount of certain capital instruments (for example, term subordinated debt) that could be included in tier 2 capital. In addition, the proposal would have required banking organizations to include in common equity tier 1 capital accumulated other comprehensive income (AOCI) (with the exception of gains and losses on cash-flow hedges related to items that are not fair-valued on the balance sheet), and also would have established new limits on the amount of minority interest a banking organization could include in regulatory capital. The proposal also would have established more stringent requirements for several deductions from and adjustments to regulatory capital, including with respect to deferred tax assets (DTAs), investments in a banking organization’s own capital instruments and the capital instruments of other financial institutions, and mortgage servicing assets (MSAs). The proposed revisions would have been incorporated into the regulatory capital ratios in the prompt corrective action (PCA) framework for depository institutions. B. The Standardized Approach Notice of Proposed Rulemaking The Standardized Approach NPR proposed changes to the agencies’ and the FDIC’s general risk-based capital rules for determining risk-weighted assets (that is, the calculation of the denominator of a banking organization’s risk-based capital ratios). The proposed changes were intended to revise and harmonize the agencies’ and the FDIC’s rules for calculating risk-weighted assets, enhance risk sensitivity, and address weaknesses in the regulatory capital framework identified over recent years, including by strengthening the risk sensitivity of the regulatory capital treatment for, among other items, credit derivatives, central counterparties (CCPs), high-volatility commercial real estate, and collateral and guarantees. In the Standardized Approach NPR, the agencies and the FDIC also proposed alternatives to credit ratings for calculating risk-weighted assets for certain assets, consistent with section 939A of the Dodd-Frank Act. These alternatives included methodologies for determining risk-weighted assets for exposures to sovereigns, foreign banks, and public sector entities, securitization exposures, and counterparty credit risk. The Standardized Approach NPR also proposed to include a framework for PO 00000 Frm 00006 Fmt 4701 Sfmt 4700 risk weighting residential mortgages based on underwriting and product features, as well as loan-to-value (LTV) ratios, and disclosure requirements for top-tier banking organizations domiciled in the United States with $50 billion or more in total assets, including disclosures related to regulatory capital instruments. C. The Advanced Approaches Notice of Proposed Rulemaking The Advanced Approaches NPR proposed revisions to the advanced approaches rule to incorporate certain aspects of Basel III, the 2009 Enhancements, and subsequent consultative papers. The proposal also would have implemented relevant provisions of the Dodd-Frank Act, including section 939A (regarding the use of credit ratings in agency regulations),20 and incorporated certain technical amendments to the existing requirements. In addition, the Advanced Approaches NPR proposed to codify the market risk rule in a manner similar to the codification of the other regulatory capital rules under the proposals. Consistent with Basel III and the 2009 Enhancements, under the Advanced Approaches NPR, the agencies and the FDIC proposed further steps to strengthen capital requirements for internationally active banking organizations. This NPR would have required advanced approaches banking organizations to hold more appropriate levels of capital for counterparty credit risk, credit valuation adjustments (CVA), and wrong-way risk; would have strengthened the risk-based capital requirements for certain securitization exposures by requiring advanced approaches banking organizations to conduct more rigorous credit analysis of securitization exposures; and would have enhanced the disclosure requirements related to those exposures. The Board proposed to apply the advanced approaches rule to SLHCs, and the agencies and the FDIC proposed to apply the market risk rule to SLHCs and to state and Federal savings associations. 20 See section 939A of Dodd-Frank Act (15 U.S.C. 78o-7 note). E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations III. Summary of General Comments on the Basel III Notice of Proposed Rulemaking and on the Standardized Approach Notice of Proposed Rulemaking; Overview of the Final Rule wreier-aviles on DSK5TPTVN1PROD with RULES2 A. General Comments on the Basel III Notice of Proposed Rulemaking and on the Standardized Approach Notice of Proposed Rulemaking Each agency received over 2,500 public comments on the proposals from banking organizations, trade associations, supervisory authorities, consumer advocacy groups, public officials (including members of the U.S. Congress), private individuals, and other interested parties. Overall, while most commenters supported more robust capital standards and the agencies’ and the FDIC’s efforts to improve the resilience of the banking system, many commenters expressed concerns about the potential costs and burdens of various aspects of the proposals, particularly for smaller banking organizations. A substantial number of commenters also requested withdrawal of, or significant revisions to, the proposals. A few commenters argued that new capital rules were not necessary at this time. Some commenters requested that the agencies and the FDIC perform additional studies of the economic impact of part or all of the proposed rules. Many commenters asked for additional time to transition to the new requirements. A more detailed discussion of the comments provided on particular aspects of the proposals is provided in the remainder of this preamble. 1. Applicability and Scope The agencies and the FDIC received a significant number of comments regarding the proposed scope and applicability of the Basel III NPR and the Standardized Approach NPR. The majority of comments submitted by or on behalf of community banking organizations requested an exemption from the proposals. These commenters suggested basing such an exemption on a banking organization’s asset size—for example, total assets of less than $500 million, $1 billion, $10 billion, $15 billion, or $50 billion—or on its risk profile or business model. Under the latter approach, the commenters suggested providing an exemption for banking organizations with balance sheets that rely less on leverage, shortterm funding, or complex derivative transactions. In support of an exemption from the proposed rule for community banking organizations, a number of commenters VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 argued that the proposed revisions to the definition of capital would be overly conservative and would prohibit some of the instruments relied on by community banking organizations from satisfying regulatory capital requirements. Many of these commenters stated that, in general, community banking organizations have less access to the capital markets relative to larger banking organizations and could increase capital only by accumulating retained earnings. Owing to slow economic growth and relatively low earnings among community banking organizations, the commenters asserted that implementation of the proposal would be detrimental to their ability to serve local communities while providing reasonable returns to shareholders. Other commenters requested exemptions from particular sections of the proposed rules, such as maintaining capital against transactions with particular counterparties, or based on transaction types that they considered lower-risk, such as derivative transactions hedging interest rate risk. The commenters also argued that application of the Basel III NPR and Standardized Approach NPR to community banking organizations would be unnecessary and inappropriate for the business model and risk profile of such organizations. These commenters asserted that Basel III was designed for large, internationallyactive banking organizations in response to a financial crisis attributable primarily to those institutions. Accordingly, the commenters were of the view that community banking organizations require a different capital framework with less stringent capital requirements, or should be allowed to continue to use the general risk-based capital rules. In addition, many commenters, in particular minority depository institutions (MDIs), mutual banking organizations, and community development financial institutions (CDFIs), expressed concern regarding their ability to raise capital to meet the increased minimum requirements in the current environment and upon implementation of the proposed definition of capital. One commenter asked for an exemption from all or part of the proposed rules for CDFIs, indicating that the proposal would significantly reduce the availability of capital for low- and moderate-income communities. Another commenter stated that the U.S. Congress has a policy of encouraging the creation of MDIs and expressed concern that the PO 00000 Frm 00007 Fmt 4701 Sfmt 4700 62023 proposed rules contradicted this purpose. In contrast, however, a few commenters supported the proposed application of the Basel III NPR to all banking organizations. For example, one commenter stated that increasing the quality and quantity of capital at all banking organizations would create a more resilient financial system and discourage inappropriate risk-taking by forcing banking organizations to put more of their own ‘‘skin in the game.’’ This commenter also asserted that the proposed scope of the Basel III NPR would reduce the probability and impact of future financial crises and support the objectives of sustained growth and high employment. Another commenter favored application of the Basel III NPR to all banking organizations to ensure a level playing field among banking organizations within the same competitive market. Comments submitted by or on behalf of banking organizations that are engaged primarily in insurance activities also requested an exemption from the Basel III NPR and the Standardized Approach NPR to recognize differences in their business model compared with those of more traditional banking organizations. According to the commenters, the activities of these organizations are fundamentally different from traditional banking organizations and have a unique risk profile. One commenter expressed concern that the Basel III NPR focuses primarily on assets in the denominator of the risk-based capital ratio as the primary basis for determining capital requirements, in contrast to capital requirements for insurance companies, which are based on the relationship between a company’s assets and liabilities. Similarly, other commenters expressed concern that bank-centric rules would conflict with the capital requirements of state insurance regulators and provide regulatory incentives for unsound assetliability mismatches. Several commenters argued that the U.S. Congress intended that banking organizations primarily engaged in insurance activities should be covered by different capital regulations that accounted for the characteristics of insurance activities. These commenters, therefore, encouraged the agencies and the FDIC to recognize capital requirements adopted by state insurance regulators. Further, commenters asserted that the agencies and the FDIC did not appropriately consider regulatory capital requirements for insurance-based banking organizations E:\FR\FM\11OCR2.SGM 11OCR2 62024 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 whose banking operations are a small part of their overall operations. Some SLHC commenters that are substantially engaged in commercial activities also asserted that the proposals would be inappropriate in scope as proposed and asked that capital rules not be applied to them until an intermediate holding company regime could be established. They also requested that any capital regime applicable to them be tailored to take into consideration their commercial operations and that they be granted longer transition periods. As noted above, small BHCs are exempt from the final rule (consistent with the proposals and section 171 of the Dodd-Frank Act) and continue to be subject to the Board’s Small Bank Holding Company Policy Statement. Comments submitted on behalf of SLHCs with assets less than $500 million requested an analogous exemption to that for small BHCs. These commenters argued that section 171 of the Dodd-Frank Act does not prohibit such an exemption for small SLHCs. 2. Aggregate Impact A majority of the commenters expressed concern regarding the potential aggregate impact of the proposals, together with other provisions of the Dodd-Frank Act. Some of these commenters urged the agencies and the FDIC to withdraw the proposals and to conduct a quantitative impact study (QIS) to assess the potential aggregate impact of the proposals on banking organizations and the overall U.S. economy. Many commenters argued that the proposals would have significant negative consequences for the financial services industry. According to the commenters, by requiring banking organizations to hold more capital and increase risk weighting on some of their assets, as well as to meet higher risk-based and leverage capital measures for certain PCA categories, the proposals would negatively affect the banking sector. Commenters cited, among other potential consequences of the proposals: restricted job growth; reduced lending or higher-cost lending, including to small businesses and low-income or minority communities; limited availability of certain types of financial products; reduced investor demand for banking organizations’ equity; higher compliance costs; increased mergers and consolidation activity, specifically in rural markets, because banking organizations would need to spread compliance costs among a larger customer base; and diminished access to the capital markets resulting from VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 reduced profit and from dividend restrictions associated with the capital buffers. The commenters also asserted that the recovery of the U.S. economy would be impaired by the proposals as a result of reduced lending by banking organizations that the commenters believed would be attributable to the higher costs of regulatory compliance. In particular, the commenters expressed concern that a contraction in smallbusiness lending would adversely affect job growth and employment. 3. Competitive Concerns Many commenters raised concerns that implementation of the proposals would create an unlevel playing field between banking organizations and other financial services providers. For example, a number of commenters expressed concern that credit unions would be able to gain market share from banking organizations by offering similar products at substantially lower costs because of differences in taxation combined with potential costs from the proposals. The commenters also argued that other financial service providers, such as foreign banks with significant U.S. operations, members of the Federal Farm Credit System, and entities in the shadow banking industry, would not be subject to the proposed rule and, therefore, would have a competitive advantage over banking organizations. These commenters also asserted that the proposals could cause more consumers to choose lower-cost financial products from the unregulated, nonbank financial sector. 4. Costs Commenters representing all types of banking organizations expressed concern that the complexity and implementation cost of the proposals would exceed their expected benefits. According to these commenters, implementation of the proposals would require software upgrades for new internal reporting systems, increased employee training, and the hiring of additional employees for compliance purposes. Some commenters urged the agencies and the FDIC to recognize that compliance costs have increased significantly over recent years due to other regulatory changes and to take these costs into consideration. As an alternative, some commenters encouraged the agencies and the FDIC to consider a simple increase in the minimum regulatory capital requirements, suggesting that such an approach would provide increased protection to the Deposit Insurance Fund and increase safety and soundness PO 00000 Frm 00008 Fmt 4701 Sfmt 4700 without adding complexity to the regulatory capital framework. B. Comments on Particular Aspects of the Basel III Notice of Proposed Rulemaking and on the Standardized Approach Notice of Proposed Rulemaking In addition to the general comments described above, the agencies and the FDIC received a significant number of comments on four particular elements of the proposals: the requirement to include most elements of AOCI in regulatory capital; the new framework for risk weighting residential mortgages; the requirement to phase out TruPS from tier 1 capital for all banking organizations; and the application of the rule to BHCs and SLHCs (collectively, depository institution holding companies) with substantial insurance and commercial activities. 1. Accumulated Other Comprehensive Income AOCI generally includes accumulated unrealized gains and losses on certain assets and liabilities that have not been included in net income, yet are included in equity under U.S. generally accepted accounting principles (GAAP) (for example, unrealized gains and losses on securities designated as available-for-sale (AFS)). Under the agencies’ and the FDIC’s general riskbased capital rules, most components of AOCI are not reflected in a banking organization’s regulatory capital. In the proposed rule, consistent with Basel III, the agencies and the FDIC proposed to require banking organizations to include the majority of AOCI components in common equity tier 1 capital. The agencies and the FDIC received a significant number of comments on the proposal to require banking organizations to recognize AOCI in common equity tier 1 capital. Generally, the commenters asserted that the proposal would introduce significant volatility in banking organizations’ capital ratios due in large part to fluctuations in benchmark interest rates, and would result in many banking organizations moving AFS securities into a held-to-maturity (HTM) portfolio or holding additional regulatory capital solely to mitigate the volatility resulting from temporary unrealized gains and losses in the AFS securities portfolio. The commenters also asserted that the proposed rules would likely impair lending and negatively affect banking organizations’ ability to manage liquidity and interest rate risk and to maintain compliance with legal lending limits. Commenters representing community banking organizations in E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 particular asserted that they lack the sophistication of larger banking organizations to use certain riskmanagement techniques for hedging interest rate risk, such as the use of derivative instruments. 2. Residential Mortgages The Standardized Approach NPR would have required banking organizations to place residential mortgage exposures into one of two categories to determine the applicable risk weight. Category 1 residential mortgage exposures were defined to include mortgage products with underwriting and product features that have demonstrated a lower risk of default, such as consideration and documentation of a borrower’s ability to repay, and generally excluded mortgage products that included terms or other characteristics that the agencies and the FDIC have found to be indicative of higher credit risk, such as deferral of repayment of principal. Residential mortgage exposures with higher risk characteristics were defined as category 2 residential mortgage exposures. The agencies and the FDIC proposed to apply relatively lower risk weights to category 1 residential mortgage exposures, and higher risk weights to category 2 residential mortgage exposures. The proposal provided that the risk weight assigned to a residential mortgage exposure also depended on its LTV ratio. The agencies and the FDIC received a significant number of comments objecting to the proposed treatment for one-to-four family residential mortgages and requesting retention of the mortgage treatment in the agencies’ and the FDIC’s general risk-based capital rules. Commenters generally expressed concern that the proposed treatment would inhibit lending to creditworthy borrowers and could jeopardize the recovery of a still-fragile housing market. Commenters also criticized the distinction between category 1 and category 2 mortgages, asserting that the characteristics proposed for each category did not appropriately distinguish between lower- and higherrisk products and would adversely impact certain loan products that performed relatively well even during the recent crisis. Commenters also highlighted concerns regarding regulatory burden and the uncertainty of other regulatory initiatives involving residential mortgages. In particular, these commenters expressed considerable concern regarding the potential cumulative impact of the proposed new mortgage requirements combined with the Dodd-Frank Act’s VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 requirements relating to the definitions of qualified mortgage and qualified residential mortgage 21 and asserted that when considered together with the proposed mortgage treatment, the combined effect could have an adverse impact on the mortgage industry. 3. Trust Preferred Securities for Smaller Banking Organizations The proposed rules would have required all banking organizations to phase-out TruPS from tier 1 capital under either a 3- or 10-year transition period based on the organization’s total consolidated assets. The proposal would have required banking organizations with more than $15 billion in total consolidated assets (as of December 31, 2009) to phase-out of tier 1 capital any non-qualifying capital instruments (such as TruPS and cumulative preferred shares) issued before May 19, 2010. The exclusion of non-qualifying capital instruments would have taken place incrementally over a three-year period beginning on January 1, 2013. Section 171 provides an exception that permits banking organizations with total consolidated assets of less than $15 billion as of December 31, 2009, and banking organizations that were mutual holding companies as of May 19, 2010 (2010 MHCs), to include in tier 1 capital all TruPS (and other instruments that could no longer be included in tier 1 capital pursuant to the requirements of section 171) that were issued prior to May 19, 2010.22 However, consistent with Basel III and the general policy purpose of the proposed revisions to regulatory capital, the agencies and the FDIC proposed to require banking organizations with total consolidated assets less than $15 billion as of December 31, 2009 and 2010 MHCs to phase out their non-qualifying capital instruments from regulatory capital over ten years.23 21 See, e.g., the definition of ‘‘qualified mortgage’’ in section 1412 of the Dodd-Frank Act (15 U.S.C. 129C) and ‘‘qualified residential mortgage’’ in section 941(e)(4) of the Dodd-Frank Act (15 U.S.C. 78o-11(e)(4)). 22 Specifically, section 171 provides that deductions of instruments ‘‘that would be required’’ under the section are not required for depository institution holding companies with total consolidated assets of less than $15 billion as of December 31, 2009 and 2010 MHCs. See 12 U.S.C. 5371(b)(4)(C). 23 See 12 U.S.C. 5371(b)(5)(A). While section 171 of the Dodd-Frank Act requires the agencies to establish minimum risk-based and leverage capital requirements subject to certain limitations, the agencies and the FDIC retain their general authority to establish capital requirements under other laws and regulations, including under the National Bank Act, 12 U.S.C. 1, et seq., Federal Reserve Act, Federal Deposit Insurance Act, Bank Holding Company Act, International Lending Supervision PO 00000 Frm 00009 Fmt 4701 Sfmt 4700 62025 Many commenters representing community banking organizations criticized the proposal’s phase-out schedule for TruPS and encouraged the agencies and the FDIC to grandfather TruPS in tier 1 capital to the extent permitted by section 171 of the DoddFrank Act. Commenters asserted that this was the intent of the U.S. Congress, including this provision in the statute. These commenters also asserted that this aspect of the proposal would unduly burden community banking organizations that have limited ability to raise capital, potentially impairing the lending capacity of these banking organizations. 4. Insurance Activities The agencies and the FDIC received numerous comments from SLHCs, trade associations, insurance companies, and members of the U.S. Congress on the proposed capital requirements for SLHCs, in particular those with significant insurance activities. As noted above, commenters raised concerns that the proposed requirements would apply what are perceived as bank-centric consolidated capital requirements to these entities. Commenters suggested incorporating insurance risk-based capital requirements established by the state insurance regulators into the Board’s consolidated risk-based capital requirements for the holding company, or including certain insurance riskbased metrics that, in the commenters’ view, would measure the risk of insurance activities more accurately. A few commenters asked the Board to conduct an additional cost-benefit analysis prior to implementing the proposed capital requirements for this subset of SLHCs. In addition, several commenters expressed concern with the burden associated with the proposed requirement to prepare financial statements according to GAAP, because a few SLHCs with substantial insurance operations only prepare financial statements according to Statutory Accounting Principles (SAP). These commenters noted that the Board has accepted non-GAAP financial statements from foreign entities in the past for certain non-consolidated reporting requirements related to the foreign subsidiaries of U.S. banking organizations.24 Some commenters stated that the proposal presents serious issues in light Act, 12 U.S.C. 3901, et seq., and Home Owners Loan Act, 12 U.S.C. 1461, et seq. 24 See form FR 2314. E:\FR\FM\11OCR2.SGM 11OCR2 62026 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 of the McCarran-Ferguson Act.25 These commenters stated that section 171 of the Dodd-Frank Act does not specifically refer to the business of insurance. Further, the commenters asserted that the proposal disregards the state-based regulatory capital and reserving regimes applicable to insurance companies and thus would impair the solvency laws enacted by the states for the purpose of regulating insurance. The commenters also said that the proposal would alter the riskmanagement practices and other aspects of the insurance business conducted in accordance with the state laws, in contravention of the McCarran-Ferguson Act. Some commenters also cited section 502 of the Dodd-Frank Act, asserting that it continues the primacy of state regulation of insurance companies.26 C. Overview of the Final Rule The final rule will replace the agencies’ general risk-based capital rules, advanced approaches rule, market risk rule, and leverage rules in accordance with the transition provisions described below. After considering the comments received, the agencies have made substantial modifications in the final rule to address specific concerns raised by commenters regarding the cost, complexity, and burden of the proposals. During the recent financial crisis, lack of confidence in the banking sector increased banking organizations’ cost of funding, impaired banking organizations’ access to short-term funding, depressed values of banking organizations’ equities, and required many banking organizations to seek government assistance. Concerns about banking organizations arose not only because market participants expected steep losses on banking organizations’ assets, but also because of substantial uncertainty surrounding estimated loss rates, and thus future earnings. Further, heightened systemic risks, falling asset values, and reduced credit availability had an adverse impact on business and consumer confidence, significantly affecting the overall economy. The final rule addresses these weaknesses by helping to ensure a banking and financial system that will be better able to absorb losses and continue to lend in 25 The McCarran-Ferguson Act provides that ‘‘[N]o act of Congress shall be construed to invalidate, impair, or supersede any law enacted by any State for the purpose of regulating the business of insurance . . . unless such Act specifically relates to the business of insurance.’’ 15 U.S.C. 1012. 26 31 U.S.C. 313(f). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 future periods of economic stress. This important benefit in the form of a safer, more resilient, and more stable banking system is expected to substantially outweigh any short-term costs that might result from the final rule. In this context, the agencies are adopting most aspects of the proposals, including the minimum risk-based capital requirements, the capital conservation and countercyclical capital buffers, and many of the proposed risk weights. The agencies have also decided to apply most aspects of the Basel III NPR and Standardized Approach NPR to all banking organizations, with some significant changes. Implementing the final rule in a consistent fashion across the banking system will improve the quality and increase the level of regulatory capital, leading to a more stable and resilient system for banking organizations of all sizes and risk profiles. The improved resilience will enhance their ability to continue functioning as financial intermediaries, including during periods of financial stress and reduce risk to the deposit insurance fund and to the financial system. The agencies believe that, together, the revisions to the proposals meaningfully address the commenters’ concerns regarding the potential implementation burden of the proposals. The agencies have considered the concerns raised by commenters and believe that it is important to take into account and address regulatory costs (and their potential effect on banking organizations’ role as financial intermediaries in the economy) when the agencies establish or revise regulatory requirements. In developing regulatory capital requirements, these concerns are considered in the context of the agencies’ broad goals—to enhance the safety and soundness of banking organizations and promote financial stability through robust capital standards for the entire banking system. The agencies participated in the development of a number of studies to assess the potential impact of the revised capital requirements, including participating in the BCBS’s Macroeconomic Assessment Group as well as its QIS, the results of which were made publicly available by the BCBS upon their completion.27 The BCBS analysis suggested that stronger capital requirements help reduce the 27 See ‘‘Assessing the macroeconomic impact of the transition to stronger capital and liquidity requirements’’ (MAG Analysis), Attachment E, also available at: https://www.bis.orpublIothp12.pdf. See also ‘‘Results of the comprehensive quantitative impact study,’’ Attachment F, also available at: https://www.bis.org/publ/bcbs186.pdf. PO 00000 Frm 00010 Fmt 4701 Sfmt 4700 likelihood of banking crises while yielding positive net economic benefits.28 To evaluate the potential reduction in economic output resulting from the new framework, the analysis assumed that banking organizations replaced debt with higher-cost equity to the extent needed to comply with the new requirements, that there was no reduction in the cost of equity despite the reduction in the riskiness of banking organizations’ funding mix, and that the increase in funding cost was entirely passed on to borrowers. Given these assumptions, the analysis concluded there would be a slight increase in the cost of borrowing and a slight decrease in the growth of gross domestic product. The analysis concluded that this cost would be more than offset by the benefit to gross domestic product resulting from a reduced likelihood of prolonged economic downturns associated with a banking system whose lending capacity is highly vulnerable to economic shocks. The agencies’ analysis also indicates that the overwhelming majority of banking organizations already have sufficient capital to comply with the final rule. In particular, the agencies estimate that over 95 percent of all insured depository institutions would be in compliance with the minimums and buffers established under the final rule if it were fully effective immediately. The final rule will help to ensure that these banking organizations maintain their capacity to absorb losses in the future. Some banking organizations may need to take advantage of the transition period in the final rule to accumulate retained earnings, raise additional external regulatory capital, or both. As noted above, however, the overwhelming majority of banking organizations have sufficient capital to comply with the final rule, and the agencies believe that the resulting improvements to the stability and resilience of the banking system outweigh any costs associated with its implementation. The final rule includes some significant revisions from the proposals in response to commenters’ concerns, particularly with respect to the treatment of AOCI; residential mortgages; tier 1 non-qualifying capital instruments such as TruPS issued by smaller depository institution holding companies; the applicability of the rule to SLHCs with substantial insurance or commercial activities; and the 28 See ‘‘An assessment of the long-term economic impact of stronger capital and liquidity requirements,’’ Executive Summary, pg. 1, Attachment G. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations implementation timeframes. The timeframes for compliance are described in the next section and more detailed discussions of modifications to the proposals are provided in the remainder of the preamble. Consistent with the proposed rules, the final rule requires all banking organizations to recognize in regulatory capital all components of AOCI, excluding accumulated net gains and losses on cash-flow hedges that relate to the hedging of items that are not recognized at fair value on the balance sheet. However, while the agencies believe that the proposed AOCI treatment results in a regulatory capital measure that better reflects banking organizations’ actual loss absorption capacity at a specific point in time, the agencies recognize that for many banking organizations, the volatility in regulatory capital that could result from the proposals could lead to significant difficulties in capital planning and asset-liability management. The agencies also recognize that the tools used by larger, more complex banking organizations for managing interest rate risk are not necessarily readily available for all banking organizations. Accordingly, under the final rule, and as discussed in more detail in section V.B of this preamble, a banking organization that is not subject to the advanced approaches rule may make a one-time election not to include most elements of AOCI in regulatory capital under the final rule and instead effectively use the existing treatment under the general risk-based capital rules that excludes most AOCI elements from regulatory capital (AOCI opt-out election). Such a banking organization must make its AOCI opt-out election in the banking organization’s Consolidated Reports of Condition and Income (Call Report) or FR Y–9 series report filed for the first reporting period after the banking organization becomes subject to the final rule. Consistent with regulatory capital calculations under the agencies’ general risk-based capital rules, a banking organization that makes an AOCI opt-out election under the final rule must adjust common equity tier 1 capital by: (1) Subtracting any net unrealized gains and adding any net unrealized losses on AFS securities; (2) subtracting any unrealized losses on AFS preferred stock classified as an equity security under GAAP and AFS equity exposures; (3) subtracting any accumulated net gains and adding any accumulated net losses on cash-flow hedges; (4) subtracting amounts recorded in AOCI attributed to defined benefit postretirement plans resulting from the initial and subsequent VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 application of the relevant GAAP standards that pertain to such plans (excluding, at the banking organization’s option, the portion relating to pension assets deducted under section 22(a)(5) of the final rule); and (5) subtracting any net unrealized gains and adding any net unrealized losses on held-to-maturity securities that are included in AOCI. Consistent with the general risk-based capital rules, common equity tier 1 capital includes any net unrealized losses on AFS equity securities and any foreign currency translation adjustment. A banking organization that makes an AOCI opt-out election may incorporate up to 45 percent of any net unrealized gains on AFS preferred stock classified as an equity security under GAAP and AFS equity exposures into its tier 2 capital. A banking organization that does not make an AOCI opt-out election on the Call Report or applicable FR Y–9 report filed for the first reporting period after the banking organization becomes subject to the final rule will be required to recognize AOCI (excluding accumulated net gains and losses on cash-flow hedges that relate to the hedging of items that are not recognized at fair value on the balance sheet) in regulatory capital as of the first quarter in which it calculates its regulatory capital requirements under the final rule and continuing thereafter. The agencies have decided not to adopt the proposed treatment of residential mortgages. The agencies have considered the commenters’ observations about the burden of calculating the risk weights for banking organizations’ existing mortgage portfolios, and have taken into account the commenters’ concerns that the proposal did not properly assess the use of different mortgage products across different types of markets in establishing the proposed risk weights. The agencies are also particularly mindful of comments regarding the potential effect of the proposal and other mortgage-related rulemakings on credit availability. In light of these considerations, as well as others raised by commenters, the agencies have decided to retain in the final rule the current treatment for residential mortgage exposures under the general risk-based capital rules. Consistent with the general risk-based capital rules, the final rule assigns a 50 or 100 percent risk weight to exposures secured by one-to-four family residential properties. Generally, residential mortgage exposures secured by a first lien on a one-to-four family residential property that are prudently underwritten and that are performing PO 00000 Frm 00011 Fmt 4701 Sfmt 4700 62027 according to their original terms receive a 50 percent risk weight. All other oneto four-family residential mortgage loans, including exposures secured by a junior lien on residential property, are assigned a 100 percent risk weight. If a banking organization holds the first and junior lien(s) on a residential property and no other party holds an intervening lien, the banking organization must treat the combined exposure as a single loan secured by a first lien for purposes of assigning a risk weight. The agencies also considered comments on the proposal to require banking organizations with total consolidated assets less than $15 billion as of December 31, 2009, and 2010 MHCs, to phase out their non-qualifying tier 1 capital instruments from regulatory capital over ten years. Although the agencies continue to believe that TruPS do not absorb losses sufficiently to be included in tier 1 capital as a general matter, the agencies are also sensitive to the difficulties community banking organizations often face when issuing new capital instruments and are aware of the importance their capacity to lend can play in local economies. Therefore, the final rule permanently grandfathers non-qualifying capital instruments in the tier 1 capital of depository institution holding companies with total consolidated assets of less than $15 billion as of December 31, 2009, and 2010 MHCs (subject to limits). Nonqualifying capital instruments under the final rule include TruPS and cumulative perpetual preferred stock issued before May 19, 2010, that BHCs included in tier 1 capital under the limitations for restricted capital elements in the general risk-based capital rules. After considering the comments received from SLHCs substantially engaged in commercial activities or insurance underwriting activities, the Board has decided to consider further the development of appropriate capital requirements for these companies, taking into consideration information provided by commenters as well as information gained through the supervisory process. The Board will explore further whether and how the proposed rule should be modified for these companies in a manner consistent with section 171 of the Dodd-Frank Act and safety and soundness concerns. Consequently, as defined in the final rule, a covered SLHC that is subject to the final rule (covered SLHC) is a toptier SLHC other than a top-tier SLHC that meets the exclusion criteria set forth in the definition. With respect to commercial activities, a top-tier SLHC that is a grandfathered unitary savings E:\FR\FM\11OCR2.SGM 11OCR2 62028 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations and loan holding company (as defined in section 10(c)(9)(A) of the Home Owners’ Loan Act (HOLA)) 29 is not a covered SLHC if as of June 30 of the previous calendar year, either 50 percent or more of the total consolidated assets of the company or 50 percent of the revenues of the company on an enterprise-wide basis (as calculated under GAAP) were derived from activities that are not financial in nature under section 4(k) of the Bank Holding Company Act.30 This exclusion is similar to the exemption from reporting on the form FR Y–9C for grandfathered unitary savings and loan holding companies with significant commercial activities and is designed to capture those SLHCs substantially engaged in commercial activities.31 The Board is excluding grandfathered unitary savings and loan holding companies that meet these criteria from the capital requirements of the final rule while it continues to contemplate a proposal for SLHC intermediate holding companies. Under section 626 of the Dodd-Frank Act, the Board may require a grandfathered unitary savings and loan holding company to establish and conduct all or a portion of its financial activities in or through an intermediate holding company and the intermediate holding company itself becomes an SLHC subject to Board supervision and regulation.32 The Board anticipates that it will release a proposal for public comment on intermediate holding companies in the near term that would specify the criteria for establishing and transferring activities to intermediate holding companies, consistent with section 626 of the Dodd-Frank Act, and propose to apply the Board’s capital requirements in this final rule to such intermediate holding companies. Under the final rule, top-tier SLHCs that are substantially engaged in insurance underwriting activities are also excluded from the definition of ‘‘covered SLHC’’ and the requirements of the final rule. SLHCs that are themselves insurance underwriting companies (as defined in the final rule) are excluded from the definition.33 Also excluded are SLHCs that, as of June 30 29 12 U.S.C. 1461 et seq. U.S.C. 1843(k). 31 See 76 FR 81935 (December 29, 2011). 32 See section 626 of the Dodd-Frank Act (12 U.S.C. 1467b). 33 The final rule defines ‘‘insurance underwriting company’’ to mean an insurance company, as defined in section 201 of the Dodd-Frank Act (12 U.S.C. 5381), that engages in insurance underwriting activities. This definition includes companies engaged in insurance underwriting activities that are subject to regulation by a State insurance regulator and covered by a State insurance company insolvency law. wreier-aviles on DSK5TPTVN1PROD with RULES2 30 12 VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 of the previous calendar year, held 25 percent or more of their total consolidated assets in insurance underwriting subsidiaries (other than assets associated with insurance underwriting for credit risk). Under the final rule, the calculation of total consolidated assets for this purpose must generally be in accordance with GAAP. Many SLHCs that are substantially engaged in insurance underwriting activities do not calculate total consolidated assets under GAAP. Therefore, the Board has determined to allow estimated calculations at this time for the purposes of determining whether a company is excluded from the definition of ‘‘covered SLHC,’’ subject to possible review and adjustment by the Board. The Board expects to implement a framework for SLHCs that are not subject to the final rule by the time covered SLHCs must comply with the final rule in 2015. The final rule also contains provisions applicable to insurance underwriting activities conducted within a BHC or covered SLHC. These provisions are effective as part of the final rule. D. Timeframe for Implementation and Compliance In order to give covered SLHCs and non-internationally active banking organizations more time to comply with the final rule and simplify their transition to the new regime, the final rule will require compliance from different types of organizations at different times. Generally, and as described in further detail below, banking organizations that are not subject to the advanced approaches rule must begin complying with the final rule on January 1, 2015, whereas advanced approaches banking organizations must begin complying with the final rule on January 1, 2014. The agencies believe that advanced approaches banking organizations have the sophistication, infrastructure, and capital markets access to implement the final rule earlier than either banking organizations that do not meet the asset size or foreign exposure threshold for application of those rules or covered SLHCs that have not previously been subject to consolidated capital requirements. A number of commenters requested that the agencies and the FDIC clarify the point at which a banking organization that meets the asset size or foreign exposure threshold for application of the advanced approaches rule becomes subject to subpart E of the proposed rule, and thus all of the provisions that apply to an advanced approaches banking organization. In PO 00000 Frm 00012 Fmt 4701 Sfmt 4700 particular, commenters requested that the agencies and the FDIC clarify whether subpart E of the proposed rule only applies to those banking organizations that have completed the parallel run process and that have received notification from their primary Federal supervisor pursuant to section 121(d) of subpart E, or whether subpart E would apply to all banking organizations that meet the relevant thresholds without reference to completion of the parallel run process. The final rule provides that an advanced approaches banking organization is one that meets the asset size or foreign exposure thresholds for or has opted to apply the advanced approaches rule, without reference to whether that banking organization has completed the parallel run process and has received notification from its primary Federal supervisor pursuant to section 121(d) of subpart E of the final rule. The agencies have also clarified in the final rule when completion of the parallel run process and receipt of notification from the primary Federal supervisor pursuant to section 121(d) of subpart E is necessary for an advanced approaches banking organization to comply with a particular aspect of the rules. For example, only an advanced approaches banking organization that has completed parallel run and received notification from its primary Federal supervisor under section 121(d) of subpart E must make the disclosures set forth under subpart E of the final rule. However, an advanced approaches banking organization must recognize most components of AOCI in common equity tier 1 capital and must meet the supplementary leverage ratio when applicable without reference to whether the banking organization has completed its parallel run process. Beginning on January 1, 2015, banking organizations that are not subject to the advanced approaches rule, as well as advanced approaches banking organizations that are covered SLHCs, become subject to: The revised definitions of regulatory capital; the new minimum regulatory capital ratios; and the regulatory capital adjustments and deductions according to the transition provisions.34 All banking organizations must begin calculating standardized total risk-weighted assets in accordance with subpart D of the final rule, and if applicable, the revised 34 Prior to January 1, 2015, such banking organizations, other than covered SLHCs, must continue to use the agencies’ general risk-based capital rules and tier 1 leverage rules. E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations market risk rule under subpart F, on January 1, 2015.35 Beginning on January 1, 2014, advanced approaches banking organizations that are not SLHCs must begin the transition period for the revised minimum regulatory capital ratios, definitions of regulatory capital, and regulatory capital adjustments and deductions established under the final rule. The revisions to the advanced approaches risk-weighted asset calculations will become effective on January 1, 2014. From January 1, 2014 to December 31, 2014, an advanced approaches banking organization that is on parallel run must calculate risk-weighted assets using the general risk-based capital rules and substitute such risk-weighted assets for its standardized total risk-weighted assets for purposes of determining its risk-based capital ratios. An advanced approaches banking organization on parallel run must also calculate advanced approaches total riskweighted assets using the advanced approaches rule in subpart E of the final rule for purposes of confidential reporting to its primary Federal supervisor on the Federal Financial Institutions Examination Council’s (FFIEC) 101 report. An advanced approaches banking organization that has completed the parallel run process and that has received notification from its primary Federal supervisor pursuant to section 121(d) of subpart E will calculate its risk-weighted assets using the general risk-based capital rules and substitute such risk-weighted assets for its standardized total risk-weighted assets and also calculate advanced approaches total risk-weighted assets using the advanced approaches rule in 62029 subpart E of the final rule for purposes of determining its risk-based capital ratios from January 1, 2014 to December 31, 2014. Regardless of an advanced approaches banking organization’s parallel run status, on January 1, 2015, the banking organization must begin to apply subpart D, and if applicable, subpart F, of the final rule to determine its standardized total risk-weighted assets. The transition period for the capital conservation and countercyclical capital buffers for all banking organizations will begin on January 1, 2016. A banking organization that is required to comply with the market risk rule must comply with the revised market risk rule (subpart F) as of the same date that it must comply with other aspects of the rule for determining its total risk-weighted assets. Date Banking organizations not subject to the advanced approaches rule and banking organizations that are covered SLHCs * January 1, 2015 ................. January 1, 2016 ................. Begin compliance with the revised minimum regulatory capital ratios and begin the transition period for the revised definitions of regulatory capital and the revised regulatory capital adjustments and deductions. Begin compliance with the standardized approach for determining risk-weighted assets. Begin the transition period for the capital conservation and countercyclical capital buffers. Date Advanced approaches banking organizations that are not SLHCs * January 1, 2014 ................. Begin the transition period for the revised minimum regulatory capital ratios, definitions of regulatory capital, and regulatory capital adjustments and deductions. Begin compliance with the revised advanced approaches rule for determining risk-weighted assets. Begin compliance with the standardized approach for determining risk-weighted assets. Begin the transition period for the capital conservation and countercyclical capital buffers. January 1, 2015 ................. January 1, 2016 ................. * If applicable, banking organizations must use the calculations in subpart F of the final rule (market risk) concurrently with the calculation of risk-weighted assets according either to subpart D (standardized approach) or subpart E (advanced approaches) of the final rule. A. Minimum Risk-Based Capital Ratios and Other Regulatory Capital Provisions Consistent with Basel III, the proposed rule would have required banking organizations to comply with the following minimum capital ratios: a common equity tier 1 capital to riskweighted assets ratio of 4.5 percent; a tier 1 capital to risk-weighted assets ratio of 6 percent; a total capital to riskweighted assets ratio of 8 percent; a leverage ratio of 4 percent; and for advanced approaches banking organizations only, a supplementary leverage ratio of 3 percent. The common equity tier 1 capital ratio is a new minimum requirement designed to ensure that banking organizations hold sufficient high-quality regulatory capital that is available to absorb losses on a going-concern basis. The proposed capital ratios would apply to a banking organization on a consolidated basis. The agencies received a substantial number of comments on the proposed minimum risk-based capital requirements. Several commenters supported the proposal to increase the minimum tier 1 risk-based capital requirement. Other commenters commended the agencies and the FDIC for proposing to implement a minimum capital requirement that focuses primarily on common equity. These commenters argued that common equity is the strongest form of capital and that the proposed minimum common equity tier 1 capital ratio of 4.5 percent would promote the safety and soundness of the banking industry. Other commenters provided general support for the proposed increases in minimum risk-based capital requirements, but expressed concern that the proposals could present unique 35 The revised PCA thresholds, discussed further in section IV.E of this preamble, become effective wreier-aviles on DSK5TPTVN1PROD with RULES2 challenges to mutual institutions because they can only raise common equity through retained earnings. A number of commenters asserted that the objectives of the proposal could be achieved through regulatory mechanisms other than the proposed risk-based capital requirements, including enhanced safety and soundness examinations, more stringent underwriting standards, and alternative measures of capital. Other commenters objected to the proposed increase in the minimum tier 1 capital ratio and the implementation of a common equity tier 1 capital ratio. One commenter indicated that increases in regulatory capital ratios would severely limit growth at many community banking organizations and could encourage consolidation through mergers and acquisitions. Other commenters stated that for banks under $750 million in total assets, increased for all insured depository institutions on January 1, 2015. IV. Minimum Regulatory Capital Ratios, Additional Capital Requirements, and Overall Capital Adequacy VerDate Mar<15>2010 14:37 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00013 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62030 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations compliance costs would not allow them to provide a reasonable return to shareholders, and thus would force them to consolidate. Several commenters urged the agencies and the FDIC to recognize community banking organizations’ limited access to the capital markets and related difficulties raising capital to comply with the proposal. One banking organization indicated that implementation of the common equity tier 1 capital ratio would significantly reduce its capacity to grow and recommended that the proposal recognize differences in the risk and complexity of banking organizations and provide favorable, less stringent requirements for smaller and noncomplex institutions. Another commenter suggested that the proposed implementation of an additional riskbased capital ratio would confuse market observers and recommended that the agencies and the FDIC implement a regulatory capital framework that allows investors and the market to ascertain regulatory capital from measures of equity derived from a banking organization’s balance sheet. Other commenters expressed concern that the proposed common equity tier 1 capital ratio would disadvantage MDIs relative to other banking organizations. According to the commenters, in order to retain their minority-owned status, MDIs historically maintain a relatively high percentage of non-voting preferred stockholders that provide long-term, stable sources of capital. Any public offering to increase common equity tier 1 capital levels would dilute the minority investors owning the common equity of the MDI and could potentially compromise the minority-owned status of such institutions. One commenter asserted that, for this reason, the implementation of the Basel III NPR would be contrary to the statutory mandate of section 308 of the Financial Institutions, Reform, Recovery and Enforcement Act (FIRREA).36 Accordingly, the commenters encouraged the agencies and the FDIC to exempt MDIs from the proposed common equity tier 1 capital ratio requirement. The agencies believe that all banking organizations must have an adequate amount of loss-absorbing capital to continue to lend to their communities during times of economic stress, and therefore have decided to implement the regulatory capital requirements, including the minimum common equity tier 1 capital requirement, as proposed. For the reasons described in the NPR, 36 12 U.S.C. 1463 note. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 including the experience during the crisis with lower quality capital instruments, the agencies do not believe it is appropriate to maintain the general risk-based capital rules or to rely on the supervisory process or underwriting standards alone. Accordingly, the final rule maintains the minimum common equity tier 1 capital to total riskweighted assets ratio of 4.5 percent. The agencies have decided not to pursue the alternative regulatory mechanisms suggested by commenters, as such alternatives would be difficult to implement consistently across banking organizations and would not necessarily fulfill the objective of increasing the amount and quality of regulatory capital for all banking organizations. In view of the concerns expressed by commenters with respect to MDIs, the agencies and the FDIC evaluated the risk-based and leverage capital levels of MDIs to determine whether the final rule would disproportionately impact such institutions. This analysis found that of the 178 MDIs in existence as of March 31, 2013, 12 currently are not well capitalized for PCA purposes, whereas (according to the agencies’ and the FDIC’s estimates) 14 would not be considered well capitalized for PCA purposes under the final rule if it were fully implemented without transition today. Accordingly, the agencies do not believe that the final rule would disproportionately impact MDIs and are not adopting any exemptions or special provisions for these institutions. While the agencies recognize MDIs may face impediments in meeting the common equity tier 1 capital ratio, the agencies believe that the improvements to the safety and soundness of these institutions through higher capital standards are warranted and consistent with their obligations under section 308 of FIRREA. As a prudential matter, the agencies have a long-established regulatory policy that banking organizations should hold capital commensurate with the level and nature of the risks to which they are exposed, which may entail holding capital significantly above the minimum requirements, depending on the nature of the banking organization’s activities and risk profile. Section IV.G of this preamble describes the requirement for overall capital adequacy of banking organizations and the supervisory assessment of capital adequacy. Furthermore, consistent with the agencies’ authority under the general risk-based capital rules and the proposals, section 1(d) of the final rule includes a reservation of authority that allows a banking organization’s primary Federal supervisor to require the PO 00000 Frm 00014 Fmt 4701 Sfmt 4700 banking organization to hold a greater amount of regulatory capital than otherwise is required under the final rule, if the supervisor determines that the regulatory capital held by the banking organization is not commensurate with its credit, market, operational, or other risks. In exercising reservation of authority under the rule, the agencies expect to consider the size, complexity, risk profile, and scope of operations of the banking organization; and whether any public benefits would be outweighed by risk to an insured depository institution or to the financial system. B. Leverage Ratio The proposals would require a banking organization to satisfy a leverage ratio of 4 percent, calculated using the proposed definition of tier 1 capital and the banking organization’s average total consolidated assets, minus amounts deducted from tier 1 capital. The agencies and the FDIC also proposed to eliminate the exception in the agencies’ and the FDIC’s leverage rules that provides for a minimum leverage ratio of 3 percent for banking organizations with strong supervisory ratings or BHCs that are subject to the market risk rule. The agencies and the FDIC received a number of comments on the proposed leverage ratio applicable to all banking organizations. Several of these commenters supported the proposed leverage ratio, stating that it serves as a simple regulatory standard that constrains the ability of a banking organization to leverage its equity capital base. Some of the commenters encouraged the agencies and the FDIC to consider an alternative leverage ratio measure of tangible common equity to tangible assets, which would exclude non-common stock elements from the numerator and intangible assets from the denominator of the ratio and thus, according to these commenters, provide a more reliable measure of a banking organization’s viability in a crisis. A number of commenters criticized the proposed removal of the 3 percent exception to the minimum leverage ratio requirement for certain banking organizations. One of these commenters argued that removal of this exception is unwarranted in view of the cumulative impact of the proposals and that raising the minimum leverage ratio requirement for the strongest banking organizations may lead to a deleveraging by the institutions most able to extend credit in a safe and sound manner. In addition, the commenters cautioned the agencies and the FDIC that a restrictive leverage measure, together with more stringent E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations risk-based capital requirements, could magnify the potential impact of an economic downturn. Several commenters suggested modifications to the minimum leverage ratio requirement. One commenter suggested increasing the minimum leverage ratio requirement for all banking organizations to 6 percent, whereas another commenter recommended a leverage ratio requirement as high as 20 percent. Another commenter suggested a tiered approach, with minimum leverage ratio requirements of 6.25 percent and 8.5 percent for community banking organizations and large banking organizations, respectively. According to this commenter, such an approach could be based on the risk characteristics of a banking organization, including liquidity, asset quality, and local deposit levels, as well as its supervisory rating. Another commenter suggested a fluid leverage ratio requirement that would adjust based on certain macroeconomic variables. Under such an approach, the agencies and the FDIC could require banking organizations to meet a minimum leverage ratio of 10 percent under favorable economic conditions and a 6 percent leverage ratio during an economic contraction. In addition, a number of commenters encouraged the agencies and the FDIC to reconsider the scope of exposures that banking organizations include in the denominator of the leverage ratio, which is based on average total consolidated assets under GAAP. Several of these commenters criticized the proposed minimum leverage ratio requirement because it would not include an exemption for certain exposures that are unique to banking organizations engaged in insurance activities. Specifically, these commenters encouraged the Board to consider excluding assets held in separate accounts and stated that such assets are not available to satisfy the claims of general creditors and do not affect the leverage position of an insurance company. A few commenters asserted that the inclusion of separate account assets in the calculation of the leverage ratio stands in contrast to the agencies’ and the FDIC’s treatment of banking organization’s trust accounts, bankaffiliated mutual funds, and bankmaintained common and collective investment funds. In addition, some of these commenters argued for a partial exclusion of trading account assets supporting insurance liabilities because, according to these commenters, the risks attributable to these assets accrue to contract owners. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 The agencies continue to believe that a minimum leverage ratio requirement of 4 percent for all banking organizations is appropriate in light of its role as a complement to the riskbased capital ratios. The proposed leverage ratio is more conservative than the current leverage ratio because it incorporates a more stringent definition of tier 1 capital. In addition, the agencies believe that it is appropriate for all banking organizations, regardless of their supervisory rating or trading activities, to meet the same minimum leverage ratio requirements. As a practical matter, the agencies generally have found a leverage ratio of less than 4 percent to be inconsistent with a supervisory composite rating of ‘‘1.’’ Modifying the scope of the leverage ratio measure or implementing a fluid or tiered approach for the minimum leverage ratio requirement would create additional operational complexity and variability in a minimum ratio requirement that is intended to place a constraint on the maximum degree to which a banking organization can leverage its equity base. Accordingly, the final rule retains the existing minimum leverage ratio requirement of 4 percent and removes the 3 percent leverage ratio exception as of January 1, 2014 for advanced approaches banking organizations and as of January 1, 2015 for all other banking organizations. With respect to including separate account assets in the leverage ratio denominator, the Board continues to consider this issue together with other issues raised by commenters regarding the regulatory capital treatment of insurance activities. The final rule continues to include separate account assets in total assets, consistent with the proposal and the leverage ratio rule for BHCs. C. Supplementary Leverage Ratio for Advanced Approaches Banking Organizations As part of Basel III, the BCBS introduced a minimum leverage ratio requirement of 3 percent (the Basel III leverage ratio) as a backstop measure to the risk-based capital requirements, designed to improve the resilience of the banking system worldwide by limiting the amount of leverage that a banking organization may incur. The Basel III leverage ratio is defined as the ratio of tier 1 capital to a combination of on- and off-balance sheet exposures. As discussed in the Basel III NPR, the agencies and the FDIC proposed the supplementary leverage ratio only for advanced approaches banking organizations because these banking organizations tend to have more PO 00000 Frm 00015 Fmt 4701 Sfmt 4700 62031 significant amounts of off-balance sheet exposures that are not captured by the current leverage ratio. Under the proposal, consistent with Basel III, advanced approaches banking organizations would be required to maintain a minimum supplementary leverage ratio of 3 percent of tier 1 capital to on- and off-balance sheet exposures (total leverage exposure). The agencies and the FDIC received a number of comments on the proposed supplementary leverage ratio. Several commenters stated that the proposed supplementary leverage ratio is unnecessary in light of the minimum leverage ratio requirement applicable to all banking organizations. These commenters stated that the implementation of the supplementary leverage ratio requirement would create market confusion as to the interrelationships among the ratios and as to which ratio serves as the binding constraint for an individual banking organization. One commenter noted that an advanced approaches banking organization would be required to calculate eight distinct regulatory capital ratios (common equity tier 1, tier 1, and total capital to risk-weighted assets under the advanced approaches and the standardized approach, as well as two leverage ratios) and encouraged the agencies and the FDIC to streamline the application of regulatory capital ratios. In addition, commenters suggested that the agencies and the FDIC postpone the implementation of the supplementary leverage ratio until January 1, 2018, after the international supervisory monitoring process is complete, and to collect supplementary leverage ratio information on a confidential basis until then. At least one commenter encouraged the agencies and the FDIC to consider extending the application of the proposed supplementary leverage ratio on a case-by-case basis to banking organizations with total assets of between $50 billion and $250 billion, stating that such institutions may have significant off-balance sheet exposures and engage in a substantial amount of repo-style transactions. Other commenters suggested increasing the proposed supplementary leverage ratio requirement to at least 8 percent for BHCs, under the Board’s authority in section 165 of the Dodd-Frank Act to implement enhanced capital requirements for systemically important financial institutions.37 With respect to specific aspects of the supplementary leverage ratio, some 37 See section 165 of the Dodd-Frank Act, 12 U.S.C. 5365. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62032 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations commenters criticized the methodology for the total leverage exposure. Specifically, one commenter expressed concern that using GAAP as the basis for determining a banking organization’s total leverage exposure would exclude a wide range of off-balance sheet exposures, including derivatives and securities lending transactions, as well as permit extensive netting. To address these issues, the commenter suggested requiring advanced approaches banking organizations to determine their total leverage exposure using International Financial Reporting Standards (IFRS), asserting that it restricts netting and, relative to GAAP, requires the recognition of more off-balance sheet securities lending transactions. Several commenters criticized the proposed incorporation of off-balance sheet exposures into the total leverage exposure. One commenter argued that including unfunded commitments in the total leverage exposure runs counter to the purpose of the supplementary leverage ratio as an on-balance sheet measure of capital that complements the risk-based capital ratios. This commenter was concerned that the proposed inclusion of unfunded commitments would result in a duplicative assessment against banking organizations when the forthcoming liquidity ratio requirements are implemented in the United States. The commenter noted that the proposed 100 percent credit conversion factor for all unfunded commitments is not appropriately calibrated to the vastly different types of commitments that exist across the industry. If the supplementary leverage ratio is retained in the final rule, the commenter requested that the agencies and the FDIC align the credit conversion factors for unfunded commitments under the supplementary leverage ratio and any forthcoming liquidity ratio requirements. Another commenter encouraged the agencies and the FDIC to allow advanced approaches banking organizations to exclude from total leverage exposure the notional amount of any unconditionally cancellable commitment. According to this commenter, unconditionally cancellable commitments are not credit exposures because they can be extinguished at any time at the sole discretion of the issuing entity. Therefore, the commenter argued, the inclusion of these commitments could potentially distort a banking organization’s measure of total leverage exposure. A few commenters requested that the agencies and the FDIC exclude offbalance sheet trade finance instruments VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 from the total leverage exposure, asserting that such instruments are based on underlying client transactions (for example, a shipment of goods) and are generally short-term. The commenters argued that trade finance instruments do not create excessive systemic leverage and that they are liquidated by fulfillment of the underlying transaction and payment at maturity. Another commenter requested that the agencies and the FDIC apply the same credit conversion factors to trade finance instruments as under the general risk-based capital rules—that is, 20 percent of the notional value for trade-related contingent items that arise from the movement of goods, and 50 percent of the notional value for transaction-related contingent items, including performance bonds, bid bonds, warranties, and performance standby letters of credit. According to this commenter, such an approach would appropriately consider the lowrisk characteristics of these instruments and ensure price stability in trade finance. Several commenters supported the proposed treatment for repo-style transactions (including repurchase agreements, securities lending and borrowing transactions, and reverse repos). These commenters stated that securities lending transactions are fully collateralized and marked to market daily and, therefore, the on-balance sheet amounts generated by these transactions appropriately capture the exposure for purposes of the supplementary leverage ratio. These commenters also supported the proposed treatment for indemnified securities lending transactions and encouraged the agencies and the FDIC to retain this treatment in the final rule. Other commenters stated that the proposed measurement of repo-style transactions is not sufficiently conservative and recommended that the agencies and the FDIC implement a methodology that includes in total leverage exposure the notional amounts of these transactions. A few commenters raised concerns about the proposed methodology for determining the exposure amount of derivative contracts. Some commenters criticized the agencies and the FDIC for not allowing advanced approaches banking organizations to use the internal models methodology to calculate the exposure amount for derivative contracts. According to these commenters, the agencies and the FDIC should align the methods for calculating exposure for derivative contracts for purposes of the supplementary leverage ratio and the advanced approaches risk- PO 00000 Frm 00016 Fmt 4701 Sfmt 4700 based capital ratios to more appropriately reflect the riskmanagement activities of advanced approaches banking organizations and to measure these exposures consistently across the regulatory capital ratios. At least one commenter requested clarification of the proposed treatment of collateral received in connection with derivative contracts. This commenter also encouraged the agencies and the FDIC to permit recognition of eligible collateral for purposes of reducing total leverage exposure, consistent with proposed legislation in other BCBS member jurisdictions. The introduction of an international leverage ratio requirement in the Basel III capital framework is an important development that would provide a consistent leverage ratio measure across internationally-active institutions. Furthermore, the supplementary leverage ratio is reflective of the on- and off-balance sheet activities of large, internationally active banking organizations. Accordingly, consistent with Basel III, the final rule implements for reporting purposes the proposed supplementary leverage ratio for advanced approaches banking organizations starting on January 1, 2015 and requires advanced approaches banking organizations to comply with the minimum supplementary leverage ratio requirement starting on January 1, 2018. Public reporting of the supplementary leverage ratio during the international supervisory monitoring period is consistent with the international implementation timeline and enables transparency and comparability of reporting the leverage ratio requirement across jurisdictions. The agencies are not applying the supplementary leverage ratio requirement to banking organizations that are not subject to the advanced approaches rule in the final rule. Applying the supplementary leverage ratio routinely could create operational complexity for smaller banking organizations that are not internationally active, and that generally do not have off-balance sheet activities that are as extensive as banking organizations that are subject to the advanced approaches rule. The agencies note that the final rule imposes riskbased capital requirements on all repostyle transactions and otherwise imposes constraints on all banking organizations’ off-balance sheet exposures. With regard to the commenters’ views to require the use of IFRS for purposes of the supplementary leverage ratio, the agencies note that the use of GAAP in the final rule as a starting point to E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations measure exposure of certain derivatives and repo-style transactions, has the advantage of maintaining consistency between regulatory capital calculations and regulatory reporting, the latter of which must be consistent with GAAP or, if another accounting principle is used, no less stringent than GAAP.38 In response to the commenters’ views regarding the scope of the total leverage exposure, the agencies note that the supplementary leverage ratio is intended to capture on- and off-balance sheet exposures of a banking organization. Commitments represent an agreement to extend credit and thus including commitments (both funded and unfunded) in the supplementary leverage ratio is consistent with its purpose to measure the on- and offbalance sheet leverage of a banking organization, as well as with safety and soundness principles. Accordingly, the agencies believe that total leverage exposure should include banking organizations’ off-balance sheet exposures, including all loan commitments that are not unconditionally cancellable, financial standby letters of credit, performance standby letters of credit, and commercial and other similar letters of credit. The proposal to include unconditionally cancellable commitments in the total leverage exposure recognizes that a banking organization may extend credit under the commitment before it is cancelled. If the banking organization exercises its option to cancel the commitment, its total leverage exposure amount with respect to the commitment will be limited to any extension of credit prior to cancellation. The proposal considered banking organizations’ ability to cancel such commitments and, therefore, limited the amount of unconditionally cancellable commitments included in total leverage exposure to 10 percent of the notional amount of such commitments. The agencies note that the credit conversion factors used in the supplementary leverage ratio and in any forthcoming liquidity ratio requirements have been developed to serve the purposes of the respective frameworks and may not be identical. Similarly, the commenters’ proposed modifications to credit conversion factors for trade finance transactions would be inconsistent with the purpose of the supplementary leverage ratio—to capture all off-balance sheet exposures of banking organizations in a primarily non-risk-based manner. 38 See 12 U.S.C. 1831n(a)(2). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 For purposes of incorporating derivative contracts in the total leverage exposure, the proposal would require all advanced approaches banking organizations to use the same methodology to measure such exposures. The proposed approach provides a uniform measure of exposure for derivative contracts across banking organizations, without regard to their models. Accordingly, the agencies do not believe a banking organization should be permitted to use internal models to measure the exposure amount of derivative contracts for purposes of the supplementary leverage ratio. With regard to commenters requesting a modification of the proposed treatment for repo-style transactions, the agencies do not believe that the proposed modifications are warranted at this time because international discussions and quantitative analysis of the exposure measure for repo-style transactions are still ongoing. The agencies are continuing to work with the BCBS to assess the Basel III leverage ratio, including its calibration and design, as well as the impact of any differences in national accounting frameworks material to the denominator of the Basel III leverage ratio. The agencies will consider any changes to the supplementary leverage ratio as the BCBS revises the Basel III leverage ratio. Therefore, the agencies have adopted the proposed supplementary leverage ratio in the final rule without modification. An advanced approaches banking organization must calculate the supplementary leverage ratio as the simple arithmetic mean of the ratio of the banking organization’s tier 1 capital to total leverage exposure as of the last day of each month in the reporting quarter. The agencies also note that collateral may not be applied to reduce the potential future exposure (PFE) amount for derivative contracts. Under the final rule, total leverage exposure equals the sum of the following: (1) The balance sheet carrying value of all of the banking organization’s onbalance sheet assets less amounts deducted from tier 1 capital under section 22(a), (c), and (d) of the final rule; (2) The PFE amount for each derivative contract to which the banking organization is a counterparty (or each single-product netting set of such transactions) determined in accordance with section 34 of the final rule, but without regard to section 34(b); (3) 10 percent of the notional amount of unconditionally cancellable commitments made by the banking organization; and PO 00000 Frm 00017 Fmt 4701 Sfmt 4700 62033 (4) The notional amount of all other off-balance sheet exposures of the banking organization (excluding securities lending, securities borrowing, reverse repurchase transactions, derivatives and unconditionally cancellable commitments). Advanced approaches banking organizations must maintain a minimum supplementary leverage ratio of 3 percent beginning on January 1, 2018, consistent with Basel III. However, as noted above, beginning on January 1, 2015, advanced approaches banking organizations must calculate and report their supplementary leverage ratio. D. Capital Conservation Buffer During the recent financial crisis, some banking organizations continued to pay dividends and substantial discretionary bonuses even as their financial condition weakened. Such capital distributions had a significant negative impact on the overall strength of the banking sector. To encourage better capital conservation by banking organizations and to enhance the resilience of the banking system, the proposed rule would have limited capital distributions and discretionary bonus payments for banking organizations that do not hold a specified amount of common equity tier 1 capital in addition to the amount of regulatory capital necessary to meet the minimum risk-based capital requirements (capital conservation buffer), consistent with Basel III. In this way, the capital conservation buffer is intended to provide incentives for banking organizations to hold sufficient capital to reduce the risk that their capital levels would fall below their minimum requirements during a period of financial stress. The proposed rules incorporated a capital conservation buffer composed of common equity tier 1 capital in addition to the minimum risk-based capital requirements. Under the proposal, a banking organization would need to hold a capital conservation buffer in an amount greater than 2.5 percent of total risk-weighted assets (plus, for an advanced approaches banking organization, 100 percent of any applicable countercyclical capital buffer amount) to avoid limitations on capital distributions and discretionary bonus payments to executive officers, as defined in the proposal. The proposal provided that the maximum dollar amount that a banking organization could pay out in the form of capital distributions or discretionary bonus payments during the current calendar quarter (the maximum payout amount) E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62034 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations would be equal to a maximum payout ratio, multiplied by the banking organization’s eligible retained income, as discussed below. The proposal provided that a banking organization with a buffer of more than 2.5 percent of total risk-weighted assets (plus, for an advanced approaches banking organization, 100 percent of any applicable countercyclical capital buffer), would not be subject to a maximum payout amount. The proposal clarified that the agencies and the FDIC reserved the ability to restrict capital distributions under other authorities and that restrictions on capital distributions and discretionary bonus payments associated with the capital conservation buffer would not be part of the PCA framework. The calibration of the buffer is supported by an evaluation of the loss experience of U.S. banking organizations as part of an analysis conducted by the BCBS, as well as by evaluation of historical levels of capital at U.S. banking organizations.39 The agencies and the FDIC received a significant number of comments on the proposed capital conservation buffer. In general, the commenters characterized the capital conservation buffer as overly conservative, and stated that the aggregate amount of capital that would be required for a banking organization to avoid restrictions on dividends and discretionary bonus payments under the proposed rule exceeded the amount required for a safe and prudent banking system. Commenters expressed concern that the capital conservation buffer could disrupt the priority of payments in a banking organization’s capital structure, as any restrictions on dividends would apply to both common and preferred stock. Commenters also questioned the appropriateness of restricting a banking organization that fails to comply with the capital conservation buffer from paying dividends or bonus payments if it has established and maintained cash reserves to cover future uncertainty. One commenter supported the establishment of a formal mechanism for banking organizations to request agency approval to make capital distributions even if doing so would otherwise be restricted under the capital conservation buffer. Other commenters recommended an exemption from the proposed capital conservation buffer for certain types of banking organizations, such as community banking organizations, 39 ‘‘Calibrating regulatory capital requirements and buffers: A top-down approach.’’ Basel Committee on Banking Supervision, October, 2010, available at www.bis.org. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 banking organizations organized in mutual form, and rural BHCs that rely heavily on bank stock loans for growth and expansion purposes. Commenters also recommended a wide range of institutions that should be excluded from the buffer based on a potential size threshold, such as banking organizations with total consolidated assets of less than $250 billion. Commenters also recommended that Scorporations be exempt from the proposed capital conservation buffer because under the U.S. Internal Revenue Code, S-corporations are not subject to a corporate-level tax; instead, Scorporation shareholders must report income and pay income taxes based on their share of the corporation’s profit or loss. An S-corporation generally declares a dividend to help shareholders pay their tax liabilities that arise from reporting their share of the corporation’s profits. According to some commenters, the proposal disadvantaged Scorporations because shareholders of Scorporations would be liable for tax on the S-corporation’s net income, and the S-corporation may be prohibited from making a dividend to these shareholders to fund the tax payment. One commenter criticized the proposed composition of the capital conservation buffer (which must consist solely of common equity tier 1 capital) and encouraged the agencies and the FDIC to allow banking organizations to include noncumulative perpetual preferred stock and other tier 1 capital instruments. Several commenters questioned the empirical basis for a capital conservation buffer of 2.5 percent, and encouraged the agencies and the FDIC to provide a quantitative analysis for the proposal. One commenter suggested application of the capital conservation buffer only during economic downturn scenarios, consistent with the agencies’ and the FDIC’s objective to restrict dividends and discretionary bonus payments during these periods. According to this commenter, a banking organization that fails to maintain a sufficient capital conservation buffer during periods of economic stress also could be required to submit a plan to increase its capital. After considering these comments, the agencies have decided to maintain common equity tier 1 capital as the basis of the capital conservation buffer and to apply the capital conservation buffer to all types of banking organizations at all times. Application of the buffer to all types of banking organizations and maintenance of a capital buffer during periods of market and economic stability is appropriate to encourage sound capital management PO 00000 Frm 00018 Fmt 4701 Sfmt 4700 and help ensure that banking organizations will maintain adequate amounts of loss-absorbing capital going forward, strengthening the ability of the banking system to continue serving as a source of credit to the economy in times of stress. A buffer framework that restricts dividends and discretionary bonus payments only for certain types of banking organizations or only during an economic contraction would not achieve these objectives. Similarly, basing the capital conservation buffer on the most loss-absorbent form of capital is most consistent with the purpose of the capital conservation buffer as it helps to ensure that the buffer can be used effectively by banking organizations at a time when they are experiencing losses. The agencies recognize that Scorporation banking organizations structure their tax payments differently from C corporations. However, the agencies note that this distinction results from S-corporations’ passthrough taxation, in which profits are not subject to taxation at the corporate level, but rather at the shareholder level. The agencies are charged with evaluating the capital levels and safety and soundness of the banking organization. At the point where a decrease in the organization’s capital triggers dividend restrictions, the agencies believe that capital should stay within the banking organization. Scorporation shareholders may receive a benefit from pass-through taxation, but with that benefit comes the risk that the corporation has no obligation to make dividend distributions to help shareholders pay their tax liabilities. Therefore, the final rule does not exempt S-corporations from the capital conservation buffer. Accordingly, under the final rule a banking organization must maintain a capital conservation buffer of common equity tier 1 capital in an amount greater than 2.5 percent of total riskweighted assets (plus, for an advanced approaches banking organization, 100 percent of any applicable countercyclical capital buffer amount) to avoid being subject to limitations on capital distributions and discretionary bonus payments to executive officers. The proposal defined eligible retained income as a banking organization’s net income (as reported in the banking organization’s quarterly regulatory reports) for the four calendar quarters preceding the current calendar quarter, net of any capital distributions and associated tax effects not already reflected in net income. The agencies and the FDIC received a number of comments regarding the proposed E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations definition of eligible retained income, which is used to calculate the maximum payout amount. Some commenters suggested that the agencies and the FDIC limit capital distributions based on retained earnings instead of eligible retained income, citing the Board’s Regulation H as an example of this regulatory practice.40 Several commenters representing banking organizations organized as Scorporations recommended revisions to the definition of eligible retained income so that it would be net of passthrough tax distributions to shareholders that have made a passthrough election for tax purposes, allowing S-corporation shareholders to pay their tax liability notwithstanding any dividend restrictions resulting from failure to comply with the capital conservation buffer. Some commenters suggested that the definition of eligible retained income be adjusted for items such as goodwill impairment that are captured in the definition of ‘‘net income’’ for regulatory reporting purposes but which do not affect regulatory capital. The final rule adopts the proposed definition of eligible retained income without change. The agencies believe the commenters’ suggested modifications to the definition of eligible retained income would add complexity to the final rule and in some cases may be counter-productive by weakening the incentives of the capital conservation buffer. The agencies note that the definition of eligible retained income appropriately accounts for impairment charges, which reduce eligible retained income but also reduce the balance sheet amount of goodwill that is deducted from regulatory capital. Further, the proposed definition of eligible retained income, which is based on net income as reported in the banking organization’s quarterly regulatory reports, reflects a simple measure of a banking organization’s recent performance upon which to base restrictions on capital distributions and discretionary payments to executive officers. For the same reasons as described above regarding the application of the capital conservation buffer to S-corporations generally, the agencies have determined that the definition of eligible retained income should not be modified to address the tax-related concerns raised by commenters writing on behalf of Scorporations. The proposed rule generally defined a capital distribution as a reduction of tier 1 or tier 2 capital through the 40 See 12 CFR part 208. VerDate Mar<15>2010 13:14 Oct 10, 2013 repurchase or redemption of a capital instrument or by other means; a dividend declaration or payment on any tier 1 or tier 2 capital instrument if the banking organization has full discretion to permanently or temporarily suspend such payments without triggering an event of default; or any similar transaction that the primary Federal supervisor determines to be in substance a distribution of capital. Commenters provided suggestions on the definition of ‘‘capital distribution.’’ One commenter requested that a ‘‘capital distribution’’ be defined to exclude any repurchase or redemption to the extent the capital repurchased or redeemed was replaced in a contemporaneous transaction by the issuance of capital of an equal or higher quality tier. The commenter maintained that the proposal would unnecessarily penalize banking organizations that redeem capital but contemporaneously replace such capital with an equal or greater amount of capital of an equivalent or higher quality. In response to comments, and recognizing that redeeming capital instruments that are replaced with instruments of the same or similar quality does not weaken a banking organization’s overall capital position, the final rule provides that a redemption or repurchase of a capital instrument is not a distribution provided that the banking organization fully replaces that capital instrument by issuing another capital instrument of the same or better quality (that is, more subordinate) based on the final rule’s eligibility criteria for capital instruments, and provided that such issuance is completed within the same calendar quarter the banking organization announces the repurchase or redemption. For purposes of this definition, a capital instrument is issued at the time that it is fully paid in. For purposes of the final rule, the agencies changed the defined term from ‘‘capital distribution’’ to ‘‘distribution’’ to avoid confusion with the term ‘‘capital distribution’’ used in the Board’s capital plan rule.41 The proposed rule defined discretionary bonus payment as a payment made to an executive officer of a banking organization (as defined below) that meets the following conditions: the banking organization retains discretion as to the fact of the payment and as to the amount of the payment until the payment is awarded to the executive officer; the amount paid is determined by the banking organization without prior promise to, or agreement with, the executive officer; 41 See Jkt 232001 PO 00000 12 CFR 225.8. Frm 00019 Fmt 4701 Sfmt 4700 62035 and the executive officer has no contractual right, express or implied, to the bonus payment. The agencies and the FDIC received a number of comments on the proposed definition of discretionary bonus payments to executive officers. One commenter expressed concern that the proposed definition of discretionary bonus payment may not be effective unless the agencies and the FDIC provided clarification as to the type of payments covered, as well as the timing of such payments. This commenter asked whether the proposed rule would prohibit the establishment of a prefunded bonus pool with mandatory distributions and sought clarification as to whether non-cash compensation payments, such as stock options, would be considered a discretionary bonus payment. The final rule’s definition of discretionary bonus payment is unchanged from the proposal. The agencies note that if a banking organization prefunds a pool for bonuses payable under a contract, the bonus pool is not discretionary and, therefore, is not subject to the capital conservation buffer limitations. In addition, the definition of discretionary bonus payment does not include noncash compensation payments that do not affect capital or earnings such as, in some cases, stock options. Commenters representing community banking organizations maintained that the proposed restrictions on discretionary bonus payments would disproportionately impact such institutions’ ability to attract and retain qualified employees. One commenter suggested revising the proposed rule so that a banking organization that fails to satisfy the capital conservation buffer would be restricted from making a discretionary bonus payment only to the extent it exceeds 15 percent of the employee’s salary, asserting that this would prevent excessive bonus payments while allowing community banking organizations flexibility to compensate key employees. The final rule does not incorporate this suggestion. The agencies note that the potential limitations and restrictions under the capital conservation buffer framework do not automatically translate into a prohibition on discretionary bonus payments. Instead, the overall dollar amount of dividends and bonuses to executive officers is capped based on how close the banking organization’s regulatory capital ratios are to its minimum capital ratios and on the earnings of the banking organization that are available for distribution. This approach provides appropriate E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62036 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations incentives for capital conservation while preserving flexibility for institutions to decide how to allocate income available for distribution between discretionary bonus payments and other distributions. The proposal defined executive officer as a person who holds the title or, without regard to title, salary, or compensation, performs the function of one or more of the following positions: President, chief executive officer, executive chairman, chief operating officer, chief financial officer, chief investment officer, chief legal officer, chief lending officer, chief risk officer, or head of a major business line, and other staff that the board of directors of the banking organization deems to have equivalent responsibility.42 Commenters generally supported a more restrictive definition of executive officer, arguing that the definition of executive officer should be no broader than the definition under the Board’s Regulation O,43 which governs any extension of credit between a member bank and an executive officer, director, or principal shareholder. Some commenters, however, favored a more expansive definition of executive officer, with one commenter supporting the inclusion of directors of the banking organization or directors of any of the banking organization’s affiliates, any other person in control of the banking organization or the banking organizations’ affiliates, and any person in control of a major business line. In accordance with the agencies’ objective to include those individuals within a banking organization with the greatest responsibility for the organization’s financial condition and risk exposure, the final rule maintains the definition of executive officer as proposed. Under the proposal, advanced approaches banking organizations would have calculated their capital conservation buffer (and any applicable countercyclical capital buffer amount) using their advanced approaches total risk-weighted assets. Several commenters supported this aspect of the proposal, and one stated that the methodologies for calculating riskweighted assets under the advanced approaches rule would more effectively capture the individual risk profiles of such banking organizations, asserting further that advanced approaches banking organizations would face a competitive disadvantage relative to foreign banking organizations if they were required to use standardized total 42 See 76 FR 21170 (April 14, 2011) for a comparable definition of ‘‘executive officer.’’ 43 See 12 CFR part 215. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 risk-weighted assets to determine compliance with the capital conservation buffer. In contrast, another commenter suggested that advanced approaches banking organizations be allowed to use the advanced approaches methodologies as the basis for calculating the capital conservation buffer only when it would result in a more conservative outcome than under the standardized approach in order to maintain competitive equity domestically. Another commenter expressed concerns that the capital conservation buffer is based only on risk-weighted assets and recommended additional application of a capital conservation buffer to the leverage ratio to avoid regulatory arbitrage opportunities and to accomplish the agencies’ and the FDIC’s stated objective of ensuring that banking organizations have sufficient capital to absorb losses. The final rule requires that advanced approaches banking organizations that have completed the parallel run process and that have received notification from their primary Federal supervisor pursuant to section 121(d) of subpart E use their risk-based capital ratios under section 10 of the final rule (that is, the lesser of the standardized and the advanced approaches ratios) as the basis for calculating their capital conservation buffer (and any applicable countercyclical capital buffer). The agencies believe such an approach is appropriate because it is consistent with how advanced approaches banking organizations compute their minimum risk-based capital ratios. Many commenters discussed the interplay between the proposed capital conservation buffer and the PCA framework. Some commenters encouraged the agencies and the FDIC to reset the buffer requirement to two percent of total risk-weighted assets in order to align it with the margin between the ‘‘adequately-capitalized’’ category and the ‘‘well-capitalized’’ category under the PCA framework. Similarly, some commenters characterized the proposal as confusing because a banking organization could be considered well capitalized for PCA purposes, but at the same time fail to maintain a sufficient capital conservation buffer and be subject to restrictions on capital distributions and discretionary bonus payments. These commenters encouraged the agencies and the FDIC to remove the capital conservation buffer for purposes of the final rule, and instead use their existing authority to impose restrictions on dividends and discretionary bonus payments on a case-by-case basis through formal enforcement actions. PO 00000 Frm 00020 Fmt 4701 Sfmt 4700 Several commenters stated that compliance with a capital conservation buffer that operates outside the traditional PCA framework adds complexity to the final rule, and suggested increasing minimum capital requirements if the agencies and the FDIC determine they are currently insufficient. Specifically, one commenter encouraged the agencies and the FDIC to increase the minimum total risk-based capital requirement to 10.5 percent and remove the capital conservation buffer from the rule. The capital conservation buffer has been designed to give banking organizations the flexibility to use the buffer while still being well capitalized. Banking organizations that maintain their risk-based capital ratios at least 50 basis points above the well capitalized PCA levels will not be subject to any restrictions imposed by the capital conservation buffer, as applicable. As losses begin to accrue or a banking organization’s risk-weighted assets begin to grow such that the capital ratios of a banking organization are below the capital conservation buffer but above the well capitalized thresholds, the incremental limitations on distributions are unlikely to affect planned capital distributions or discretionary bonus payments but may provide a check on rapid expansion or other activities that would weaken the organization’s capital position. Under the final rule, the maximum payout ratio is the percentage of eligible retained income that a banking organization is allowed to pay out in the form of distributions and discretionary bonus payments, each as defined under the rule, during the current calendar quarter. The maximum payout ratio is determined by the banking organization’s capital conservation buffer as calculated as of the last day of the previous calendar quarter. A banking organization’s capital conservation buffer is the lowest of the following ratios: (i) The banking organization’s common equity tier 1 capital ratio minus its minimum common equity tier 1 capital ratio; (ii) the banking organization’s tier 1 capital ratio minus its minimum tier 1 capital ratio; and (iii) the banking organization’s total capital ratio minus its minimum total capital ratio. If the banking organization’s common equity tier 1, tier 1 or total capital ratio is less than or equal to its minimum common equity tier 1, tier 1 or total capital ratio, respectively, the banking organization’s capital conservation buffer is zero. The mechanics of the capital conservation buffer under the final rule are unchanged from the proposal. A E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations banking organization’s maximum payout amount for the current calendar quarter is equal to the banking organization’s eligible retained income, multiplied by the applicable maximum payout ratio, in accordance with Table 1. A banking organization with a capital conservation buffer that is greater than 2.5 percent (plus, for an advanced approaches banking organization, 100 percent of any applicable countercyclical capital buffer) is not subject to a maximum payout amount as a result of the application of this provision. However, a banking organization may otherwise be subject to limitations on capital distributions as a result of supervisory actions or other laws or regulations.44 Table 1 illustrates the relationship between the capital conservation buffer and the maximum payout ratio. The maximum dollar amount that a banking organization is permitted to pay out in 62037 the form of distributions or discretionary bonus payments during the current calendar quarter is equal to the maximum payout ratio multiplied by the banking organization’s eligible retained income. The calculation of the maximum payout amount is made as of the last day of the previous calendar quarter and any resulting restrictions apply during the current calendar quarter. TABLE 1—CAPITAL CONSERVATION BUFFER AND MAXIMUM PAYOUT RATIO 45 Capital conservation buffer (as a percentage of standardized or advanced total risk-weighted assets, as applicable) wreier-aviles on DSK5TPTVN1PROD with RULES2 Greater than 2.5 percent .......................................................................................................................... Less than or equal to 2.5 percent, and greater than 1.875 percent ....................................................... Less than or equal to 1.875 percent, and greater than 1.25 percent ..................................................... Less than or equal to 1.25 percent, and greater than 0.625 percent ..................................................... Less than or equal to 0.625 percent ........................................................................................................ Maximum payout ratio (as a percentage of eligible retained income) No payout ratio limitation applies. 60 percent. 40 percent. 20 percent. 0 percent. Table 1 illustrates that the capital conservation buffer requirements are divided into equal quartiles, each associated with increasingly stringent limitations on distributions and discretionary bonus payments to executive officers as the capital conservation buffer approaches zero. As described in the next section, each quartile expands proportionately for advanced approaches banking organizations when the countercyclical capital buffer amount is greater than zero. In a scenario where a banking organization’s risk-based capital ratios fall below its minimum risk-based capital ratios plus 2.5 percent of total risk-weighted assets, the maximum payout ratio also would decline. A banking organization that becomes subject to a maximum payout ratio remains subject to restrictions on capital distributions and certain discretionary bonus payments until it is able to build up its capital conservation buffer through retained earnings, raising additional capital, or reducing its riskweighted assets. In addition, as a general matter, a banking organization cannot make distributions or certain discretionary bonus payments during the current calendar quarter if the banking organization’s eligible retained income is negative and its capital conservation buffer was less than 2.5 percent as of the end of the previous quarter. Compliance with the capital conservation buffer is determined prior to any distribution or discretionary bonus payment. Therefore, a banking organization with a capital buffer of more than 2.5 percent is not subject to any restrictions on distributions or discretionary bonus payments even if such distribution or payment would result in a capital buffer of less than or equal to 2.5 percent in the current calendar quarter. However, to remain free of restrictions for purposes of any subsequent quarter, the banking organization must restore capital to increase the buffer to more than 2.5 percent prior to any distribution or discretionary bonus payment in any subsequent quarter. In the proposal, the agencies and the FDIC solicited comment on the impact, if any, of prohibiting a banking organization that is subject to a maximum payout ratio of zero percent from making a penny dividend to common stockholders. One commenter stated that such banking organizations should be permitted to pay a penny dividend on their common stock notwithstanding the limitations imposed by the capital conservation buffer. This commenter maintained that the inability to pay any dividend on common stock could make it more difficult to attract equity investors such as pension funds that often are required to invest only in institutions that pay a quarterly dividend. While the agencies did not incorporate a blanket exemption for penny dividends on common stock, under the final rule, as under the proposal, the primary Federal supervisor may permit a banking organization to make a distribution or discretionary bonus payment if the primary Federal supervisor determines that such distribution or payment would not be contrary to the purpose of the capital conservation buffer or the safety and soundness of the organization. In making such determinations, the primary Federal supervisor would consider the nature of and circumstances giving rise to the request. 44 See, e.g., 12 U.S.C. 56, 60, and 1831o(d)(1) and 12 CFR part 3, subparts H and I, 12 CFR part 5.46, 12 CFR part 5, subpart E, and 12 CFR part 6 (national banks) and 12 U.S.C. 1467a(f) and 1467a(m)(B)(i)(III) and 12 CFR part 165 (Federal savings associations); see also 12 CFR 225.8 (Board). 45 Calculations in this table are based on the assumption that the countercyclical capital buffer amount is zero. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00021 Fmt 4701 Sfmt 4700 E. Countercyclical Capital Buffer The proposed rule introduced a countercyclical capital buffer applicable to advanced approaches banking organizations to augment the capital conservation buffer during periods of excessive credit growth. Under the proposed rule, the countercyclical capital buffer would have required advanced approaches banking organizations to hold additional common equity tier 1 capital during specific, agency-determined periods in order to avoid limitations on distributions and discretionary bonus payments. The agencies and the FDIC requested comment on the countercyclical capital buffer and, specifically, on any factors that should be considered for purposes of determining whether to activate it. One commenter encouraged the agencies and the FDIC to consider readily available indicators of economic growth, employment levels, and financial sector profits. This commenter stated generally that the agencies and the FDIC should activate the countercyclical capital E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62038 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations buffer during periods of general economic growth or high financial sector profits, instead of reserving it only for periods of ‘‘excessive credit growth.’’ Other commenters did not support using the countercyclical capital buffer as a macroeconomic tool. One commenter encouraged the agencies and the FDIC not to include the countercyclical capital buffer in the final rule and, instead, rely on the Board’s longstanding authority over monetary policy to mitigate excessive credit growth and potential asset bubbles. Another commenter questioned the buffer’s effectiveness and encouraged the agencies and the FDIC to conduct a QIS prior to its implementation. One commenter recommended expanding the applicability of the proposed countercyclical capital buffer on a caseby-case basis to institutions with total consolidated assets between $50 and $250 billion. Another commenter, however, supported the application of the countercyclical capital buffer only to institutions with total consolidated assets above $250 billion. The Dodd-Frank Act requires the agencies to consider the use of countercyclical aspects of capital regulation, and the countercyclical capital buffer is an explicitly countercyclical element of capital regulation.46 The agencies note that implementation of the countercyclical capital buffer for advanced approaches banking organizations is an important part of the Basel III framework, which aims to enhance the resilience of the banking system and reduce systemic vulnerabilities. The agencies believe that the countercyclical capital buffer is most appropriately applied only to advanced approaches banking organizations because, generally, such organizations are more interconnected with other financial institutions. Therefore, the marginal benefits to financial stability from a countercyclical capital buffer function should be greater with respect to such institutions. Application of the countercyclical capital buffer only to advanced approaches banking organizations also reflects the fact that making cyclical adjustments to capital requirements may produce smaller financial stability benefits and potentially higher marginal costs for smaller banking organizations. The countercyclical capital buffer is designed to take into account the macro- financial environment in which banking organizations function and to protect the banking system from the systemic vulnerabilities that may build-up during periods of excessive credit growth, which may potentially unwind in a disorderly way, causing disruptions to financial institutions and ultimately economic activity. The countercyclical capital buffer aims to protect the banking system and reduce systemic vulnerabilities in two ways. First, the accumulation of a capital buffer during an expansionary phase could increase the resilience of the banking system to declines in asset prices and consequent losses that may occur when the credit conditions weaken. Specifically, when the credit cycle turns following a period of excessive credit growth, accumulated capital buffers act to absorb the abovenormal losses that a banking organization likely would face. Consequently, even after these losses are realized, banking organizations would remain healthy and able to access funding, meet obligations, and continue to serve as credit intermediaries. Second, a countercyclical capital buffer also may reduce systemic vulnerabilities and protect the banking system by mitigating excessive credit growth and increases in asset prices that are not supported by fundamental factors. By increasing the amount of capital required for further credit extensions, a countercyclical capital buffer may limit excessive credit.47 Thus, the agencies believe that the countercyclical capital buffer is an appropriate macroeconomic tool and are including it in the final rule. One commenter expressed concern that the proposed rule would not require the agencies and the FDIC to activate the countercyclical capital buffer pursuant to a joint, interagency determination. This commenter encouraged the agencies and the FDIC to adopt an interagency process for activating the buffer for purposes of the final rule. As discussed in the Basel III NPR, the agencies and the FDIC anticipate making such determinations jointly. Because the countercyclical capital buffer amount would be linked to the condition of the overall U.S. financial system and not the characteristics of an individual banking organization, the agencies expect that the countercyclical capital buffer amount would be the same at the depository institution and holding company levels. The agencies and the 46 Section 616(a), (b), and (c) of the Dodd-Frank Act, codified at 12 U.S.C. 1844(b), 1464a(g)(1), and 3907(a)(1). . 47 The operation of the countercyclical capital buffer is also consistent with sections 616(a), (b), and (c) of the Dodd-Frank Act, codified at 12 U.S.C. 1844(b), 1464a(g)(1), and 3907(a)(1). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00022 Fmt 4701 Sfmt 4700 FDIC solicited comment on the appropriateness of the proposed 12month prior notification period for the countercyclical capital buffer amount. One commenter expressed concern regarding the potential for the agencies and the FDIC to activate the countercyclical capital buffer without providing banking organizations sufficient notice, and specifically requested the implementation of a prior notification requirement of not less than 12 months for purposes of the final rule. In general, to provide banking organizations with sufficient time to adjust to any changes to the countercyclical capital buffer under the final rule, the agencies and the FDIC expect to announce an increase in the U.S. countercyclical capital buffer amount with an effective date at least 12 months after their announcement. However, if the agencies and the FDIC determine that a more immediate implementation is necessary based on economic conditions, the agencies may require an earlier effective date. The agencies and the FDIC will follow the same procedures in adjusting the countercyclical capital buffer applicable for exposures located in foreign jurisdictions. For purposes of the final rule, consistent with the proposal, a decrease in the countercyclical capital buffer amount will be effective on the day following announcement of the final determination or the earliest date permissible under applicable law or regulation, whichever is later. In addition, the countercyclical capital buffer amount will return to zero percent 12 months after its effective date, unless the agencies and the FDIC announce a decision to maintain the adjusted countercyclical capital buffer amount or adjust it again before the expiration of the 12-month period. The countercyclical capital buffer augments the capital conservation buffer by up to 2.5 percent of a banking organization’s total risk-weighted assets. Consistent with the proposal, the final rule requires an advanced approaches banking organization to determine its countercyclical capital buffer amount by calculating the weighted average of the countercyclical capital buffer amounts established for the national jurisdictions where the banking organization has private sector credit exposures. The contributing weight assigned to a jurisdiction’s countercyclical capital buffer amount is calculated by dividing the total risk-weighted assets for the banking organization’s private sector credit exposures located in the jurisdiction by the total risk-weighted assets for all of the banking E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations organization’s private sector credit exposures. Under the proposed rule, private sector credit exposure was defined as an exposure to a company or an individual that is included in credit risk-weighted assets, not including an exposure to a sovereign entity, the Bank for International Settlements, the European Central Bank, the European Commission, the International Monetary Fund, a multilateral development bank (MDB), a public sector entity (PSE), or a Government-sponsored Enterprise (GSE). While the proposed definition excluded covered positions with specific risk under the market risk rule, the agencies and the FDIC explicitly recognized that they should be included in the measure of risk-weighted assets for private-sector exposures and asked a question regarding how to incorporate these positions in the measure of riskweighted assets, particularly for positions for which a banking organization uses models to measure specific risk. The agencies and the FDIC did not receive comments on this question. The final rule includes covered positions under the market risk rule in the definition of private sector credit exposure. Thus, a private sector credit exposure is an exposure to a company or an individual, not including an exposure to a sovereign entity, the Bank for International Settlements, the European Central Bank, the European Commission, the International Monetary Fund, an MDB, a PSE, or a GSE. The final rule is also more specific than the proposal regarding how to calculate risk-weighted assets for private sector credit exposures, and harmonizes that calculation with the advanced approaches banking organization’s determination of its capital conservation buffer generally. An advanced approaches banking organization is subject to the countercyclical capital buffer regardless of whether it has completed the parallel run process and received notification from its primary Federal supervisor pursuant to section 121(d) of the rule. The methodology an advanced approaches banking organization must use for determining risk-weighted assets for private sector credit exposures must be the methodology that the banking organization uses to determine its riskbased capital ratios under section 10 of the final rule. Notwithstanding this provision, the risk-weighted asset amount for a private sector credit exposure that is a covered position is its specific risk add-on, as determined under the market risk rule’s standardized measurement method for specific risk, multiplied by 12.5. The agencies chose this methodology because it allows the specific risk of a position to be allocated to the position’s geographic location in a consistent manner across banking organizations. Consistent with the proposal, under the final rule the geographic location of a private sector credit exposure (that is not a securitization exposure) is the national jurisdiction where the borrower is located (that is, where the borrower is incorporated, chartered, or similarly established or, if it is an individual, where the borrower resides). If, however, the decision to issue the private sector credit exposure is based primarily on the creditworthiness of a protection provider, the location of the 62039 non-securitization exposure is the location of the protection provider. The location of a securitization exposure is the location of the underlying exposures, determined by reference to the location of the borrowers on those exposures. If the underlying exposures are located in more than one national jurisdiction, the location of a securitization exposure is the national jurisdiction where the underlying exposures with the largest aggregate unpaid principal balance are located. Table 2 illustrates how an advanced approaches banking organization calculates its weighted average countercyclical capital buffer amount. In the following example, the countercyclical capital buffer established in the various jurisdictions in which the banking organization has private sector credit exposures is reported in column A. Column B contains the banking organization’s riskweighted asset amounts for the private sector credit exposures in each jurisdiction. Column C shows the contributing weight for each countercyclical capital buffer amount, which is calculated by dividing each of the rows in column B by the total for column B. Column D shows the contributing weight applied to each countercyclical capital buffer amount, calculated as the product of the corresponding contributing weight (column C) and the countercyclical capital buffer set by each jurisdiction’s national supervisor (column A). The sum of the rows in column D shows the banking organization’s weighted average countercyclical capital buffer, which is 1.4 percent of risk-weighted assets. TABLE 2—EXAMPLE OF WEIGHTED AVERAGE BUFFER CALCULATION FOR AN ADVANCED APPROACHES BANKING ORGANIZATION Countercyclical capital buffer amount set by national supervisor (percent) Banking organization’s risk-weighted assets for private sector credit exposures ($b) Contributing weight (column B/ column B total) Contributing weight applied to each countercyclical capital buffer amount (column A * column C) (A) (B) (C) (D) wreier-aviles on DSK5TPTVN1PROD with RULES2 Non-U.S. jurisdiction 1 ..................................................................... Non-U.S. jurisdiction 2 ..................................................................... U.S ................................................................................................... 2.0 1.5 1 250 100 500 0.29 0.12 0.59 0.6 0.2 0.6 Total .......................................................................................... ............................ 850 1.00 1.4 The countercyclical capital buffer expands a banking organization’s capital conservation buffer range for purposes of determining the banking VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 organization’s maximum payout ratio. For instance, if an advanced approaches banking organization’s countercyclical capital buffer amount is equal to zero PO 00000 Frm 00023 Fmt 4701 Sfmt 4700 percent of total risk-weighted assets, the banking organization must maintain a buffer of greater than 2.5 percent of total risk-weighted assets to avoid restrictions E:\FR\FM\11OCR2.SGM 11OCR2 62040 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations on its distributions and discretionary bonus payments. However, if its countercyclical capital buffer amount is equal to 2.5 percent of total riskweighted assets, the banking organization must maintain a buffer of greater than 5 percent of total riskweighted assets to avoid restrictions on its distributions and discretionary bonus payments. As another example, if the advanced approaches banking organization from the example in Table 2 above has a capital conservation buffer of 2.0 percent, and each of the jurisdictions in which it has private sector credit exposures sets its countercyclical capital buffer amount equal to zero, the banking organization would be subject to a maximum payout ratio of 60 percent. If, instead, each country sets its countercyclical capital buffer amount as shown in Table 2, resulting in a countercyclical capital buffer amount of 1.4 percent of total risk-weighted assets, the banking organization’s capital conservation buffer ranges would be expanded as shown in Table 3 below. As a result, the banking organization would now be subject to a stricter 40 percent maximum payout ratio based on its capital conservation buffer of 2.0 percent. TABLE 3—CAPITAL CONSERVATION BUFFER AND MAXIMUM PAYOUT RATIO 48 Maximum payout ratio (as a percentage of eligible retained income) Capital conservation buffer as expanded by the countercyclical capital buffer amount from Table 2 Greater than 3.9 percent (2.5 percent + 100 percent of the countercyclical capital buffer of 1.4) ......... Less than or equal to 3.9 percent, and greater than 2.925 percent (1.875 percent plus 75 percent of the countercyclical capital buffer of 1.4). Less than or equal to 2.925 percent, and greater than 1.95 percent (1.25 percent plus 50 percent of the countercyclical capital buffer of 1.4). Less than or equal to 1.95 percent, and greater than 0.975 percent (.625 percent plus 25 percent of the countercyclical capital buffer of 1.4). Less than or equal to 0.975 percent ........................................................................................................ The countercyclical capital buffer amount under the final rule for U.S. credit exposures is initially set to zero, but it could increase if the agencies and the FDIC determine that there is excessive credit in the markets that could lead to subsequent wide-spread market failures. Generally, a zero percent countercyclical capital buffer amount will reflect an assessment that economic and financial conditions are consistent with a period of little or no excessive ease in credit markets associated with no material increase in system-wide credit risk. A 2.5 percent countercyclical capital buffer amount will reflect an assessment that financial markets are experiencing a period of excessive ease in credit markets associated with a material increase in system-wide credit risk. wreier-aviles on DSK5TPTVN1PROD with RULES2 F. Prompt Corrective Action Requirements All insured depository institutions, regardless of total asset size or foreign exposure, currently are required to compute PCA capital levels using the agencies’ and the FDIC’s general riskbased capital rules, as supplemented by the market risk rule. Section 38 of the Federal Deposit Insurance Act directs the federal banking agencies and the FDIC to resolve the problems of insured depository institutions at the least cost to the Deposit Insurance Fund.49 To 48 Calculations in this table are based on the assumption that the countercyclical capital buffer amount is 1.4 percent of risk-weighted assets, per the example in Table 2. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 facilitate this purpose, the agencies and the FDIC have established five regulatory capital categories in the PCA regulations that include capital thresholds for the leverage ratio, tier 1 risk-based capital ratio, and the total risk-based capital ratio for insured depository institutions. These five PCA categories under section 38 of the Act and the PCA regulations are: ‘‘well capitalized,’’ ‘‘adequately capitalized,’’ ‘‘undercapitalized,’’ ‘‘significantly undercapitalized,’’ and ‘‘critically undercapitalized.’’ Insured depository institutions that fail to meet these capital measures are subject to increasingly strict limits on their activities, including their ability to make capital distributions, pay management fees, grow their balance sheet, and take other actions.50 Insured depository institutions are expected to be closed within 90 days of becoming ‘‘critically undercapitalized,’’ unless their primary Federal supervisor takes such other action as that primary Federal supervisor determines, with the concurrence of the FDIC, would better achieve the purpose of PCA.51 The proposal maintained the structure of the PCA framework while increasing some of the thresholds for the PCA capital categories and adding the proposed common equity tier 1 capital ratio. For example, under the proposed rule, the thresholds for adequately 49 12 U.S.C. 1831o. U.S.C. 1831o(e)–(i). See 12 CFR part 6 (national banks) and 12 CFR part 165 (Federal 50 12 PO 00000 Frm 00024 Fmt 4701 Sfmt 4700 No payout ratio limitation applies. 60 percent. 40 percent. 20 percent. 0 percent. capitalized banking organizations would be equal to the minimum capital requirements. The risk-based capital ratios for well capitalized banking organizations under PCA would continue to be two percentage points higher than the ratios for adequatelycapitalized banking organizations, and the leverage ratio for well capitalized banking organizations under PCA would be one percentage point higher than for adequately-capitalized banking organizations. Advanced approaches banking organizations that are insured depository institutions also would be required to satisfy a supplementary leverage ratio of 3 percent in order to be considered adequately capitalized. While the proposed PCA levels do not incorporate the capital conservation buffer, the PCA and capital conservation buffer frameworks would complement each other to ensure that banking organizations hold an adequate amount of common equity tier 1 capital. The agencies and the FDIC received a number of comments on the proposed PCA framework. Several commenters suggested modifications to the proposed PCA levels, particularly with respect to the leverage ratio. For example, a few commenters encouraged the agencies and the FDIC to increase the adequatelycapitalized and well capitalized categories for the leverage ratio to six percent or more and eight percent or savings associations) (OCC); 12 CFR part 208, subpart D (Board). 51 12 U.S.C. 1831o(g)(3). E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations more, respectively. According to one commenter, such thresholds would more closely align with the actual leverage ratios of many state-charted depository institutions. Another commenter expressed concern regarding the operational complexity of the proposed PCA framework in view of the addition of the common equity tier 1 capital ratio and the interaction of the PCA framework and the capital conservation buffer. For example, under the proposed rule a banking organization could be well capitalized for PCA purposes and, at the same time, be subject to restrictions on dividends and bonus payments. Other banking organizations expressed concern that the proposed PCA levels would adversely affect their ability to lend and generate income. This, according to a commenter, also would reduce net income and return-on-equity. The agencies believe the capital conservation buffer complements the PCA framework—the former works to keep banking organizations above the minimum capital ratios, whereas the latter imposes increasingly stringent consequences on depository institutions, particularly as they fall below the minimum capital ratios. Because the capital conservation buffer is designed to absorb losses in stressful periods, the agencies believe it is appropriate for a depository institution to be able to use some of its capital conservation buffer without being considered less than well capitalized for PCA purposes. A few comments pertained specifically to issues affecting BHCs and SLHCs. A commenter encouraged the Board to require an advanced approaches banking organization, including a BHC, to use the advanced approaches rule for determining whether it is well capitalized for PCA purposes. This commenter maintained that neither the Bank Holding Company Act 52 nor section 171 of the Dodd-Frank Act requires an advanced approaches banking organization to use the lower of its minimum ratios as calculated under the general risk-based capital rules and the advanced approaches rule to determine well capitalized status. Another commenter requested clarification from the Board that section 171 of the Dodd-Frank Act does not apply to determinations regarding whether a BHC is a financial holding company under Board regulations. In order to elect to be a financial holding company under the Bank Holding Company Act, as amended by section 616 of the Dodd-Frank Act, a BHC and all of its depository institution subsidiaries must be well capitalized and well managed. The final rule does not establish the standards for determining whether a BHC is ‘‘wellcapitalized.’’ Consistent with the proposal, the final rule augments the PCA capital categories by introducing a common equity tier 1 capital measure for four of the five PCA categories (excluding the critically undercapitalized PCA category).53 In addition, the final rule revises the three current risk-based capital measures for four of the five PCA categories to reflect the final rule’s changes to the minimum risk-based capital ratios, as provided in the agencyspecific revisions to the agencies’ PCA regulations. All banking organizations that are insured depository institutions will remain subject to leverage measure thresholds using the current leverage ratio in the form of tier 1 capital to 62041 average total consolidated assets. In addition, the final rule amends the PCA leverage measure for advanced approaches depository institutions to include the supplementary leverage ratio that explicitly applies to the ‘‘adequately capitalized’’ and ‘‘undercapitalized’’ capital categories. All insured depository institutions must comply with the revised PCA thresholds beginning on January 1, 2015. Consistent with transition provisions in the proposed rules, the supplementary leverage measure for advanced approaches banking organizations that are insured depository institutions becomes effective on January 1, 2018. Changes to the definitions of the individual capital components that are used to calculate the relevant capital measures under PCA are governed by the transition arrangements discussed in section VIII.3 below. Thus, the changes to these definitions, including any deductions from or adjustments to regulatory capital, automatically flow through to the definitions in the PCA framework. Table 4 sets forth the risk-based capital and leverage ratio thresholds under the final rule for each of the PCA capital categories for all insured depository institutions. For each PCA category except critically undercapitalized, an insured depository institution must satisfy a minimum common equity tier 1 capital ratio, in addition to a minimum tier 1 risk-based capital ratio, total risk-based capital ratio, and leverage ratio. In addition to the aforementioned requirements, advanced approaches banking organizations that are insured depository institutions are also subject to a supplementary leverage ratio. TABLE 4—PCA LEVELS FOR ALL INSURED DEPOSITORY INSTITUTIONS wreier-aviles on DSK5TPTVN1PROD with RULES2 PCA category Total riskbased capital (RBC) measure (total RBC ratio— (percent)) Leverage measure Leverage ratio (percent) Supplementary leverage ratio (percent) * PCA requirements ≥10 ≥8 ≥8 ≥6 ≥6.5 ≥4.5 ≥5 ≥4 Not applicable ≥3.0 Unchanged from current rule * * <8 <6 Well capitalized .... Adequately-capitalized. Undercapitalized .. Significantly undercapitalized. Critically undercapitalized. Common equity tier 1 RBC measure (common equity tier 1 RBC ratio (percent)) Tier 1 RBC measure (tier 1 RBC ratio (percent)) <6 <4 <4.5 <3 <4 <3 <3.00 Not applicable * * Not applicable * Tangible equity (defined as tier 1 capital plus non-tier 1 perpetual preferred stock) to total assets ≤2 * The supplementary leverage ratio as a PCA requirement applies only to advanced approaches banking organizations that are insured depository institutions. The supplementary leverage ratio also applies to advanced approaches bank holding companies, although not in the form of a PCA requirement. 52 12 U.S.C. 1841, et seq. VerDate Mar<15>2010 13:14 Oct 10, 2013 53 12 Jkt 232001 PO 00000 U.S.C. 1831o(c)(1)(B)(i). Frm 00025 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 62042 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 To be well capitalized for purposes of the final rule, an insured depository institution must maintain a total riskbased capital ratio of 10 percent or more; a tier 1 capital ratio of 8 percent or more; a common equity tier 1 capital ratio of 6.5 percent or more; and a leverage ratio of 5 percent or more. An adequately-capitalized depository institution must maintain a total riskbased capital ratio of 8 percent or more; a tier 1 capital ratio of 6 percent or more; a common equity tier 1 capital ratio of 4.5 percent or more; and a leverage ratio of 4 percent or more. An insured depository institution is undercapitalized under the final rule if its total capital ratio is less than 8 percent, if its tier 1 capital ratio is less than 6 percent, its common equity tier 1 capital ratio is less than 4.5 percent, or its leverage ratio is less than 4 percent. If an institution’s tier 1 capital ratio is less than 4 percent, or its common equity tier 1 capital ratio is less than 3 percent, it would be considered significantly undercapitalized. The other numerical capital ratio thresholds for being significantly undercapitalized remain unchanged from the current rules.54 The determination of whether an insured depository institution is critically undercapitalized for PCA purposes is based on its ratio of tangible equity to total assets.55 This is a statutory requirement within the PCA framework, and the experience of the recent financial crisis has confirmed that tangible equity is of critical importance in assessing the viability of an insured depository institution. Tangible equity for PCA purposes is currently defined as including core capital elements,56 which consist of: (1) Common stockholder’s equity, (2) qualifying noncumulative perpetual preferred stock (including related surplus), and (3) minority interest in the 54 Under current PCA standards, in order to qualify as well-capitalized, an insured depository institution must not be subject to any written agreement, order, capital directive, or prompt corrective action directive issued by its primary Federal regulator pursuant to section 8 of the Federal Deposit Insurance Act, the International Lending Supervision Act of 1983, or section 38 of the Federal Deposit Insurance Act, or any regulation thereunder. See 12 CFR 6.4(b)(1)(iv) (national banks), 12 CFR 165.4(b)(1)(iv) (Federal savings associations) (OCC); 12 CFR 208.43(b)(1)(iv) (Board). The final rule does not change this requirement. 55 See 12 U.S.C. 1831o(c)(3)(A) and (B), which for purposes of the ‘‘critically undercapitalized’’ PCA category requires the ratio of tangible equity to total assets to be set at an amount ‘‘not less than 2 percent of total assets.’’ 56 The OCC notes that under the OCC’s PCA rule with respect to national banks, the definition of tangible equity does not use the term ‘‘core capital elements.’’ 12 CFR 6.2(g). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 equity accounts of consolidated subsidiaries; plus outstanding cumulative preferred perpetual stock; minus all intangible assets except mortgage servicing rights to the extent permitted in tier 1 capital. The current PCA definition of tangible equity does not address the treatment of DTAs in determining whether an insured depository institution is critically undercapitalized. Consistent with the proposal, the final rule revises the calculation of the capital measure for the critically undercapitalized PCA category by revising the definition of tangible equity to consist of tier 1 capital, plus outstanding perpetual preferred stock (including related surplus) not included in tier 1 capital. The revised definition more appropriately aligns the calculation of tangible equity with the calculation of tier 1 capital generally for regulatory capital requirements. Assets included in a banking organization’s equity under GAAP, such as DTAs, are included in tangible equity only to the extent that they are included in tier 1 capital. The agencies believe this modification promotes consistency and provides for clearer boundaries across and between the various PCA categories. In addition to the changes described in this section, the OCC proposed to integrate its PCA rules for national banks and Federal savings associations. Specifically, the OCC proposed to make 12 CFR part 6 applicable to Federal savings associations, and to rescind the current PCA rules in 12 CFR part 165 governing Federal savings associations, with the exception of § 165.8 (Procedures for reclassifying a federal savings association based on criteria other than capital), and § 165.9 (Order to dismiss a director or senior executive officer). The OCC proposed to retain §§ 165.8 and 165.9 because those sections relate to enforcement procedures and the procedural rules in 12 CFR part 19 do not apply to Federal savings associations at this time. Therefore, the OCC must retain §§ 165.8 and 165.9. Finally, the proposal also made non-substantive, technical amendments to part 6 and §§ 165.8 and 165.9. The OCC received no comments on these proposed changes and therefore is adopting these proposed amendments as final, with minor technical edits. The OCC notes that, consistent with the proposal, as part of the integration of Federal savings associations, Federal savings associations will now calculate tangible equity based on average total assets rather than period-end total assets. PO 00000 Frm 00026 Fmt 4701 Sfmt 4700 G. Supervisory Assessment of Overall Capital Adequacy Capital helps to ensure that individual banking organizations can continue to serve as credit intermediaries even during times of stress, thereby promoting the safety and soundness of the overall U.S. banking system. The agencies’ general risk-based capital rules indicate that the capital requirements are minimum standards generally based on broad credit-risk considerations.57 The risk-based capital ratios under these rules do not explicitly take account of the quality of individual asset portfolios or the range of other types of risk to which banking organizations may be exposed, such as interest-rate, liquidity, market, or operational risks.58 A banking organization is generally expected to have internal processes for assessing capital adequacy that reflect a full understanding of its risks and to ensure that it holds capital corresponding to those risks to maintain overall capital adequacy.59 The nature of such capital adequacy assessments should be commensurate with banking organizations’ size, complexity, and risk-profile. Consistent with longstanding practice, supervisory assessment of capital adequacy will take account of whether a banking organization plans appropriately to maintain an adequate level of capital given its activities and risk profile, as well as risks and other factors that can affect a banking organization’s financial condition, including, for example, the level and severity of problem assets and its exposure to operational and interest rate risk, and significant asset concentrations. For this reason, a supervisory assessment of capital adequacy may differ significantly from conclusions that might be drawn solely from the level of a banking organization’s regulatory capital ratios. In light of these considerations, as a prudential matter, a banking organization is generally expected to operate with capital positions well 57 See 12 CFR part 3, App. A, Sec. 1(b)(1) (national banks) and 12 CFR part 167.3(b) and (c) (Federal savings associations) (OCC); 12 CFR 208.4 (state member banks). 58 The risk-based capital ratios of a banking organization subject to the market risk rule do include capital requirements for the market risk of covered positions, and the risk-based capital ratios calculated using advanced approaches total riskweighted assets for an advanced approaches banking organization that has completed the parallel run process and received notification from its primary Federal supervisor pursuant to section 121(d) do include a capital requirement for operational risks. 59 The Basel framework incorporates similar requirements under Pillar 2 of Basel II. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations above the minimum risk-based ratios and to hold capital commensurate with the level and nature of the risks to which it is exposed, which may entail holding capital significantly above the minimum requirements. For example, banking organizations contemplating significant expansion proposals are expected to maintain strong capital levels substantially above the minimum ratios and should not allow significant diminution of financial strength below these strong levels to fund their expansion plans. Banking organizations with high levels of risk are also expected to operate even further above minimum standards. In addition to evaluating the appropriateness of a banking organization’s capital level given its overall risk profile, the supervisory assessment takes into account the quality and trends in a banking organization’s capital composition, including the share of common and non-common-equity capital elements. Some commenters stated that they manage their capital so that they operate with a buffer over the minimum and that examiners expect such a buffer. These commenters expressed concern that examiners will expect even higher capital levels, such as a buffer in addition to the new higher minimums and capital conservation buffer (and countercyclical capital buffer, if applicable). Consistent with the longstanding approach employed by the agencies in their supervision of banking organizations, section 10(d) of the final rule maintains and reinforces supervisory expectations by requiring that a banking organization maintain capital commensurate with the level and nature of all risks to which it is exposed and that a banking organization have a process for assessing its overall capital adequacy in relation to its risk profile, as well as a comprehensive strategy for maintaining an appropriate level of capital. The supervisory evaluation of a banking organization’s capital adequacy, including compliance with section 10(d), may include such factors as whether the banking organization is newly chartered, entering new activities, or introducing new products. The assessment also would consider whether a banking organization is receiving special supervisory attention, has or is expected to have losses resulting in capital inadequacy, has significant exposure due to risks from concentrations in credit or nontraditional activities, or has significant exposure to interest rate risk, operational risk, or could be adversely affected by the activities or condition of VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 a banking organization’s holding company or other affiliates. Supervisors also evaluate the comprehensiveness and effectiveness of a banking organization’s capital planning in light of its activities and capital levels. An effective capital planning process involves an assessment of the risks to which a banking organization is exposed and its processes for managing and mitigating those risks, an evaluation of its capital adequacy relative to its risks, and consideration of the potential impact on its earnings and capital base from current and prospective economic conditions.60 While the elements of supervisory review of capital adequacy would be similar across banking organizations, evaluation of the level of sophistication of an individual banking organization’s capital adequacy process would be commensurate with the banking organization’s size, sophistication, and risk profile, similar to the current supervisory practice. H. Tangible Capital Requirement for Federal Savings Associations As part of the OCC’s overall effort to integrate the regulatory requirements for national banks and Federal savings associations, the OCC proposed to include a tangible capital requirement for Federal savings associations.61 Under section 5(t)(2)(B) of HOLA,62 Federal savings associations are required to maintain tangible capital in an amount not less than 1.5 percent of total assets.63 This statutory 60 See, e.g., SR 09–4, Applying Supervisory Guidance and Regulations on the Payment of Dividends, Stock Redemptions, and Stock Repurchases at Bank Holding Companies (Board); see also OCC Bulletin 2012–16, Guidance for Evaluating Capital Planning and Adequacy. 61 Under Title III of the Dodd-Frank Act, the OCC assumed all functions of the Office of Thrift Supervision (OTS) and the Director of the OTS relating to Federal savings associations. As a result, the OCC has responsibility for the ongoing supervision, examination and regulation of Federal savings associations as of the transfer date of July 21, 2011. The Act also transfers to the OCC the rulemaking authority of the OTS relating to all savings associations, both state and Federal for certain rules. Section 312(b)(2)(B)(i) (codified at 12 U.S.C. 5412(b)(2)(B)(i)). The FDIC has rulemaking authority for the capital and PCA rules pursuant to section 38 of the FDI Act (12 U.S.C. 1831n) and section 5(t)(1)(A) of the Home Owners’ Loan Act (12 U.S.C.1464(t)(1)(A)). 62 12 U.S.C. 1464(t). 63 ‘‘Tangible capital’’ is defined in section 5(t)(9)(B) of HOLA to mean ‘‘core capital minus any intangible assets (as intangible assets are defined by the Comptroller of the Currency for national banks.)’’ 12 U.S.C. 1464(t)(9)(B). Section 5(t)(9)(A) of HOLA defines ‘‘core capital’’ to mean ‘‘core capital as defined by the Comptroller of the Currency for national banks, less any unidentifiable intangible assets [goodwill]’’ unless the OCC prescribes a more stringent definition. 12 U.S.C. 1464(t)(9)(A). PO 00000 Frm 00027 Fmt 4701 Sfmt 4700 62043 requirement is implemented in the OCC’s current capital rules applicable to Federal savings associations at 12 CFR 167.9.64 Under that rule, tangible capital is defined differently from other capital measures, such as tangible equity in current 12 CFR part 165. After reviewing HOLA, the OCC determined that a unique regulatory definition of tangible capital is not necessary to satisfy the requirement of the statute. Therefore, the OCC is defining ‘‘tangible capital’’ as the amount of tier 1 capital plus the amount of outstanding perpetual preferred stock (including related surplus) not included in tier 1 capital. This definition mirrors the proposed definition of ‘‘tangible equity’’ for PCA purposes.65 While the OCC recognizes that the terms used are not identical (‘‘capital’’ as compared to ‘‘equity’’), the OCC believes that this revised definition of tangible capital will reduce the computational burden on Federal savings associations in complying with this statutory mandate, as well as remaining consistent with both the purposes of HOLA and PCA. The final rule adopts this definition as proposed. In addition, in § 3.10(b)(5) and (c)(5) of the proposal, the OCC defined the term ‘‘Federal savings association tangible capital ratio’’ to mean the ratio of the Federal savings association’s core capital (Tier 1 capital) to total adjusted assets as calculated under subpart B of part 3. The OCC notes that this definition is inconsistent with the proposed definition of the tangible equity ratio for national banks and Federal savings associations, at § 6.4(b)(5) and (c)(5), in which the denominator of the ratio is quarterly average total assets. Accordingly, in keeping with the OCC’s goal of integrating rules for Federal savings associations and national banks wherever possible and reducing implementation burden associated with a separate measure of tangible capital, the final rule replaces the term ‘‘total adjusted assets’’ in the definition of ‘‘Federal savings association tangible capital ratio’’ with the term ‘‘average total assets.’’ As a result of the changes in these definitions, Federal savings associations will no longer calculate the tangible capital ratio using period end total assets. 64 54 FR 49649 (Nov. 30, 1989). 12 CFR 6.2. 65 See E:\FR\FM\11OCR2.SGM 11OCR2 62044 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations V. Definition of Capital wreier-aviles on DSK5TPTVN1PROD with RULES2 A. Capital Components and Eligibility Criteria for Regulatory Capital Instruments 1. Common Equity Tier 1 Capital Under the proposed rule, common equity tier 1 capital was defined as the sum of a banking organization’s outstanding common equity tier 1 capital instruments that satisfy the criteria set forth in section 20(b) of the proposal, related surplus (net of treasury stock), retained earnings, AOCI, and common equity tier 1 minority interest subject to certain limitations, minus regulatory adjustments and deductions. The proposed rule set forth a list of criteria that an instrument would be required to meet to be included in common equity tier 1 capital. The proposed criteria were designed to ensure that common equity tier 1 capital instruments do not possess features that would cause a banking organization’s condition to further weaken during periods of economic and market stress. In the proposals, the agencies and the FDIC indicated that they believe most existing common stock instruments issued by U.S. banking organizations already would satisfy the proposed criteria. The proposed criteria also applied to instruments issued by banking organizations such as mutual banking organizations where ownership of the organization is not freely transferable or evidenced by certificates of ownership or stock. For these entities, the proposal provided that instruments issued by such organizations would be considered common equity tier 1 capital if they are fully equivalent to common stock instruments in terms of their subordination and availability to absorb losses, and do not possess features that could cause the condition of the organization to weaken as a going concern during periods of market stress. The agencies and the FDIC noted in the proposal that stockholders’ voting rights generally are a valuable corporate governance tool that permits parties with an economic interest to participate in the decision-making process through votes on establishing corporate objectives and policy, and in electing the banking organization’s board of directors. Therefore, the agencies believe that voting common stockholders’ equity (net of the adjustments to and deductions from common equity tier 1 capital proposed under the rule) should be the dominant element within common equity tier 1 capital. The proposal also provided that to the extent that a banking organization VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 issues non-voting common stock or common stock with limited voting rights, the underlying stock must be identical to those underlying the banking organization’s voting common stock in all respects except for any limitations on voting rights. To ensure that a banking organization’s common equity tier 1 capital would be available to absorb losses as they occur, the proposed rule would have required common equity tier 1 capital instruments issued by a banking organization to satisfy the following criteria: (1) The instrument is paid-in, issued directly by the banking organization, and represents the most subordinated claim in a receivership, insolvency, liquidation, or similar proceeding of the banking organization. (2) The holder of the instrument is entitled to a claim on the residual assets of the banking organization that is proportional with the holder’s share of the banking organization’s issued capital after all senior claims have been satisfied in a receivership, insolvency, liquidation, or similar proceeding. That is, the holder has an unlimited and variable claim, not a fixed or capped claim. (3) The instrument has no maturity date, can only be redeemed via discretionary repurchases with the prior approval of the banking organization’s primary Federal supervisor, and does not contain any term or feature that creates an incentive to redeem. (4) The banking organization did not create at issuance of the instrument, through any action or communication, an expectation that it will buy back, cancel, or redeem the instrument, and the instrument does not include any term or feature that might give rise to such an expectation. (5) Any cash dividend payments on the instrument are paid out of the banking organization’s net income and retained earnings and are not subject to a limit imposed by the contractual terms governing the instrument. (6) The banking organization has full discretion at all times to refrain from paying any dividends and making any other capital distributions on the instrument without triggering an event of default, a requirement to make a payment-in-kind, or an imposition of any other restrictions on the banking organization. (7) Dividend payments and any other capital distributions on the instrument may be paid only after all legal and contractual obligations of the banking organization have been satisfied, including payments due on more senior claims. PO 00000 Frm 00028 Fmt 4701 Sfmt 4700 (8) The holders of the instrument bear losses as they occur equally, proportionately, and simultaneously with the holders of all other common stock instruments before any losses are borne by holders of claims on the banking organization with greater priority in a receivership, insolvency, liquidation, or similar proceeding. (9) The paid-in amount is classified as equity under GAAP. (10) The banking organization, or an entity that the banking organization controls, did not purchase or directly or indirectly fund the purchase of the instrument. (11) The instrument is not secured, not covered by a guarantee of the banking organization or of an affiliate of the banking organization, and is not subject to any other arrangement that legally or economically enhances the seniority of the instrument. (12) The instrument has been issued in accordance with applicable laws and regulations. In most cases, the agencies understand that the issuance of these instruments would require the approval of the board of directors of the banking organization or, where applicable, of the banking organization’s shareholders or of other persons duly authorized by the banking organization’s shareholders. (13) The instrument is reported on the banking organization’s regulatory financial statements separately from other capital instruments. The agencies and the FDIC requested comment on the proposed criteria for inclusion in common equity tier 1, and specifically on whether any of the criteria would be problematic, given the main characteristics of existing outstanding common stock instruments. A substantial number of comments addressed the criteria for common equity tier 1 capital. Generally, commenters stated that the proposed criteria could prevent some instruments currently included in tier 1 capital from being included in the new common equity tier 1 capital measure. Commenters stated that this could create complicated and unnecessary burden for banking organizations that either would have to raise capital to meet the common equity tier 1 capital requirement or shrink their balance sheets by selling off or winding down assets and exposures. Many commenters stated that the burden of raising new capital would have the effect of reducing lending overall, and that it would be especially acute for smaller banking organizations that have limited access to capital markets. Many commenters asked the agencies and the FDIC to clarify several aspects of the proposed criteria. For instance, a E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 few commenters asked the agencies and the FDIC to clarify the proposed requirement that a common equity tier 1 capital instrument be redeemed only with prior approval by a banking organization’s primary Federal supervisor. These commenters asked if this criterion would require a banking organization to note this restriction on the face of a regulatory capital instrument that it may be redeemed only with the prior approval of the banking organization’s primary Federal supervisor. The agencies note that the requirement that common equity tier 1 capital instruments be redeemed only with prior agency approval is consistent with the agencies’ rules and federal law, which generally provide that a banking organization may not reduce its capital by redeeming capital instruments without receiving prior approval from its primary Federal supervisor.66 The final rule does not obligate the banking organization to include this restriction explicitly in the common equity tier 1 capital instrument’s documentation. However, regardless of whether the instrument documentation states that its redemption is subject to agency approval, the banking organization must receive prior approval before redeeming such instruments. The agencies believe that the approval requirement is appropriate as it provides for the monitoring of the strength of a banking organization’s capital position, and therefore, have retained the proposed requirement in the final rule. Several commenters also expressed concern about the proposed requirement that dividend payments and any other distributions on a common equity tier 1 capital instrument may be paid only after all legal and contractual obligations of the banking organization have been satisfied, including payments due on more senior claims. Commenters stated that, as proposed, this requirement could be construed to prevent a banking organization from paying a dividend on a common equity tier 1 capital instrument because of obligations that have not yet become due or because of immaterial delays in paying trade creditors 67 for obligations incurred in the ordinary course of business. 66 See 12 CFR 5.46 (national banks) and 12 CFR part 163, subpart E (Federal savings associations) (OCC); 12 CFR parts 208 and 225, appendix A, section II(iii) (Board). 67 Trade creditors, for this purpose, would include counterparties with whom the banking organization contracts to procure office space and/ or supplies as well as basic services, such as building maintenance. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 The agencies note that this criterion should not prevent a banking organization from paying a dividend on a common equity tier 1 capital instrument where it has incurred operational obligations in the normal course of business that are not yet due or that are subject to minor delays for reasons unrelated to the financial condition of the banking organization, such as delays related to contractual or other legal disputes. A number of commenters also suggested that the proposed criteria providing that dividend payments may be paid only out of current and retained earnings potentially could conflict with state corporate law, including Delaware state law. According to these commenters, Delaware state law permits a corporation to make dividend payments out of its capital surplus account, even when the organization does not have current or retained earnings. The agencies observe that requiring that dividends be paid only out of net income and retained earnings is consistent with federal law and the existing regulations applicable to insured depository institutions. Under applicable statutes and regulations, a national bank or federal savings association may not declare and pay dividends in any year in an amount that exceeds the sum of its total net income for that year plus its retained net income for the preceding two years (minus certain transfers), unless it receives prior approval from the OCC. Therefore, as applied to national banks and Federal savings associations, this aspect of the proposal did not include any substantive changes from the general risk-based capital rules.68 Accordingly, with respect to national banks and savings associations, the criterion does not include surplus. However, because this criterion applies to the terms of the capital instrument, which is governed by state law, the Board is broadening the criterion in the final rule to include surplus for state-chartered companies under its supervision that are subject to the final rule. However, regardless of provisions of state law, under the Federal Reserve Act, state member banks are subject to the same restrictions as national banks that relate to the withdrawal or impairment of their capital stock, and the Board’s regulations for state member banks reflect these limitations on dividend 68 See 12 U.S.C. 60(b) and 12 CFR 5.63 and 5.64 (national banks) and 12 CFR 163.143 (Federal savings associations) (OCC). PO 00000 Frm 00029 Fmt 4701 Sfmt 4700 62045 payments.69 It should be noted that restrictions may be applied to BHC dividends under the Board’s capital plan rule for companies subject to that rule.70 Finally, several commenters expressed concerns about the potential impact of the proposed criteria on stock issued as part of certain employee stock ownership plans (ESOPs) (as defined under Employee Retirement Income Security Act of 1974 71 (ERISA) regulations at 29 CFR 2550.407d–6). Under the proposed rule, an instrument would not be included in common equity tier 1 capital if the banking organization creates an expectation that it will buy back, cancel, or redeem the instrument, or if the instrument includes any term or feature that might give rise to such an expectation. Additionally, the criteria would prevent a banking organization from including in common equity tier 1 capital any instrument that is subject to any type of arrangement that legally or economically enhances the seniority of the instrument. Commenters noted that under ERISA, stock that is not publicly traded and issued as part of an ESOP must include a ‘‘put option’’ that requires the company to repurchase the stock. By exercising the put option, an employee can redeem the stock instrument upon termination of employment. Commenters noted that this put option clearly creates an expectation that the instrument will be redeemed and arguably enhances the seniority of the instrument. Therefore, the commenters stated that the put option could prevent a privately-held banking organization from including earned ESOP shares in its common equity tier 1 capital. The agencies do not believe that an ERISA-mandated put option should prohibit ESOP shares from being included in common equity tier 1 capital. Therefore, under the final rule, shares issued under an ESOP by a banking organization that is not publicly-traded are exempt from the criteria that the shares can be redeemed only via discretionary repurchases and are not subject to any other arrangement that legally or economically enhances their seniority, and that the banking organization not create an expectation that the shares will be redeemed. In addition to the concerns described above, because stock held in an ESOP is awarded by a banking organization for the retirement benefit of its employees, some commenters expressed concern 69 12 CFR 208.5. 12 CFR 225.8. 71 29 U.S.C. 1002, et seq. 70 See E:\FR\FM\11OCR2.SGM 11OCR2 62046 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 that such stock may not conform to the criterion prohibiting a banking organization from directly or indirectly funding a capital instrument. Because the agencies believe that a banking organization should have the flexibility to provide an ESOP as a benefit for its employees, the final rule provides that ESOP stock does not violate such criterion. Under the final rule, a banking organization’s common stock held in trust for the benefit of employees as part of an ESOP in accordance with both ERISA and ERISA-related U.S. tax code requirements will qualify for inclusion as common equity tier 1 capital only to the extent that the instrument is includable as equity under GAAP and that it meets all other criteria of section 20(b)(1) of the final rule. Stock instruments held by an ESOP that are unawarded or unearned by employees or reported as ‘‘temporary equity’’ under GAAP (in the case of U.S. Securities and Exchange Commission (SEC) registrants), may not be counted as equity under GAAP and therefore may not be included in common equity tier 1 capital. After reviewing the comments received, the agencies have decided to finalize the proposed criteria for common equity tier 1 capital instruments, modified as discussed above. Although it is possible some currently outstanding common equity instruments may not meet the common equity tier 1 capital criteria, the agencies believe that most common equity instruments that are currently eligible for inclusion in banking organizations’ tier 1 capital meet the common equity tier 1 capital criteria, and have not received information that would support a different conclusion. The agencies therefore believe that most banking organizations will not be required to reissue common equity instruments in order to comply with the final common equity tier 1 capital criteria. The final revised criteria for inclusion in common equity tier 1 capital are set forth in section 20(b)(1) of the final rule. 2. Additional Tier 1 Capital Consistent with Basel III, the agencies and the FDIC proposed that additional tier 1 capital would equal the sum of: Additional tier 1 capital instruments that satisfy the criteria set forth in section 20(c) of the proposal, related surplus, and any tier 1 minority interest that is not included in a banking organization’s common equity tier 1 capital (subject to the proposed limitations on minority interest), less applicable regulatory adjustments and deductions. The agencies and the FDIC VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 proposed the following criteria for additional tier 1 capital instruments in section 20(c): (1) The instrument is issued and paidin. (2) The instrument is subordinated to depositors, general creditors, and subordinated debt holders of the banking organization in a receivership, insolvency, liquidation, or similar proceeding. (3) The instrument is not secured, not covered by a guarantee of the banking organization or of an affiliate of the banking organization, and not subject to any other arrangement that legally or economically enhances the seniority of the instrument. (4) The instrument has no maturity date and does not contain a dividend step-up or any other term or feature that creates an incentive to redeem. (5) If callable by its terms, the instrument may be called by the banking organization only after a minimum of five years following issuance, except that the terms of the instrument may allow it to be called earlier than five years upon the occurrence of a regulatory event (as defined in the agreement governing the instrument) that precludes the instrument from being included in additional tier 1 capital or a tax event. In addition: (i) The banking organization must receive prior approval from its primary Federal supervisor to exercise a call option on the instrument. (ii) The banking organization does not create at issuance of the instrument, through any action or communication, an expectation that the call option will be exercised. (iii) Prior to exercising the call option, or immediately thereafter, the banking organization must either: (A) Replace the instrument to be called with an equal amount of instruments that meet the criteria under section 20(b) or (c) of the proposed rule (replacement can be concurrent with redemption of existing additional tier 1 capital instruments); or (B) Demonstrate to the satisfaction of its primary Federal supervisor that following redemption, the banking organization will continue to hold capital commensurate with its risk. (6) Redemption or repurchase of the instrument requires prior approval from the banking organization’s primary Federal supervisor. (7) The banking organization has full discretion at all times to cancel dividends or other capital distributions on the instrument without triggering an event of default, a requirement to make a payment-in-kind, or an imposition of PO 00000 Frm 00030 Fmt 4701 Sfmt 4700 other restrictions on the banking organization except in relation to any capital distributions to holders of common stock. (8) Any capital distributions on the instrument are paid out of the banking organization’s net income and retained earnings. (9) The instrument does not have a credit-sensitive feature, such as a dividend rate that is reset periodically based in whole or in part on the banking organization’s credit quality, but may have a dividend rate that is adjusted periodically independent of the banking organization’s credit quality, in relation to general market interest rates or similar adjustments. (10) The paid-in amount is classified as equity under GAAP. (11) The banking organization, or an entity that the banking organization controls, did not purchase or directly or indirectly fund the purchase of the instrument. (12) The instrument does not have any features that would limit or discourage additional issuance of capital by the banking organization, such as provisions that require the banking organization to compensate holders of the instrument if a new instrument is issued at a lower price during a specified time frame. (13) If the instrument is not issued directly by the banking organization or by a subsidiary of the banking organization that is an operating entity, the only asset of the issuing entity is its investment in the capital of the banking organization, and proceeds must be immediately available without limitation to the banking organization or to the banking organization’s top-tier holding company in a form which meets or exceeds all of the other criteria for additional tier 1 capital instruments.72 (14) For an advanced approaches banking organization, the governing agreement, offering circular, or prospectus of an instrument issued after January 1, 2013, must disclose that the holders of the instrument may be fully subordinated to interests held by the U.S. government in the event that the banking organization enters into a receivership, insolvency, liquidation, or similar proceeding. The proposed criteria were designed to ensure that additional tier 1 capital instruments would be available to absorb losses on a going-concern basis. TruPS and cumulative perpetual preferred securities, which are eligible for limited inclusion in tier 1 capital 72 De minimis assets related to the operation of the issuing entity could be disregarded for purposes of this criterion. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations under the general risk-based capital rules for bank holding companies, generally would not qualify for inclusion in additional tier 1 capital.73 As explained in the proposal, the agencies believe that instruments that allow for the accumulation of interest payable, like cumulative preferred securities, are not likely to absorb losses to the degree appropriate for inclusion in tier 1 capital. In addition, the exclusion of these instruments from the tier 1 capital of depository institution holding companies would be consistent with section 171 of the Dodd-Frank Act. The agencies noted in the proposal that under Basel III, instruments classified as liabilities for accounting purposes could potentially be included in additional tier 1 capital. However, the agencies and the FDIC proposed that an instrument classified as a liability under GAAP could not qualify as additional tier 1 capital, reflecting the agencies’ and the FDIC’s view that allowing only instruments classified as equity under GAAP in tier 1 capital helps strengthen the loss-absorption capabilities of additional tier 1 capital instruments, thereby increasing the quality of the capital base of U.S. banking organizations. The agencies and the FDIC also proposed to allow banking organizations to include in additional tier 1 capital instruments that were: (1) Issued under the Small Business Jobs Act of 2010 74 or, prior to October 4, 2010, under the Emergency Economic Stabilization Act of 2008,75 and (2) included in tier 1 capital under the agencies’ and the FDIC’s general risk-based capital rules. Under the proposal, these instruments would be included in tier 1 capital regardless of whether they satisfied the proposed qualifying criteria for common equity tier 1 or additional tier 1 capital. The agencies and the FDIC explained in the proposal that continuing to permit these instruments to be included in tier 1 capital is important to promote financial recovery and stability following the recent financial crisis.76 A number of commenters addressed the proposed criteria for additional tier 1 capital. Consistent with comments on the criteria for common equity tier 1 capital, commenters generally argued that imposing new restrictions on qualifying regulatory capital instruments would be burdensome for many banking organizations that would 73 See 12 CFR part 225, appendix A, section II.A.1. 74 Public Law 111–240, 124 Stat. 2504 (2010). 75 Public Law 110–343, 122 Stat. 3765 (October 3, 2008). 76 See, e.g., 73 FR 43982 (July 29, 2008); see also 76 FR 35959 (June 21, 2011). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 be required to raise additional capital or to shrink their balance sheets to phase out existing regulatory capital instruments that no longer qualify as regulatory capital under the proposed rule. With respect to the proposed criteria, commenters requested that the agencies and the FDIC make a number of changes and clarifications. Specifically, commenters asked the agencies and the FDIC to clarify the use of the term ‘‘secured’’ in criterion (3) above. In this context, a ‘‘secured’’ instrument is an instrument that is backed by collateral. In order to qualify as additional tier 1 capital, an instrument may not be collateralized, guaranteed by the issuing organization or an affiliate of the issuing organization, or subject to any other arrangement that legally or economically enhances the seniority of the instrument relative to more senior claims. Instruments backed by collateral, guarantees, or other arrangements that affect their seniority are less able to absorb losses than instruments without such enhancements. Therefore, instruments secured by collateral, guarantees, or other enhancements would not be included in additional tier 1 capital under the proposal. The agencies have adopted this criterion as proposed. Commenters also asked the agencies and the FDIC to clarify whether terms allowing a banking organization to convert a fixed-rate instrument to a floating rate in combination with a call option, without any increase in credit spread, would constitute an ‘‘incentive to redeem’’ under criterion (4). The agencies do not consider the conversion from a fixed rate to a floating rate (or from a floating rate to a fixed rate) in combination with a call option without any increase in credit spread to constitute an ‘‘incentive to redeem’’ for purposes of this criterion. More specifically, a call option combined with a change in reference rate where the credit spread over the second reference rate is equal to or less than the initial dividend rate less the swap rate (that is, the fixed rate paid to the call date to receive the second reference rate) would not be considered an incentive to redeem. For example, if the initial reference rate is 0.9 percent, the credit spread over the initial reference rate is 2 percent (that is, the initial dividend rate is 2.9 percent), and the swap rate to the call date is 1.2 percent, a credit spread over the second reference rate greater than 1.7 percent (2.9 percent minus 1.2 percent) would be considered an incentive to redeem. The agencies believe that the clarification above should address the PO 00000 Frm 00031 Fmt 4701 Sfmt 4700 62047 commenters’ concerns, and the agencies are retaining this criterion in the final rule as proposed. Several commenters noted that the proposed requirement that a banking organization seek prior approval from its primary Federal supervisor before exercising a call option is redundant with the existing requirement that a banking organization seek prior approval before reducing regulatory capital by redeeming a capital instrument. The agencies believe that the proposed requirement clarifies existing requirements and does not add any new substantive restrictions or burdens. Including this criterion also helps to ensure that the regulatory capital rules provide banking organizations a complete list of the requirements applicable to regulatory capital instruments in one location. Accordingly, the agencies have retained this requirement in the final rule. Banking industry commenters also asserted that some of the proposed criteria could have an adverse impact on ESOPs. Specifically, the commenters noted that the proposed requirement that instruments not be callable for at least five years after issuance could be problematic for compensation plans that enable a company to redeem shares after employment is terminated. Commenters asked the agencies and the FDIC to exempt from this requirement stock issued as part of an ESOP. For the reasons stated above in the discussion of common equity tier 1 capital instruments, under the final rule, additional tier 1 instruments issued under an ESOP by a banking organization that is not publicly traded are exempt from the criterion that additional tier 1 instruments not be callable for at least five years after issuance. Moreover, similar to the discussion above regarding the criteria for common equity tier 1 capital, the agencies believe that required compliance with ERISA and ERISArelated tax code requirements alone should not prevent an instrument from being included in regulatory capital. Therefore, the agencies are including a provision in the final rule to clarify that the criterion prohibiting a banking organization from directly or indirectly funding a capital instrument, the criterion prohibiting a capital instrument from being covered by a guarantee of the banking organization or from being subject to an arrangement that enhances the seniority of the instrument, and the criterion pertaining to the creation of an expectation that the instrument will be redeemed, shall not prevent an instrument issued by a nonpublicly traded banking organization as E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62048 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations part of an ESOP from being included in additional tier 1 capital. In addition, capital instruments held by an ESOP trust that are unawarded or unearned by employees or reported as ‘‘temporary equity’’ under GAAP (in the case of U.S. SEC registrants) may not be counted as equity under GAAP and therefore may not be included in additional tier 1 capital. Commenters also asked the agencies and the FDIC to add exceptions for early calls within five years of issuance in the case of an ‘‘investment company event’’ or a ‘‘rating agency event,’’ in addition to the proposed exceptions for regulatory and tax events. After considering the comments on these issues, the agencies have decided to revise the rule to permit a banking organization to call an instrument prior to five years after issuance in the event that the issuing entity is required to register as an investment company pursuant to the Investment Company Act of 1940.77 The agencies recognize that the legal and regulatory burdens of becoming an investment company could make it uneconomic to leave some structured capital instruments outstanding, and thus would permit the banking organization to call such instruments early. In order to ensure the loss-absorption capacity of additional tier 1 capital instruments, the agencies have decided not to revise the rule to permit a banking organization to include in its additional tier 1 capital instruments issued on or after the effective date of the rule that may be called prior to five years after issuance upon the occurrence of a rating agency event. However, understanding that many currently outstanding instruments have this feature, the agencies have decided to revise the rule to allow an instrument that may be called prior to five years after its issuance upon the occurrence of a rating agency event to be included into additional tier 1 capital, provided that (i) the instrument was issued and included in a banking organization’s tier 1 capital prior to the effective date of the rule, and (ii) that such instrument meets all other criteria for additional tier 1 capital instruments under the final rule. In addition, a number of commenters reiterated the concern that restrictions on the payment of dividends from net income and current and retained earnings may conflict with state corporate laws that permit an organization to issue dividend payments from its capital surplus accounts. This criterion for additional tier 1 capital in the final rule reflects the identical final 77 15 U.S.C. 80 a–1 et seq. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 criterion for common equity tier 1 for the reasons discussed above with respect to common equity tier 1 capital. Commenters also noted that proposed criterion (10), which requires the paidin amounts of tier 1 capital instruments to be classified as equity under GAAP before they may be included in regulatory capital, generally would prevent contingent capital instruments, which are classified as liabilities, from qualifying as additional tier 1 capital. These commenters asked the agencies and the FDIC to revise the rules to provide that contingent capital instruments will qualify as additional tier 1 capital, regardless of their treatment under GAAP. Another commenter noted the challenges for U.S. banking organizations in devising contingent capital instruments that would satisfy the proposed criteria, and noted that if U.S. banking organizations develop an acceptable instrument, the instrument likely would initially be classified as debt instead of equity for GAAP purposes. Thus, in order to accommodate this possibility, the commenter urged the agencies and the FDIC to revise the criterion to allow the agencies and the FDIC to permit such an instrument in additional tier 1 capital through interpretive guidance or specifically in the case of a particular instrument. The agencies continue to believe that restricting tier 1 capital instruments to those classified as equity under GAAP will help to ensure those instruments’ capacity to absorb losses and further increase the quality of U.S. banking organizations’ regulatory capital. The agencies therefore have decided to retain this aspect of the proposal. To the extent that a contingent capital instrument is considered a liability under GAAP, a banking organization may not include the instrument in its tier 1 capital under the final rule. At such time as an instrument converts from debt to equity under GAAP, the instrument would then satisfy this criterion. In the preamble to the proposed rule, the agencies included a discussion regarding whether criterion (7) should be revised to require banking organizations to reduce the dividend payment on tier 1 capital instruments to a penny when a banking organization reduces dividend payments on a common equity tier 1 capital instrument to a penny per share. Such a revision would increase the capacity of additional tier 1 instruments to absorb losses as it would permit a banking organization to reduce its capital distributions on additional tier 1 instruments without eliminating PO 00000 Frm 00032 Fmt 4701 Sfmt 4700 entirely its common stock dividend. Commenters asserted that such a revision would be unnecessary and could affect the hierarchy of subordination in capital instruments. Commenters also claimed the revision could prove burdensome as it could substantially increase the cost of raising capital through additional tier 1 capital instruments. In light of these comments the agencies have decided to not modify criterion (7) to accommodate the issuance of a penny dividend as discussed in the proposal. Several commenters expressed concern that criterion (7) for additional tier 1 capital, could affect the tier 1 eligibility of existing noncumulative perpetual preferred stock. Specifically, the commenters were concerned that such a criterion would disallow contractual terms of an additional tier 1 capital instrument that restrict payment of dividends on another capital instrument that is pari passu in liquidation with the additional tier 1 capital instrument (commonly referred to as dividend stoppers). Consistent with Basel III, the agencies agree that restrictions related to capital distributions to holders of common stock instruments and holders of other capital instruments that are pari passu in liquidation with such additional tier 1 capital instruments are acceptable, and have amended this criterion accordingly for purposes of the final rule. After considering the comments on the proposal, the agencies have decided to finalize the criteria for additional tier 1 capital instruments with the modifications discussed above. The final revised criteria for additional tier 1 capital are set forth in section 20(c)(1) of the final rule. The agencies expect that most outstanding noncumulative perpetual preferred stock that qualifies as tier 1 capital under the agencies’ general risk-based capital rules will qualify as additional tier 1 capital under the final rule. 3. Tier 2 Capital Consistent with Basel III, under the proposed rule, tier 2 capital would equal the sum of: Tier 2 capital instruments that satisfy the criteria set forth in section 20(d) of the proposal, related surplus, total capital minority interest not included in a banking organization’s tier 1 capital (subject to certain limitations and requirements), and limited amounts of the allowance for loan and lease losses (ALLL) less any applicable regulatory adjustments and deductions. Consistent with the general risk-based capital rules, when calculating its total capital ratio using E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations the standardized approach, a banking organization would be permitted to include in tier 2 capital the amount of ALLL that does not exceed 1.25 percent of its standardized total risk-weighted assets which would not include any amount of the ALLL. A banking organization subject to the market risk rule would exclude its standardized market risk-weighted assets from the calculation.78 In contrast, when calculating its total capital ratio using the advanced approaches, a banking organization would be permitted to include in tier 2 capital the excess of its eligible credit reserves over its total expected credit loss, provided the amount does not exceed 0.6 percent of its credit risk-weighted assets. Consistent with Basel III, the agencies and the FDIC proposed the following criteria for tier 2 capital instruments: (1) The instrument is issued and paidin. (2) The instrument is subordinated to depositors and general creditors of the banking organization. (3) The instrument is not secured, not covered by a guarantee of the banking organization or of an affiliate of the banking organization, and not subject to any other arrangement that legally or economically enhances the seniority of the instrument in relation to more senior claims. (4) The instrument has a minimum original maturity of at least five years. At the beginning of each of the last five years of the life of the instrument, the amount that is eligible to be included in tier 2 capital is reduced by 20 percent of the original amount of the instrument (net of redemptions) and is excluded from regulatory capital when remaining maturity is less than one year. In addition, the instrument must not have any terms or features that require, or create significant incentives for, the banking organization to redeem the instrument prior to maturity. (5) The instrument, by its terms, may be called by the banking organization only after a minimum of five years following issuance, except that the terms of the instrument may allow it to be called sooner upon the occurrence of an event that would preclude the instrument from being included in tier 2 capital, or a tax event. In addition: (i) The banking organization must receive the prior approval of its primary Federal supervisor to exercise a call option on the instrument. 78 A banking organization would deduct the amount of ALLL in excess of the amount permitted to be included in tier 2 capital, as well as allocated transfer risk reserves, from its standardized total risk-weighted risk assets. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (ii) The banking organization does not create at issuance, through action or communication, an expectation the call option will be exercised. (iii) Prior to exercising the call option, or immediately thereafter, the banking organization must either: (A) Replace any amount called with an equivalent amount of an instrument that meets the criteria for regulatory capital under section 20 of the proposed rule; 79 or (B) Demonstrate to the satisfaction of the banking organization’s primary Federal supervisor that following redemption, the banking organization would continue to hold an amount of capital that is commensurate with its risk. (6) The holder of the instrument must have no contractual right to accelerate payment of principal or interest on the instrument, except in the event of a receivership, insolvency, liquidation, or similar proceeding of the banking organization. (7) The instrument has no creditsensitive feature, such as a dividend or interest rate that is reset periodically based in whole or in part on the banking organization’s credit standing, but may have a dividend rate that is adjusted periodically independent of the banking organization’s credit standing, in relation to general market interest rates or similar adjustments. (8) The banking organization, or an entity that the banking organization controls, has not purchased and has not directly or indirectly funded the purchase of the instrument. (9) If the instrument is not issued directly by the banking organization or by a subsidiary of the banking organization that is an operating entity, the only asset of the issuing entity is its investment in the capital of the banking organization, and proceeds must be immediately available without limitation to the banking organization or the banking organization’s top-tier holding company in a form that meets or exceeds all the other criteria for tier 2 capital instruments under this section.80 (10) Redemption of the instrument prior to maturity or repurchase requires the prior approval of the banking organization’s primary Federal supervisor. (11) For an advanced approaches banking organization, the governing agreement, offering circular, or 79 Replacement of tier 2 capital instruments can be concurrent with redemption of existing tier 2 capital instruments. 80 De minimis assets related to the operation of the issuing entity can be disregarded for purposes of this criterion. PO 00000 Frm 00033 Fmt 4701 Sfmt 4700 62049 prospectus of an instrument issued after January 1, 2013, must disclose that the holders of the instrument may be fully subordinated to interests held by the U.S. government in the event that the banking organization enters into a receivership, insolvency, liquidation, or similar proceeding. The agencies and the FDIC also proposed to eliminate the inclusion of a portion of certain unrealized gains on AFS equity securities in tier 2 capital given that unrealized gains and losses on AFS securities would flow through to common equity tier 1 capital under the proposed rules. As a result of the proposed new minimum common equity tier 1 capital requirement, higher tier 1 capital requirement, and the broader goal of simplifying the definition of tier 2 capital, the proposal eliminated the existing limitations on the amount of tier 2 capital that could be recognized in total capital, as well as the existing limitations on the amount of certain capital instruments (that is, term subordinated debt) that could be included in tier 2 capital. Finally, the agencies and the FDIC proposed to allow an instrument that qualified as tier 2 capital under the general risk-based capital rules and that was issued under the Small Business Jobs Act of 2010,81 or, prior to October 4, 2010, under the Emergency Economic Stabilization Act of 2008, to continue to be includable in tier 2 capital regardless of whether it met all of the proposed qualifying criteria. Several commenters addressed the proposed eligibility criteria for tier 2 capital. A few banking industry commenters asked the agencies and the FDIC to clarify criterion (2) above to provide that trade creditors are not among the class of senior creditors whose claims rank ahead of subordinated debt holders. In response to these comments, the agencies note that the intent of the final rule, with its requirement that tier 2 capital instruments be subordinated to depositors and general creditors, is to effectively retain the subordination standards for tier 2 capital subordinated debt under the general risk-based capital rules. Therefore, the agencies are clarifying that under the final rule, and consistent with the agencies’ general risk-based capital rules, subordinated debt instruments that qualify as tier 2 capital must be subordinated to general creditors, which generally means senior indebtedness, excluding trade creditors. Such creditors include at a minimum all borrowed money, similar obligations 81 Public E:\FR\FM\11OCR2.SGM Law 111–240, 124 Stat. 2504 (2010). 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62050 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations arising from off-balance sheet guarantees and direct-credit substitutes, and obligations associated with derivative products such as interest rate and foreign-exchange contracts, commodity contracts, and similar arrangements, and, in addition, for depository institutions, depositors. In addition, one commenter noted that while many existing banking organizations’ subordinated debt indentures contain subordination provisions, they may not explicitly include a subordination provision with respect to ‘‘general creditors’’ of the banking organization. Thus, they recommended that this aspect of the rules be modified to have only prospective application. The agencies note that if it is clear from an instrument’s governing agreement, offering circular, or prospectus, that the instrument is subordinated to general creditors despite not specifically stating ‘‘general creditors,’’ criterion (2) above is satisfied (that is, criterion (2) should not be read to mean that the phrase ‘‘general creditors’’ must appear in the instrument’s governing agreement, offering circular, or prospectus, as the case may be). One commenter also asked whether a debt instrument that automatically converts to an equity instrument within five years of issuance, and that satisfies all criteria for tier 2 instruments other than the five-year maturity requirement, would qualify as tier 2 capital. The agencies note that because such an instrument would automatically convert to a permanent form of regulatory capital, the five-year maturity requirement would not apply and, thus, it would qualify as tier 2 capital. The agencies have clarified the final rule in this respect. Commenters also expressed concern about the impact of a number of the proposed criteria on outstanding TruPS. For example, commenters stated that a strict reading of criterion (3) above could exclude certain TruPS under which the banking organization guarantees that any payments made by the banking organization to the trust will be used by the trust to pay its obligations to security holders. However, the proposed rule would not have disqualified an instrument with this type of guarantee, which does not enhance or otherwise alter the subordination level of an instrument. Additionally, the commenters asked the agencies and the FDIC to allow in tier 2 capital instruments that provide for default and the acceleration of principal and interest if the issuer banking organization defers interest payments for five consecutive years. Commenters VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 stated that these exceptions would be necessary to accommodate existing TruPS, which generally include such call, default and acceleration features. Commenters also asked the agencies and the FDIC to clarify the use of the term ‘‘secured’’ in criterion (3). As discussed above with respect to the criteria for additional tier 1 capital, a ‘‘secured’’ instrument is an instrument where payments on the instrument are secured by collateral. Therefore, under criterion (3), a collateralized instrument will not qualify as tier 2 capital. Instruments secured by collateral are less able to absorb losses than instruments without such enhancement. With respect to subordinated debt instruments included in tier 2 capital, a commenter recommended eliminating criterion (4)’s proposed five-year amortization requirement, arguing that that it was unnecessary given other capital planning requirements that banking organizations must satisfy. The agencies declined to adopt the commenter’s recommendation, as they believe that the proposed amortization schedule results in a more accurate reflection of the loss-absorbency of a banking organization’s tier 2 capital. The agencies note that if a banking organization begins deferring interest payments on a TruPS instrument included in tier 2 capital, such an instrument will be treated as having a maturity of five years at that point and the banking organization must begin excluding the appropriate amount of the instrument from capital in accordance with section 20(d)(1)(iv) of the final rule. Similar to the comments received on the criteria for additional tier 1 capital, commenters asked the agencies and the FDIC to add exceptions to the prohibition against call options that could be exercised within five years of the issuance of a capital instrument, specifically for an ‘‘investment company event’’ and a ‘‘rating agency event.’’ Although the agencies declined to permit instruments that include acceleration provisions in tier 2 capital in the final rule, the agencies believe that the inclusion in tier 2 capital of existing TruPS, which allow for acceleration after five years of interest deferral, does not raise safety and soundness concerns. Although the majority of existing TruPS would not technically comply with the final rule’s tier 2 eligibility criteria, the agencies acknowledge that the inclusion of existing TruPS in tier 2 capital (until they are redeemed or they mature) would benefit certain banking organizations until they are able to replace such instruments with new PO 00000 Frm 00034 Fmt 4701 Sfmt 4700 capital instruments that fully comply with the eligibility criteria of the final rule. Accordingly, the agencies have decided to permit non-advanced approaches depository institution holding companies with over $15 billion in total consolidated assets to include in tier 2 capital TruPS that are phased-out of tier 1 capital in tier 2 capital. However, advanced approaches depository institution holding companies would not be allowed to permanently include existing TruPS in tier 2 capital. Rather, these banking organizations would include in tier 2 capital TruPS phased out of tier 1 capital from January 1, 2014 to year-end 2015. From January 1, 2016 to year-end 2021, these banking organizations would be required to phase out TruPS from tier 2 capital in line with Table 9 of the transitions section of the final rule. As with additional tier 1 capital instruments, the final rule permits a banking organization to call an instrument prior to five years after issuance in the event that the issuing entity is required to register with the SEC as an investment company pursuant to the Investment Company Act of 1940, for the reasons discussed above with respect to additional tier 1 capital. Also for the reasons discussed above with respect to additional tier 1 capital instruments, the agencies have decided not to permit a banking organization to include in its tier 2 capital an instrument issued on or after the effective date of the final rule that may be called prior to five years after its issuance upon the occurrence of a rating agency event. However, the agencies have decided to allow such an instrument to be included in tier 2 capital, provided that the instrument was issued and included in a banking organization’s tier 1 or tier 2 capital prior to January 1, 2014, and that such instrument meets all other criteria for tier 2 capital instruments under the final rule. In addition, similar to the comment above with respect to the proposed criteria for additional tier 1 capital instruments, commenters noted that the proposed criterion that a banking organization seek prior approval from its primary Federal supervisor before exercising a call option is redundant with the requirement that a banking organization seek prior approval before reducing regulatory capital by redeeming a capital instrument. Again, the agencies believe that this proposed requirement restates and clarifies existing requirements without adding any new substantive restrictions, and that it will help to ensure that the E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations regulatory capital rules provide banking organizations with a complete list of the requirements applicable to their regulatory capital instruments. Therefore, the agencies are retaining the requirement as proposed. Under the proposal, an advanced approaches banking organization may include in tier 2 capital the excess of its eligible credit reserves over expected credit loss (ECL) to the extent that such amount does not exceed 0.6 percent of credit risk-weighted assets, rather than including the amount of ALLL described above. Commenters asked the agencies and the FDIC to clarify whether an advanced approaches banking organization that is in parallel run includes in tier 2 capital its ECL or ALLL (as described above). To clarify, for purposes of the final rule, an advanced approaches banking organization will always include in total capital its ALLL up to 1.25 percent of (non-market risk) risk-weighted assets when measuring its total capital relative to standardized risk-weighted assets. When measuring its total capital relative to its advanced approaches riskweighted assets, as described in section 10(c)(3)(ii) of the final rule, an advanced approaches banking organization that has completed the parallel run process and that has received notification from its primary Federal supervisor pursuant to section 121(d) of subpart E must adjust its total capital to reflect its excess eligible credit reserves rather than its ALLL. Some commenters recommended that the agencies and the FDIC remove the limit on the amount of the ALLL includable in regulatory capital. Specifically, one commenter recommended allowing banking organizations to include ALLL in tier 1 capital equal to an amount of up to 1.25 percent of total risk-weighted assets, with the balance in tier 2 capital, so that the entire ALLL would be included in regulatory capital. Moreover, some commenters recommended including in tier 2 capital the entire amount of reserves held for residential mortgage loans sold with recourse, given that the proposal would require a 100 percent credit conversion factor for such loans. Consistent with the ALLL treatment under the general risk-based capital rules, for purposes of the final rule the agencies have elected to permit only limited amounts of the ALLL in tier 2 capital given its limited purpose of covering incurred rather than unexpected losses. For similar reasons, the agencies have further elected not to recognize in tier 2 capital reserves held for residential mortgage loans sold with recourse. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 62051 As described above, a banking organization that has made an AOCI opt-out election may incorporate up to 45 percent of any net unrealized gains on AFS preferred stock classified as an equity security under GAAP and AFS equity exposures into its tier 2 capital. Some commenters requested that the eligibility criteria for tier 2 capital be clarified with regard to surplus notes. For example, commenters suggested that the requirement for approval of any payment of principal or interest on a surplus note by the applicable insurance regulator is deemed to satisfy the criterion of the tier 2 capital instrument for prior approval for redemption of the instrument prior to maturity by a Federal banking agency. As described under the proposal, surplus notes generally are financial instruments issued by insurance companies that are included in surplus for statutory accounting purposes as prescribed or permitted by state laws and regulations, and typically have the following features: (1) The applicable state insurance regulator approves in advance the form and content of the note; (2) the instrument is subordinated to policyholders, to claimant and beneficiary claims, and to all other classes of creditors other than surplus note holders; and (3) the applicable state insurance regulator is required to approve in advance any interest payments and principal repayments on the instrument. The Board notes that a surplus note could be eligible for inclusion in tier 2 capital provided that the note meets the proposed tier 2 capital eligibility criteria. However, the Board does not consider approval of payments by an insurance regulator to satisfy the criterion for approval by a Federal banking agency. Accordingly, the Board has adopted the final rule without change. After reviewing the comments received on this issue, the agencies have determined to finalize the criteria for tier 2 capital instruments to include the aforementioned changes. The revised criteria for inclusion in tier 2 capital are set forth in section 20(d)(1) of the final rule. 4. Capital Instruments of Mutual Banking Organizations Under the proposed rule, the qualifying criteria for common equity tier 1, additional tier 1, and tier 2 capital generally would apply to mutual banking organizations. Mutual banking organizations and industry groups representing mutual banking organizations encouraged the agencies and the FDIC to expand the qualifying criteria for additional tier 1 capital to recognize certain cumulative instruments. These commenters stressed that mutual banking organizations, which do not issue common stock, have fewer options for raising regulatory capital relative to other types of banking organizations. The agencies do not believe that cumulative instruments are able to absorb losses sufficiently reliably to be included in tier 1 capital. Therefore, after considering these comments, the agencies have decided not to include in tier 1 capital under the final rule any cumulative instrument. This would include any previously-issued mutual capital instrument that was included in the tier 1 capital of mutual banking organizations under the general riskbased capital rules, but that does not meet the eligibility requirements for tier 1 capital under the final rule. These cumulative capital instruments will be subject to the transition provisions and phased out of the tier 1 capital of mutual banking organizations over time, as set forth in Table 9 of section 300 in the final rule. However, if a mutual banking organization develops a new capital instrument that meets the qualifying criteria for regulatory capital under the final rule, such an instrument may be included in regulatory capital with the prior approval of the banking organization’s primary Federal supervisor under section 20(e) of the final rule. The agencies note that the qualifying criteria for regulatory capital instruments under the final rule permit mutual banking organizations to include in regulatory capital many of their existing regulatory capital instruments (for example, non-withdrawable accounts, pledged deposits, or mutual capital certificates). The agencies believe that the quality and quantity of regulatory capital currently maintained by most mutual banking organizations should be sufficient to satisfy the requirements of the final rule. For those organizations that do not currently hold enough capital to meet the revised minimum requirements, the transition arrangements are designed to ease the burden of increasing regulatory capital over time. 5. Grandfathering of Certain Capital Instruments As described above, a substantial number of commenters objected to the proposed phase-out of non-qualifying capital instruments, including TruPS and cumulative perpetual preferred stock, from tier 1 capital. Community banking organizations in particular expressed concerns that the costs related to the replacement of such PO 00000 Frm 00035 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62052 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations capital instruments, which they generally characterized as safe and lossabsorbent, would be excessive and unnecessary. Commenters noted that the proposal was more restrictive than section 171 of the Dodd-Frank Act, which requires the phase-out of nonqualifying capital instruments issued prior to May 19, 2010, only for depository institution holding companies with $15 billion or more in total consolidated assets as of December 31, 2009. Commenters argued that the agencies and the FDIC were exceeding Congressional intent by going beyond what was required under the DoddFrank Act. Commenters requested that the agencies and the FDIC grandfather existing TruPS and cumulative perpetual preferred stock issued by depository institution holding companies with less than $15 billion and 2010 MHCs. The agencies agree that under the Dodd-Frank Act the agencies have the flexibility to permit depository institution holding companies with less than $15 billion in total consolidated assets as of December 31, 2009 and banking organizations that were mutual holding companies as of May 19, 2010 (2010 MHCs) to include in additional tier 1 capital TruPS and cumulative perpetual preferred stock issued and included in tier 1 capital prior to May 19, 2010. Although the agencies continue to believe that TruPS are not sufficiently loss-absorbing to be includable in tier 1 capital as a general matter, the agencies are also sensitive to the difficulties community banking organizations often face when issuing new capital instruments and are aware of the importance their capacity to lend plays in local economies. Therefore the agencies have decided in the final rule to grandfather such non-qualifying capital instruments in tier 1 capital subject to a limit of 25 percent of tier 1 capital elements excluding any nonqualifying capital instruments and after all regulatory capital deductions and adjustments applied to tier 1 capital, which is substantially similar to the limit in the general risk-based capital rules. In addition, the agencies acknowledge that the inclusion of existing TruPS in tier 2 capital would benefit certain banking organizations until they are able to replace such instruments with new capital instruments that fully comply with the eligibility criteria of the final rule. Accordingly, the agencies have decided to permit depository institution holding companies not subject to the advanced approaches rule with over $15 billion in total consolidated assets to permanently VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 include in tier 2 capital TruPS that are phased-out of tier 1 capital in accordance with Table 8 of the transitions section of the final rule. 6. Agency Approval of Capital Elements The agencies and the FDIC noted in the proposal that they believe most existing regulatory capital instruments will continue to be includable in banking organizations’ regulatory capital. However, over time, capital instruments that are equivalent in quality and capacity to absorb losses to existing instruments may be created to satisfy different market needs. Therefore, the agencies and the FDIC proposed to create a process to consider the eligibility of such instruments on a case-by-case basis. Under the proposed rule, a banking organization must request approval from its primary Federal supervisor before including a capital element in regulatory capital, unless: (i) Such capital element is currently included in regulatory capital under the agencies’ and the FDIC’s general risk-based capital and leverage rules and the underlying instrument complies with the applicable proposed eligibility criteria for regulatory capital instruments; or (ii) the capital element is equivalent, in terms of capital quality and ability to absorb losses, to an element described in a previous decision made publicly available by the banking organization’s primary Federal supervisor. In the preamble to the proposal, the agencies and the FDIC indicated that they intend to consult each other when determining whether a new element should be included in common equity tier 1, additional tier 1, or tier 2 capital, and indicated that once one agency determines that a capital element may be included in a banking organization’s common equity tier 1, additional tier 1, or tier 2 capital, that agency would make its decision publicly available, including a brief description of the capital element and the rationale for the conclusion. The agencies continue to believe that it is appropriate to retain the flexibility necessary to consider new instruments on a case-by-case basis as they are developed over time to satisfy different market needs. The agencies have decided to move the agencies’ authority in section 20(e)(1) of the proposal to the agencies’ reservation of authority provision included in section 1(d)(2)(ii) of the final rule. Therefore, the agencies are adopting this aspect of the final rule substantively as proposed to create a process to consider the eligibility of such instruments on a permanent or temporary basis, in accordance with the PO 00000 Frm 00036 Fmt 4701 Sfmt 4700 applicable requirements in subpart C of the final rule (section 20(e) of the final rule). Section 20(e)(1) of the final rule provides that a banking organization must receive its primary Federal supervisor’s prior approval to include a capital element in its common equity tier 1 capital, additional tier 1 capital, or tier 2 capital unless that element: (i) Was included in the banking organization’s tier 1 capital or tier 2 capital prior to May 19, 2010 in accordance with that supervisor’s riskbased capital rules that were effective as of that date and the underlying instrument continues to be includable under the criteria set forth in this section; or (ii) is equivalent, in terms of capital quality and ability to absorb credit losses with respect to all material terms, to a regulatory capital element determined by that supervisor to be includable in regulatory capital pursuant to paragraph (e)(3) of section 20. In exercising this reservation of authority, the agencies expect to consider the requirements for capital elements in the final rule; the size, complexity, risk profile, and scope of operations of the banking organization, and whether any public benefits would be outweighed by risk to an insured depository institution or to the financial system. 7. Addressing the Point of Non-Viability Requirements Under Basel III During the recent financial crisis, the United States and foreign governments lent to, and made capital investments in, banking organizations. These investments helped to stabilize the recipient banking organizations and the financial sector as a whole. However, because of the investments, the recipient banking organizations’ existing tier 2 capital instruments, and (in some cases) tier 1 capital instruments, did not absorb the banking organizations’ credit losses consistent with the purpose of regulatory capital. At the same time, taxpayers became exposed to potential losses. On January 13, 2011, the BCBS issued international standards for all additional tier 1 and tier 2 capital instruments issued by internationally-active banking organizations to ensure that such regulatory capital instruments fully absorb losses before taxpayers are exposed to such losses (the Basel nonviability standard). Under the Basel non-viability standard, all non-common stock regulatory capital instruments issued by an internationally-active banking organization must include terms that subject the instruments to write-off or conversion to common E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations equity at the point at which either: (1) The write-off or conversion of those instruments occurs; or (2) a public sector injection of capital would be necessary to keep the banking organization solvent. Alternatively, if the governing jurisdiction of the banking organization has established laws that require such tier 1 and tier 2 capital instruments to be written off or otherwise fully absorb losses before taxpayers are exposed to loss, the standard is already met. If the governing jurisdiction has such laws in place, the Basel non-viability standard states that documentation for such instruments should disclose that information to investors and market participants, and should clarify that the holders of such instruments would fully absorb losses before taxpayers are exposed to loss.82 U.S. law is consistent with the Basel non-viability standard. The resolution regime established in Title II, section 210 of the Dodd-Frank Act provides the FDIC with the authority necessary to place failing financial companies that pose a significant risk to the financial stability of the United States into receivership.83 The Dodd-Frank Act provides that this authority shall be exercised in a manner that minimizes systemic risk and moral hazard, so that (1) Creditors and shareholders will bear the losses of the financial company; (2) management responsible for the condition of the financial company will not be retained; and (3) the FDIC and other appropriate agencies will take steps necessary and appropriate to ensure that all parties, including holders of capital instruments, management, directors, and third parties having responsibility for the condition of the financial company, bear losses consistent with their respective ownership or responsibility.84 Section 11 of the Federal Deposit Insurance Act has similar provisions for the resolution of depository institutions.85 Additionally, under U.S. bankruptcy law, regulatory capital instruments issued by a company would absorb losses in bankruptcy before instruments held by more senior unsecured creditors. Consistent with the Basel nonviability standard, under the proposal, additional tier 1 and tier 2 capital instruments issued by advanced approaches banking organizations after the date on which such organizations 82 See ‘‘Final Elements of the Reforms to Raise the Quality of Regulatory Capital’’ (January 2011), available at: https://www.bis.org/press/p110113.pdf. 83 See 12 U.S.C. 5384. 84 See 12 U.S.C. 5384. 85 12 U.S.C. 1821. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 would have been required to comply with any final rule would have been required to include a disclosure that the holders of the instrument may be fully subordinated to interests held by the U.S. government in the event that the banking organization enters into a receivership, insolvency, liquidation, or similar proceeding. The agencies are adopting this provision of the proposed rule without change. 8. Qualifying Capital Instruments Issued by Consolidated Subsidiaries of a Banking Organization As highlighted during the recent financial crisis, capital issued by consolidated subsidiaries and not owned by the parent banking organization (minority interest) is available to absorb losses at the subsidiary level, but that capital does not always absorb losses at the consolidated level. Accordingly, and consistent with Basel III, the proposed rule revised limitations on the amount of minority interest that may be included in regulatory capital at the consolidated level to prevent highly capitalized subsidiaries from overstating the amount of capital available to absorb losses at the consolidated organization. Under the proposal, minority interest would have been classified as a common equity tier 1, tier 1, or total capital minority interest depending on the terms of the underlying capital instrument and on the type of subsidiary issuing such instrument. Any instrument issued by a consolidated subsidiary to third parties would have been required to satisfy the qualifying criteria under the proposal to be included in the banking organization’s common equity tier 1, additional tier 1, or tier 2 capital, as appropriate. In addition, common equity tier 1 minority interest would have been limited to instruments issued by a depository institution or a foreign bank that is a consolidated subsidiary of a banking organization. The proposed limits on the amount of minority interest that could have been included in the consolidated capital of a banking organization would have been based on the amount of capital held by the consolidated subsidiary, relative to the amount of capital the subsidiary would have had to hold to avoid any restrictions on capital distributions and discretionary bonus payments under the capital conservation buffer framework. For example, a subsidiary with a common equity tier 1 capital ratio of 8 percent that needs to maintain a common equity tier 1 capital ratio of more than 7 percent to avoid limitations on capital distributions and PO 00000 Frm 00037 Fmt 4701 Sfmt 4700 62053 discretionary bonus payments would have been considered to have ‘‘surplus’’ common equity tier 1 capital and, at the consolidated level, the banking organization would not have been able to include the portion of such surplus common equity tier 1 capital that is attributable to third party investors. In general, the amount of common equity tier 1 minority interest that could have been included in the common equity tier 1 capital of a banking organization under the proposal would have been equal to: (i) The common equity tier 1 minority interest of the subsidiary minus (ii) The ratio of the subsidiary’s common equity tier 1 capital owned by third parties to the total common equity tier 1 capital of the subsidiary, multiplied by the difference between the common equity tier 1 capital of the subsidiary and the lower of: (1) The amount of common equity tier 1 capital the subsidiary must hold to avoid restrictions on capital distributions and discretionary bonus payments, or (2)(a) the standardized total riskweighted assets of the banking organization that relate to the subsidiary, multiplied by (b) The common equity tier 1 capital ratio needed by the banking organization subsidiary to avoid restrictions on capital distributions and discretionary bonus payments. If a subsidiary were not subject to the same minimum regulatory capital requirements or capital conservation buffer framework as the banking organization, the banking organization would have needed to assume, for the purposes of the calculation described above, that the subsidiary is in fact subject to the same minimum capital requirements and the same capital conservation buffer framework as the banking organization. To determine the amount of tier 1 minority interest that could be included in the tier 1 capital of the banking organization and the total capital minority interest that could be included in the total capital of the banking organization, a banking organization would follow the same methodology as the one outlined previously for common equity tier 1 minority interest. The proposal set forth sample calculations. The amount of tier 1 minority interest that could have been included in the additional tier 1 capital of a banking organization under the proposal was equivalent to the banking organization’s tier 1 minority interest, subject to the limitations outlined above, less any common equity tier 1 minority interest included in the banking organization’s E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62054 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations common equity tier 1 capital. Likewise, the amount of total capital minority interest that could have been included in the tier 2 capital of the banking organization was equivalent to its total capital minority interest, subject to the limitations outlined above, less any tier 1 minority interest that is included in the banking organization’s tier 1 capital. Under the proposal, minority interest related to qualifying common or noncumulative perpetual preferred stock directly issued by a consolidated U.S. depository institution or foreign bank subsidiary, which is eligible for inclusion in tier 1 capital under the general risk-based capital rules without limitation, generally would qualify for inclusion in common equity tier 1 and additional tier 1 capital, respectively, subject to the proposed limits. However, under the proposal, minority interest related to qualifying cumulative perpetual preferred stock directly issued by a consolidated U.S. depository institution or foreign bank subsidiary, which is eligible for limited inclusion in tier 1 capital under the general riskbased capital rules, generally would not have qualified for inclusion in additional tier 1 capital under the proposal. A number of commenters addressed the proposed limits on the inclusion of minority interest in regulatory capital. Commenters generally asserted that the proposed methodology for calculating the amount of minority interest that could be included in regulatory capital was overly complex, overly conservative, and would reduce incentives for bank subsidiaries to issue capital to third-party investors. Several commenters suggested that the agencies and the FDIC should adopt a more straightforward and simple approach that would provide a single blanket limitation on the amount of minority interest includable in regulatory capital. For example, one commenter suggested allowing a banking organization to include minority interest equal to 18 percent of common equity tier 1 capital. Another commenter suggested that minority interest where shareholders have commitments to provide additional capital, as well as minority interest in joint ventures where there are guarantees or other credit enhancements, should not be subject to the proposed limitations. Commenters also objected to any limitations on the amount of minority interest included in the regulatory capital of a parent banking organization attributable to instruments issued by a subsidiary when the subsidiary is a depository institution. These commenters stated that restricting such VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 minority interest could create a disincentive for depository institutions to issue capital instruments directly or to maintain capital at levels substantially above regulatory minimums. To address this concern, commenters asked the agencies and the FDIC to consider allowing a depository institution subsidiary to consider a portion of its capital above its minimum as not being part of its ‘‘surplus’’ capital for the purpose of calculating the minority interest limitation. Alternatively, some commenters suggested allowing depository institution subsidiaries to calculate surplus capital independently for each component of capital. Several commenters also addressed the proposed minority interest limitation as it would apply to subordinated debt issued by a depository institution. Generally, these commenters stated that the proposed minority interest limitation either should not apply to such subordinated debt, or that the limitation should be more flexible to permit a greater amount to be included in the total capital of the consolidated organization. Commenters also suggested that the agencies and the FDIC create an exception to the limitation for bank holding companies with only a single subsidiary that is a depository institution. These commenters indicated that the limitation should not apply in such a situation because a BHC that conducts all business through a single bank subsidiary is not exposed to losses outside of the activities of the subsidiary. Finally, some commenters pointed out that the application of the proposed calculation for the minority interest limitation was unclear in circumstances where a subsidiary depository institution does not have ‘‘surplus’’ capital. With respect to this comment, the agencies have revised the proposed rule to specifically provide that the minority interest limitation will not apply in circumstances where a subsidiary’s capital ratios are equal to or below the level of capital necessary to meet the minimum capital requirements plus the capital conservation buffer. That is, in the final rule the minority interest limitation would apply only where a subsidiary has ‘‘surplus’’ capital. The agencies continue to believe that the proposed limitations on minority interest are appropriate, including for capital instruments issued by depository institution subsidiaries, tier 2 capital instruments, and situations in which a depository institution holding company conducts the majority of its business PO 00000 Frm 00038 Fmt 4701 Sfmt 4700 through a single depository institution subsidiary. As noted above, the agencies’ experience during the recent financial crisis showed that while minority interest generally is available to absorb losses at the subsidiary level, it may not always absorb losses at the consolidated level. Therefore, the agencies continue to believe limitations on including minority interest will prevent highly-capitalized subsidiaries from overstating the amount of capital available to absorb losses at the consolidated organization. The increased safety and soundness benefits resulting from these limitations should outweigh any compliance burden issues related to the complexity of the calculations. Therefore, the agencies are adopting the proposed treatment of minority interest without change, except for the clarification described above. 9. Real Estate Investment Trust Preferred Capital A real estate investment trust (REIT) is a company that is required to invest in real estate and real estate-related assets and make certain distributions in order to maintain a tax-advantaged status. Some banking organizations have consolidated subsidiaries that are REITs, and such REITs may have issued capital instruments included in the regulatory capital of the consolidated banking organization as minority interest under the general risk-based capital rules. Under the general risk-based capital rules, preferred stock issued by a REIT subsidiary generally can be included in a banking organization’s tier 1 capital as minority interest if the preferred stock meets the eligibility requirements for tier 1 capital.86 The agencies and the FDIC interpreted this to require that the REIT-preferred stock be exchangeable automatically into noncumulative perpetual preferred stock of the banking organization under certain circumstances. Specifically, the primary Federal supervisor may direct the banking organization in writing to convert the REIT preferred stock into noncumulative perpetual preferred stock of the banking organization because the banking organization: (1) Became undercapitalized under the PCA regulations; 87 (2) was placed into conservatorship or receivership; or (3) 86 12 CFR part 325, subpart B (FDIC); 12 CFR part 3, appendix A, Sec. 2(a)(3) (OCC); see also Comptroller’s Licensing Manual, Capital and Dividends, p. 14 (Nov. 2007). 87 12 CFR part 3, appendix A, section 2(a)(3) (national banks) and 12 CFR 167.5(a)(1)(iii) (Federal savings associations) (OCC); 12 CFR part 208, subpart D (Board); 12 CFR part 325, subpart B, 12 CFR part 390, subpart Y (FDIC). E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 was expected to become undercapitalized in the near term.88 Under the proposed rule, the limitations described previously on the inclusion of minority interest in regulatory capital would have applied to capital instruments issued by consolidated REIT subsidiaries. Specifically, preferred stock issued by a REIT subsidiary that met the proposed definition of an operating entity (as defined below) would have qualified for inclusion in the regulatory capital of a banking organization subject to the limitations outlined in section 21 of the proposed rule only if the REIT preferred stock met the criteria for additional tier 1 or tier 2 capital instruments outlined in section 20 of the proposed rules. Because a REIT must distribute 90 percent of its earnings to maintain its tax-advantaged status, a banking organization might be reluctant to cancel dividends on the REIT preferred stock. However, for a capital instrument to qualify as additional tier 1 capital the issuer must have the ability to cancel dividends. In cases where a REIT could maintain its tax status, for example, by declaring a consent dividend and it has the ability to do so, the agencies generally would consider REIT preferred stock to satisfy criterion (7) of the proposed eligibility criteria for additional tier 1 capital instruments.89 The agencies note that the ability to declare a consent dividend need not be included in the documentation of the REIT preferred instrument, but the banking organization must provide evidence to the relevant banking agency that it has such an ability. The agencies do not expect preferred stock issued by a REIT that does not have the ability to declare a consent dividend or otherwise cancel cash dividends to qualify as tier 1 minority interest under the final rule; however, such an instrument could qualify as total capital minority interest if it meets all of the relevant tier 2 88 See OCC Corporate Decision No. 97–109 (December 1997) available at https://www.occ.gov/ static/interpretations-and-precedents/dec97/cd97109.pdf and the Comptroller’s Licensing Manual, Capital and Dividends available at https:// www.occ.gov/static/publications/capital3.pdf; (national banks) and OTS Examination Handbook, Section 120, appendix A, (page A7) (September 2010), available at https://www.occ.gov/static/newsissuances/ots/exam-handbook/ots-exam-handbook120aa.pdf (Federal savings associations) (OCC); 12 CFR parts 208 and 225, appendix A (Board); 12 CFR part 325, subpart B (state nonmember banks), and 12 CFR part 390, subpart Y (state savings associations). 89 A consent dividend is a dividend that is not actually paid to the shareholders, but is kept as part of a company’s retained earnings, yet the shareholders have consented to treat the dividend as if paid in cash and include it in gross income for tax purposes. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 capital eligibility criteria under the final rule. Commenters requested clarification on whether a REIT subsidiary would be considered an operating entity for the purpose of the final rule. For minority interest issued from a subsidiary to be included in regulatory capital, the subsidiary must be either an operating entity or an entity whose only asset is its investment in the capital of the parent banking organization and for which proceeds are immediately available without limitation to the banking organization. Since a REIT has assets that are not an investment in the capital of the parent banking organization, minority interest in a REIT subsidiary can be included in the regulatory capital of the consolidated parent banking organization only if the REIT is an operating entity. For purposes of the final rule, an operating entity is defined as a company established to conduct business with clients with the intention of earning a profit in its own right. However, certain REIT subsidiaries currently used by banking organizations to raise regulatory capital are not actively managed for the purpose of earning a profit in their own right, and therefore, will not qualify as operating entities for the purpose of the final rule. Minority interest investments in REIT subsidiaries that are actively managed for purposes of earning a profit in their own right will be eligible for inclusion in the regulatory capital of the banking organization subject to the limits described in section 21 of the final rule. To the extent that a banking organization is unsure whether minority interest investments in a particular REIT subsidiary will be includable in the banking organization’s regulatory capital, the organization should discuss the concern with its primary Federal supervisor prior to including any amount of the minority interest in its regulatory capital. Several commenters objected to the application of the limitations on the inclusion of minority interest resulting from noncumulative perpetual preferred stock issued by REIT subsidiaries. Commenters noted that to be included in the regulatory capital of the consolidated parent banking organization under the general riskbased capital rules, REIT preferred stock must include an exchange feature that allows the REIT preferred stock to absorb losses at the parent banking organization through the exchange of REIT preferred instruments into noncumulative perpetual preferred stock of the parent banking organization. Because of this exchange feature, the commenters stated that REIT PO 00000 Frm 00039 Fmt 4701 Sfmt 4700 62055 preferred instruments should be included in the tier 1 capital of the parent consolidated organization without limitation. Alternatively, some commenters suggested that the agencies and the FDIC should allow REIT preferred instruments to be included in the tier 2 capital of the consolidated parent organization without limitation. Commenters also noted that in light of the eventual phase-out of TruPS pursuant to the Dodd-Frank Act, REIT preferred stock would be the only taxadvantaged means for bank holding companies to raise tier 1 capital. According to these commenters, limiting this tax-advantaged option would increase the cost of doing business for many banking organizations. After considering these comments, the agencies have decided not to create specific exemptions to the limitations on the inclusion of minority interest with respect to REIT preferred instruments. As noted above, the agencies believe that the inclusion of minority interest in regulatory capital at the consolidated level should be limited to prevent highly-capitalized subsidiaries from overstating the amount of capital available to absorb losses at the consolidated organization. B. Regulatory Adjustments and Deductions 1. Regulatory Deductions From Common Equity Tier 1 Capital Under the proposal, a banking organization must deduct from common equity tier 1 capital elements the items described in section 22 of the proposed rule. A banking organization would exclude the amount of these deductions from its total risk-weighted assets and leverage exposure. This section B discusses the deductions from regulatory capital elements as revised for purposes of the final rule. a. Goodwill and Other Intangibles (Other Than Mortgage Servicing Assets) U.S. federal banking statutes generally prohibit the inclusion of goodwill (as it is an ‘‘unidentified intangible asset’’) in the regulatory capital of insured depository institutions.90 Accordingly, goodwill and other intangible assets have long been either fully or partially excluded from regulatory capital in the United States because of the high level of uncertainty regarding the ability of the banking organization to realize value from these assets, especially under 90 12 E:\FR\FM\11OCR2.SGM U.S.C. 1828(n). 11OCR2 62056 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 adverse financial conditions.91 Under the proposed rule, a banking organization was required to deduct from common equity tier 1 capital elements goodwill and other intangible assets other than MSAs 92 net of associated deferred tax liabilities (DTLs). For purposes of this deduction, goodwill would have included any goodwill embedded in the valuation of significant investments in the capital of an unconsolidated financial institution in the form of common stock. This deduction of embedded goodwill would have applied to investments accounted for under the equity method.93 Consistent with Basel III, these items would have been deducted from common equity tier 1 capital elements. MSAs would have been subject to a different treatment under Basel III and the proposal, as explained below in this section. One commenter sought clarification regarding the amount of goodwill that must be deducted from common equity tier 1 capital elements when a banking organization has an investment in the capital of an unconsolidated financial institution that is accounted for under the equity method of accounting under GAAP. The agencies have revised section 22(a)(1) in the final rule to clarify that it is the amount of goodwill that is embedded in the valuation of a significant investment in the capital of an unconsolidated financial institution in the form of common stock that is accounted for under the equity method, and reflected in the consolidated financial statements of the banking organization that a banking organization must deduct from common equity tier 1 capital elements. Another commenter requested clarification regarding the amount of embedded goodwill that a banking organization would be required to deduct where there are impairments to the embedded goodwill subsequent to the initial investment. The agencies note that, for purposes of the final rule, a banking organization must deduct from common equity tier 1 capital elements any embedded goodwill in the valuation of significant investments in the capital of an unconsolidated financial institution in the form of common stock 91 See 54 FR 4186, 4196 (January 27, 1989) (Board); 54 FR 4168, 4175 (January 27, 1989) (OCC); 54 FR 11500, 11509 (March 21, 1989) (FDIC). 92 Examples of other intangible assets include purchased credit card relationships (PCCRs) and non-mortgage servicing assets. 93 Under GAAP, if there is a difference between the initial cost basis of the investment and the amount of underlying equity in the net assets of the investee, the resulting difference should be accounted for as if the investee were a consolidated subsidiary (which may include imputed goodwill). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 net of any related impairments (subsequent to the initial investment) as determined under GAAP, not the goodwill reported on the balance sheet of the unconsolidated financial institution. The proposal did not include a transition period for the implementation of the requirement to deduct goodwill from common equity tier 1 capital. A number of commenters expressed concern that this could disadvantage U.S. banking organizations relative to those in jurisdictions that permit such a transition period. The agencies note that section 221 of FIRREA (12 U.S.C. 1828(n)) requires all unidentifiable intangible assets (goodwill) acquired after April 12, 1989, to be deducted from a banking organization’s capital elements. The only exception to this requirement, permitted under 12 U.S.C. 1464(t) (applicable to Federal savings association), has expired. Therefore, consistent with the requirements of section 221 of FIRREA and the general risk-based capital rules, the agencies believe that it is not appropriate to permit any goodwill to be included in a banking organization’s capital. The final rule does not include a transition period for the deduction of goodwill. b. Gain-on-Sale Associated With a Securitization Exposure Under the proposal, a banking organization would deduct from common equity tier 1 capital elements any after-tax gain-on-sale associated with a securitization exposure. Under the proposal, gain-on-sale was defined as an increase in the equity capital of a banking organization resulting from a securitization (other than an increase in equity capital resulting from the banking organization’s receipt of cash in connection with the securitization). A number of commenters requested clarification that the proposed deduction for gain-on-sale would not require a double deduction for MSAs. According to the commenters, a sale of loans to a securitization structure that creates a gain may include an MSA that also meets the proposed definition of ‘‘gain-on-sale.’’ The agencies agree that a double deduction for MSAs is not required, and the final rule clarifies in the definition of ‘‘gain-on-sale’’ that a gain-on-sale excludes any portion of the gain that was reported by the banking organization as an MSA. The agencies also note that the definition of gain-onsale was intended to relate only to gains associated with the sale of loans for the purpose of traditional securitization. Thus, the definition of gain-on-sale has been revised in the final rule to mean an increase in common equity tier 1 capital PO 00000 Frm 00040 Fmt 4701 Sfmt 4700 of the banking organization resulting from a traditional securitization except where such an increase results from the banking organization’s receipt of cash in connection with the securitization or initial recognition of an MSA. c. Defined Benefit Pension Fund Net Assets For banking organizations other than insured depository institutions, the proposal required the deduction of a net pension fund asset in calculating common equity tier 1 capital. A banking organization was permitted to make such deduction net of any associated DTLs. This deduction would be required where a defined benefit pension fund is over-funded due to the high level of uncertainty regarding the ability of the banking organization to realize value from such assets. The proposal did not require a BHC or SLHC to deduct the net pension fund asset of its insured depository institution subsidiary. The proposal provided that, with supervisory approval, a banking organization would not have been required to deduct defined benefit pension fund assets to which the banking organization had unrestricted and unfettered access.94 In this case, the proposal established that the banking organization would have assigned to such assets the risk weight they would receive if the assets underlying the plan were directly owned and included on the balance sheet of the banking organization. The proposal set forth that unrestricted and unfettered access would mean that a banking organization would not have been required to request and receive specific approval from pension beneficiaries each time it accessed excess funds in the plan. One commenter asked whether shares of a banking organization that are owned by the banking organization’s pension fund are subject to deduction. The agencies note that the final rule does not require deduction of banking organization shares owned by the pension fund. Another commenter asked for clarification regarding the treatment of an overfunded pension asset at an insured depository institution if the pension plan sponsor is the parent BHC. The agencies clarify that the requirement to deduct a defined benefit pension plan net asset is not dependent upon the sponsor of the plan; rather it is dependent upon whether the 94 The FDIC has unfettered access to the pension fund assets of an insured depository institution’s pension plan in the event of receivership; therefore, the agencies determined that an insured depository institution would not be required to deduct a net pension fund asset. E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 net pension fund asset is an asset of an insured depository institution. The agencies and the FDIC also received questions regarding the appropriate riskweight treatment for a pension fund asset. As discussed above, with the prior agency approval, a banking organization that is not an insured depository institution may elect to not deduct any defined benefit pension fund net asset to the extent such banking organization has unrestricted and unfettered access to the assets in that defined benefit pension fund. Any portion of the defined benefit pension fund net asset that is not deducted by the banking organization must be risk-weighted as if the banking organization directly holds a proportional ownership share of each exposure in the defined benefit pension fund. For example, if the banking organization has a defined benefit pension fund net asset of $10 and it has unfettered and unrestricted access to the assets of defined benefit pension fund, and assuming 20 percent of the defined benefit pension fund is composed of assets that are risk-weighted at 100 percent and 80 percent is composed of assets that are risk-weighted at 300 percent, the banking organization would risk weight $2 at 100 percent and $8 at 300 percent. This treatment is consistent with the full look-through approach described in section 53(b) of the final rule. If the defined benefit pension fund invests in the capital of a financial institution, including an investment in the banking organization’s own capital instruments, the banking organization would risk weight the proportional share of such exposure in accordance with the treatment under subparts D or E, as appropriate. The agencies are adopting as final this section of the proposal with the changes described above. d. Expected Credit Loss That Exceeds Eligible Credit Reserves The proposal required an advanced approaches banking organization to deduct from common equity tier 1 capital elements the amount of expected credit loss that exceeds the banking organization’s eligible credit reserves. Commenters sought clarification that the proposed deduction would not apply for advanced approaches banking organizations that have not received the approval of their primary Federal supervisor to exit parallel run. The agencies agree that the deduction would not apply to banking organizations that have not received approval from their primary Federal supervisor to exit parallel run. In response, the agencies have revised this provision of the final rule to apply to a banking organization VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 subject to subpart E of the final rule that has completed the parallel run process and that has received notification from its primary Federal supervisor under section 121(d) of the advanced approaches rule. e. Equity Investments in Financial Subsidiaries Section 121 of the Gramm-LeachBliley Act allows national banks and insured state banks to establish entities known as financial subsidiaries.95 One of the statutory requirements for establishing a financial subsidiary is that a national bank or insured state bank must deduct any investment in a financial subsidiary from the depository institution’s assets and tangible equity.96 The agencies implemented this statutory requirement through regulation at 12 CFR 5.39(h)(1) (OCC) and 12 CFR 208.73 (Board). Under section 22(a)(7) of the proposal, investments by a national bank or insured state bank in financial subsidiaries would be deducted entirely from the bank’s common equity tier 1 capital.97 Because common equity tier 1 capital is a component of tangible equity, the proposed deduction from common equity tier 1 would have automatically resulted in a deduction from tangible equity. The agencies believe that the more conservative treatment is appropriate for financial subsidiaries given the risks associated with nonbanking activities, and are adopting this treatment as proposed. Therefore, under the final rule, a depository institution must deduct the aggregate amount of its outstanding equity investment in a financial subsidiary, including the retained earnings of a subsidiary from common equity tier 1 capital elements, and the assets and liabilities of the subsidiary may not be consolidated with those of the parent bank. f. Deduction for Subsidiaries of Savings Associations That Engage in Activities That Are Not Permissible for National Banks Section 5(t)(5) 98 of HOLA requires a separate capital calculation for Federal savings associations for ‘‘investments in and extensions of credit to any subsidiary engaged in activities not permissible for a national bank.’’ This statutory provision was implemented in the Federal savings associations’ capital 95 Public Law 106–102, 113 Stat. 1338, 1373 (Nov. 12, 1999). 96 12 U.S.C. 24a(c); 12 U.S.C. 1831w(a)(2). 97 The deduction provided for in the agencies’ existing regulations would be removed and would exist solely in the final rule. 98 12 U.S.C. 1464(t)(5). PO 00000 Frm 00041 Fmt 4701 Sfmt 4700 62057 rules through a deduction from the core (tier 1) capital of the Federal savings association for those subsidiaries that are not ‘‘includable subsidiaries.’’ 99 The OCC proposed to continue the general risk-based capital treatment of includable subsidiaries, with some technical modifications. Aside from those technical modifications, the proposal would have transferred, without substantive change, the current general regulatory treatment of deducting subsidiary investments where a subsidiary is engaged in activities not permissible for a national bank. Such treatment is consistent with how a national bank deducts its equity investments in financial subsidiaries. The FDIC proposed an identical treatment for state savings associations.100 The OCC received no comments on this proposed deduction. The final rule adopts the proposal with one change and other minor technical edits, consistent with 12 U.S.C. 1464(t)(5), to clarify that the required deduction for a Federal savings association’s investment in a subsidiary that is engaged in activities not permissible for a national bank includes extensions of credit to such a subsidiary. 2. Regulatory Adjustments to Common Equity Tier 1 Capital a. Accumulated Net Gains and Losses on Certain Cash-Flow Hedges Consistent with Basel III, under the proposal, a banking organization would have been required to exclude from regulatory capital any accumulated net gains and losses on cash-flow hedges relating to items that are not recognized at fair value on the balance sheet. This proposed regulatory adjustment was intended to reduce the artificial volatility that can arise in a situation in which the accumulated net gain or loss of the cash-flow hedge is included in regulatory capital but any change in the fair value of the hedged item is not. The agencies and the FDIC received a number of comments on this proposed regulatory capital adjustment. In general, the commenters noted that while the intent of the adjustment is to remove an element that gives rise to artificial volatility in common equity, the proposed adjustment may actually increase volatility in the measure of common equity tier 1 capital. These commenters indicated that the proposed adjustment, together with the proposed treatment of net unrealized gains and losses on AFS debt securities, would create incentives for banking 99 See 100 12 E:\FR\FM\11OCR2.SGM 12 CFR 167.1; 12 CFR 167.5(a)(2)(iv). CFR 324.22. 11OCR2 62058 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 organizations to avoid hedges that reduce interest rate risk; shorten maturity of their investments in AFS securities; or move their investment securities portfolio from AFS to HTM. To address these concerns, commenters suggested several alternatives, such as including all accumulated net gains and losses on cash-flow hedges in common equity tier 1 capital to match the proposal to include in common equity tier 1 capital net unrealized gains and losses on AFS debt securities; retaining the provisions in the agencies’ and the FDIC’s general risk-based capital rules that exclude most elements of AOCI from regulatory capital; or using a principles-based approach to accommodate variations in the interest rate management techniques employed by each banking organization. Under the final rule, the agencies have retained the requirement that all banking organizations subject to the advanced approaches rule, and those banking organizations that elect to include AOCI in common equity tier 1 capital, must subtract from common equity tier 1 capital elements any accumulated net gains and must add any accumulated net losses on cashflow hedges included in AOCI that relate to the hedging of items that are not recognized at fair value on the balance sheet. The agencies believe that this adjustment removes an element that gives rise to artificial volatility in common equity tier 1 capital as it would avoid a situation in which the changes in the fair value of the cash-flow hedge are reflected in capital but the changes in the fair value of the hedged item are not. b. Changes in a Banking Organization’s Own Credit Risk The proposal provided that a banking organization would not be permitted to include in regulatory capital any change in the fair value of a liability attributable to changes in the banking organization’s own credit risk. In addition, the proposal would have required advanced approaches banking organizations to deduct the credit spread premium over the risk-free rate for derivatives that are liabilities. Consistent with Basel III, these provisions were intended to prevent a banking organization from recognizing increases in regulatory capital resulting from any change in the fair value of a liability attributable to changes in the banking organization’s own creditworthiness. Under the final rule, all banking organizations not subject to the advanced approaches rule must deduct any cumulative gain from and add back to common equity tier 1 capital elements any cumulative loss VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 attributed to changes in the value of a liability measured at fair value arising from changes in the banking organization’s own credit risk. This requirement would apply to all liabilities that a banking organization must measure at fair value under GAAP, such as derivative liabilities, or for which the banking organization elects to measure at fair value under the fair value option.101 Similarly, advanced approaches banking organizations must deduct any cumulative gain from and add back any cumulative loss to common equity tier 1 capital elements attributable to changes in the value of a liability that the banking organization elects to measure at fair value under GAAP. For derivative liabilities, advanced approaches banking organizations must implement this requirement by deducting the credit spread premium over the risk-free rate. c. Accumulated Other Comprehensive Income Under the agencies’ general risk-based capital rules, most of the components of AOCI included in a company’s GAAP equity are not included in a banking organization’s regulatory capital. Under GAAP, AOCI includes unrealized gains and losses on certain assets and liabilities that are not included in net income. Among other items, AOCI includes unrealized gains and losses on AFS securities; other than temporary impairment on securities reported as HTM that are not credit-related; cumulative gains and losses on cashflow hedges; foreign currency translation adjustments; and amounts attributed to defined benefit postretirement plans resulting from the initial and subsequent application of the relevant GAAP standards that pertain to such plans Under the agencies’ general risk-based capital rules, banking organizations do not include most amounts reported in AOCI in their regulatory capital calculations. Instead, they exclude these amounts by subtracting unrealized or accumulated net gains from, and adding back unrealized or accumulated net losses to, equity capital. The only amounts of AOCI included in regulatory capital are unrealized losses on AFS equity securities and foreign currency translation adjustments, which are included in tier 1 capital. Additionally, banking organizations may include up to 45 percent of unrealized gains on AFS equity securities in their tier 2 capital. 101 825–10–25 (former Financial Accounting Standards Board Statement No. 159). PO 00000 Frm 00042 Fmt 4701 Sfmt 4700 In contrast, consistent with Basel III, the proposed rule required banking organizations to include all AOCI components in common equity tier 1 capital elements, except gains and losses on cash-flow hedges where the hedged item is not recognized on a banking organization’s balance sheet at fair value. Unrealized gains and losses on all AFS securities would flow through to common equity tier 1 capital elements, including unrealized gains and losses on debt securities due to changes in valuations that result primarily from fluctuations in benchmark interest rates (for example, U.S. Treasuries and U.S. government agency debt obligations), as opposed to changes in credit risk. In the Basel III NPR, the agencies and the FDIC indicated that the proposed regulatory capital treatment of AOCI would better reflect an institution’s actual risk. In particular, the agencies and the FDIC stated that while unrealized gains and losses on AFS debt securities might be temporary in nature and reverse over a longer time horizon (especially when those gains and losses are primarily attributable to changes in benchmark interest rates), unrealized losses could materially affect a banking organization’s capital position at a particular point in time and associated risks should therefore be reflected in its capital ratios. In addition, the agencies and the FDIC observed that the proposed treatment would be consistent with the common market practice of evaluating a firm’s capital strength by measuring its tangible common equity, which generally includes AOCI. However, the agencies and the FDIC also acknowledged that including unrealized gains and losses related to debt securities (especially those whose valuations primarily change as a result of fluctuations in a benchmark interest rate) could introduce substantial volatility in a banking organization’s regulatory capital ratios. Specifically, the agencies and the FDIC observed that for some banking organizations, including unrealized losses on AFS debt securities in their regulatory capital calculations could mean that fluctuations in a benchmark interest rate could lead to changes in their PCA categories from quarter to quarter. Recognizing the potential impact of such fluctuations on regulatory capital management for some institutions, the agencies and the FDIC described possible alternatives to the proposed treatment of unrealized gains and losses on AFS debt securities, including an approach that would exclude from regulatory capital calculations those unrealized gains and losses that are E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations related to AFS debt securities whose valuations primarily change as a result of fluctuations in benchmark interest rates, including U.S. government and agency debt obligations, GSE debt obligations, and other sovereign debt obligations that would qualify for a zero percent risk weight under the standardized approach. A large proportion of commenters addressed the proposed treatment of AOCI in regulatory capital. Banking organizations of all sizes, banking and other industry groups, public officials (including members of the U.S. Congress), and other individuals strongly opposed the proposal to include most AOCI components in common equity tier 1 capital. Specifically, commenters asserted that the agencies and the FDIC should not implement the proposal and should instead continue to apply the existing treatment for AOCI that excludes most AOCI amounts from regulatory capital. Several commenters stated that the accounting standards that require banking organizations to take a charge against earnings (and thus reduce capital levels) to reflect credit-related losses as part of other-than-temporary impairments already achieve the agencies’ and the FDIC’s goal to create regulatory capital ratios that provide an accurate picture of a banking organization’s capital position, without also including AOCI in regulatory capital. For unrealized gains and losses on AFS debt securities that typically result from changes in benchmark interest rates rather than changes in credit risk, most commenters expressed concerns that the value of such securities on any particular day might not be a good indicator of the value of those securities for a banking organization, given that the banking organization could hold them until they mature and realize the amount due in full. Most commenters argued that the inclusion of unrealized gains and losses on AFS debt securities in regulatory capital could result in volatile capital levels and adversely affect other measures tied to regulatory capital, such as legal lending limits, especially if and when interest rates rise from their current historically-low levels. Accordingly, several commenters requested that the agencies and the FDIC permit banking organizations to remove from regulatory capital calculations unrealized gains and losses on AFS debt securities that have low credit risk but experience price movements based primarily on fluctuations in benchmark interest rates. According to commenters, these debt securities would include securities VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 issued by the United States and other stable sovereign entities, U.S. agencies and GSEs, as well as some municipal entities. One commenter expressed concern that the proposed treatment of AOCI would lead banking organizations to invest excessively in securities with low volatility. Some commenters also suggested that unrealized gains and losses on high-quality asset-backed securities and high-quality corporate securities should be excluded from regulatory capital calculations. The commenters argued that these adjustments to the proposal would allow regulatory capital to reflect unrealized gains or losses related to the credit quality of a banking organization’s AFS debt securities. Additionally, commenters noted that, under the proposal, offsetting changes in the value of other items on a banking organization’s balance sheet would not be recognized for regulatory capital purposes when interest rates change. For example, the commenters observed that banking organizations often hold AFS debt securities to hedge interest rate risk associated with deposit liabilities, which are not marked to fair value on the balance sheet. Therefore, requiring banking organizations to include AOCI in regulatory capital would mean that interest rate fluctuations would be reflected in regulatory capital only for one aspect of this hedging strategy, with the result that the proposed treatment could greatly overstate the economic impact that interest rate changes have on the safety and soundness of the banking organization. Several commenters used sample AFS securities portfolio data to illustrate how an upward shift in interest rates could have a substantial impact on a banking organization’s capital levels (depending on the composition of its AFS portfolio and its defined benefit postretirement obligations). According to these commenters, the potential negative impact on capital levels that could follow a substantial increase in interest rates would place significant strains on banking organizations. To address the potential impact of incorporating the volatility associated with AOCI into regulatory capital, banking organizations also noted that they could increase their overall capital levels to create a buffer above regulatory minimums, hedge or reduce the maturities of their AFS debt securities, or shift more debt securities into their HTM portfolio. However, commenters asserted that these strategies would be complicated and costly, especially for smaller banking organizations, and could lead to a significant decrease in PO 00000 Frm 00043 Fmt 4701 Sfmt 4700 62059 lending activity. Many community banking organization commenters observed that hedging or raising additional capital may be especially difficult for banking organizations with limited access to capital markets, while shifting more debt securities into the HTM portfolio would impair active management of interest rate risk positions and negatively impact a banking organization’s liquidity position. These commenters also expressed concern that this could be especially problematic given the increased attention to liquidity by banking regulators and industry analysts. A number of commenters indicated that in light of the potential impact of the proposed treatment of AOCI on a banking organization’s liquidity position, the agencies and the FDIC should, at the very least, postpone implementing this aspect of the proposal until after implementation of the BCBS’s revised liquidity standards. Commenters suggested that postponing the implementation of the AOCI treatment would help to ensure that the final capital rules do not create disincentives for a banking organization to increase its holdings of high-quality liquid assets. In addition, several commenters suggested that the agencies and the FDIC not require banking organizations to include in regulatory capital unrealized gains and losses on assets that would qualify as ‘‘high quality liquid assets’’ under the BCBS’s ‘‘liquidity coverage ratio’’ under the Basel III liquidity framework. Finally, several commenters addressed the inclusion in AOCI of actuarial gains and losses on defined benefit pension fund obligations. Commenters stated that many banking organizations, particularly mutual banking organizations, offer defined benefit pension plans to attract employees because they are unable to offer stock options to employees. These commenters noted that actuarial gains and losses on defined benefit obligations represent the difference between benefit assumptions and, among other things, actual investment experiences during a given year, which is influenced predominantly by the discount rate assumptions used to determine the value of the plan obligation. The discount rate is tied to prevailing long-term interest rates at a point in time each year, and while market returns on the underlying assets of the plan and the discount rates may fluctuate year to year, the underlying liabilities typically are longer term—in some cases 15 to 20 years. Therefore, changing interest rate environments E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62060 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations could lead to material fluctuations in the value of a banking organization’s defined benefit post-retirement fund assets and liabilities, which in turn could create material swings in a banking organization’s regulatory capital that would not be tied to changes in the credit quality of the underlying assets. Commenters stated that the added volatility in regulatory capital could lead some banking organizations to reconsider offering defined benefit pension plans. The agencies have considered the comments on the proposal to incorporate most elements of AOCI in regulatory capital, and have taken into account the potential effects that the proposed AOCI treatment could have on banking organizations and their function in the economy. As discussed in the proposal, the agencies believe that the proposed AOCI treatment results in a regulatory capital measure that better reflects banking organizations’ actual risk at a specific point in time. The agencies also believe that AOCI is an important indicator that market observers use to evaluate the capital strength of a banking organization. However, the agencies recognize that for many banking organizations, the volatility in regulatory capital that could result from the proposal could lead to significant difficulties in capital planning and asset-liability management. The agencies also recognize that the tools used by advanced approaches banking organizations and other larger, more complex banking organizations for managing interest rate risk are not necessarily readily available to all banking organizations. Therefore, in the final rule, the agencies have decided to permit those banking organizations that are not subject to the advanced approaches riskbased capital rules to elect to calculate regulatory capital by using the treatment for AOCI in the agencies’ general riskbased capital rules, which excludes most AOCI amounts. Such banking organizations, may make a one-time, permanent election 102 to effectively continue using the AOCI treatment under the general risk-based capital rules for their regulatory calculations (‘‘AOCI opt-out election’’) when filing the Call Report or FR Y–9 series report for the first reporting period after the 102 This one-time, opt-out selection does not cover a merger, acquisition or purchase transaction involving all or substantially all of the assets or voting stock between two banking organizations of which only one made an AOCI opt-out election. The resulting organization may make an AOCI election with prior agency approval. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 date upon which they become subject to the final rule. Pursuant to a separate notice under the Paperwork Reduction Act, the agencies intend to propose revisions to the Call Report and FR Y–9 series report to implement changes in reporting items that would correspond to the final rule. These revisions will include a line item for banking organizations to indicate their AOCI opt-out election in their first regulatory report filed after the date the banking organization becomes subject to the final rule. Information regarding the AOCI opt-out election will be made available to the public and will be reflected on an ongoing basis in publicly-available regulatory reports. A banking organization that does not make an AOCI opt-out election on the Call Report or FR Y–9 series report filed for the first reporting period after the effective date of the final rule must include all AOCI components, except accumulated net gains and losses on cash-flow hedges related to items that are not recognized at fair value on the balance sheet, in regulatory capital elements starting the first quarter in which the banking organization calculates its regulatory capital requirements under the final rule. Consistent with regulatory capital calculations under the agencies’ general risk-based capital rules, a banking organization that makes an AOCI optout election under the final rule must adjust common equity tier 1 capital elements by: (1) Subtracting any net unrealized gains and adding any net unrealized losses on AFS securities; (2) subtracting any net unrealized losses on AFS preferred stock classified as an equity security under GAAP and AFS equity exposures; (3) subtracting any accumulated net gains and adding back any accumulated net losses on cashflow hedges included in AOCI; (4) subtracting amounts attributed to defined benefit postretirement plans resulting from the initial and subsequent application of the relevant GAAP standards that pertain to such plans (excluding, at the banking organization’s option, the portion relating to pension assets deducted under section 22(a)(5)); and (5) subtracting any net unrealized gains and adding any net unrealized losses on held-to-maturity securities that are included in AOCI. In addition, consistent with the general risk-based capital rules, the banking organization must incorporate into common equity tier 1 capital any foreign currency translation adjustment. A banking organization may also incorporate up to 45 percent of any net unrealized gains on AFS preferred stock classified as an PO 00000 Frm 00044 Fmt 4701 Sfmt 4700 equity security under GAAP and AFS equity exposures into its tier 2 capital elements. However, the primary Federal supervisor may exclude all or a portion of these unrealized gains from a banking organization’s tier 2 capital under the reservation of authority provision of the final rule if the primary Federal supervisor determines that such preferred stock or equity exposures are not prudently valued. The agencies believe that banking organizations that apply the advanced approaches rule or that have opted to use the advanced approaches rule should already have the systems in place necessary to manage the added volatility resulting from the new AOCI treatment. Likewise, pursuant to the Dodd-Frank Act, these large, complex banking organizations are subject to enhanced prudential standards, including stress-testing requirements, and therefore should be prepared to manage their capital levels through the types of stressed economic environments, including environments with shifting interest rates, that could lead to substantial changes in amounts reported in AOCI. Accordingly, under the final rule, advanced approaches banking organizations will be required to incorporate all AOCI components, except accumulated net gains and losses on cash-flow hedges that relate to items that are not measured at fair value on the balance sheet, into their common equity tier 1 capital elements according to the transition provisions set forth in the final rule. The final rule additionally provides that in a merger, acquisition, or purchase transaction between two banking organizations that have each made an AOCI opt-out election, the surviving entity will be required to continue with the AOCI opt-out election, unless the surviving entity is an advanced approaches banking organization. Similarly, in a merger, acquisition, or purchase transaction between two banking organizations that have each not made an AOCI opt-out election, the surviving entity must continue implementing such treatment going forward. If an entity surviving a merger, acquisition, or purchase transaction becomes subject to the advanced approaches rule, it is no longer permitted to make an AOCI optout election and, therefore, must include most elements of AOCI in regulatory capital in accordance with the final rule. However, following a merger, acquisition or purchase transaction involving all or substantially all of the assets or voting stock between two banking organizations of which only E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 one made an AOCI opt-out election (and the surviving entity is not subject to the advanced approaches rule), the surviving entity must decide whether to make an AOCI opt-out election by its first regulatory reporting date following the consummation of the transaction.103 For example, if all of the equity of a banking organization that has made an AOCI opt-out election is acquired by a banking organization that has not made such an election, the surviving entity may make a new AOCI opt-out election in the Call Report or FR Y–9 series report filed for the first reporting period after the effective date of the merger. The final rule also provides the agencies with discretion to allow a new AOCI opt-out election where a merger, acquisition or purchase transaction between two banking organizations that have made different AOCI opt-out elections does not involve all or substantially all of the assets or voting stock of the purchased or acquired banking organization. In making such a determination, the agencies may consider the terms of the merger, acquisition, or purchase transaction, as well as the extent of any changes to the risk profile, complexity, and scope of operations of the banking organization resulting from the merger, acquisition, or purchase transaction. The agencies may also look to the Bank Merger Act 104 for guidance on the types of transactions that would allow the surviving entity to make a new AOCI opt-out election. Finally, a de novo banking organization formed after the effective date of the final rule is required to make a decision to opt out in the first Call Report or FR Y–9 series report it is required to file. The final rule also provides that if a top-tier depository institution holding company makes an AOCI opt-out election, any subsidiary insured depository institution that is consolidated by the depository institution holding company also must make an AOCI opt-out election. The agencies are concerned that if some banking organizations subject to regulatory capital rules under a common parent holding company make an AOCI 103 A merger would involve ‘‘all or substantially all’’ of the assets or voting stock where, for example: (1) A banking organization buys all of the voting stock of a target banking organization, except for the stock of a dissenting, non-controlling minority shareholder; or (2) the banking organization buys all of the assets and major business lines of a target banking organization, but does not purchase a minor business line of the target. Circumstances in which the ‘‘all or substantially all’’ standard likely would not be met would be, for example: (1) A banking organization buys less than 80 percent of another banking organization; or (3) a banking organization buys only three out of four of another banking organization’s major business lines. 104 12 U.S.C. 1828(c). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 opt-out election and others do not, there is a potential for these organizations to engage in capital arbitrage by choosing to book exposures or activities in the legal entity for which the relevant components of AOCI are treated most favorably. Notwithstanding the availability of the AOCI opt-out election under the final rule, the agencies have reserved the authority to require a banking organization to recognize all or some components of AOCI in regulatory capital if an agency determines it would be appropriate given a banking organization’s risks under the agency’s general reservation of authority under the final rule. The agencies will continue to expect each banking organization to maintain capital appropriate for its actual risk profile, regardless of whether it has made an AOCI opt-out election. Therefore, the agencies may determine that a banking organization with a large portfolio of AFS debt securities, or that is otherwise engaged in activities that expose it to high levels of interest-rate or other risks, should raise its common equity tier 1 capital level substantially above the regulatory minimums, regardless of whether that banking organization has made an AOCI opt-out election. d. Investments in Own Regulatory Capital Instruments To avoid the double-counting of regulatory capital, the proposal would have required a banking organization to deduct the amount of its investments in its own capital instruments, including direct and indirect exposures, to the extent such instruments are not already excluded from regulatory capital. Specifically, the proposal would require a banking organization to deduct its investment in its own common equity tier 1, additional tier 1, and tier 2 capital instruments from the sum of its common equity tier 1, additional tier 1, and tier 2 capital, respectively. In addition, under the proposal any common equity tier 1, additional tier 1, or tier 2 capital instrument issued by a banking organization that the banking organization could be contractually obligated to purchase also would have been deducted from common equity tier 1, additional tier 1, or tier 2 capital elements, respectively. The proposal noted that if a banking organization had already deducted its investment in its own capital instruments (for example, treasury stock) from its common equity tier 1 capital, it would not need to make such deductions twice. The proposed rule would have required a banking organization to look through its holdings of an index to PO 00000 Frm 00045 Fmt 4701 Sfmt 4700 62061 deduct investments in its own capital instruments. Gross long positions in investments in its own regulatory capital instruments resulting from holdings of index securities would have been netted against short positions in the same underlying index. Short positions in indexes to hedge long cash or synthetic positions could have been decomposed to recognize the hedge. More specifically, the portion of the index composed of the same underlying exposure that is being hedged could have been used to offset the long position only if both the exposure being hedged and the short position in the index were covered positions under the market risk rule and the hedge was deemed effective by the banking organization’s internal control processes which would have been assessed by the primary Federal supervisor of the banking organization. If the banking organization found it operationally burdensome to estimate the investment amount of an index holding, the proposal permitted the institution to use a conservative estimate with prior approval from its primary Federal supervisor. In all other cases, gross long positions would have been allowed to be deducted net of short positions in the same underlying instrument only if the short positions involved no counterparty risk (for example, the position was fully collateralized or the counterparty is a qualifying central counterparty (QCCP)). As discussed above, under the proposal, a banking organization would be required to look through its holdings of an index security to deduct investments in its own capital instruments. Some commenters asserted that the burden of the proposed lookthrough approach outweighs its benefits because it is not likely a banking organization would re-purchase its own stock through such indirect means. These commenters suggested that the agencies and the FDIC should not require a look-through test for index securities on the grounds that they are not ‘‘covert buybacks,’’ but rather are incidental positions held within a banking organization’s trading book, often entered into on behalf of clients, customers or counterparties, and are economically hedged. However, the agencies believe that it is important to avoid the double-counting of regulatory capital, whether held directly or indirectly. Therefore, the final rule implements the look-through requirements of the proposal without change. In addition, consistent with the treatment for indirect investments in a banking organization’s own capital E:\FR\FM\11OCR2.SGM 11OCR2 62062 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 instruments, the agencies have clarified in the final rule that banking organizations must deduct synthetic exposures related to investments in own capital instruments. e. Definition of Financial Institution Under the proposed rule, a banking organization would have been required to deduct an investment in the capital of an unconsolidated financial institution exceeding certain thresholds, as described below. The proposed definition of financial institution was designed to include entities whose activities and primary business are financial in nature and therefore could contribute to interconnectedness in the financial system. The proposed definition covered entities whose primary business is banking, insurance, investing, and trading, or a combination thereof, and included BHCs, SLHCs, nonbank financial institutions supervised by the Board under Title I of the Dodd-Frank Act, depository institutions, foreign banks, credit unions, insurance companies, securities firms, commodity pools, covered funds for purposes of section 13 of the Bank Holding Company Act and regulations issued thereunder, companies ‘‘predominantly engaged’’ in financial activities, non-U.S.-domiciled entities that would otherwise have been covered by the definition if they were U.S.domiciled, and any other company that the agencies and the FDIC determined was a financial institution based on the nature and scope of its activities. The definition excluded GSEs and firms that were ‘‘predominantly engaged’’ in activities that are financial in nature but focus on community development, public welfare projects, and similar objectives. Under the proposed definition, a company would have been ‘‘predominantly engaged’’ in financial activities if (1) 85 percent or more of the total consolidated annual gross revenues (as determined in accordance with applicable accounting standards) of the company in either of the two most recent calendar years were derived, directly or indirectly, by the company on a consolidated basis from the activities; or (2) 85 percent or more of the company’s consolidated total assets (as determined in accordance with applicable accounting standards) as of the end of either of the two most recent calendar years were related to the activities. The proposed definition of ‘‘financial institution’’ was also relevant for purposes of the Advanced Approaches NPR. Specifically, the proposed rule would have required banking organizations to apply a multiplier of VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 1.25 to the correlation factor for wholesale exposures to unregulated financial institutions that generate a majority of their revenue from financial activities. The proposed rule also would have required advanced approaches banking organizations to apply a multiplier of 1.25 to wholesale exposures to regulated financial institutions with consolidated assets greater than or equal to $100 billion.105 The agencies and the FDIC received a number of comments on the proposed definition of ‘‘financial institution.’’ Commenters expressed concern that the definition of a financial institution was overly broad and stated that it should not include investments in funds, commodity pools, or ERISA plans. Other commenters stated that the ‘‘predominantly engaged’’ test would impose significant operational burdens on banking organizations in determining what companies would be included in the proposed definition of ‘‘financial institution.’’ Commenters suggested that the agencies and the FDIC should risk weight such exposures, rather than subjecting them to a deduction from capital based on the definition of financial institution. Some of the commenters noted that many of the exposures captured by the financial institution definition may be risk-weighted under certain circumstances, and expressed concerns that overlapping regulation would result in confusion. For similar reasons, commenters recommended that the agencies and the FDIC limit the definition of financial institution to specific enumerated entities, such as regulated financial institutions, including insured depository institutions and holding companies, nonbank financial companies designated by the Financial Stability Oversight Council, insurance companies, securities holding companies, foreign banks, securities firms, futures commission merchants, swap dealers, and security based swap dealers. Other commenters stated that the definition should cover only those entities subject to consolidated regulatory capital requirements. Commenters also encouraged the agencies and the FDIC to adopt 105 The definitions of regulated financial institutions and unregulated financial institutions are discussed in further detail in section XII.A of this preamble. Under the proposal, a ‘‘regulated financial institution’’ would include a financial institution subject to consolidated supervision and regulation comparable to that imposed on U.S. companies that are depository institutions, depository institution holding companies, nonbank financial companies supervised by the Board, broker dealers, credit unions, insurance companies, and designated financial market utilities. PO 00000 Frm 00046 Fmt 4701 Sfmt 4700 alternatives to the ‘‘predominantly engaged’’ test for identifying a financial institution, such as the use of standard industrial classification codes or legal entity identifiers. Other commenters suggested that the agencies and the FDIC should limit the application of the ‘‘predominantly engaged’’ test in the definition of ‘‘financial institution’’ to companies above a specified size threshold. Similarly, others requested that the agencies and the FDIC exclude any company with total assets of less than $50 billion. Many commenters indicated that the broad definition proposed by the agencies and the FDIC was not required by Basel III and was unnecessary to promote systemic stability and avoid interconnectivity. Some commenters stated that funds covered by Section 13 of the Bank Holding Company Act also should be excluded. Other commenters suggested that the agencies and the FDIC should exclude investment funds registered with the SEC under the Investment Company Act of 1940 and their foreign equivalents, while some commenters suggested methods of narrowing the definition to cover only leveraged funds. Commenters also requested that the agencies and the FDIC clarify that investment or financial advisory activities include providing both discretionary and non-discretionary investment or financial advice to customers, and that the definition would not capture either registered investment companies or investment advisers to registered funds. After considering the comments, the agencies have modified the definition of ‘‘financial institution’’ to provide more clarity around the scope of the definition as well as reduce operational burden. Separate definitions are adopted under the advanced approaches provisions of the final rule for ‘‘regulated financial institution’’ and ‘‘unregulated financial institution’’ for purposes of calculating the correlation factor for wholesale exposures, as discussed in section XII.A of this preamble. Under the final rule, the first paragraph of the definition of a financial institution includes an enumerated list of regulated institutions similar to the list that appeared in the first paragraph of the proposed definition: A BHC; SLHC; nonbank financial institution supervised by the Board under Title I of the Dodd-Frank Act; depository institution; foreign bank; credit union; industrial loan company, industrial bank, or other similar institution described in section 2 of the Bank Holding Company Act; national association, state member bank, or state E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations nonmember bank that is not a depository institution; insurance company; securities holding company as defined in section 618 of the DoddFrank Act; broker or dealer registered with the SEC; futures commission merchant and swap dealer, each as defined in the Commodity Exchange Act; or security-based swap dealer; or any designated financial market utility (FMU). The definition also includes foreign companies that would be covered by the definition if they are supervised and regulated in a manner similar to the institutions described above that are included in the first paragraph of the definition of ‘‘financial institution.’’ The agencies also have retained in the final definition of ‘‘financial institution’’ a modified version of the proposed ‘‘predominantly engaged’’ test to capture additional entities that perform certain financial activities that the agencies believe appropriately addresses those relationships among financial institutions that give rise to concerns about interconnectedness, while reducing operational burden. Consistent with the proposal, a company is ‘‘predominantly engaged’’ in financial activities for the purposes of the definition if it meets the test to the extent the following activities make up more than 85 percent of the company’s total assets or gross revenues: (1) Lending money, securities or other financial instruments, including servicing loans; (2) Insuring, guaranteeing, indemnifying against loss, harm, damage, illness, disability, or death, or issuing annuities; (3) Underwriting, dealing in, making a market in, or investing as principal in securities or other financial instruments; or (4) Asset management activities (not including investment or financial advisory activities). In response to comments expressing concerns regarding operational burden and potential lack of access to necessary information in applying the proposed ‘‘predominantly engaged’’ test, the agencies have revised that portion of the definition. Now, the banking organization would only apply the test if it has an investment in the GAAP equity instruments of the company with an adjusted carrying value or exposure amount equal to or greater than $10 million, or if it owns more than 10 percent of the company’s issued and outstanding common shares (or similar equity interest). The agencies believe that this modification would reduce burden on banking organizations with small exposures, while those with larger VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 exposures should have sufficient information as a shareholder to conduct the predominantly engaged analysis.106 In cases when a banking organization’s investment in the banking organization exceeds one of the thresholds described above, the banking organization must determine whether the company is predominantly engaged in financial activities, in accordance with the final rule. The agencies believe that this modification will substantially reduce operational burden for banking organizations with investments in multiple institutions. The agencies also believe that an investment of $10 million in or a holding of 10 percent of the outstanding common shares (or equivalent ownership interest) of an entity has the potential to create a risk of interconnectedness, and also makes it reasonable for the banking organization to gain information necessary to understand the operations and activities of the company in which it has invested and to apply the proposed ‘‘predominantly engaged’’ test under the definition. The agencies are clarifying that, consistent with the proposal, investment or financial advisers (whether they provide discretionary or non-discretionary advisory services) are not covered under the definition of financial institution. The revised definition also specifically excludes employee benefit plans. The agencies believe, upon review of the comments, that employee benefit plans are heavily regulated under ERISA and do not present the same kind of risk of systemic interconnectedness that the enumerated financial institutions present. The revised definition also explicitly excludes investment funds registered with the SEC under the Investment Company Act of 1940, as the agencies believe that such funds create risks of systemic interconnectedness largely through their investments in the capital of financial institutions. These investments are addressed directly by the final rule’s treatment of indirect investments in financial institutions. Although the revised definition does not specifically include commodities pools, under some circumstances a banking organization’s investment in a commodities pool might meet the requirements of the modified ‘‘predominantly engaged’’ test. Some commenters also requested that the agencies and the FDIC establish an asset threshold below which an entity 106 For advanced approaches banking organizations, for purposes of section 131 of the final rule, the definition of ‘‘unregulated financial institution’’ does not include the ownership limitation in applying the ‘‘predominantly engaged’’ standard. PO 00000 Frm 00047 Fmt 4701 Sfmt 4700 62063 would not be included in the definition of ‘‘financial institution.’’ The agencies have not included such a threshold because they are concerned that it could create an incentive for multiple investments and aggregated exposures in smaller financial institutions, thereby undermining the rationale underlying the treatment of investments in the capital of unconsolidated financial institutions. The agencies believe that the definition of financial institution appropriately captures both large and small entities engaged in the core financial activities that the agencies believe should be addressed by the definition and associated deductions from capital. The agencies believe, however, that the modification to the ‘‘predominantly engaged’’ test, should serve to alleviate some of the burdens with which the commenters who made this point were concerned. Consistent with the proposal, investments in the capital of unconsolidated financial institutions that are held indirectly (indirect exposures) are subject to deduction. Under the proposal, a banking organization’s entire investment in, for example, a registered investment company would have been subject to deduction from capital. Although those entities are excluded from the definition of financial institution in the final rule unless the ownership threshold is met, any holdings in the capital instruments of financial institutions held indirectly through investment funds are subject to deduction from capital. More generally, and as described later in this section of the preamble, the final rule provides an explicit mechanism for calculating the amount of an indirect investment subject to deduction. f. The Corresponding Deduction Approach The proposals incorporated the Basel III corresponding deduction approach for the deductions from regulatory capital related to reciprocal crossholdings, non-significant investments in the capital of unconsolidated financial institutions, and non-common stock significant investments in the capital of unconsolidated financial institutions. Under the proposal, a banking organization would have been required to make any such deductions from the same component of capital for which the underlying instrument would qualify if it were issued by the banking organization itself. If a banking organization did not have a sufficient amount of a specific regulatory capital component against which to effect the deduction, the shortfall would have E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62064 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations been deducted from the next higher (that is, more subordinated) regulatory capital component. For example, if a banking organization did not have enough additional tier 1 capital to satisfy the required deduction, the shortfall would be deducted from common equity tier 1 capital elements. Under the proposal, if the banking organization invested in an instrument issued by an financial institution that is not a regulated financial institution, the banking organization would have treated the instrument as common equity tier 1 capital if the instrument is common stock (or if it is otherwise the most subordinated form of capital of the financial institution) and as additional tier 1 capital if the instrument is subordinated to all creditors of the financial institution except common shareholders. If the investment is in the form of an instrument issued by a regulated financial institution and the instrument does not meet the criteria for any of the regulatory capital components for banking organizations, the banking organization would treat the instrument as: (1) Common equity tier 1 capital if the instrument is common stock included in GAAP equity or represents the most subordinated claim in liquidation of the financial institution; (2) additional tier 1 capital if the instrument is GAAP equity and is subordinated to all creditors of the financial institution and is only senior in liquidation to common shareholders; and (3) tier 2 capital if the instrument is not GAAP equity but it is considered regulatory capital by the primary supervisor of the financial institution. Some commenters sought clarification on whether, under the corresponding deduction approach, TruPS would be deducted from tier 1 or tier 2 capital. In response to these comments the agencies have revised the final rule to clarify the deduction treatment for investments of non-qualifying capital instruments, including TruPS, under the corresponding deduction approach. The final rule includes a new paragraph section 22(c)(2)(iii) to provide that if an investment is in the form of a nonqualifying capital instrument described in section 300(d) of the final rule, the banking organization must treat the instrument as a: (1) Tier 1 capital instrument if it was included in the issuer’s tier 1 capital prior to May 19, 2010; or (2) tier 2 capital instrument if it was included in the issuer’s tier 2 capital (but not eligible for inclusion in the issuer’s tier 1 capital) prior to May 19, 2010. In addition, to avoid a potential circularity issue (related to the combined impact of the treatment of VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 ALLL and the risk-weight treatment for threshold items that are not deducted from common equity tier 1 capital) in the calculation of common equity tier 1 capital, the final rule clarifies that banking organizations must apply any deductions under the corresponding deduction approach resulting from insufficient amounts of a specific regulatory capital component after applying any deductions from the items subject to the 10 and 15 percent common equity tier 1 capital deduction thresholds discussed further below. This was accomplished by removing proposed paragraph 22(c)(2)(i) from the corresponding deduction approach section and inserting paragraph 22(f). Under section 22(f) of the final rule, and as noted above, if a banking organization does not have a sufficient amount of a specific component of capital to effect the required deduction under the corresponding deduction approach, the shortfall must be deducted from the next higher (that is, more subordinated) component of regulatory capital. g. Reciprocal Crossholdings in the Capital Instruments of Financial Institutions A reciprocal crossholding results from a formal or informal arrangement between two financial institutions to swap, exchange, or otherwise intend to hold each other’s capital instruments. The use of reciprocal crossholdings of capital instruments to artificially inflate the capital positions of each of the financial institutions involved would undermine the purpose of regulatory capital, potentially affecting the stability of such financial institutions as well as the financial system. Under the agencies’ general risk-based capital rules, reciprocal crossholdings of capital instruments of banking organizations are deducted from regulatory capital. Consistent with Basel III, the proposal would have required a banking organization to deduct reciprocal crossholdings of capital instruments of other financial institutions using the corresponding deduction approach. The final rule maintains this treatment. h. Investments in the Banking Organization’s Own Capital Instruments or in the Capital of Unconsolidated Financial Institutions In the final rule, the agencies made several non-substantive changes to the wording in the proposal to clarify that the amount of an investment in the banking organization’s own capital instruments or in the capital of unconsolidated financial institutions is PO 00000 Frm 00048 Fmt 4701 Sfmt 4700 the net long position (as calculated under section 22(h) of the final rule) of such investments. The final rule also clarifies how to calculate the net long position of these investments, especially for the case of indirect exposures. It is the net long position that is subject to deduction. In addition, the final rule generally harmonizes the recognition of hedging for own capital instruments and for investments in the capital of unconsolidated financial institutions. Under the final rule, an investment in a banking organization’s own capital instrument is deducted from regulatory capital and an investment in the capital of an unconsolidated financial institution is subject to deduction from regulatory capital if such investment exceeds certain thresholds. An investment in the capital of an unconsolidated financial institution refers to the net long position (calculated in accordance with section 22(h) of the final rule) in an instrument that is recognized as capital for regulatory purposes by the primary supervisor of an unconsolidated regulated financial institution or in an instrument that is part of GAAP equity of an unconsolidated unregulated financial institution. It includes direct, indirect, and synthetic exposures to capital instruments, and excludes underwriting positions held by a banking organization for fewer than five business days. An investment in the banking organization’s own capital instrument means a net long position calculated in accordance with section 22(h) of the final rule in the banking organization’s own common stock instrument, own additional tier 1 capital instrument or own tier 2 capital instrument, including direct, indirect or synthetic exposures to such capital instruments. An investment in the banking organization’s own capital instrument includes any contractual obligation to purchase such capital instrument. The final rule also clarifies that the gross long position for an investment in the banking organization’s own capital instrument or the capital of an unconsolidated financial institution that is an equity exposure refers to the adjusted carrying value (determined in accordance with section 51(b) of the final rule). For the case of an investment in the banking organization’s own capital instrument or the capital of an unconsolidated financial institution that is not an equity exposure, the gross long position is defined as the exposure amount (determined in accordance with section 2 of the final rule). Under the proposal, the agencies and the FDIC included the methodology for E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations the recognition of hedging and for the calculation of the net long position regarding investments in the banking organization’s own capital instruments and in investments in the capital of unconsolidated financial institutions in the definitions section. However, such methodology appears in section 22 of the final rule as the agencies believe it is more appropriate to include it in the adjustments and deductions to regulatory capital section. The final rule provides that the net long position is the gross long position in the underlying instrument (including covered positions under the market risk rule) net of short positions in the same instrument where the maturity of the short position either matches the maturity of the long position or has a residual maturity of at least one year. A banking organization may only net a short position against a long position in the banking organization’s own capital instrument if the short position involves no counterparty credit risk. The long and short positions in the same index without a maturity date are considered to have matching maturities. If both the long position and the short position do not have contractual maturity dates, then the positions are considered maturity-matched. For positions that are reported on a banking organization’s regulatory report as trading assets or trading liabilities, if the banking organization has a contractual right or obligation to sell a long position at a specific point in time, and the counterparty to the contract has an obligation to purchase the long position if the banking organization exercises its right to sell, this point in time may be treated as the maturity of the long position. Therefore, if these conditions are met, the maturity of the long position and the short position would be deemed to be matched even if the maturity of the short position is less than one year. Gross long positions in own capital instruments or in the capital instruments of unconsolidated financial institutions resulting from positions in an index may be netted against short positions in the same underlying index. Short positions in indexes that are hedging long cash or synthetic positions may be decomposed to recognize the hedge. More specifically, the portion of the index that is composed of the same underlying exposure that is being hedged may be used to offset the long position, provided both the exposure being hedged and the short position in the index are trading assets or trading liabilities, and the hedge is deemed effective by the banking organization’s internal control processes, which the VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 banking organization’s primary Federal supervisor has found not to be inadequate. An indirect exposure results from a banking organization’s investment in an investment fund that has an investment in the banking organization’s own capital instrument or the capital of an unconsolidated financial institution. A synthetic exposure results from a banking organization’s investment in an instrument where the value of such instrument is linked to the value of the banking organization’s own capital instrument or a capital instrument of a financial institution. Examples of indirect and synthetic exposures include: (1) An investment in the capital of an investment fund that has an investment in the capital of an unconsolidated financial institution; (2) a total return swap on a capital instrument of the banking organization or another financial institution; (3) a guarantee or credit protection, provided to a third party, related to the third party’s investment in the capital of another financial institution; (4) a purchased call option or a written put option on the capital instrument of another financial institution; (5) a forward purchase agreement on the capital of another financial institution; and (6) a trust preferred security collateralized debt obligation (TruPS CDO). Investments, including indirect and synthetic exposures, in the capital of unconsolidated financial institutions are subject to the corresponding deduction approach if they surpass certain thresholds described below. With the prior written approval of the primary Federal supervisor, for the period of time stipulated by the supervisor, a banking organization is not required to deduct investments in the capital of unconsolidated financial institutions described in this section if the investment is made in connection with the banking organization providing financial support to a financial institution in distress, as determined by the supervisor. Likewise, a banking organization that is an underwriter of a failed underwriting can request approval from its primary Federal supervisor to exclude underwriting positions related to such failed underwriting held for longer than five days. Some commenters requested clarification that a long position and short hedging position are considered ‘‘maturity matched’’ if (1) the maturity period of the short position extends beyond the maturity period of the long position or (2) both long and short positions mature or terminate within the PO 00000 Frm 00049 Fmt 4701 Sfmt 4700 62065 same calendar quarter. The agencies note that they concur with these commenters’ interpretation of the maturity matching of long and short hedging positions. For purposes of calculating the net long position in the capital of an unconsolidated financial institution, several commenters expressed concern that allowing banking organizations to net gross long positions with short positions only where the maturity of the short position either matches the maturity of the long position or has a maturity of at least one year is not practical, as some exposures, such as cash equities, have no maturity. These commenters expressed concern that such a maturity requirement could result in banking organizations deducting equities held as hedges for equity swap transactions with a client, making the latter transactions uneconomical and resulting in disruptions to market activity. Similarly, these commenters argued that providing customer accommodation equity swaps could become burdensome as a strict reading of the proposal could affect the ability of banking organizations to offset the equity swap with the long equity position because the maturity of the equity swap is typically less than one year. The agencies have considered the comments and have decided to retain the maturity requirement as proposed. The agencies believe that the proposed maturity requirements will reduce the possibility of ‘‘cliff effects’’ resulting from the deduction of open equity positions when a banking organization is unable to replace the hedge or sell the long equity position. i. Indirect Exposure Calculations The proposal provided that an indirect exposure would result from a banking organization’s investment in an unconsolidated entity that has an exposure to a capital instrument of a financial institution, while a synthetic exposure would result from the banking organization’s investment in an instrument where the value of such instrument is linked to the value of a capital instrument of a financial institution. With the exception of index securities, the proposal did not, however, provide a mechanism for calculating the amount of the indirect exposure that is subject to deduction. The final rule clarifies the methodologies for calculating the net long position related to an indirect exposure (which is subject to deduction under the final rule) by providing a methodology for calculating the gross long position of such indirect exposure. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62066 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations The agencies believe that the options provided in the final rule will provide banking organizations with increased clarity regarding the treatment of indirect exposures, as well as increased risk-sensitivity to the banking organization’s actual potential exposure. In order to limit the potential difficulties in determining whether an unconsolidated entity in fact holds the banking organization’s own capital or the capital of unconsolidated financial institutions, the final rule also provides that the indirect exposure requirements only apply when the banking organization holds an investment in an investment fund, as defined in the rule. Accordingly, a banking organization invested in, for example, a commercial company is not required to determine whether the commercial company has any holdings of the banking organization’s own capital or the capital instruments of financial institutions. The final rule provides that a banking organization may determine that its gross long position is equivalent to its carrying value of its investment in an investment fund that holds the banking organization’s own capital or that holds an investment in the capital of an unconsolidated financial institution, which would be subject to deduction according to section 22(c). Recognizing, however, that the banking organization’s exposure to those capital instruments may be less than its carrying value of its investment in the investment fund, the final rule provides two alternatives for calculating the gross long position of an indirect exposure. For an indirect exposure resulting from a position in an index, a banking organization may, with the prior approval of its primary Federal supervisor, use a conservative estimate of the amount of its investment in its own capital instruments or the capital instruments of other financial institutions. If the investment is held through an investment fund, a banking organization may use a look-through approach similar to the approach used for risk weighting equity exposures to investment funds. Under this approach, a banking organization may multiply the carrying value of its investment in an investment fund by either the exact percentage of the banking organization’s own capital instrument or capital instruments of unconsolidated financial institutions held by the investment fund or by the highest stated prospectus limit for such investments held by the investment fund. Accordingly, if a banking organization with a carrying value of $10,000 for its investment in an investment fund knows that the investment fund has invested 30 percent of its assets in the capital of financial VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 institutions, then the banking organization could subject $3,000 (the carrying value times the percentage invested in the capital of financial institutions) to deduction from regulatory capital. The agencies believe that the approach is flexible and benefits a banking organization that obtains and maintains information about its investments through investment funds. It also provides a simpler calculation method for a banking organization that either does not have information about the holdings of the investment fund or chooses not to do the more complex calculation. j. Non-Significant Investments in the Capital of Unconsolidated Financial Institutions The proposal provided that nonsignificant investments in the capital of unconsolidated financial institutions would be the net long position in investments where a banking organization owns 10 percent or less of the issued and outstanding common stock of an unconsolidated financial institution. Under the proposal, if the aggregate amount of a banking organization’s nonsignificant investments in the capital of unconsolidated financial institutions exceeds 10 percent of the sum of the banking organization’s own common equity tier 1 capital, minus certain applicable deductions and other regulatory adjustments to common equity tier 1 capital (the 10 percent threshold for non-significant investments), the banking organization would have been required to deduct the amount of the non-significant investments that are above the 10 percent threshold for non-significant investments, applying the corresponding deduction approach.107 Under the proposal, the amount to be deducted from a specific capital 107 The regulatory adjustments and deductions applied in the calculation of the 10 percent threshold for non-significant investments are those required under sections 22(a) through 22(c)(3) of the proposal. That is, the required deductions and adjustments for goodwill and other intangibles (other than MSAs) net of associated DTLs (when the banking organization has elected to net DTLs in accordance with section 22(e)), DTAs that arise from net operating loss and tax credit carryforwards net of related valuation allowances and DTLs (in accordance with section 22(e)), cash-flow hedges associated with items that are not recognized at fair value on the balance sheet, excess ECLs (for advanced approaches banking organizations only), gains-on-sale on securitization exposures, gains and losses due to changes in own credit risk on financial liabilities measured at fair value, defined benefit pension fund net assets for banking organizations that are not insured by the FDIC (net of associated DTLs in accordance with section 22(e)), investments in own regulatory capital instruments (not deducted as treasury stock), and reciprocal crossholdings. PO 00000 Frm 00050 Fmt 4701 Sfmt 4700 component would be equal to the amount of a banking organization’s nonsignificant investments in the capital of unconsolidated financial institutions exceeding the 10 percent threshold for non-significant investments multiplied by the ratio of: (1) The amount of nonsignificant investments in the capital of unconsolidated financial institutions in the form of such capital component to (2) the amount of the banking organization’s total non-significant investments in the capital of unconsolidated financial institutions. The amount of a banking organization’s non-significant investments in the capital of unconsolidated financial institutions that does not exceed the 10 percent threshold for non-significant investments would, under the proposal, generally be assigned the applicable risk weight under section 32 or section 131, as applicable (in the case of noncommon stock instruments), section 52 or section 152, as applicable (in the case of common stock instruments), or section 53, section 154, as applicable (in the case of indirect investments via an investment fund), or, in the case of a covered position, in accordance with subpart F, as applicable. One commenter requested clarification that a banking organization would not have to take a ‘‘double deduction’’ for an investment made in unconsolidated financial institutions held through another unconsolidated financial institution in which the banking organization has invested. The agencies note that, under the final rule, where a banking organization has an investment in an unconsolidated financial institution (Institution A) and Institution A has an investment in another unconsolidated financial institution (Institution B), the banking organization would not be deemed to have an indirect investment in Institution B for purposes of the final rule’s capital thresholds and deductions because the banking organization’s investment in Institution A is already subject to capital thresholds and deductions. However, if a banking organization has an investment in an investment fund that does not meet the definition of a financial institution, it must consider the assets of the investment fund to be indirect holdings. Some commenters requested clarification that the deductions for nonsignificant investments in the capital of unconsolidated financial institutions may be net of associated DTLs. The agencies have clarified in the final rule that a banking organization must deduct the net long position in non-significant investments in the capital of unconsolidated financial institutions, E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 net of associated DTLs in accordance with section 22(e) of the final rule, that exceeds the 10 percent threshold for non-significant investments. Under section 22(e) of the final rule, the netting of DTLs against assets that are subject to deduction or fully deducted under section 22 of the final rule is permitted but not required. Other commenters asked the agencies and the FDIC to confirm that the proposal would not require that investments in TruPS CDOs be treated as investments in the capital of unconsolidated financial institutions, but rather treat the investments as securitization exposures. The agencies believe that investments in TruPS CDOs are synthetic exposures to the capital of unconsolidated financial institutions and are thus subject to deduction. Under the final rule, any amounts of TruPS CDOs that are not deducted are subject to the securitization treatment. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 k. Significant Investments in the Capital of Unconsolidated Financial Institutions That Are Not in the Form of Common Stock Under the proposal, a significant investment in the capital of an unconsolidated financial institution would be the net long position in an investment where a banking organization owns more than 10 percent of the issued and outstanding common stock of the unconsolidated financial institution. Significant investments in the capital of unconsolidated financial institutions that are not in the form of common stock are investments where the banking organization owns capital of an unconsolidated financial institution that is not in the form of common stock in addition to 10 percent of the issued and outstanding common stock of that financial institution. Such a noncommon stock investment would be deducted by applying the corresponding deduction approach. Significant investments in the capital of unconsolidated financial institutions that are in the form of common stock PO 00000 Frm 00051 Fmt 4701 Sfmt 4700 62067 would be subject to 10 and 15 percent common equity tier 1 capital threshold deductions described below in this section. A number of commenters sought clarification as to whether under section 22(c) of the proposal, a banking organization may deduct any significant investments in the capital of unconsolidated financial institutions that are not in the form of common stock net of associated DTLs. The final rule clarifies that such deductions may be net of associated DTLs in accordance with paragraph 22(e) of the final rule. Other than this revision, the final rule adopts the proposed rule. More generally, commenters also sought clarification on the treatment of investments in the capital of unconsolidated financial institutions (for example, the distinction between significant and non-significant investments). Thus, the chart below summarizes the treatment of investments in the capital of unconsolidated financial institutions. BILLING CODE 4810–33–P E:\FR\FM\11OCR2.SGM 11OCR2 VerDate Mar<15>2010 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00052 Fmt 4701 Sfmt 4725 E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.000</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 62068 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations l. Items Subject to the 10 and 15 Percent Common Equity Tier 1 Capital Threshold Deductions Under the proposal, a banking organization would have deducted from the sum of its common equity tier 1 capital elements the amount of each of the following items that individually exceeds the 10 percent common equity tier 1 capital deduction threshold described below: (1) DTAs arising from temporary differences that could not be realized through net operating loss carrybacks (net of any related valuation allowances and net of DTLs, as described in section 22(e) of the proposal); (2) MSAs, net of associated DTLs in accordance with section 22(e) of the proposal; and (3) significant investments in the capital of unconsolidated financial institutions in the form of common stock (referred to herein as items subject to the threshold deductions). Under the proposal, a banking organization would have calculated the 10 percent common equity tier 1 capital deduction threshold by taking 10 percent of the sum of a banking organization’s common equity tier 1 elements, less adjustments to, and deductions from common equity tier 1 capital required under sections 22(a) through (c) of the proposal. As mentioned above in section V.B, under the proposal banking organizations would have been required to deduct from common equity tier 1 capital any goodwill embedded in the valuation of significant investments in the capital of unconsolidated financial institutions in the form of common stock. A banking organization would have been allowed to reduce the investment amount of such significant investment by the goodwill embedded in such investment. For example, if a banking organization has deducted $10 of goodwill embedded in a $100 significant investment in the capital of an unconsolidated financial institution in the form of common stock, the banking organization would be allowed to reduce the investment amount of such significant investment by the amount of embedded goodwill (that is, the value of the investment would be $90 for purposes of the calculation of the amount that would be subject to deduction under this part of the proposal). In addition, under the proposal the aggregate amount of the items subject to the threshold deductions that are not deducted as a result of the 10 percent common equity tier 1 capital deduction threshold described above must not exceed 15 percent of a banking VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 organization’s common equity tier 1 capital, as calculated after applying all regulatory adjustments and deductions required under the proposal (the 15 percent common equity tier 1 capital deduction threshold). That is, a banking organization would have been required to deduct in full the amounts of the items subject to the threshold deductions on a combined basis that exceed 17.65 percent (the proportion of 15 percent to 85 percent) of common equity tier 1 capital elements, less all regulatory adjustments and deductions required for the calculation of the 10 percent common equity tier 1 capital deduction threshold mentioned above, and less the items subject to the 10 and 15 percent deduction thresholds. As described below, the proposal required a banking organization to include the amounts of these three items that are not deducted from common equity tier 1 capital in its risk-weighted assets and assign a 250 percent risk weight to them. Some commenters asserted that subjecting DTAs resulting from net unrealized losses in an investment portfolio to the proposed 10 percent common equity tier 1 capital deduction threshold under section 22(d) of the proposal would result in a ‘‘double deduction’’ in that the net unrealized losses would have already been included in common equity tier 1 through the AOCI treatment. Under GAAP, net unrealized losses recognized in AOCI are reported net of tax effects (that is, taxes that give rise to DTAs). The tax effects related to net unrealized losses would reduce the amount of net unrealized losses reflected in common equity tier 1 capital. Given that the tax effects reduce the losses that would otherwise accrue to common equity tier 1 capital, the agencies are of the view that subjecting these DTAs to the 10 percent limitation would not result in a ‘‘double deduction.’’ More generally, several commenters noted that the proposed 10 and 15 percent common equity tier 1 capital deduction thresholds and the proposed 250 percent risk-weight are unduly punitive. Commenters recommended several alternatives including, for example, that the agencies and the FDIC should only retain the 10 percent limit on each threshold item but eliminate the 15 percent aggregate limit. The agencies believe that the proposed thresholds are appropriate as they increase the quality and loss-absorbency of regulatory capital, and are therefore adopting the proposed deduction thresholds as final. The agencies realize that these stricter limits on threshold items may require banking organizations to make PO 00000 Frm 00053 Fmt 4701 Sfmt 4700 62069 appropriate changes in their capital structure or business model, and thus have provided a lengthy transition period to allow banking organizations to adequately plan for the new limits. Under section 475 of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) (12 U.S.C. 1828 note), the amount of readily marketable purchased mortgage servicing rights (PMSRs) that a banking organization may include in regulatory capital cannot be more than 90 percent of their fair value. In addition to this statutory requirement, the general riskbased capital rules require the same treatment for all MSAs, including PMSRs. Under the proposed rule, if the amount of MSAs a banking organization deducts after applying the 10 percent and 15 percent common equity tier 1 deduction threshold is less than 10 percent of the fair value of its MSAs, then the banking organization would have deducted an additional amount of MSAs so that the total amount of MSAs deducted is at least 10 percent of the fair value of its MSAs. Some commenters requested removal of the 90 percent MSA fair value limitation, including for PMSRs under FDICIA. These commenters note that section 475(b) of FDICIA provides the agencies and the FDIC with authority to remove the 90 percent limitation on PMSRs, subject to a joint determination by the agencies and the FDIC that its removal would not have an adverse effect on the deposit insurance fund or the safety and soundness of insured depository institutions. The commenters asserted that removal of the 90 percent limitation would be appropriate because other provisions of the proposal pertaining to MSAs (including PMSRs) would require more capital to be retained even if the fair value limitation were removed. The agencies agree with these commenters and, pursuant to section 475(b) of FDICIA, have determined that PMSRs may be valued at not more than 100 percent of their fair value, because the capital treatment of PMSRs in the final rule (specifically, the deduction approach for MSAs (including PMSRs) exceeding the 10 and 15 common equity deduction thresholds and the 250 percent risk weight applied to all MSAs not subject to deduction) is more conservative than the FDICIA fair value limitation and the 100 percent risk weight applied to MSAs under existing rules and such approach will not have an adverse effect on the deposit insurance fund or safety and soundness of insured depository institutions. For the same reasons, the agencies are also E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62070 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations removing the 90 percent fair value limitation for all other MSAs. Commenters also provided a variety of recommendations related to the proposed limitations on the inclusion of MSAs in regulatory capital. For instance, some commenters advocated removing the proposed deduction provision for hedged and commercial and multifamily-related MSAs, as well as requested an exemption from the proposed deduction requirement for community banking organizations with less than $10 billion. Other commenters recommended increasing the amount of MSAs includable in regulatory capital. For example, one commenter recommended that MSAs should be limited to 100 percent of tier l capital if the underlying loans are prudently underwritten. Another commenter requested that the final rule permit thrifts and commercial banking organizations to include in regulatory capital MSAs equivalent to 50 and 25 percent of tier 1 capital, respectively. Several commenters also objected to the proposed risk weights for MSAs, asserting that a 250 percent risk weight for an asset that is marked-to-fair value quarterly is unreasonably punitive and that a 100 percent risk weight should apply; that MSAs allowable in capital should be increased, at a minimum, to 30 percent of tier 1 capital, with a risk weight of no greater than 50 percent for existing MSAs; that commercial MSAs should continue to be subject to the risk weighting and deduction methodology under the general risk-based capital rules; and that originated MSAs should retain the same risk weight treatment under the general risk-based capital rules given that the ability to originate new servicing to replace servicing lost to prepayment in a falling-rate environment provides for a substantial hedge. Another commenter recommended that the agencies and the FDIC grandfather all existing MSAs that are being fair valued on banking organizations’ balance sheets and exclude MSAs from the proposed 15 percent deduction threshold. After considering these comments, the agencies are adopting the proposed limitation on MSAs includable in common equity tier 1 capital without change in the final rule. MSAs, like other intangible assets, have long been either fully or partially excluded from regulatory capital in the United States because of the high level of uncertainty regarding the ability of banking organizations to realize value from these assets, especially under adverse financial conditions. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 m. Netting of Deferred Tax Liabilities Against Deferred Tax Assets and Other Deductible Assets Under the proposal, banking organizations would have been permitted to net DTLs against assets (other than DTAs) subject to deduction under section 22 of the proposal, provided the DTL is associated with the asset and the DTL would be extinguished if the associated asset becomes impaired or is derecognized under GAAP. Likewise, banking organizations would be prohibited from using the same DTL more than once for netting purposes. This practice would be generally consistent with the approach that the agencies currently take with respect to the netting of DTLs against goodwill. With respect to the netting of DTLs against DTAs, under the proposal the amount of DTAs that arise from net operating loss and tax credit carryforwards, net of any related valuation allowances, and the amount of DTAs arising from temporary differences that the banking organization could not realize through net operating loss carrybacks, net of any related valuation allowances, could be netted against DTLs if certain conditions are met. The agencies and the FDIC received numerous comments recommending changes to and seeking clarification on various aspects of the proposed treatment of deferred taxes. Certain commenters asked whether deductions of significant and non-significant investments in the capital of unconsolidated financial institutions under section 22(c)(4) and 22(c)(5) of the proposed rule may be net of associated DTLs. A commenter also recommended that a banking organization be permitted to net a DTA against a fair value measurement or similar adjustment to an asset (for example, in the case of a certain cashflow hedges) or a liability (for example, in the case of changes in the fair value of a banking organization’s liabilities attributed to changes in the banking organization’s own credit risk) that is associated with the adjusted value of the asset or liability that itself is subject to a capital adjustment or deduction under the Basel III NPR. These DTAs would be derecognized under GAAP if the adjustment were reversed. Accordingly, one commenter recommended that proposed text in section 22(e) be revised to apply to netting of DTAs as well as DTLs. The agencies agree that for regulatory capital purposes, a banking organization may exclude from the deduction PO 00000 Frm 00054 Fmt 4701 Sfmt 4700 thresholds DTAs and DTLs associated with fair value measurement or similar adjustments to an asset or liability that are excluded from common equity tier 1 capital under the final rule. The agencies note that GAAP requires net unrealized gains and losses 108 recognized in AOCI to be recorded net of deferred tax effects. Moreover, under the agencies’ general risk-based capital rules and associated regulatory reporting instructions, banking organizations must deduct certain net unrealized gains, net of applicable taxes, and add back certain net unrealized losses, again, net of applicable taxes. Permitting banking organizations to exclude net unrealized gains and losses included in AOCI without netting of deferred tax effects would cause a banking organization to overstate the amount of net unrealized gains and losses excluded from regulatory capital and potentially overstate or understate deferred taxes included in regulatory capital. Accordingly, under the final rule, banking organizations must make all adjustments to common equity tier 1 capital under section 22(b) of the final rule net of any associated deferred tax effects. In addition, banking organizations may make all deductions from common equity tier 1 capital elements under section 22(c) and (d) of the final rule net of associated DTLs, in accordance with section 22(e) of the final rule. Commenters also sought clarification as to whether banking organizations may change from reporting period to reporting period their decision to net DTLs against DTAs as opposed to netting DTLs against other assets subject to deduction. Consistent with the agencies’ general risk-based capital rules, the final rule permits, but does not require, a banking organization to net DTLs associated with items subject to regulatory deductions from common equity tier 1 capital under section 22(a). The agencies’ general risk-based capital rules do not explicitly address whether or how often a banking organization may change its DTL netting approach for items subject to deduction, such as goodwill and other intangible assets. If a banking organization elects to either net DTLs against DTAs or to net DTLs against other assets subject to deduction, the final rule requires that it must do so consistently. For example, a banking organization that elects to deduct goodwill net of associated DTLs will be required to continue that 108 The word ‘‘net’’ in the term ‘‘net unrealized gains and losses’’ refers to the netting of gains and losses before tax. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations practice for all future reporting periods. Under the final rule, a banking organization must obtain approval from its primary Federal supervisor before changing its approach for netting DTLs against DTAs or assets subject to deduction under section 22(a), which would be permitted, for example, in situations where a banking organization merges with or acquires another banking organization, or upon a substantial change in a banking organization’s business model. Commenters also asked whether banking organizations would be permitted or required to exclude (from the amount of DTAs subject to the threshold deductions under section 22(d) of the proposal) deferred tax assets and liabilities relating to net unrealized gains and losses reported in AOCI that are subject to: (1) Regulatory adjustments to common equity tier 1 capital (section 22(b) of the proposal), (2) deductions from regulatory capital related to investments in capital instruments (section 22(c) of the proposal), and (3) items subject to the 10 and 15 percent common equity tier 1 capital deduction thresholds (section 22(d) of the proposal). Under the agencies’ general risk-based capital rules, before calculating the amount of DTAs subject to the DTA limitations for inclusion in tier 1 capital, a banking organization may eliminate the deferred tax effects of any net unrealized gains and losses on AFS debt securities. A banking organization that adopts a policy to eliminate such deferred tax effects must apply that approach consistently in all future calculations of the amount of disallowed DTAs. For purposes of the final rule, the agencies have decided to permit banking organizations to eliminate from the calculation of DTAs subject to threshold deductions under section 22(d) of the final rule the deferred tax effects associated with any items that are subject to regulatory adjustment to common equity tier 1 capital under section 22(b). A banking organization that elects to eliminate such deferred tax effects must continue that practice consistently from period to period. A banking organization must obtain approval from its primary Federal supervisor before changing its election to exclude or not exclude these amounts from the calculation of DTAs. Additionally, the agencies have decided to require DTAs associated with any net unrealized losses or differences between the tax basis and the accounting basis of an asset pertaining to items (other than those items subject to adjustment under section 22(b)) that are: (1) Subject to VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 deduction from common equity tier 1 capital under section 22(c) or (2) subject to the threshold deductions under section 22(d) to be subject to the threshold deductions under section 22(d) of the final rule. Commenters also sought clarification as to whether banking organizations would be required to compute DTAs and DTLs quarterly for regulatory capital purposes. In this regard, commenters stated that GAAP requires annual computation of DTAs and DTLs, and that more frequent computation requirements for regulatory capital purposes would be burdensome. Some DTA and DTL items must be adjusted at least quarterly, such as DTAs and DTLs associated with certain gains and losses included in AOCI. Therefore, the agencies expect banking organizations to use the DTA and DTL amounts reported in the regulatory reports for balance sheet purposes to be used for regulatory capital calculations. The final rule does not require banking organizations to perform these calculations more often than would otherwise be required in order to meet quarterly regulatory reporting requirements. A few commenters also asked whether the agencies and the FDIC would continue to allow banking organizations to use DTLs embedded in the carrying value of a leveraged lease to reduce the amount of DTAs subject to the 10 percent and 15 percent common equity tier 1 capital deduction thresholds contained in section 22(d) of the proposal. The valuation of a leveraged lease acquired in a business combination gives recognition to the estimated future tax effect of the remaining cash-flows of the lease. Therefore, any future tax liabilities related to an acquired leveraged lease are included in the valuation of the leveraged lease, and are not separately reported under GAAP as DTLs. This can artificially increase the amount of net DTAs reported by banking organizations that acquire a leveraged lease portfolio under purchase accounting. Accordingly, the agencies’ currently allow banking organizations to treat future taxes payable included in the valuation of a leveraged lease portfolio as a reversing taxable temporary difference available to support the recognition of DTAs.109 The final rule amends the proposal by explicitly 109 Temporary differences arise when financial events or transactions are recognized in one period for financial reporting purposes and in another period, or periods, for tax purposes. A reversing taxable temporary difference is a temporary difference that produces additional taxable income future periods. PO 00000 Frm 00055 Fmt 4701 Sfmt 4700 62071 permitting a banking organization to use the DTLs embedded in the carrying value of a leveraged lease to reduce the amount of DTAs consistent with section 22(e). In addition, commenters asked the agencies and the FDIC to clarify whether a banking organization is required to deduct from the sum of its common equity tier 1 capital elements net DTAs arising from timing differences that the banking organization could realize through net operating loss carrybacks. The agencies confirm that under the final rule, DTAs that arise from temporary differences that the banking organization may realize through net operating loss carrybacks are not subject to the 10 percent and 15 percent common equity tier 1 capital deduction thresholds (deduction thresholds). This is consistent with the agencies’ general risk-based capital rules, which do not limit DTAs that can potentially be realized from taxes paid in prior carryback years. However, consistent with the proposal, the final rule requires that banking organizations deduct from common equity tier 1 capital elements the amount of DTAs arising from temporary differences that the banking organization could not realize through net operating loss carrybacks that exceed the deduction thresholds under section 22(d) of the final rule. Some commenters recommended that the agencies and the FDIC retain the provision in the agencies’ and the FDIC’s general risk-based capital rules that permits a banking organization to measure the amount of DTAs subject to inclusion in tier 1 capital by the amount of DTAs that the banking organization could reasonably be expected to realize within one year, based on its estimate of future taxable income.110 In addition, commenters argued that the full deduction of net operating loss and tax credit carryforwards from common equity tier 1 capital is an inappropriate reaction to concerns about DTAs as an element of capital, and that there are 110 Under the agencies’ general risk-based capital rules, a banking organization generally must deduct from tier 1 capital DTAs that are dependent upon future taxable income, which exceed the lesser of either: (1) The amount of DTAs that the bank could reasonably expect to realize within one year of the quarter-end regulatory report, based on its estimate of future taxable income for that year, or (2) 10 percent of tier 1 capital, net of goodwill and all intangible assets other than purchased credit card relationships, and servicing assets. See 12 CFR part 3, appendix A, section 2(c)(1)(iii) (national banks) and 12 CFR 167.12(h)(1)(i) (Federal savings associations (OCC); 12 CFR part 208, appendix A, section 2(b)(4), 12 CFR part 225, appendix A, section 2(b)(4) (Board); 12 CFR part 325, appendix A section I.A.1.iii(a) (state nonmember banks), and 12 CFR 390.465(a)(2)(vii) (state savings associations). E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62072 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations appropriate circumstances where an institution should be allowed to include the value of its DTAs related to net operating loss carryforwards in regulatory capital. The deduction thresholds for DTAs in the final rule are intended to address the concern that GAAP standards for DTAs could allow banking organizations to include in regulatory capital excessive amounts of DTAs that are dependent upon future taxable income. The concern is particularly acute when banking organizations begin to experience financial difficulty. In this regard, the agencies and the FDIC observed that as the recent financial crisis began, many banking organizations that had included DTAs in regulatory capital based on future taxable income were no longer able to do so because they projected more than one year of losses for tax purposes. The agencies note that under the proposal and final rule, DTAs that arise from temporary differences that the banking organization may realize through net operating loss carrybacks are not subject to the deduction thresholds and will be subject to a risk weight of 100 percent. Further, banking organizations will continue to be permitted to include some or all of their DTAs that are associated with timing differences that are not realizable through net operating loss carrybacks in regulatory capital. In this regard, the final rule strikes an appropriate balance between prudential concerns and practical considerations about the ability of banking organizations to realize DTAs. The proposal stated: ‘‘A [BANK] is not required to deduct from the sum of its common equity tier 1 capital elements net DTAs arising from timing differences that the [BANK] could realize through net operating loss carrybacks (emphasis added).’’ 111 Commenters requested that the agencies and the FDIC clarify that the word ‘‘net’’ in this sentence was intended to refer to DTAs ‘‘net of valuation allowances.’’ The agencies have amended section 22(e) of the final rule text to clarify that the word ‘‘net’’ in this instance was intended to refer to DTAs ‘‘net of any related valuation allowances and net of DTLs.’’ In addition, a commenter requested that the agencies and the FDIC remove the condition in section 22(e) of the final rule providing that only DTAs and DTLs that relate to taxes levied by the same taxing authority may be offset for purposes of the deduction of DTAs. This 111 See footnote 14, 77 FR 52863 (August 30, 2012). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 commenter notes that under a GAAP, a company generally calculates its DTAs and DTLs relating to state income tax in the aggregate by applying a blended state rate. Thus, banking organizations do not typically track DTAs and DTLs on a state-by-state basis for financial reporting purposes. The agencies recognize that under GAAP, if the tax laws of the relevant state and local jurisdictions do not differ significantly from federal income tax laws, then the calculation of deferred tax expense can be made in the aggregate considering the combination of federal, state, and local income tax rates. The rate used should consider whether amounts paid in one jurisdiction are deductible in another jurisdiction. For example, since state and local taxes are deductible for federal purposes, the aggregate combined rate would generally be (1) the federal tax rate plus (2) the state and local tax rates, minus (3) the federal tax effect of the deductibility of the state and local taxes at the federal tax rate. Also, for financial reporting purposes, consistent with GAAP, the agencies allow banking organizations to offset DTAs (net of valuation allowance) and DTLs related to a particular tax jurisdiction. Moreover, for regulatory reporting purposes, consistent with GAAP, the agencies require separate calculations of income taxes, both current and deferred amounts, for each tax jurisdiction. Accordingly, banking organizations must calculate DTAs and DTLs on a state-by-state basis for financial reporting purposes under GAAP and for regulatory reporting purposes. with, a hedge fund or a private equity fund.113 Section 13(d)(3) of the Bank Holding Company Act provides that the relevant agencies ‘‘shall . . . adopt rules imposing additional capital requirements and quantitative limitations, including diversification requirements, regarding activities permitted under [Section 13] if the appropriate Federal banking agencies, the SEC, and the Commodity Futures Trading Commission (CFTC) determine that additional capital and quantitative limitations are appropriate to protect the safety and soundness of banking entities engaged in such activities.’’ The DoddFrank Act also added section 13(d)(4)(B)(iii) to the Bank Holding Company Act, which pertains to investments in a hedge fund or private equity fund organized and offered by a banking entity and provides for deductions from the assets and tangible equity of the banking entity for these investments in hedge funds or private equity funds. On November 7, 2011, the agencies, the FDIC, and the SEC issued a proposal to implement Section 13 of the Bank Holding Company Act.114 The proposal would require a ‘‘banking entity’’ to deduct from tier 1 capital its investments in a hedge fund or a private equity fund that the banking entity organizes and offers.115 The agencies intend to address this capital requirement, as it applies to banking organizations, within the context of the agencies’ entire regulatory capital framework, so that its potential interaction with all other regulatory capital requirements can be fully assessed. 3. Investments in Hedge Funds and Private Equity Funds Pursuant to Section 13 of the Bank Holding Company Act VI. Denominator Changes Related to the Regulatory Capital Changes Consistent with Basel III, the proposal provided a 250 percent risk weight for the portion of the following items that are not otherwise subject to deduction: (1) MSAs, (2) DTAs arising from temporary differences that a banking organization could not realize through net operating loss carrybacks (net of any related valuation allowances and net of Section 13 of the Bank Holding Company Act, which was added by section 619 of the Dodd-Frank Act, contains a number of restrictions and other prudential requirements applicable to any ‘‘banking entity’’ 112 that engages in proprietary trading or has certain interests in, or relationships 112 See 12 U.S.C. 1851. The term ‘‘banking entity’’ is defined in section 13(h)(1) of the Bank Holding Company Act, as amended by section 619 of the Dodd-Frank Act. See 12 U.S.C. 1851(h)(1). The statutory definition includes any insured depository institution (other than certain limited purpose trust institutions), any company that controls an insured depository institution, any company that is treated as a bank holding company for purposes of section 8 of the International Banking Act of 1978 (12 U.S.C. 3106), and any affiliate or subsidiary of any of the foregoing. PO 00000 Frm 00056 Fmt 4701 Sfmt 4700 113 Section 13 of the Bank Holding Company Act defines the terms ‘‘hedge fund’’ and ‘‘private equity fund’’ as ‘‘an issuer that would be an investment company, as defined in the Investment Company Act of 1940, but for section 3(c)(1) or 3(c)(7) of that Act, or such similar funds as the [relevant agencies] may, by rule . . . determine.’’ See 12 U.S.C. 1851(h)(2). 114 See 76 FR 68846 (November 7, 2011). On February 14, 2012, the CFTC published a substantively similar proposed rule implementing section 13 of the Bank Holding Company Act. See 77 FR 8332 (February 14, 2012). 115 See Id., § l.12(d). E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 DTLs, as described in section 22(e) of the rule), and (3) significant investments in the capital of unconsolidated financial institutions in the form of common stock that are not deducted from tier 1 capital. Several commenters objected to the proposed 250 percent risk weight and stated that the agencies and the FDIC instead should apply a 100 percent risk weight to the amount of these assets below the deduction thresholds. Commenters stated that the relatively high risk weight would drive business, particularly mortgage servicing, out of the banking sector and into unregulated shadow banking entities. After considering the comments, the agencies continue to believe that the 250 percent risk weight is appropriate in light of the relatively greater risks inherent in these assets, as described above. These risks are sufficiently significant that concentrations in these assets warrant deductions from capital, and any exposure to these assets merits a higher-than 100 percent risk weight. Therefore, the final rule adopts the proposed treatment without change. The final rule, consistent with the proposal, requires banking organizations to apply a 1,250 percent risk weight to certain exposures that were subject to deduction under the general risk-based capital rules. Therefore, for purposes of calculating total risk-weighted assets, the final rule requires a banking organization to apply a 1,250 percent risk weight to the portion of a creditenhancing interest-only strip (CEIO) that does not constitute an after-tax-gain-onsale. VII. Transition Provisions The proposal established transition provisions for: (i) Minimum regulatory capital ratios; (ii) capital conservation and countercyclical capital buffers; (iii) regulatory capital adjustments and deductions; (iv) non-qualifying capital instruments; and (v) the supplementary leverage ratio. Most of the transition periods in the proposal began on January 1, 2013, and would have provided banking organizations between three and six years to comply with the requirements in the proposed rule. Among other provisions, the proposal would have provided a transition period for the phase-out of non-qualifying capital instruments from regulatory capital under either a three- or ten-year transition period based on the organization’s consolidated total assets. The proposed transition provisions were designed to give banking organizations sufficient time to adjust to the revised capital framework while minimizing the potential impact that implementation VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 could have on their ability to lend. The transition provisions also were designed to ensure compliance with the DoddFrank Act. As a result, they would have been, in certain circumstances, more stringent than the transition arrangements set forth in Basel III. The agencies and the FDIC received multiple comments on the proposed transition framework. Most of the commenters characterized the proposed transition schedule for the minimum capital ratios as overly aggressive and expressed concern that banking organizations would not be able to meet the increased capital requirements (in accordance with the transition schedule) in the current economic environment. Commenters representing community banking organizations argued that such organizations generally have less access to the capital markets relative to larger banking organizations and, therefore, usually increase capital primarily by accumulating retained earnings. Accordingly, these commenters requested additional time to satisfy the minimum capital requirements under the proposed rule, and specifically asked the agencies and the FDIC to provide banking organizations until January 1, 2019 to comply with the proposed minimum capital requirements. Other commenters commenting on behalf of community banking organizations, however, considered the transition period reasonable. One commenter requested a shorter implementation timeframe for the largest banking organizations, asserting that these organizations already comply with the proposed standards. Another commenter suggested removing the transition period and delaying the effective date until the industry more fully recovers from the recent crisis. According to this commenter, the effective date should be delayed to ensure that implementation of the rule would not result in a contraction in aggregate U.S. lending capacity. Several commenters representing SLHCs asked the agencies and the FDIC to delay implementation of the final rule for such organizations until July 21, 2015. Banking organizations not previously supervised by the Board, including SLHCs, become subject to the applicable requirements of section 171 on that date.116 Additionally, these commenters expressed concern that SLHCs would not be able to comply with the new minimum capital requirements before that date because they were not previously subject to the agencies’ risk-based capital framework. 116 12 PO 00000 U.S.C. 5371(b)(4)(D). Frm 00057 Fmt 4701 Sfmt 4700 62073 The commenters asserted that SLHCs would therefore need additional time to change their capital structure, balance sheets, and internal systems to comply with the proposal. These commenters also noted that the Board provided a three-year implementation period for BHCs when the general risk-based capital rules were initially adopted. Commenters representing SLHCs with substantial insurance activity also requested additional time to comply with the proposal because some of these organizations currently operate under a different accounting framework and would require a longer period of time to adapt their systems to the proposed capital rules, which generally are based on GAAP. A number of commenters suggested an effective date based on the publication date of the final rule in the Federal Register. According to the commenters, such an approach would provide banking organizations with certainty regarding the effective date of the final rule that would allow them to plan for and implement any required system and process changes. One commenter requested simultaneous implementation of all three proposals because some elements of the Standardized Approach NPR affect the implementation of the Basel III NPR. A number of commenters also requested additional time to comply with the proposed capital conservation buffer. According to these commenters, implementation of the capital conservation buffer would make the equity instruments of banking organizations less attractive to potential investors and could even encourage divestment among existing shareholders. Therefore, the commenters maintained, the proposed rule would require banking organizations to raise capital by accumulating retained earnings, and doing so could take considerable time in the current economic climate. For these reasons, the commenters asked the agencies and the FDIC to delay implementation of the capital conservation buffer for an additional five years to provide banking organizations sufficient time to increase retained earnings without curtailing lending activity. Other commenters requested that the agencies and the FDIC fully exempt banks with total consolidated assets of $50 billion or less from the capital conservation buffer, further recommending that if the agencies and the FDIC declined to make this accommodation then the phase-in period for the capital conservation buffer should be extended by at least E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62074 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations three years to January 1, 2022, to provide community banking organizations with enough time to meet the new regulatory minimums. A number of commenters noted that Basel III phases in the deduction of goodwill from 2014 to 2018, and requested that the agencies and the FDIC adopt this transition for goodwill in the United States to prevent U.S. institutions from being disadvantaged relative to their global competitors. Many commenters objected to the proposed schedule for the phase out of TruPS from tier 1 capital, particularly for banking organizations with less than $15 billion in total consolidated assets. As discussed in more detail in section V.A., the commenters requested that the agencies and the FDIC grandfather existing TruPS issued by depository institution holding companies with less than $15 billion and 2010 MHCs, as permitted by section 171 of the DoddFrank Act. In general, these commenters characterized TruPS as a relatively safe, low-cost form of capital issued in full compliance with regulatory requirements that would be difficult for smaller institutions to replace in the current economic environment. Some commenters requested that community banking organizations be exempt from the phase-out of TruPS and from the phase-out of cumulative preferred stock for these reasons. Another commenter requested that the agencies and the FDIC propose that institutions with under $5 billion in total consolidated assets be allowed to continue to include TruPS in regulatory capital at full value until the call or maturity of the TruPS instrument. Some commenters encouraged the agencies and the FDIC to adopt the tenyear transition schedule under Basel III for TruPS of banking organizations with total consolidated assets of more than $15 billion. These commenters asserted that the proposed transition framework for TruPS would disadvantage U.S. banking organizations relative to foreign competitors. One commenter expressed concern that the transition framework under the proposed rule also would disrupt payment schedules for TruPS CDOs. Commenters proposed several additional alternative transition frameworks for TruPS. For example, one commenter recommended a 10 percent annual reduction in the amount of TruPS banking organizations with $15 billion or more of total consolidated assets may recognize in tier 1 capital beginning in 2013, followed by a phaseout of the remaining amount in 2015. According to the commenter, such a framework would comply with the VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 Dodd-Frank Act and allow banking organizations more time to replace TruPS. Another commenter suggested that the final rule allow banking organizations to progressively reduce the amount of TruPS eligible for inclusion in tier 1 capital by 1.25 to 2.5 percent per year. One commenter encouraged the agencies and the FDIC to avoid penalizing banking organizations that elect to redeem TruPS during the transition period. Specifically, the commenter asked the agencies and the FDIC to revise the proposed transition framework so that any TruPS redeemed during the transition period would not reduce the total amount of TruPS eligible for inclusion in tier 1 capital. Under such an approach, the amount of TruPS eligible for inclusion in tier 1 capital during the transition period would equal the lesser of: (a) The remaining outstanding balance or (b) the percentage decline factor times the balance outstanding at the time the final rule is published in the Federal Register. One commenter encouraged the agencies and the FDIC to allow a banking organization that grows to more than $15 billion in total assets as a result of merger and acquisition activity to remain subject to the proposed transition framework for non-qualifying capital instruments issued by organizations with less than $15 billion in total assets. According to the commenter, such an approach should apply to either the buyer or seller in the transaction. Other commenters asked the agencies and the FDIC to allow banking organizations whose total consolidated assets grew to over $15 billion just prior to May 19, 2010, and whose asset base subsequently declined below that amount to include all TruPS in their tier 1 capital during 2013 and 2014 on the same basis as institutions with less than $15 billion in total consolidated assets and, thereafter, be subject to the deductions required by section 171 of the Dodd-Frank Act. Commenters representing advanced approaches banking organizations generally objected to the proposed transition framework for the supplementary leverage ratio, and requested a delay in its implementation. For example, one commenter recommended the agencies and the FDIC defer implementation of the supplementary leverage ratio until the agencies and the FDIC have had an opportunity to consider whether it is likely to result in regulatory arbitrage and international competitive inequality as a result of differences in national accounting frameworks and standards. Another commenter asked the agencies PO 00000 Frm 00058 Fmt 4701 Sfmt 4700 and the FDIC to delay implementation of the supplementary leverage ratio until no earlier than January 1, 2018, as provided in Basel III, or until the BCBS completes its assessment and reaches international agreement on any further adjustments. A few commenters, however, supported the proposed transition framework for the supplementary leverage ratio because it could be used as an important regulatory tool to ensure there is sufficient capital in the financial system. After considering the comments and the potential challenges some banking organizations may face in complying with the final rule, the agencies have agreed to delay the compliance date for banking organizations that are not advanced approaches banking organizations and for covered SLHCs until January 1, 2015. Therefore, such entities are not required to calculate their regulatory capital requirements under the final rule until January 1, 2015. Thereafter, these banking organizations must calculate their regulatory capital requirements in accordance with the final rule, subject to the transition provisions set forth in subpart G of the final rule. The final rule also establishes the effective date of the final rule for advanced approaches banking organizations that are not SLHCs as January 1, 2014. In accordance with Tables 5–17 below, the transition provisions for the regulatory capital adjustments and deductions in the final rule commence either one or two years later than in the proposal, depending on whether the banking organization is or is not an advanced approaches banking organization. The December 31, 2018, end-date for the transition period for regulatory capital adjustments and deductions is the same under the final rule as under the proposal. A. Transitions Provisions for Minimum Regulatory Capital Ratios In response to the commenters’ concerns, the final rule modifies the proposed transition provisions for the minimum capital requirements. Banking organizations that are not advanced approaches banking organizations and covered SLHCs are not required to comply with the minimum capital requirements until January 1, 2015. This is a delay of two years from the beginning of the proposed transition period. Because the agencies are not requiring compliance with the final rule until January 1, 2015 for these entities, there is no additional transition period for the minimum regulatory capital ratios. This approach should give E:\FR\FM\11OCR2.SGM 11OCR2 62075 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations banking organizations sufficient time to raise or accumulate any additional capital needed to satisfy the new minimum requirements and upgrade internal systems without adversely affecting their lending capacity. Under the final rule, an advanced approaches banking organization that is not an SLHC must comply with minimum common equity tier 1, tier 1, and total capital ratio requirements of 4.0 percent, 5.5 percent, and 8.0 percent during calendar year 2014, and 4.5 percent, 6.0 percent, 8.0 percent, respectively, beginning January 1, 2015. These transition provisions are consistent with those under Basel III for internationally-active banking organizations. During calendar year 2014, advanced approaches banking organizations must calculate their minimum common equity tier 1, tier 1, and total capital ratios using the definitions for the respective capital components in section 20 of the final rule (adjusted in accordance with the transition provisions for regulatory adjustments and deductions and for the non-qualifying capital instruments for advanced approaches banking organizations described in this section). B. Transition Provisions for Capital Conservation and Countercyclical Capital Buffers The agencies have finalized transitions for the capital conservation and countercyclical capital buffers as proposed. The capital conservation buffer transition period begins in 2016, a full year after banking organizations that are not advanced approaches banking organizations and banking organizations that are covered SLHCs are required to comply with the final rule, and two years after advanced approaches banking organizations that are not SLHCs are required to comply with the final rule. The agencies believe that this is an adequate time frame to meet the buffer level necessary to avoid restrictions on capital distributions. Table 5 shows the regulatory capital levels advanced approaches banking organizations that are not SLHCs generally must satisfy to avoid limitations on capital distributions and discretionary bonus payments during the applicable transition period, from January 1, 2016 until January 1, 2019. TABLE 5—REGULATORY CAPITAL LEVELS FOR ADVANCED APPROACHES BANKING ORGANIZATIONS Jan. 1, 2014 (percent) Capital conservation buffer .............................................. Minimum common equity tier 1 capital ratio + capital conservation buffer ....................................................... Minimum tier 1 capital ratio + capital conservation buffer Minimum total capital ratio + capital conservation buffer Maximum potential countercyclical capital buffer ............ Table 6 shows the regulatory capital levels banking organizations that are not advanced approaches banking organizations and banking organizations Jan. 1, 2015 (percent) Jan. 1, 2016 (percent) Jan. 1, 2017 (percent) Jan. 1, 2018 (percent) Jan. 1, 2019 (percent) .................... .................... 0.625 1.25 1.875 2.5 4.0 5.5 8.0 .................... 4.5 6.0 8.0 .................... 5.125 6.625 8.625 0.625 5.75 7.25 9.25 1.25 6.375 7.875 9.875 1.875 7.0 8.5 10.5 2.5 that are covered SLHCs generally must satisfy to avoid limitations on capital distributions and discretionary bonus payments during the applicable transition period, from January 1, 2016 until January 1, 2019. TABLE 6—REGULATORY CAPITAL LEVELS FOR NON-ADVANCED APPROACHES BANKING ORGANIZATIONS Jan. 1, 2015 (percent) Capital conservation buffer ...................................................................... Minimum common equity tier 1 capital ratio + capital conservation buffer .......................................................................................................... Minimum tier 1 capital ratio + capital conservation buffer ...................... Minimum total capital ratio + capital conservation buffer ........................ As provided in Table 5 and Table 6, the transition period for the capital conservation and countercyclical capital buffers does not begin until January 1, 2016. During this transition period, from January 1, 2016 through December 31, Jan. 1, 2016 (percent) Jan. 1, 2017 (percent) Jan. 1, 2018 (percent) Jan. 1, 2019 (percent) .................... 0.625 1.25 1.875 2.5 4.5 6.0 8.0 5.125 6.625 8.625 5.75 7.25 9.25 6.375 7.875 9.875 7.0 8.5 10.5 2018, all banking organizations are subject to transition arrangements with respect to the capital conservation buffer as outlined in more detail in Table 7. For advanced approaches banking organizations, the countercyclical capital buffer will be phased in according to the transition schedule set forth in Table 7 by proportionately expanding each of the quartiles of the capital conservation buffer. TABLE 7—TRANSITION PROVISION FOR THE CAPITAL CONSERVATION AND COUNTERCYCLICAL CAPITAL BUFFER Maximum payout ratio (as a percentage of eligible retained income) wreier-aviles on DSK5TPTVN1PROD with RULES2 Transition period Capital conservation buffer Calendar year 2016 ............. Greater than 0.625 percent (plus 25 percent of any applicable countercyclical capital buffer amount). Less than or equal to 0.625 percent (plus 25 percent of any applicable countercyclical capital buffer amount), and greater than 0.469 percent (plus 18.75 percent of any applicable countercyclical capital buffer amount). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00059 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 No payout ratio limitation applies. 60. 62076 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations TABLE 7—TRANSITION PROVISION FOR THE CAPITAL CONSERVATION AND COUNTERCYCLICAL CAPITAL BUFFER— Continued Transition period Calendar year 2017 ............. Calendar year 2018 ............. Less than or equal to 0.469 percent (plus 18.75 percent of any applicable countercyclical capital buffer amount), and greater than 0.313 percent (plus 12.5 percent of any applicable countercyclical capital buffer amount). Less than or equal to 0.313 percent (plus 12.5 percent of any applicable countercyclical capital buffer amount), and greater than 0.156 percent (plus 6.25 percent of any applicable countercyclical capital buffer amount). Less than or equal to 0.156 percent (plus 6.25 percent of any applicable countercyclical capital buffer amount). Greater than 1.25 percent (plus 50 percent of any applicable countercyclical capital buffer amount). Less than or equal to 1.25 percent (plus 50 percent of any applicable countercyclical capital buffer amount), and greater than 0.938 percent (plus 37.5 percent of any applicable countercyclical capital buffer amount). Less than or equal to 0.938 percent (plus 37.5 percent of any applicable countercyclical capital buffer amount), and greater than 0.625 percent (plus 25 percent of any applicable countercyclical capital buffer amount). Less than or equal to 0.625 percent (plus 25 percent of any applicable countercyclical capital buffer amount), and greater than 0.313 percent (plus 12.5 percent of any applicable countercyclical capital buffer amount). Less than or equal to 0.313 percent (plus 12.5 percent of any applicable countercyclical capital buffer amount). Greater than 1.875 percent (plus 75 percent of any applicable countercyclical capital buffer amount). Less than or equal to 1.875 percent (plus 75 percent of any applicable countercyclical capital buffer amount), and greater than 1.406 percent (plus 56.25 percent of any applicable countercyclical capital buffer amount). Less than or equal to 1.406 percent (plus 56.25 percent of any applicable countercyclical capital buffer amount), and greater than 0.938 percent (plus 37.5 percent of any applicable countercyclical capital buffer amount). Less than or equal to 0.938 percent (plus 37.5 percent of any applicable countercyclical capital buffer amount), and greater than 0.469 percent (plus 18.75 percent of any applicable countercyclical capital buffer amount). Less than or equal to 0.469 percent (plus 18.75 percent of any applicable countercyclical capital buffer amount). wreier-aviles on DSK5TPTVN1PROD with RULES2 C. Transition Provisions for Regulatory Capital Adjustments and Deductions To give sufficient time to banking organizations to adapt to the new regulatory capital adjustments and deductions, the final rule incorporates transition provisions for such adjustments and deductions that commence at the time at which the banking organization becomes subject to the final rule. As explained above, the final rule maintains the proposed transition periods, except for nonqualifying capital instruments as described below. Banking organizations that are not advanced approaches banking organizations and banking organizations that are covered SLHCs will begin the transitions for regulatory capital adjustments and deductions on January 1, 2015. From January 1, 2015, through December 31, 2017, these banking organizations will be required to make the regulatory capital adjustments to and deductions from regulatory capital in section 22 of the final rule in VerDate Mar<15>2010 13:14 Oct 10, 2013 Maximum payout ratio (as a percentage of eligible retained income) Capital conservation buffer Jkt 232001 accordance with the proposed transition provisions for such adjustments and deductions outlined below. Starting on January 1, 2018, these banking organizations will apply all regulatory capital adjustments and deductions as set forth in section 22 of the final rule. For an advanced approaches banking organization that is not an SLHC, the first year of transition for adjustments and deductions begins on January 1, 2014. From January 1, 2014, through December 31, 2017, such banking organizations will be required to make the regulatory capital adjustments to and deductions from regulatory capital in section 22 of the final rule in accordance with the proposed transition provisions for such adjustments and deductions outlined below. Starting on January 1, 2018, advanced approaches banking organizations will be subject to all regulatory capital adjustments and deductions as described in section 22 of the final rule. PO 00000 Frm 00060 Fmt 4701 Sfmt 4700 40. 20. 0. No payout ratio limitation applies. 60. 40. 20. 0. No payout ratio limitation applies. 60. 40. 20. 0. 1. Deductions for Certain Items Under Section 22(a) of the Final Rule The final rule provides that banking organizations will deduct from common equity tier 1 capital or tier 1 capital in accordance with Table 8 below: (1) Goodwill (section 22(a)(1)); (2) DTAs that arise from operating loss and tax credit carryforwards (section 22(a)(3)); (3) gain-on-sale associated with a securitization exposure (section 22(a)(4)): (4) defined benefit pension fund assets (section 22(a)(5)); (5) for an advanced approaches banking organization that has completed the parallel run process and that has received notification from its primary Federal supervisor pursuant to section 121(d) of subpart E of the final rule, expected credit loss that exceeds eligible credit reserves (section 22(a)(6)); and (6) financial subsidiaries (section 22(a)(7)). During the transition period, the percentage of these items that is not deducted from common equity tier 1 capital must be deducted from tier 1 capital. E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 62077 TABLE 8—TRANSITION DEDUCTIONS UNDER SECTION 22(a)(1) AND SECTIONS 22(a)(3)–(a)(7) OF THE FINAL RULE Transition deductions under sections 22(a)(3)–(a)(6) Transition deductions under section 22(a)(1) and (7) 1 Percentage of the deductions from common equity tier 1 capital Transition period Percentage of the deductions from common equity tier 1 capital January 1, 2014 to December 31, 2014 (advanced approaches banking organizations only) ............................................................................................................... January 1, 2015 to December 31, 2015 ................................................................... January 1, 2016 to December 31, 2016 ................................................................... January 1, 2017 to December 31, 2017 ................................................................... January 1, 2018 and thereafter ................................................................................. 1 In Percentage of the deductions from tier 1 capital 20 40 60 80 100 80 60 40 20 0 100 100 100 100 100 addition, a FSA should deduct from common equity tier 1 non-includable subsidiaries. See 12 CFR 3.22(a)(8). Beginning on January 1, 2014, advanced approaches banking organizations that are not SLHCs will be required to deduct the full amount of goodwill (which may be net of any associated DTLs), including any goodwill embedded in the valuation of significant investments in the capital of unconsolidated financial institutions, from common equity tier 1 capital. All other banking organizations will begin deducting goodwill (which may be net of any associated DTLs), including any goodwill embedded in the valuation of significant investments in the capital of unconsolidated financial institutions from common equity tier 1 capital, on January 1, 2015. This approach is stricter than the Basel III approach, which transitions the goodwill deduction from common equity tier 1 capital through 2017. However, as discussed in section V.B of this preamble, under U.S. law, goodwill cannot be included in a banking organization’s regulatory capital and has not been included in banking organizations’ regulatory capital under the general risk-based capital rules.117 Additionally, the agencies believe that fully deducting goodwill from common equity tier 1 capital from the date a banking organization must comply with the final rule will result in a more appropriate measure of common equity tier 1 capital. Beginning on January 1, 2014, a national bank or insured state bank subject to the advanced approaches rule will be required to deduct 100 percent of the aggregate amount of its outstanding equity investment, including the retained earnings, in any financial subsidiary from common equity tier 1 capital. All other national and insured state banks will begin deducting 100 percent of the aggregate amount of their outstanding equity investment, including the retained earnings, in a financial subsidiary from common equity tier 1 capital on January 1, 2015. The deduction from common equity tier 1 capital represents a change from the general risk-based capital rules, which require the deduction to be made from total capital. As explained in section V.B of this preamble, similar to goodwill, this deduction is required by statute and is consistent with the general risk-based capital rules. Accordingly, the deduction is not subject to a transition period. The final rule also retains the existing deduction for Federal associations’ investments in, and extensions of credit to, non-includable subsidiaries at 12 CFR 3.22(a)(8).118 This deduction is required by statute 119 and is consistent with the general risk-based capital rules. Accordingly, the deduction is not subject to a transition period and must be fully deducted in the first year that the Federal or state savings association becomes subject to the final rule. 2. Deductions for Intangibles Other Than Goodwill and Mortgage Servicing Assets For deductions of intangibles other than goodwill and MSAs, including purchased credit-card relationships (PCCRs) (see section 22(a)(2) of the final rule), the applicable transition period in the final rule is set forth in Table 9. During the transition period, any of these items that are not deducted will be subject to a risk weight of 100 percent. Advanced approaches banking organizations that are not SLHCs will begin the transition on January 1, 2014, and other banking organizations will begin the transition on January 1, 2015. TABLE 9—TRANSITION DEDUCTIONS UNDER SECTION 22(a)(2) OF THE PROPOSAL Transition deductions under section 22(a)(2)—Percentage of the deductions from common equity tier 1 capital wreier-aviles on DSK5TPTVN1PROD with RULES2 Transition period January January January January January 1, 1, 1, 1, 1, 2014 2015 2016 2017 2018 to December 31, 2014 (advanced approaches banking organizations only) .......... to December 31, 2015 ............................................................................................. to December 31, 2016 ............................................................................................. to December 31, 2017 ............................................................................................. and thereafter ........................................................................................................... 117 See 12 U.S.C. 1464(t)(9)(A) and 12 U.S.C. 1828(n). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 118 For additional information on this deduction, see section V.B ‘‘Activities by savings association PO 00000 Frm 00061 Fmt 4701 Sfmt 4700 20 40 60 80 100 subsidiaries that are impermissible for national banks’’ of this preamble. 119 See 12 U.S.C. 1464(t)(5). E:\FR\FM\11OCR2.SGM 11OCR2 62078 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 3. Regulatory Adjustments Under Section 22(b)(1) of the Final Rule During the transition period, any of the adjustments required under section 22(b)(1) that are not applied to common equity tier 1 capital must be applied to tier 1 capital instead, in accordance with Table 10. Advanced approaches banking organizations that are not SLHCs will begin the transition on January 1, 2014, and other banking organizations will begin the transition on January 1, 2015. TABLE 10—TRANSITION ADJUSTMENTS UNDER SECTION 22(b)(1) Transition adjustments under section 22(b)(1) Transition period Percentage of the adjustment applied to common equity tier 1 capital Percentage of the adjustment applied to tier 1 capital 20 40 60 80 100 80 60 40 20 0 January 1, 2014, to December 31, 2014 (advanced approaches banking organizations only) ......................................................... January 1, 2015, to December 31, 2015 ........................................ January 1, 2016, to December 31, 2016 ........................................ January 1, 2017, to December 31, 2017 ........................................ January 1, 2018 and thereafter ....................................................... 4. Phase-out of Current Accumulated Other Comprehensive Income Regulatory Capital Adjustments Under the final rule, the transition period for the inclusion of the aggregate amount of: (1) Unrealized gains on available-for-sale equity securities; (2) net unrealized gains or losses on available-for-sale debt securities; (3) any amounts recorded in AOCI attributed to defined benefit postretirement plans resulting from the initial and subsequent application of the relevant GAAP standards that pertain to such plans (excluding, at the banking organization’s option, the portion relating to pension assets deducted under section 22(a)(5)); (4) accumulated net gains or losses on cash-flow hedges related to items that are reported on the balance sheet at fair value included in AOCI; and (5) net unrealized gains or losses on held-to-maturity securities that are included in AOCI (transition AOCI adjustment amount) only applies to advanced approaches banking organizations and other banking organizations that have not made an AOCI opt-out election under section 22(b)(2) of the rule and described in section V.B of this preamble. Advanced approaches banking organizations that are not SLHCs will begin the phase out of the current AOCI regulatory capital adjustments on January 1, 2014; other banking organizations that have not made the AOCI opt-out election will begin making these adjustments on January 1, 2015. Specifically, if a banking organization’s transition AOCI adjustment amount is positive, it will adjust its common equity tier 1 capital by deducting the appropriate percentage of such aggregate amount in accordance with Table 11 below. If such amount is negative, it will adjust its common equity tier 1 capital by adding back the appropriate percentage of such aggregate amount in accordance with Table 11 below. The agencies and the FDIC did not include net unrealized gains or losses on held-to-maturity securities that are included in AOCI as part of the transition AOCI adjustment amount in the proposal. However, the agencies have decided to add such an adjustment as it reflects the agencies’ approach towards AOCI adjustments in the general risk: Based capital rules. TABLE 11—PERCENTAGE OF THE TRANSITION AOCI ADJUSTMENT AMOUNT Percentage of the transition AOCI adjustment amount to be applied to common equity tier 1 capital Transition period wreier-aviles on DSK5TPTVN1PROD with RULES2 January 1, 2014, to December 31, 2014 (advanced approaches banking organizations only) ......... January 1, 2015, to December 31, 2015 (advanced approaches banking organizations and banking organizations that have not made an opt-out election) ............................................................. January 1, 2016, to December 31, 2016 (advanced approaches banking organizations and banking organizations that have not made an opt-out election) ............................................................. January 1, 2017, to December 31, 2017 (advanced approaches banking organizations and banking organizations that have not made an opt-out election) ............................................................. January 1, 2018 and thereafter (advanced approaches banking organizations and banking organizations that have not made an opt-out election) ............................................................................. Beginning on January 1, 2018, advanced approaches banking organizations and other banking organizations that have not made an AOCI opt-out election must include AOCI in common equity tier 1 capital, with the exception of accumulated net gains and losses on cash-flow hedges related to items that are not measured at fair value on the balance sheet, which VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 must be excluded from common equity tier 1 capital. 5. Phase-Out of Unrealized Gains on Available for Sale Equity Securities in Tier 2 Capital Advanced approaches banking organizations and banking organizations not subject to the advanced approaches rule that have not made an AOCI optout election will decrease the amount of PO 00000 Frm 00062 Fmt 4701 Sfmt 4700 80 60 40 20 0 unrealized gains on AFS preferred stock classified as an equity security under GAAP and AFS equity exposures currently held in tier 2 capital during the transition period in accordance with Table 12. An advanced approaches banking organization that is not an SLHC will begin the adjustments on January 1, 2014; all other banking organizations that have not made an E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 62079 AOCI opt-out election will begin the adjustments on January 1, 2015. TABLE 12—PERCENTAGE OF UNREALIZED GAINS ON AFS PREFERRED STOCK CLASSIFIED AS AN EQUITY SECURITY UNDER GAAP AND AFS EQUITY EXPOSURES THAT MAY BE INCLUDED IN TIER 2 CAPITAL Percentage of unrealized gains on AFS preferred stock classified as an equity security under GAAP and AFS equity exposures that may be included in tier 2 capital Transition period January 1, 2014, to December 31, 2014 (advanced approaches banking organizations only) ......... January 1, 2015, to December 31, 2015 (advanced approaches banking organizations and banking organizations that have not made an opt-out election) ............................................................. January 1, 2016, to December 31, 2016 (advanced approaches banking organizations and banking organizations that have not made an opt-out election) ............................................................. January 1, 2017, to December 31, 2017 (advanced approaches banking organizations and banking organizations that have not made an opt-out election) ............................................................. January 1, 2018 and thereafter (advanced approaches banking organizations and banking organizations that have not made an opt-out election) ............................................................................. 6. Phase-in of Deductions Related to Investments in Capital Instruments and to the Items Subject to the 10 and 15 Percent Common Equity Tier 1 Capital Deduction Thresholds (Sections 22(c) and 22(d)) of the Final Rule Under the final rule, a banking organization must calculate the appropriate deductions under sections 22(c) and 22(d) of the rule related to investments in the capital of unconsolidated financial institutions and to the items subject to the 10 and 15 percent common equity tier 1 capital deduction thresholds (that is, MSAs, DTAs arising from temporary differences that the banking organization could not realize through net operating loss carrybacks, and significant investments in the capital of unconsolidated financial institutions in the form of common stock) as set forth in Table 13. Advanced approaches banking organizations that are not SLHCs will apply the transition framework beginning January 1, 2014. All other banking organizations will begin applying the transition framework on January 1, 2015. During the transition period, a banking 36 27 18 9 0 organization will make the aggregate common equity tier 1 capital deductions related to these items in accordance with the percentages outlined in Table 13 and must apply a 100 percent riskweight to the aggregate amount of such items that is not deducted. On January 1, 2018, and thereafter, each banking organization will be required to apply a 250 percent risk weight to the aggregate amount of the items subject to the 10 and 15 percent common equity tier 1 capital deduction thresholds that are not deducted from common equity tier 1 capital. TABLE 13—TRANSITION DEDUCTIONS UNDER SECTIONS 22(c) AND 22(d) OF THE PROPOSAL Transition deductions under sections 22(c) and 22(d)—Percentage of the deductions from common equity tier 1 capital January 1, 2014, to December 31, 2014 ............................................................................................ (advanced approaches banking organizations only) ........................................................................... January 1, 2015, to December 31, 2015 ............................................................................................ January 1, 2016, to December 31, 2016 ............................................................................................ January 1, 2017, to December 31, 2017 ............................................................................................ January 1, 2018 and thereafter ........................................................................................................... wreier-aviles on DSK5TPTVN1PROD with RULES2 Transition period 20 40 60 80 100 During the transition period, banking organizations will phase in the deduction requirement for the amounts of DTAs arising from temporary differences that could not be realized through net operating loss carryback, MSAs, and significant investments in the capital of unconsolidated financial institutions in the form of common stock that exceed the 10 percent threshold in section 22(d) according to Table 13. During the transition period, banking organizations will not be subject to the methodology to calculate the 15 percent common equity deduction threshold for VerDate Mar<15>2010 14:37 Oct 10, 2013 Jkt 232001 DTAs arising from temporary differences that could not be realized through net operating loss carrybacks, MSAs, and significant investments in the capital of unconsolidated financial institutions in the form of common stock described in section 22(d) of the final rule. During the transition period, a banking organization will be required to deduct from its common equity tier 1 capital the percentage as set forth in Table 13 of the amount by which the aggregate sum of the items subject to the 10 and 15 percent common equity tier 1 capital deduction thresholds exceeds 15 percent of the sum of the banking PO 00000 Frm 00063 Fmt 4701 Sfmt 4700 organization’s common equity tier 1 capital after making the deductions and adjustments required under sections 22(a) through (c). D. Transition Provisions for NonQualifying Capital Instruments Under the final rule, there are different transition provisions for nonqualifying capital instruments depending on the type and size of a banking organization as discussed below. E:\FR\FM\11OCR2.SGM 11OCR2 62080 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 1. Depository Institution Holding Companies With Less than $15 Billion in Total Consolidated Assets as of December 31, 2009 and 2010 Mutual Holding Companies BHCs have historically included (subject to limits) in tier 1 capital ‘‘restricted core capital elements’’ such as cumulative perpetual preferred stock and TruPS, which generally would not comply with the eligibility criteria for additional tier 1 capital instruments outlined in section 20 of the final rule. As discussed in section V.A of this preamble, section 171 of the DoddFrank Act would not require depository institution holding companies with less than $15 billion in total consolidated assets as of December 31, 2009, (depository institution holding companies under $15 billion) or 2010 MHCs to deduct these types of instruments from tier 1 capital. However, as discussed in section V.A of this preamble, above, because these instruments would no longer qualify as tier 1 capital under the proposed criteria and have been found to be less able to absorb losses, the agencies and the FDIC proposed to require depository institution holding companies under $15 billion and 2010 MHCs to phase these instruments out of capital over a 10-year period consistent with Basel III. For the reasons discussed in section V.A of this preamble, as permitted by section 171 of the Dodd-Frank Act, the agencies have decided not to adopt this proposal in the final rule. Depository institution holding companies under $15 billion and 2010 MHCs may continue to include non-qualifying instruments that were issued prior to May 19, 2010 in tier 1 or tier 2 capital in accordance with the general riskbased capital rules, subject to specific limitations. More specifically, these depository institution holding companies will be able to continue including outstanding tier 1 capital nonqualifying capital instruments in additional tier 1 capital (subject to the limit of 25 percent of tier 1 capital elements excluding any non-qualifying capital instruments and after all regulatory capital deductions and adjustments applied to tier 1 capital) until they redeem the instruments or until the instruments mature. Likewise, consistent with the general risk-based capital rules, any tier 1 capital instrument that is excluded from tier 1 because it exceeds the 25 percent limit referenced above can be included in tier 2 capital.120 2. Depository Institutions Under the final rule, beginning on January 1, 2014, an advanced approaches depository institution and beginning on January 1, 2015, a depository institution that is not a depository institution subject to the advanced approaches rule may include in regulatory capital debt or equity instruments issued prior to September 12, 2010 that do not meet the criteria for additional tier 1 or tier 2 capital instruments in section 20 of the final rule, but that were included in tier 1 or tier 2 capital, respectively, as of September 12, 2010 (non-qualifying capital instruments issued prior to September 12, 2010). These instruments may be included up to the percentage of the outstanding principal amount of such non-qualifying capital instruments as of the effective date of the final rule in accordance with the phase-out schedule in Table 14. As of January 1, 2014 for advanced approaches banking organizations that are not SLHCs, and January 1, 2015 for all other banking organizations and for covered SLHCs that are advanced approaches organizations, debt or equity instruments issued after September 12, 2010, that do not meet the criteria for additional tier 1 or tier 2 capital instruments in section 20 of the final rule may not be included in additional tier 1 or tier 2 capital. TABLE 14—PERCENTAGE OF NON-QUALIFYING CAPITAL INSTRUMENTS ISSUED PRIOR TO SEPTEMBER 12, 2010 INCLUDABLE IN ADDITIONAL TIER 1 OR TIER 2 CAPITAL Percentage of non-qualifying capital instruments issued prior to September 2010 includable in additional tier 1 or tier 2 capital for depository institutions Transition Period (calendar year) Calendar Calendar Calendar Calendar Calendar Calendar Calendar Calendar Calendar year year year year year year year year year 2014 2015 2016 2017 2018 2019 2020 2021 2022 (advanced approaches banking organizations only) .......................................... ............................................................................................................................. ............................................................................................................................. ............................................................................................................................. ............................................................................................................................. ............................................................................................................................. ............................................................................................................................. ............................................................................................................................. and thereafter ..................................................................................................... wreier-aviles on DSK5TPTVN1PROD with RULES2 3. Depository Institution Holding Companies With $15 Billion or More in Total Consolidated Assets as of December 31, 2009 That Are Not 2010 Mutual Holding Companies Under the final rule, consistent with the proposal and with section 171 of the Dodd-Frank Act, debt or equity instruments that do not meet the criteria for additional tier 1 or tier 2 capital instruments in section 20 of the final 120 12 CFR part 225, appendix A, 1(b)(3). with the language of the statute, this requirement also applies to those institutions 121 Consistent VerDate Mar<15>2010 14:37 Oct 10, 2013 Jkt 232001 80 70 60 50 40 30 20 10 0 rule, but that were issued and included in tier 1 or tier 2 capital, respectively, prior to May 19, 2010 (non-qualifying capital instruments) and were issued by a depository institution holding company with total consolidated assets greater than or equal to $15 billion as of December 31, 2009 (depository institution holding company of $15 billion or more) that is not a 2010 MHC must be phased out as set forth in Table 15 below.121 More specifically, depository institution holding companies of $15 billion or more that are advanced approaches banking organizations and that are not SLHCs must begin to apply this phase-out on January 1, 2014; other depository institution holding companies of $15 billion or more, including covered SLHCs, must begin to apply the phaseout on January 1, 2015. Accordingly, that, for a brief period of time, exceeded the $15 billion threshold and then subsequently have fallen below it so long as their asset size was greater than or equal to $15 billion in total consolidated assets as of December 31, 2009. PO 00000 Frm 00064 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations under the final rule, a depository institution holding company of $15 billion or more that is an advanced approaches banking organization and that is not an SLHC will be allowed to include only 50 percent of nonqualifying capital instruments in regulatory capital as of January 1, 2014; all depository institution holding companies of $15 billion or more will be allowed to include only 25 percent as of January 1, 2015, and 0 percent as of January 1, 2016, and thereafter. The agencies acknowledge that the majority of existing TruPS would not technically comply with the final rule’s tier 2 capital eligibility criteria (given that existing TruPS allow for acceleration after 5 years of interest deferral) even though these instruments are eligible for inclusion in tier 2 capital under the general risk-based capital rules. However, the agencies believe that: (1) The inclusion of existing TruPS in tier 2 capital (until they are redeemed or they mature) does not raise safety and soundness concerns, and (2) it may be less disruptive to the banking system to allow certain banking organizations to include TruPS in tier 2 capital until they are able to replace such instruments with new capital instruments that fully comply with the eligibility criteria of the final rule. Accordingly, the agencies have decided to permit non-advanced approaches depository institution holding companies with over $15 billion in total consolidated assets permanently to include non-qualifying capital instruments, including TruPS that are phased out of tier 1 capital in tier 2 capital and not phase-out those instruments. Under the final rule, advanced approaches depository institution holding companies will not be permitted to permanently include 62081 existing non-qualifying capital instruments in tier 2 capital if they do not meet tier 2 criteria under the final rule. Such banking organizations generally face fewer market obstacles in replacing non-qualifying capital instruments than smaller banking organizations. From January 1, 2016, until December 31, 2021, these banking organizations will be required to phase out non-qualifying capital instruments from tier 2 capital in accordance with the percentages in Table 14 above. Consequently, an advanced approaches depository institution holding company will be allowed to include in tier 2 capital in calendar year 2016 up to 60 percent of the principal amount of TruPS that such banking organization had outstanding as of January 1, 2014, but will not be able to include any of these instruments in regulatory capital after year-end 2021. TABLE 15—PERCENTAGE OF NON-QUALIFYING CAPITAL INSTRUMENTS INCLUDABLE IN ADDITIONAL TIER 1 OR TIER 2 CAPITAL Percentage of non-qualifying capital instruments includable in additional tier 1 or tier 2 capital for depository institution holding companies of $15 billion or more Calendar year 2014 (advanced approaches banking organizations only) .......................................... Calendar year 2015 ............................................................................................................................. Calendar year 2016 And thereafter ..................................................................................................... wreier-aviles on DSK5TPTVN1PROD with RULES2 Transition period (calendar year) 50 25 0 4. Merger and Acquisition Transition Provisions Under the final rule, consistent with the proposal, if a depository institution holding company of $15 billion or more acquires a depository institution holding company with total consolidated assets of less than $15 billion as of December 31, 2009 or a 2010 MHC, the non-qualifying capital instruments of the resulting organization will be subject to the phase-out schedule outlined in Table 15, above. Likewise, if a depository institution holding company under $15 billion makes an acquisition and the resulting organization has total consolidated assets of $15 billion or more, its non-qualifying capital instruments also will be subject to the phase-out schedule outlined in Table 15, above. Some commenters argued that this provision could create disincentives for mergers and acquisitions, but the agencies continue to believe these provisions VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 appropriately subject institutions that are larger (or that become larger) to the stricter phase-out requirements for nonqualifying capital instruments, consistent with the language and intent of section 171 of the Dodd-Frank Act. Depository institution holding companies under $15 billion and 2010 MHCs that merge with or acquire other banking organizations that result in organizations that remain below $15 billion or remain MHCs would be able to continue to include non-qualifying capital instruments in regulatory capital. 5. Phase-Out Schedule for Surplus and Non-Qualifying Minority Interest Under the transition provisions in the final rule, a banking organization is allowed to include in regulatory capital a portion of the common equity tier 1, tier 1, or total capital minority interest that is disqualified from regulatory capital as a result of the requirements and limitations outlined in section 21 PO 00000 Frm 00065 Fmt 4701 Sfmt 4700 (surplus minority interest). If a banking organization has surplus minority interest outstanding when the final rule becomes effective, that surplus minority interest will be subject to the phase-out schedule outlined in Table 16. Advanced approaches banking organizations that are not SLHCs must begin to phase out surplus minority interest in accordance with Table 16 beginning on January 1, 2014. All other banking organizations will begin the phase out for surplus minority interest on January 1, 2015. During the transition period, a banking organization will also be able to include in tier 1 or total capital a portion of the instruments issued by a consolidated subsidiary that qualified as tier 1 or total capital of the banking organization on the date the rule becomes effective, but that do not qualify as tier 1 or total capital under section 20 of the final rule (nonqualifying minority interest) in accordance with Table 16. E:\FR\FM\11OCR2.SGM 11OCR2 62082 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations TABLE 16 —PERCENTAGE OF THE AMOUNT OF SURPLUS OR NON-QUALIFYING MINORITY INTEREST INCLUDABLE IN REGULATORY CAPITAL DURING TRANSITION PERIOD Percentage of the amount of surplus or non-qualifying minority interest that can be included in regulatory capital during the transition period Transition period January January January January January 1, 1, 1, 1, 1, 2014, to December 31, 2014 (advanced approaches banking organizations only) ......... 2015, to December 31, 2015 ............................................................................................ 2016, to December 31, 2016 ............................................................................................ 2017, to December 31, 2017 ............................................................................................ 2018 and thereafter ........................................................................................................... VIII. Standardized Approach for RiskWeighted Assets In the Standardized Approach NPR, the agencies and the FDIC proposed to revise methodologies for calculating risk-weighted assets. As discussed above and in the proposal, these revisions were intended to harmonize the agencies’ and the FDIC’s rules for calculating risk-weighted assets and to enhance the risk sensitivity and remediate weaknesses identified over recent years.122 The proposed revisions incorporated elements of the Basel II standardized approach 123 as modified by the 2009 Enhancements, certain aspects of Basel III, and other proposals in recent consultative papers published by the BCBS.124 Consistent with section 939A of the Dodd-Frank Act, the agencies and the FDIC also proposed alternatives to credit ratings for calculating risk weights for certain assets. The proposal also included potential revisions for the recognition of credit risk mitigation that would allow for greater recognition of financial collateral and a wider range of eligible guarantors. In addition, the proposal set forth more risk-sensitive treatments for residential mortgages, equity exposures and past due loans, derivatives and repo-style transactions cleared through CCPs, and certain commercial real estate exposures that typically have higher credit risk, as well as operational requirements for securitization exposures. The agencies and the FDIC also proposed to apply disclosure requirements to top-tier banking organizations with $50 billion 122 77 FR 52888 (August 30, 2012). BCBS, ‘‘International Convergence of Capital Measurement and Capital Standards: A Revised Framework,’’ (June 2006), available at https://www.bis.org/publ/bcbs128.htm. 124 See, e.g., ‘‘Basel III FAQs answered by the Basel Committee’’ (July, October, December 2011), available at https://www.bis.org/list/press_releases/ index.htm; ‘‘Capitalization of Banking Organization Exposures to Central Counterparties’’ (December 2010, revised November 2011) (CCP consultative release), available at https://www.bis.org/publ/ bcbs206.pdf. wreier-aviles on DSK5TPTVN1PROD with RULES2 123 See VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 or more in total assets that are not subject to the advanced approaches rule. The agencies and the FDIC received a significant number of comments regarding the proposed standardized approach for risk-weighted assets. Although a few commenters observed that the proposals would provide a sound framework for determining riskweighted assets for all banking organizations that would generally benefit U.S. banking organizations, a significant number of other commenters asserted that the proposals were too complex and burdensome, especially for smaller banking organizations, and some argued that it was inappropriate to apply the proposed requirements to such banking organizations because such institutions did not cause the recent financial crisis. Other commenters expressed concern that the new calculation for risk-weighted assets would adversely affect banking organizations’ regulatory capital ratios and that smaller banking organizations would have difficulties obtaining the data and performing the calculations required by the proposals. A number of commenters also expressed concern about the burden of the proposals in the context of multiple new regulations, including new standards for mortgages and increased regulatory capital requirements generally. One commenter urged the agencies and the FDIC to maintain key aspects of the proposed risk-weighted asset treatment for community banking organizations, but generally requested that the agencies and the FDIC reduce the perceived complexity. The agencies have considered these comments and, where applicable, have focused on simplicity, comparability, and broad applicability of methodologies for U.S. banking organizations under the standardized approach. Some commenters asked that the proposed requirements be optional for community banking organizations until the effects of the proposals have been studied, or that the proposed standardized approach be withdrawn PO 00000 Frm 00066 Fmt 4701 Sfmt 4700 80 60 40 20 0 entirely. A number of the commenters requested specific modifications to the proposals. For example, some requested an exemption for community banking organizations from the proposed due diligence requirements for securitization exposures. Other commenters requested that the agencies and the FDIC grandfather the risk weighting of existing loans, arguing that doing so would lessen the proposed rule’s implementation burden. To address commenters’ concerns about the standardized approach’s burden and the accessibility of credit, the agencies have revised elements of the proposed rule, as described in further detail below. In particular, the agencies have modified the proposed approach to risk weighting residential mortgage loans to reflect the approach in the agencies general risk-based capital rules. The agencies believe the standardized approach more accurately captures the risk of banking organizations’ assets and, therefore, are applying this aspect of the final rule to all banking organizations subject to the rule. This section of the preamble describes in detail the specific proposals for the standardized treatment of risk-weighted assets, comments received on those proposals, and the provisions of the final rule in subpart D as adopted by the agencies. These sections of the preamble discuss how subpart D of the final rule differs from the general risk-based capital rules, and provides examples for how a banking organization must calculate risk-weighted asset amounts under the final rule. Beginning on January 1, 2015, all banking organizations will be required to calculate risk-weighted assets under subpart D of the final rule. Until then, banking organizations must calculate risk-weighted assets using the methodologies set forth in the general risk-based capital rules. Advanced approaches banking organizations are subject to additional requirements, as described in section III.D of this E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations preamble, regarding the timeframe for implementation. A. Calculation of Standardized Total Risk-Weighted Assets Consistent with the Standardized Approach NPR, the final rule requires a banking organization to calculate its risk-weighted asset amounts for its onand off-balance sheet exposures and, for market risk banks only, standardized market risk-weighted assets as determined under subpart F.125 Riskweighted asset amounts generally are determined by assigning on-balance sheet assets to broad risk-weight categories according to the counterparty, or, if relevant, the guarantor or collateral. Similarly, risk-weighted asset amounts for off-balance sheet items are calculated using a two-step process: (1) Multiplying the amount of the offbalance sheet exposure by a credit conversion factor (CCF) to determine a credit equivalent amount, and (2) assigning the credit equivalent amount to a relevant risk-weight category. A banking organization must determine its standardized total riskweighted assets by calculating the sum of (1) its risk-weighted assets for general credit risk, cleared transactions, default fund contributions, unsettled transactions, securitization exposures, and equity exposures, each as defined below, plus (2) market risk-weighted assets, if applicable, minus (3) the amount of the banking organization’s ALLL that is not included in tier 2 capital, and any amounts of allocated transfer risk reserves. wreier-aviles on DSK5TPTVN1PROD with RULES2 B. Risk-Weighted Assets for General Credit Risk Consistent with the proposal, under the final rule total risk-weighted assets for general credit risk equals the sum of the risk-weighted asset amounts as calculated under section 31(a) of the final rule. General credit risk exposures include a banking organization’s onbalance sheet exposures (other than cleared transactions, default fund contributions to CCPs, securitization exposures, and equity exposures, each as defined in section 2 of the final rule), exposures to over-the-counter (OTC) derivative contracts, off-balance sheet commitments, trade and transactionrelated contingencies, guarantees, repostyle transactions, financial standby letters of credit, forward agreements, or other similar transactions. Under the final rule, the exposure amount for the on-balance sheet 125 This final rule incorporates the market risk rule into the integrated regulatory framework as subpart F. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 component of an exposure is generally the banking organization’s carrying value for the exposure as determined under GAAP. The agencies believe that using GAAP to determine the amount and nature of an exposure provides a consistent framework that can be easily applied across all banking organizations. Generally, banking organizations already use GAAP to prepare their financial statements and regulatory reports, and this treatment reduces potential burden that could otherwise result from requiring banking organizations to comply with a separate set of accounting and measurement standards for risk-based capital calculation purposes under non-GAAP standards, such as regulatory accounting practices or legal classification standards. For purposes of the definition of exposure amount for AFS or held-tomaturity debt securities and AFS preferred stock not classified as equity under GAAP that are held by a banking organization that has made an AOCI opt-out election, the exposure amount is the banking organization’s carrying value (including net accrued but unpaid interest and fees) for the exposure, less any net unrealized gains, and plus any net unrealized losses. For purposes of the definition of exposure amount for AFS preferred stock classified as an equity security under GAAP that is held by a banking organization that has made an AOCI opt-out election, the exposure amount is the banking organization’s carrying value (including net accrued but unpaid interest and fees) for the exposure, less any net unrealized gains that are reflected in such carrying value but excluded from the banking organization’s regulatory capital. In most cases, the exposure amount for an off-balance sheet component of an exposure is determined by multiplying the notional amount of the off-balance sheet component by the appropriate CCF as determined under section 33 of the final rule. The exposure amount for an OTC derivative contract or cleared transaction is determined under sections 34 and 35, respectively, of the final rule, whereas exposure amounts for collateralized OTC derivative contracts, collateralized cleared transactions, repo-style transactions, and eligible margin loans are determined under section 37 of the final rule. 1. Exposures to Sovereigns Consistent with the proposal, the final rule defines a sovereign as a central government (including the U.S. government) or an agency, department, ministry, or central bank of a central PO 00000 Frm 00067 Fmt 4701 Sfmt 4700 62083 government. In the Standardized Approach NPR, the agencies and the FDIC proposed to retain the general riskbased capital rules’ risk weights for exposures to and claims directly and unconditionally guaranteed by the U.S. government or its agencies. The final rule adopts the proposed treatment and provides that exposures to the U.S. government, its central bank, or a U.S. government agency and the portion of an exposure that is directly and unconditionally guaranteed by the U.S. government, the U.S. central bank, or a U.S. government agency receive a zero percent risk weight.126 Consistent with the general risk-based capital rules, the portion of a deposit or other exposure insured or otherwise unconditionally guaranteed by the FDIC or the National Credit Union Administration also is assigned a zero percent risk weight. An exposure conditionally guaranteed by the U.S. government, its central bank, or a U.S. government agency receives a 20 percent risk weight.127 This includes an exposure that is conditionally guaranteed by the FDIC or the National Credit Union Administration. The agencies and the FDIC proposed in the Standardized Approach NPR to revise the risk weights for exposures to foreign sovereigns. The agencies’ general risk-based capital rules generally assign risk weights to direct exposures to sovereigns and exposures directly guaranteed by sovereigns based on whether the sovereign is a member of the Organization for Economic Cooperation and Development (OECD) and, as applicable, whether the exposure is unconditionally or conditionally guaranteed by the sovereign.128 Under the proposed rule, the risk weight for a foreign sovereign exposure 126 Similar to the general risk-based capital rules, a claim would not be considered unconditionally guaranteed by a central government if the validity of the guarantee is dependent upon some affirmative action by the holder or a third party, for example, asset servicing requirements. See 12 CFR part 3, appendix A, section 1(c)(11) (national banks) and 12 CFR 167.6 (Federal savings associations) (OCC); 12 CFR parts 208 and 225, appendix A, section III.C.1 (Board). 127 Loss-sharing agreements entered into by the FDIC with acquirers of assets from failed institutions are considered conditional guarantees for risk-based capital purposes due to contractual conditions that acquirers must meet. The guaranteed portion of assets subject to a losssharing agreement may be assigned a 20 percent risk weight. Because the structural arrangements for these agreements vary depending on the specific terms of each agreement, institutions should consult with their primary Federal regulator to determine the appropriate risk-based capital treatment for specific loss-sharing agreements. 128 12 CFR part 3, appendix A, section 3 (national banks) and 12 CFR 167.6 (Federal savings associations) (OCC); 12 CFR parts 208 and 225, appendix A, section III.C.1 (Board). E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62084 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations would have been determined using OECD Country Risk Classifications (CRCs) (the CRC methodology).129 The CRCs reflect an assessment of country risk, used to set interest rate charges for transactions covered by the OECD arrangement on export credits. The CRC methodology classifies countries into one of eight risk categories (0–7), with countries assigned to the zero category having the lowest possible risk assessment and countries assigned to the 7 category having the highest possible risk assessment. Using CRCs to risk weight sovereign exposures is an option that is included in the Basel II standardized framework. The agencies and the FDIC proposed to map risk weights ranging from 0 percent to 150 percent to CRCs in a manner consistent with the Basel II standardized approach, which provides risk weights for foreign sovereigns based on country risk scores. The agencies and the FDIC also proposed to assign a 150 percent risk weight to foreign sovereign exposures immediately upon determining that an event of sovereign default has occurred or if an event of sovereign default has occurred during the previous five years. The proposal defined sovereign default as noncompliance by a sovereign with its external debt service obligations or the inability or unwillingness of a sovereign government to service an existing loan according to its original terms, as evidenced by failure to pay principal or interest fully and on a timely basis, arrearages, or restructuring. Restructuring would include a voluntary or involuntary restructuring that results in a sovereign not servicing an existing obligation in accordance with the obligation’s original terms. The agencies and the FDIC received several comments on the proposed risk weights for foreign sovereign exposures. Some commenters criticized the proposal, arguing that CRCs are not sufficiently risk sensitive and basing risk weights on CRCs unduly benefits certain jurisdictions with unstable fiscal positions. A few commenters asserted that the increased burden associated with tracking CRCs to determine risk weights outweighs any increased risk sensitivity gained by using CRCs relative to the general risk-based capital rules. Some commenters also requested that the CRC methodology be disclosed so that banking organizations could perform their own due diligence. One commenter also indicated that community banking organizations 129 For more information on the OECD country risk classification methodology, see OECD, ‘‘Country Risk Classification,’’ available at https:// www.oecd.org/document/49/ 0,3746,en_2649_34169_1901105_1_1_1_1,00.html. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 should be permitted to maintain the treatment under the general risk-based capital rules. Following the publication of the proposed rule, the OECD determined that certain high-income countries that received a CRC of 0 in 2012 will no longer receive any CRC.130 Despite the limitations associated with risk weighting foreign sovereign exposures using CRCs, the agencies have decided to retain this methodology, modified as described below to take into account that some countries will no longer receive a CRC. Although the agencies recognize that the risk sensitivity provided by the CRCs is limited, they consider CRCs to be a reasonable alternative to credit ratings for sovereign exposures and the CRC methodology to be more granular and risk sensitive than the current riskweighting methodology based solely on OECD membership. Furthermore, the OECD regularly updates CRCs and makes the assessments publicly available on its Web site.131 Accordingly, the agencies believe that risk weighting foreign sovereign exposures with reference to CRCs (as applicable) should not unduly burden banking organizations. Additionally, the 150 percent risk weight assigned to defaulted sovereign exposures should mitigate the concerns raised by some commenters that the use of CRCs assigns inappropriate risk weights to exposures to countries experiencing fiscal stress. The final rule assigns risk weights to foreign sovereign exposures as set forth in Table 17 below. The agencies modified the final rule to reflect a change in OECD practice for assigning CRCs for certain member countries so that those member countries that no longer receive a CRC are assigned a zero percent risk weight. Applying a zero percent risk weight to exposures to these countries is appropriate because they will remain subject to the same market credit risk pricing formulas of the OECD’s rating methodologies that are applied to all OECD countries with a CRC of 0. In other words, OECD 130 See https://www.oecd.or/tad/xcred/cat0.htm Participants to the Arrangement on Officially Supported Export Credits agreed that the automatic classification of High Income OECD and High Income Euro Area countries in Country Risk Category Zero should be terminated. In the future, these countries will no longer be classified but will remain subject to the same market credit risk pricing disciplines that are applied to all Category Zero countries. This means that the change will have no practical impact on the rules that apply to the provision of official export credits. 131 For more information on the OECD country risk classification methodology, see OECD, ‘‘Country Risk Classification,’’ available at https:// www.oecd.org/document/49/0,3746,en_2649_ 34169_1901105_1_1_1_1,00.html. PO 00000 Frm 00068 Fmt 4701 Sfmt 4700 member countries that are no longer assigned a CRC exhibit a similar degree of country risk as that of a jurisdiction with a CRC of zero. The final rule, therefore, provides a zero percent risk weight in these cases. Additionally, a zero percent risk weight for these countries is generally consistent with the risk weight they would receive under the agencies’ general risk-based capital rules. TABLE 17—RISK WEIGHTS FOR SOVEREIGN EXPOSURES Risk weight (in percent) CRC: 0–1 .................................... 2 ........................................ 3 ........................................ 4–6 .................................... 7 ........................................ 0 20 50 100 150 OECD Member with No CRC 0 Non-OECD Member with No CRC .................................. 100 Sovereign Default ................. 150 Consistent with the proposal, the final rule provides that if a banking supervisor in a sovereign jurisdiction allows banking organizations in that jurisdiction to apply a lower risk weight to an exposure to the sovereign than Table 17 provides, a U.S. banking organization may assign the lower risk weight to an exposure to the sovereign, provided the exposure is denominated in the sovereign’s currency and the U.S. banking organization has at least an equivalent amount of liabilities in that foreign currency. 2. Exposures to Certain Supranational Entities and Multilateral Development Banks Under the general risk-based capital rules, exposures to certain supranational entities and MDBs receive a 20 percent risk weight. Consistent with the Basel II standardized framework, the agencies and the FDIC proposed to apply a zero percent risk weight to exposures to the Bank for International Settlements, the European Central Bank, the European Commission, and the International Monetary Fund. The agencies and the FDIC also proposed to apply a zero percent risk weight to exposures to an MDB in accordance with the Basel framework. The proposal defined an MDB to include the International Bank for Reconstruction and Development, the Multilateral Investment Guarantee Agency, the International Finance Corporation, the Inter-American Development Bank, the Asian E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 Development Bank, the African Development Bank, the European Bank for Reconstruction and Development, the European Investment Bank, the European Investment Fund, the Nordic Investment Bank, the Caribbean Development Bank, the Islamic Development Bank, the Council of Europe Development Bank, and any other multilateral lending institution or regional development bank in which the U.S. government is a shareholder or contributing member or which the primary Federal supervisor determines poses comparable credit risk. As explained in the proposal, the agencies believe this treatment is appropriate in light of the generally high-credit quality of MDBs, their strong shareholder support, and a shareholder structure comprised of a significant proportion of sovereign entities with strong creditworthiness. The agencies have adopted this aspect of the proposal without change. Exposures to regional development banks and multilateral lending institutions that are not covered under the definition of MDB generally are treated as corporate exposures assigned to the 100 percent risk weight category. 3. Exposures to Government-Sponsored Enterprises The general risk-based capital rules assign a 20 percent risk weight to exposures to GSEs that are not equity exposures and a 100 percent risk weight to GSE preferred stock in the case of the Board (the OCC has assigned a 20 percent risk weight to GSE preferred stock). The agencies and the FDIC proposed to continue to assign a 20 percent risk weight to exposures to GSEs that are not equity exposures and to also assign a 100 percent risk weight to preferred stock issued by a GSE. As explained in the proposal, the agencies believe these risk weights remain appropriate for the GSEs under their current circumstances, including those in the conservatorship of the Federal Housing Finance Agency and receiving capital support from the U.S. Treasury. The agencies maintain that the obligations of the GSEs, as private corporations whose obligations are not explicitly guaranteed by the full faith and credit of the United States, should not receive the same treatment as obligations that have such an explicit guarantee. 4. Exposures to Depository Institutions, Foreign Banks, and Credit Unions The general risk-based capital rules assign a 20 percent risk weight to all exposures to U.S. depository institutions and foreign banks VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 incorporated in an OECD country. Under the general risk-based capital rules, short-term exposures to foreign banks incorporated in a non-OECD country receive a 20 percent risk weight and long-term exposures to such entities receive a 100 percent risk weight. The proposed rule would assign a 20 percent risk weight to exposures to U.S. depository institutions and credit unions.132 Consistent with the Basel II standardized framework, under the proposed rule, an exposure to a foreign bank would receive a risk weight one category higher than the risk weight assigned to a direct exposure to the foreign bank’s home country, based on the assignment of risk weights by CRC, as discussed above.133 A banking organization would be required to assign a 150 percent risk weight to an exposure to a foreign bank immediately upon determining that an event of sovereign default has occurred in the foreign bank’s home country, or if an event of sovereign default has occurred in the foreign bank’s home country during the previous five years. A few commenters asserted that the proposed 20 percent risk weight for exposures to U.S. banking organizations—when compared to corporate exposures that are assigned a 100 percent risk weight—would continue to encourage banking organizations to become overly concentrated in the financial sector. The agencies have concluded that the proposed 20 percent risk weight is an appropriate reflection of risk for this exposure type when taking into consideration the extensive regulatory and supervisory frameworks under which these institutions operate. In addition, the agencies note that exposures to the capital of other financial institutions, including depository institutions and credit unions, are subject to deduction from capital if they exceed certain limits as set forth in section 22 of the final rule (discussed above in section V.B of this preamble). Therefore, the final rule retains, as proposed, the 20 percent risk weight for exposures to U.S. banking organizations. The agencies have adopted the proposal with modifications to take into account the OECD’s decision to 132 A depository institution is defined in section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)(1)). Under this final rule, a credit union refers to an insured credit union as defined under the Federal Credit Union Act (12 U.S.C. 1752(7)). 133 Foreign bank means a foreign bank as defined in § 211.2 of the Federal Reserve Board’s Regulation K (12 CFR 211.2), that is not a depository institution. For purposes of the proposal, home country meant the country where an entity is incorporated, chartered, or similarly established. PO 00000 Frm 00069 Fmt 4701 Sfmt 4700 62085 withdraw CRCs for certain OECD member countries. Accordingly, exposures to a foreign bank in a country that does not have a CRC, but that is a member of the OECD, are assigned a 20 percent risk weight and exposures to a foreign bank in a non-OECD member country that does not have a CRC continue to receive a 100 percent risk weight. Additionally, the agencies have adopted the proposed requirement that exposures to a financial institution that are included in the regulatory capital of such financial institution receive a risk weight of 100 percent, unless the exposure is (1) An equity exposure, (2) a significant investment in the capital of an unconsolidated financial institution in the form of common stock under section 22 of the final rule, (3) an exposure that is deducted from regulatory capital under section 22 of the final rule, or (4) an exposure that is subject to the 150 percent risk weight under Table 2 of section 32 of the final rule. As described in the Standardized Approach NPR, in 2011, the BCBS revised certain aspects of the Basel capital framework to address potential adverse effects of the framework on trade finance in low-income countries.134 In particular, the framework was revised to remove the sovereign floor for trade finance-related claims on banking organizations under the Basel II standardized approach.135 The proposal incorporated this revision and would have permitted a banking organization to assign a 20 percent risk weight to self-liquidating trade-related contingent items that arise from the movement of goods and that have a maturity of three months or less.136 Consistent with the proposal, the final rule permits a banking organization to assign a 20 percent risk weight to selfliquidating, trade-related contingent items that arise from the movement of 134 See BCBS, ‘‘Treatment of Trade Finance under the Basel Capital Framework,’’ (October 2011), available at https://www.bis.org/publ/bcbs205.pdf. ‘‘Low income country’’ is a designation used by the World Bank to classify economies (see World Bank, ‘‘How We Classify Countries,’’ available at https:// data.worldbank.org/about/country-classifications). 135 The BCBS indicated that it removed the sovereign floor for such exposures to make access to trade finance instruments easier and less expensive for low income countries. Absent removal of the floor, the risk weight assigned to these exposures, where the issuing banking organization is incorporated in a low income country, typically would be 100 percent. 136 One commenter requested that the agencies and the FDIC confirm whether short-term selfliquidating trade finance instruments are considered exempt from the one-year maturity floor in the advances approaches rule. Section 131(d)(7) of the final rule provides that a trade-related letter of credit is exempt from the one-year maturity floor. E:\FR\FM\11OCR2.SGM 11OCR2 62086 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations goods and that have a maturity of three months or less. As discussed in the proposal, although the Basel capital framework permits exposures to securities firms that meet certain requirements to be assigned the same risk weight as exposures to depository institutions, the agencies do not believe that the risk profile of securities firms is sufficiently similar to depository institutions to justify assigning the same risk weight to both exposure types. Therefore, the agencies and the FDIC proposed that banking organizations assign a 100 percent risk weight to exposures to securities firms, which is the same risk weight applied to BHCs, SLHCs, and other financial institutions that are not insured depository institutions or credit unions, as described in section VIII.B of this preamble. Several commenters asserted that the final rule should be consistent with the Basel framework and permit lower risk weights for exposures to securities firms, particularly for securities firms in a sovereign jurisdiction with a CRC of 0 or 1. The agencies considered these comments and have concluded that that exposures to securities firms exhibit a similar degree of risk as exposures to other financial institutions that are assigned a 100 percent risk weight, because of the nature and risk profile of their activities, which are more expansive and exhibit more varied risk profiles than the activities permissible for depository institutions and credit unions. Accordingly, the agencies have adopted the 100 percent risk weight for securities firms without change. 5. Exposures to Public-Sector Entities The proposal defined a PSE as a state, local authority, or other governmental subdivision below the level of a sovereign, which includes U.S. states and municipalities. The proposed definition did not include governmentowned commercial companies that engage in activities involving trade, commerce, or profit that are generally conducted or performed in the private sector. The agencies and the FDIC proposed to define a general obligation as a bond or similar obligation that is backed by the full faith and credit of a PSE, whereas a revenue obligation would be defined as a bond or similar obligation that is an obligation of a PSE, but which the PSE has committed to repay with revenues from a specific project rather than general tax funds. In the final rule, the agencies are adopting these definitions as proposed. The agencies and the FDIC proposed to assign a 20 percent risk weight to a general obligation exposure to a PSE that is organized under the laws of the United States or any state or political subdivision thereof, and a 50 percent risk weight to a revenue obligation exposure to such a PSE. These are the risk weights assigned to U.S. states and municipalities under the general riskbased capital rules. Some commenters asserted that available default data does not support a differentiated treatment between revenue obligations and general obligations. In addition, some commenters contended that higher risk weights for revenue obligation bonds would needlessly and adversely affect state and local agencies’ ability to meet the needs of underprivileged constituents. One commenter specifically recommended assigning a 20 percent risk weight to investmentgrade revenue obligations. Another commenter recommended that exposures to U.S. PSEs should receive the same treatment as exposures to the U.S. government. The agencies considered these comments, including with respect to burden on state and local programs, but concluded that the higher regulatory capital requirement for revenue obligations is appropriate because those obligations are dependent on revenue from specific projects and generally a PSE is not legally obligated to repay these obligations from other revenue sources. Although some evidence may suggest that there are not substantial differences in credit quality between general and revenue obligation exposures, the agencies believe that such dependence on project revenue presents more credit risk relative to a general repayment obligation of a state or political subdivision of a sovereign. Therefore, the proposed differentiation of risk weights between general obligation and revenue exposures is retained in the final rule. The agencies also continue to believe that PSEs collectively pose a greater credit risk than U.S. sovereign debt and, therefore, are appropriately assigned a higher risk weight under the final rule. Consistent with the Basel II standardized framework, the agencies and the FDIC proposed to require banking organizations to risk weight exposures to a non-U.S. PSE based on (1) the CRC assigned to the PSE’s home country and (2) whether the exposure is a general obligation or a revenue obligation. The risk weights assigned to revenue obligations were proposed to be higher than the risk weights assigned to a general obligation issued by the same PSE. For purposes of the final rule, the agencies have adopted the proposed risk weights for non-U.S. PSEs with modifications to take into account the OECD’s decision to withdraw CRCs for certain OECD member countries (discussed above), as set forth in Table 18 below. Under the final rule, exposures to a non-U.S. PSE in a country that does not have a CRC and is not an OECD member receive a 100 percent risk weight. Exposures to a nonU.S. PSE in a country that has defaulted on any outstanding sovereign exposure or that has defaulted on any sovereign exposure during the previous five years receive a 150 percent risk weight. TABLE 18—RISK WEIGHTS FOR EXPOSURES TO NON-U.S. PSE GENERAL OBLIGATIONS AND REVENUE OBLIGATIONS [In percent] wreier-aviles on DSK5TPTVN1PROD with RULES2 Risk weight for exposures to nonU.S. PSE general obligations Risk weight for exposures to nonU.S.PSE revenue obligations 20 50 100 150 20 100 150 50 100 100 150 50 100 150 CRC: 0–1 ............................................................................................ 2 ................................................................................................ 3 ................................................................................................ 4–7 ............................................................................................ OECD Member with No CRC .......................................................... Non-OECD member with No CRC .................................................. Sovereign Default ............................................................................ VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00070 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 Consistent with the general risk-based capital rules as well as the proposed rule, a banking organization may apply a different risk weight to an exposure to a non-U.S. PSE if the banking organization supervisor in that PSE’s home country allows supervised institutions to assign the alternative risk weight to exposures to that PSE. In no event, however, may the risk weight for an exposure to a non-U.S. PSE be lower than the risk weight assigned to direct exposures to the sovereign of that PSE’s home country. 6. Corporate Exposures Generally consistent with the general risk-based capital rules, the agencies and the FDIC proposed to require banking organizations to assign a 100 percent risk weight to all corporate exposures, including bonds and loans. The proposal defined a corporate exposure as an exposure to a company that is not an exposure to a sovereign, the Bank for International Settlements, the European Central Bank, the European Commission, the International Monetary Fund, an MDB, a depository institution, a foreign bank, a credit union, a PSE, a GSE, a residential mortgage exposure, a pre-sold construction loan, a statutory multifamily mortgage, a high-volatility commercial real estate (HVCRE) exposure, a cleared transaction, a default fund contribution, a securitization exposure, an equity exposure, or an unsettled transaction. The definition also captured all exposures that are not otherwise included in another specific exposure category. Several commenters recommended differentiating the proposed risk weights for corporate bonds based on a bond’s credit quality. Other commenters requested the agencies and the FDIC align the final rule with the Basel international standard that aligns risk weights with credit ratings. A few commenters asserted that a single 100 percent risk weight would disproportionately and adversely impact insurance companies that generally hold a higher share of corporate bonds in their investment portfolios. Another commenter contended that corporate bonds should receive a 50 percent risk weight, arguing that other exposures included in the corporate exposure category (such as commercial and industrial bank loans) are empirically of greater risk than corporate bonds. One commenter requested that the standardized approach provide a distinct capital treatment of a 75 percent risk weight for retail exposures, consistent with the international VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 standard under Basel II. The agencies have concluded that the proposed 100 percent risk weight assigned to retail exposures is appropriate given their risk profile in the United States and have retained the proposed treatment in the final rule. Consistent with the proposal, the final rule neither defines nor provides a separate treatment for retail exposures in the standardized approach. As described in the proposal, the agencies removed the use of ratings from the regulatory capital framework, consistent with section 939A of the Dodd-Frank Act. The agencies therefore evaluated a number of alternatives to credit ratings to provide a more granular risk weight treatment for corporate exposures.137 For example, the agencies considered market-based alternatives, such as the use of credit default and bond spreads, and use of particular indicators or parameters to differentiate between relative levels of credit risk. However, the agencies viewed each of the possible alternatives as having significant drawbacks, including their operational complexity, or insufficient development. For instance, the agencies were concerned that bond markets may sometimes misprice risk and bond spreads may reflect factors other than credit risk. The agencies also were concerned that such approaches could introduce undue volatility into the riskbased capital requirements. The agencies considered suggestions offered by commenters and understand that a 100 percent risk weight may overstate the credit risk associated with some high-quality bonds. However, the agencies believe that a single risk weight of less than 100 percent would understate the risk of many corporate exposures and, as explained, have not yet identified an alternative methodology to credit ratings that would provide a sufficiently rigorous basis for differentiating the risk of various corporate exposures. In addition, the agencies believe that, on balance, a 100 percent risk weight is generally representative of a welldiversified corporate exposure portfolio. The final rule retains without change the 100 percent risk weight for all corporate exposures as well as the proposed definition of corporate exposure. A few commenters requested clarification on the treatment for general-account insurance products. Under the final rule, consistent with the proposal, if a general-account exposure is to an organization that is not a banking organization, such as an 137 See, for example, 76 FR 73526 (Nov. 29, 2011) and 76 FR 73777 (Nov. 29, 2011). PO 00000 Frm 00071 Fmt 4701 Sfmt 4700 62087 insurance company, the exposure must receive a risk weight of 100 percent. Exposures to securities firms are subject to the corporate exposure treatment under the final rule, as described in section VIII.B of this preamble. 7. Residential Mortgage Exposures Under the general risk-based capital requirements, first-lien residential mortgages made in accordance with prudent underwriting standards on properties that are owner-occupied or rented typically are assigned to the 50 percent risk-weight category. Otherwise, residential mortgage exposures are assigned to the 100 percent risk weight category. The proposal would have substantially modified the risk-weight framework applicable to residential mortgage exposures and differed materially from both the general riskbased capital rules and the Basel capital framework. The agencies and the FDIC proposed to divide residential mortgage exposures into two categories. The proposal applied relatively low risk weights to residential mortgage exposures that did not have product features associated with higher credit risk, or ‘‘category 1’’ residential mortgages as defined in the proposal. The proposal defined all other residential mortgage exposures as ‘‘category 2’’ mortgages, which would receive relatively high risk weights. For both category 1 and category 2 mortgages, the proposed risk weight assigned also would have depended on the mortgage exposure’s LTV ratio. Under the proposal, a banking organization would not be able to recognize private mortgage insurance (PMI) when calculating the LTV ratio of a residential mortgage exposure. Due to the varying degree of financial strength of mortgage insurance providers, the agencies stated that they did not believe that it would be prudent to consider PMI in the determination of LTV ratios under the proposal. The agencies and the FDIC received a significant number of comments in opposition to the proposed risk weights for residential mortgages and in favor of retaining the risk-weight framework for residential mortgages in the general riskbased capital rules. Many commenters asserted that the increased risk weights for certain mortgages would inhibit lending to creditworthy borrowers, particularly when combined with the other proposed statutory and regulatory requirements being implemented under the authority of the Dodd-Frank Act, and could ultimately jeopardize the recovery of a still-fragile residential real estate market. Various commenters E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62088 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations asserted that the agencies and the FDIC did not provide sufficient empirical support for the proposal and stated the proposal was overly complex and would not contribute meaningfully to the risk sensitivity of the regulatory capital requirements. They also asserted that the proposal would require some banking organizations to raise revenue through other, more risky activities to compensate for the potential increased costs. Commenters also indicated that the distinction between category 1 and category 2 residential mortgages would adversely impact certain loan products that performed relatively well even during the recent crisis, such as balloon loans originated by community banking organizations. Other commenters criticized the proposed increased capital requirements for various loan products, including balloon and interest-only mortgages. Community banking organization commenters in particular asserted that such mortgage products are offered to hedge interest-rate risk and are frequently the only option for a significant segment of potential borrowers in their regions. A number of commenters argued that the proposal would place U.S. banking organizations at a competitive disadvantage relative to foreign banking organizations subject to the Basel II standardized framework, which generally assigns a 35 percent risk weight to residential mortgage exposures. Several commenters indicated that the proposed treatment would potentially undermine government programs encouraging residential mortgage lending to lowerincome individuals and underserved regions. Commenters also asserted that PMI should receive explicit recognition in the final rule through a reduction in risk weights, given the potential negative impact on mortgage availability (particularly to first-time borrowers) of the proposed risk weights. In addition to comments on the specific elements of the proposal, a significant number of commenters alleged that the agencies and the FDIC did not sufficiently consider the potential impact of other regulatory actions on the mortgage industry. For instance, commenters expressed considerable concern regarding the new requirements associated with the DoddFrank Act’s qualified mortgage definition under the Truth in Lending Act.138 Many of these commenters 138 The proposal was issued prior to publication of the Consumer Financial Protection Bureau’s final rule regarding qualified mortgage standards. See 78 FR 6407 (January 30, 2013). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 asserted that when combined with this proposal, the cumulative effect of the new regulatory requirements could adversely impact the residential mortgage industry. The agencies and the FDIC also received specific comments concerning potential logistical difficulties they would face implementing the proposal. Many commenters argued that tracking loans by LTV and category would be administratively burdensome, requiring the development or purchase of new systems. These commenters requested that, at a minimum, existing mortgages continue to be assigned the risk weights they would receive under the general risk-based capital rules and exempted from the proposed rules. Many commenters also requested clarification regarding the method for calculating the LTV for first and subordinate liens, as well as how and whether a loan could be reclassified between the two residential mortgage categories. For instance, commenters raised various technical questions on how to calculate the LTV of a restructured mortgage and under what conditions a restructured loan could qualify as a category 1 residential mortgage exposure. The agencies considered the comments pertaining to the residential mortgage proposal, particularly comments regarding the issuance of new regulations designed to improve the quality of mortgage underwriting and to generally reduce the associated credit risk, including the final definition of ‘‘qualified mortgage’’ as implemented by the Consumer Financial Protection Bureau (CFPB) pursuant to the DoddFrank Act.139 Additionally, the agencies are mindful of the uncertain implications that the proposal, along with other mortgage-related rulemakings, could have had on the residential mortgage market, particularly regarding underwriting and credit availability. The agencies also considered the commenters’ observations about the burden of calculating the risk weights for banking organizations’ existing mortgage portfolios, and have taken into account the commenters’ concerns about the availability of different mortgage products across different types of markets. In light of these considerations, the agencies have decided to retain in the final rule the treatment for residential mortgage exposures that is currently set forth in the general risk-based capital rules. The agencies may develop and propose changes in the treatment of residential mortgage exposures in the 139 See PO 00000 id. Frm 00072 Fmt 4701 Sfmt 4700 future, and in that process, the agencies intend to take into consideration structural and product market developments, other relevant regulations, and potential issues with implementation across various product types. Accordingly, as under the general risk-based capital rules, the final rule assigns exposures secured by one-tofour family residential properties to either the 50 percent or the 100 percent risk-weight category. Exposures secured by a first-lien on an owner-occupied or rented one-to-four family residential property that meet prudential underwriting standards, including standards relating to the loan amount as a percentage of the appraised value of the property, are not 90 days or more past due or carried on non-accrual status, and that are not restructured or modified receive a 50 percent risk weight. If a banking organization holds the first and junior lien(s) on a residential property and no other party holds an intervening lien, the banking organization must treat the combined exposure as a single loan secured by a first lien for purposes of determining the loan-to-value ratio and assigning a risk weight. A banking organization must assign a 100 percent risk weight to all other residential mortgage exposures. Under the final rule, a residential mortgage guaranteed by the federal government through the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA) generally will be risk-weighted at 20 percent. Consistent with the general risk-based capital rules, under the final rule, a residential mortgage exposure may be assigned to the 50 percent risk-weight category only if it is not restructured or modified. Under the final rule, consistent with the proposal, a residential mortgage exposure modified or restructured on a permanent or trial basis solely pursuant to the U.S. Treasury’s Home Affordable Mortgage Program (HAMP) is not considered to be restructured or modified. Several commenters from community banking organizations encouraged the agencies to broaden this exemption and not penalize banking organizations for participating in other successful loan modification programs. As described in greater detail in the proposal, the agencies believe that treating mortgage loans modified pursuant to HAMP in this manner is appropriate in light of the special and unique incentive features of HAMP, and the fact that the program is offered by the U.S. government to achieve the public policy objective of promoting sustainable loan E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations modifications for homeowners at risk of foreclosure in a way that balances the interests of borrowers, servicers, and lenders. 8. Pre-Sold Construction Loans and Statutory Multifamily Mortgages The general risk-based capital rules assign either a 50 percent or a 100 percent risk weight to certain one-tofour family residential pre-sold construction loans and to multifamily residential loans, consistent with provisions of the Resolution Trust Corporation Refinancing, Restructuring, and Improvement Act of 1991 (RTCRRI Act).140 The proposal maintained the same general treatment as the general risk-based capital rules and clarified and updated the manner in which the general risk-based capital rules define these exposures. Under the proposal, a pre-sold construction loan would be subject to a 50 percent risk weight unless the purchase contract is cancelled. The agencies are adopting this aspect of the proposal without change. The final rule defines a pre-sold construction loan, in part, as any oneto-four family residential construction loan to a builder that meets the requirements of section 618(a)(1) or (2) of the RTCRRI Act, and also harmonizes the agencies’ prior regulations. Under the final rule, a multifamily mortgage that does not meet the definition of a statutory multifamily mortgage is treated as a corporate exposure. wreier-aviles on DSK5TPTVN1PROD with RULES2 9. High-Volatility Commercial Real Estate Supervisory experience has demonstrated that certain acquisition, development, and construction loans (which are a subset of commercial real estate exposures) present particular risks for which the agencies believe banking organizations should hold additional capital. Accordingly, the agencies and the FDIC proposed to require banking organizations to assign a 150 percent risk weight to any HVCRE exposure, which is higher than the 100 percent risk weight applied to such loans under the general risk-based capital rules. The proposal defined an HVCRE exposure to include any credit facility that finances or has financed the 140 The RTCRRI Act mandates that each agency provide in its capital regulations (i) a 50 percent risk weight for certain one-to-four-family residential pre-sold construction loans and multifamily residential loans that meet specific statutory criteria in the RTCRRI Act and any other underwriting criteria imposed by the agencies, and (ii) a 100 percent risk weight for one-to-four-family residential pre-sold construction loans for residences for which the purchase contract is cancelled. 12 U.S.C. 1831n, note. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 acquisition, development, or construction of real property, unless the facility finances one- to four-family residential mortgage property, or commercial real estate projects that meet certain prudential criteria, including with respect to the LTV ratio and capital contributions or expense contributions of the borrower. Commenters criticized the proposed HVCRE definition as overly broad and suggested an exclusion for certain acquisition, development, or construction (ADC) loans, including: (1) ADC loans that are less than a specific dollar amount or have a debt service coverage ratio of 100 percent (rather than 80 percent, under the agencies’ and the FDIC’s lending standards); (2) community development projects or projects financed by low-income housing tax credits; and (3) certain loans secured by agricultural property for the sole purpose of acquiring land. Several commenters asserted that the proposed 150 percent risk weight was too high for secured loans and would hamper local commercial development. Another commenter recommended the agencies and the FDIC increase the number of HVCRE risk-weight categories to reflect LTV ratios. The agencies have considered the comments and have decided to retain the 150 percent risk weight for HVCRE exposures (modified as described below), given the increased risk of these activities when compared to other commercial real estate loans.141 The agencies believe that segmenting HVCRE by LTV ratio would introduce undue complexity without providing a sufficient improvement in risk sensitivity. The agencies have also determined not to exclude from the HVCRE definition ADC loans that are characterized by a specified dollar amount or loans with a debt service coverage ratio greater than 80 percent because an arbitrary threshold would likely not capture certain ADC loans with elevated risks. Consistent with the proposal, a commercial real estate loan that is not an HVCRE exposure is treated as a corporate exposure. Many commenters requested clarification as to whether all commercial real estate or ADC loans are considered HVCRE exposures. Consistent with the proposal, the final rule’s HVCRE definition only applies to a specific subset of ADC loans and is, therefore, not applicable to all commercial real estate loans. Specifically, some commenters sought 141 See the definition of ‘‘high-volatility commercial real estate exposure’’ in section 2 of the final rule. PO 00000 Frm 00073 Fmt 4701 Sfmt 4700 62089 clarification on whether a facility would remain an HVCRE exposure for the life of the loan and whether owner-occupied commercial real estate loans are included in the HVCRE definition. The agencies note that when the life of the ADC project concludes and the credit facility is converted to permanent financing in accordance with the banking organization’s normal lending terms, the permanent financing is not an HVCRE exposure. Thus, a loan permanently financing owner-occupied commercial real estate is not an HVCRE exposure. Given these clarifications, the agencies believe that many concerns regarding the potential adverse impact on commercial development were, in part, driven by a lack of clarity regarding the definition of the HVCRE, and believe that the treatment of HVCRE exposures in the final rule appropriately reflects their risk relative to other commercial real estate exposures. Commenters also sought clarification as to whether cash or securities used to purchase land counts as borrowercontributed capital. In addition, a few commenters requested further clarification on what constitutes contributed capital for purposes of the final rule. Consistent with existing guidance, cash used to purchase land is a form of borrower contributed capital under the HVCRE definition. In response to the comments, the final rule amends the proposed HVCRE definition to exclude loans that finance the acquisition, development, or construction of real property that would qualify as community development investments. The final rule does not require a banking organization to have an investment in the real property for it to qualify for the exemption: Rather, if the real property is such that an investment in that property would qualify as a community development investment, then a facility financing acquisition, development, or construction of that property would meet the terms of the exemption. The agencies have, however, determined not to give an automatic exemption from the HVCRE definition to all ADC loans to businesses or farms that have gross annual revenues of $1 million or less, although they could qualify for another exemption from the definition. For example, an ADC loan to a small business with annual revenues of under $1 million that meets the LTV ratio and contribution requirements set forth in paragraph (3) of the definition would qualify for that exemption from the definition as would a loan that finances real property that: Provides affordable housing (including multi-family rental housing) for low to moderate income E:\FR\FM\11OCR2.SGM 11OCR2 62090 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 individuals; is used in the provision of community services for low to moderate income individuals; or revitalizes or stabilizes low to moderate income geographies, designated disaster areas, or underserved areas specifically determined by the federal banking agencies based on the needs of low- and moderate-income individuals in those areas. The final definition also exempts ADC loans for the purchase or development of agricultural land, which is defined as all land known to be used or usable for agricultural purposes (such as crop and livestock production), provided that the valuation of the agricultural land is based on its value for agricultural purposes and the valuation does not consider any potential use of the land for nonagricultural commercial development or residential development. 10. Past-Due Exposures Under the general risk-based capital rules, the risk weight of a loan does not change if the loan becomes past due, with the exception of certain residential mortgage loans. The Basel II standardized approach provides risk weights ranging from 50 to 150 percent for exposures, except sovereign exposures and residential mortgage exposures, that are more than 90 days past due to reflect the increased risk of loss. Accordingly, to reflect the impaired credit quality of such exposures, the agencies and the FDIC proposed to require a banking organization to assign a 150 percent risk weight to an exposure that is not guaranteed or not secured (and that is not a sovereign exposure or a residential mortgage exposure) if it is 90 days or more past due or on nonaccrual. A number of commenters maintained that the proposed 150 percent risk weight is too high for various reasons. Specifically, several commenters asserted that ALLL is already reflected in the risk-based capital numerator, and therefore an increased risk weight double-counts the risk of a past-due exposure. Other commenters characterized the increased risk weight as procyclical and burdensome (particularly for community banking organizations), and maintained that it would unnecessarily discourage lending and loan modifications or workouts. The agencies have considered the comments and have decided to retain the proposed 150 percent risk weight for past-due exposures in the final rule. The agencies note that the ALLL is intended to cover estimated, incurred losses as of the balance sheet date, rather than unexpected losses. The higher risk weight on past due exposures ensures VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 sufficient regulatory capital for the increased probability of unexpected losses on these exposures. The agencies believe that any increased capital burden, potential rise in procyclicality, or impact on lending associated with the 150 percent risk weight is justified given the overall objective of better capturing the risk associated with the impaired credit quality of these exposures. One commenter requested clarification as to whether a banking organization could reduce the risk weight for past-due exposures from 150 percent when the carrying value is charged down to the amount expected to be recovered. For the purposes of the final rule, a banking organization must apply a 150 percent risk weight to all past-due exposures, including any amount remaining on the balance sheet following a charge-off, to reflect the increased uncertainty as to the recovery of the remaining carrying value. 11. Other Assets Generally consistent with the general risk-based capital rules, the agencies have decided to adopt, as proposed, the risk weights described below for exposures not otherwise assigned to a specific risk weight category. Specifically, a banking organization must assign: (1) A zero percent risk weight to cash owned and held in all of a banking organization’s offices or in transit; gold bullion held in the banking organization’s own vaults, or held in another depository institution’s vaults on an allocated basis to the extent gold bullion assets are offset by gold bullion liabilities; and to exposures that arise from the settlement of cash transactions (such as equities, fixed income, spot foreign exchange and spot commodities) with a CCP where there is no assumption of ongoing counterparty credit risk by the CCP after settlement of the trade and associated default fund contributions; (2) A 20 percent risk weight to cash items in the process of collection; and (3) A 100 percent risk weight to all assets not specifically assigned a different risk weight under the final rule (other than exposures that would be deducted from tier 1 or tier 2 capital), including deferred acquisition costs (DAC) and value of business acquired (VOBA). In addition, subject to the proposed transition arrangements under section 300 of the final rule, a banking organization must assign: (1) A 100 percent risk weight to DTAs arising from temporary differences that the banking organization could realize PO 00000 Frm 00074 Fmt 4701 Sfmt 4700 through net operating loss carrybacks; and (2) A 250 percent risk weight to the portion of MSAs and DTAs arising from temporary differences that the banking organization could not realize through net operating loss carrybacks that are not deducted from common equity tier 1 capital pursuant to section 22(d). The agencies and the FDIC received a few comments on the treatment of DAC and VOBA. DAC represents certain costs incurred in the acquisition of a new contract or renewal insurance contract that are capitalized pursuant to GAAP. VOBA refers to assets that reflect revenue streams from insurance policies purchased by an insurance company. One commenter asked for clarification on risk weights for other types of exposures that are not assigned a specific risk weight under the proposal. Consistent with the proposal, under the final rule these assets receive a 100 percent risk weight, together with other assets not specifically assigned a different risk weight under the NPR. Consistent with the general risk-based capital rules, the final rule retains the limited flexibility to address situations where exposures of a banking organization that are not exposures typically held by depository institutions do not fit wholly within the terms of another risk-weight category. Under the final rule, a banking organization may assign such exposures to the risk-weight category applicable under the capital rules for BHCs or covered SLHCs, provided that (1) the banking organization is not authorized to hold the asset under applicable law other than debt previously contracted or similar authority; and (2) the risks associated with the asset are substantially similar to the risks of assets that are otherwise assigned to a risk-weight category of less than 100 percent under subpart D of the final rule. C. Off-Balance Sheet Items 1. Credit Conversion Factors Under the proposed rule, as under the general risk-based capital rules, a banking organization would calculate the exposure amount of an off-balance sheet item by multiplying the offbalance sheet component, which is usually the contractual amount, by the applicable credit conversion factors (CCF). This treatment would apply to all off-balance sheet items, such as commitments, contingent items, guarantees, certain repo-style transactions, financial standby letters of credit, and forward agreements. The proposed rule, however, introduced E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations new CCFs applicable to certain exposures, such as a higher CCF for commitments with an original maturity of one year or less that are not unconditionally cancelable. Commenters offered a number of suggestions for revising the proposed CCFs that would be applied to offbalance sheet exposures. Commenters generally asked for lower CCFs that, according to the commenters, are more directly aligned with a particular offbalance sheet exposure’s loss history. In addition, some commenters asked the agencies and the FDIC to conduct a calibration study to show that the proposed CCFs were appropriate. The agencies have decided to retain the proposed CCFs for off-balance sheet exposures without change for purposes of the final rule. The agencies believe that the proposed CCFs meet the agencies’ goals of improving risk sensitivity and implementing higher capital requirements for certain exposures through a simple methodology. Furthermore, alternatives proposed by commenters, such as exposure measures tied directly to a particular exposure’s loss history, would create significant operational burdens for many small- and mid-sized banking organizations, by requiring them to keep accurate historical records of losses and continuously adjust their capital requirements for certain exposures to account for new loss data. Such a system would be difficult for the agencies to monitor, as the agencies would need to verify the accuracy of historical loss data and ensure that capital requirements are properly applied across institutions. Incorporation of additional factors, such as loss history or increasing the number of CCF categories, would detract from the agencies’ stated goal of simplicity in its capital treatment of off-balance sheet exposures. Additionally, the agencies believe that the CCFs, as proposed, were properly calibrated to reflect the risk profiles of the exposures to which they are applied and do not believe a calibration study is required. Accordingly, under the final rule, as proposed, a banking organization may apply a zero percent CCF to the unused portion of commitments that are unconditionally cancelable by the banking organization. For purposes of the final rule, a commitment means any legally binding arrangement that obligates a banking organization to extend credit or to purchase assets. Unconditionally cancelable means a commitment for which a banking organization may, at any time, with or without cause, refuse to extend credit (to the extent permitted under VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 applicable law). In the case of a residential mortgage exposure that is a line of credit, a banking organization can unconditionally cancel the commitment if it, at its option, may prohibit additional extensions of credit, reduce the credit line, and terminate the commitment to the full extent permitted by applicable law. If a banking organization provides a commitment that is structured as a syndication, the banking organization is only required to calculate the exposure amount for its pro rata share of the commitment. The proposed rule provided a 20 percent CCF for commitments with an original maturity of one year or less that are not unconditionally cancelable by a banking organization, and for selfliquidating, trade-related contingent items that arise from the movement of goods with an original maturity of one year or less. Some commenters argued that the proposed designation of a 20 percent CCF for certain exposures was too high. For example, they requested that the final rule continue the current practice of applying a zero percent CCF to all unfunded lines of credit with less than one year maturity, regardless of the lender’s ability to unconditionally cancel the line of credit. They also requested a CCF lower than 20 percent for the unused portions of letters of credit extended to a small, mid-market, or trade finance company with durations of less than one year or less. These commenters asserted that current market practice for these lines have covenants based on financial ratios, and any increase in riskiness that violates the contractual minimum ratios would prevent the borrower from drawing down the unused portion. For purposes of the final rule, the agencies are retaining the 20 percent CCF, as it accounts for the elevated level of risk banking organizations face when extending short-term commitments that are not unconditionally cancelable. Although the agencies understand certain contractual provisions are common in the market, these practices are not static, and it is more appropriate from a regulatory standpoint to base a CCF on whether a commitment is unconditionally cancellable. A banking organization must apply a 20 percent CCF to a commitment with an original maturity of one year or less that is not unconditionally cancellable by the banking organization. The final rule also maintains the 20 percent CCF for selfliquidating, trade-related contingent items that arise from the movement of goods with an original maturity of one year or less. The final rule also requires a banking organization to apply a 50 PO 00000 Frm 00075 Fmt 4701 Sfmt 4700 62091 percent CCF to commitments with an original maturity of more than one year that are not unconditionally cancelable by the banking organization, and to transaction-related contingent items, including performance bonds, bid bonds, warranties, and performance standby letters of credit. Some commenters requested clarification regarding the treatment of commitments to extend letters of credit. They argued that these commitments are no more risky than commitments to extend loans and should receive similar treatment (20 percent or 50 percent CCF). For purposes of the final rule, the agencies note that section 33(a)(2) allows banking organizations to apply the lower of the two applicable CCFs to the exposures related to commitments to extend letters of credit. Banking organizations will need to make this determination based upon the individual characteristics of each letter of credit. Under the final rule, a banking organization must apply a 100 percent CCF to off-balance sheet guarantees, repurchase agreements, creditenhancing representations and warranties that are not securitization exposures, securities lending or borrowing transactions, financial standby letters of credit, and forward agreements, and other similar exposures. The off-balance sheet component of a repurchase agreement equals the sum of the current fair values of all positions the banking organization has sold subject to repurchase. The offbalance sheet component of a securities lending transaction is the sum of the current fair values of all positions the banking organization has lent under the transaction. For securities borrowing transactions, the off-balance sheet component is the sum of the current fair values of all non-cash positions the banking organization has posted as collateral under the transaction. In certain circumstances, a banking organization may instead determine the exposure amount of the transaction as described in section 37 of the final rule. In contrast to the general risk-based capital rules, which require capital for securities lending and borrowing transactions and repurchase agreements that generate an on-balance sheet exposure, the final rule requires a banking organization to hold risk-based capital against all repo-style transactions, regardless of whether they generate on-balance sheet exposures, as described in section 37 of the final rule. One commenter disagreed with this treatment and requested an exemption from the capital treatment for offbalance sheet repo-style exposures. E:\FR\FM\11OCR2.SGM 11OCR2 62092 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 However, the agencies adopted this approach because banking organizations face counterparty credit risk when engaging in repo-style transactions, even if those transactions do not generate onbalance sheet exposures, and thus should not be exempt from risk-based capital requirements. 2. Credit-Enhancing Representations and Warranties Under the general risk-based capital rules, a banking organization is subject to a risk-based capital requirement when it provides credit-enhancing representations and warranties on assets sold or otherwise transferred to third parties as such positions are considered recourse arrangements.142 However, the general risk-based capital rules do not impose a risk-based capital requirement on assets sold or transferred with representations and warranties that (1) Contain early default clauses or similar warranties that permit the return of, or premium refund clauses covering, oneto-four family first-lien residential mortgage loans for a period not to exceed 120 days from the date of transfer; and (2) contain premium refund clauses that cover assets guaranteed, in whole or in part, by the U.S. government, a U.S. government agency, or a U.S. GSE, provided the premium refund clauses are for a period not to exceed 120 days; or (3) permit the return of assets in instances of fraud, misrepresentation, or incomplete documentation.143 In contrast, under the proposal, if a banking organization provides a creditenhancing representation or warranty on assets it sold or otherwise transferred to third parties, including early default clauses that permit the return of, or premium refund clauses covering, oneto-four family residential first mortgage loans, the banking organization would treat such an arrangement as an offbalance sheet guarantee and apply a 100 percent CCF to determine the exposure amount, provided the exposure does not meet the definition of a securitization exposure. The agencies and the FDIC proposed a different treatment than the one under the general risk-based capital rules because of the risk to which banking organizations are exposed while credit-enhancing representations and warranties are in effect. Some commenters asked for clarification on what qualifies as a credit-enhancing 142 12 CFR part 3, appendix A, section 4(a)(11) and 12 CFR 167.6(b) (OCC); 12 CFR parts 208 and 225 appendix A, section III.B.3.a.xii (Board). 143 12 CFR part 3, appendix A, section 4(a)(8) and 12 CFR 167.6(b) (OCC); 12 CFR part 208, appendix A, section II.B.3.a.ii.1 and 12 CFR part 225, appendix A, section III.B.3.a.ii.(1) (Board). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 representation and warranty, and commenters made numerous suggestions for revising the proposed definition. In particular, they disagreed with the agencies’ and the FDIC’s proposal to remove the exemptions related to early default clauses and premium refund clauses since these representations and warranties generally are considered to be low risk exposures and banking organizations are not currently required to hold capital against these representations and warranties. Some commenters encouraged the agencies and the FDIC to retain the 120day safe harbor from the general riskbased capital rules, which would not require holding capital against assets sold with certain early default clauses of 120 days or less. These commenters argued that the proposal to remove the 120-day safe harbor would impede the ability of banking organizations to make loans and would increase the cost of credit to borrowers. Furthermore, certain commenters asserted that removal of the 120-day safe harbor was not necessary for loan portfolios that are well underwritten, those for which putbacks are rare, and where the banking organization maintains robust buyback reserves. After reviewing the comments, the agencies decided to retain in the final rule the 120-day safe harbor in the definition of credit-enhancing representations and warranties for early default and premium refund clauses on one-to-four family residential mortgages that qualify for the 50 percent risk weight as well as for premium refund clauses that cover assets guaranteed, in whole or in part, by the U.S. government, a U.S. government agency, or a U.S. GSE. The agencies determined that retaining the safe harbor would help to address commenters’ confusion about what qualifies as a creditenhancing representation and warranty. Therefore, consistent with the general risk-based capital rules, under the final rule, credit-enhancing representations and warranties will not include (1) Early default clauses and similar warranties that permit the return of, or premium refund clauses covering, one-to-four family first-lien residential mortgage loans that qualify for a 50 percent risk weight for a period not to exceed 120 days from the date of transfer; 144 (2) premium refund clauses that cover assets guaranteed by the U.S. government, a U.S. Government agency, or a GSE, provided the premium refund 144 These warranties may cover only those loans that were originated within 1 year of the date of transfer. PO 00000 Frm 00076 Fmt 4701 Sfmt 4700 clauses are for a period not to exceed 120 days from the date of transfer; or (3) warranties that permit the return of underlying exposures in instances of misrepresentation, fraud, or incomplete documentation. Some commenters requested clarification from the agencies and the FDIC regarding representations made about the value of the underlying collateral of a sold loan. For example, many purchasers of mortgage loans originated by banking organizations require that the banking organization repurchase the loan if the value of the collateral is other than as stated in the documentation provided to the purchaser or if there were any material misrepresentations in the appraisal process. The agencies confirm that such representations meets the ‘‘misrepresentation, fraud, or incomplete documentation’’ exclusion in the definition of credit-enhancing representations and warranties and is not subject to capital treatment. A few commenters also requested clarification regarding how the definition of credit-enhancing representations and warranties in the proposal interacts with Federal Home Loan Mortgage Corporation (FHLMC), Federal National Mortgage Association (FNMA), and Government National Mortgage Association (GNMA) sales conventions. These same commenters also requested verification in the final rule that mortgages sold with representations and warranties would all receive a 100 percent risk weight, regardless of the characteristics of the mortgage exposure. First, the definition of credit-enhancing representations and warranties described in this final rule is separate from the sales conventions required by FLHMA, FNMA, and GNMA. Those entities will continue to set their own requirements for secondary sales, including representation and warranty requirements. Second, the risk weights applied to mortgage exposures themselves are not affected by the inclusion of representations and warranties. Mortgage exposures will continue to receive either a 50 or 100 percent risk weight, as outlined in section 32(g) of this final rule, regardless of the inclusion of representations and warranties when they are sold in the secondary market. If such representations and warranties meet the rule’s definition of credit-enhancing representations and warranties, then the institution must maintain regulatory capital against the associated credit risk. Some commenters disagreed with the proposed methodology for determining the capital requirement for E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations representations and warranties, and offered alternatives that they argued would conform to existing market practices and better incentivize highquality underwriting. Some commenters indicated that many originators already hold robust buyback reserves and argued that the agencies and the FDIC should require originators to hold adequate liquidity in their buyback reserves, instead of requiring a duplicative capital requirement. Other commenters asked that any capital requirement be directly aligned to that originator’s history of honoring representation and warranty claims. These commenters stated that originators who underwrite high-quality loans should not be required to hold as much capital against their representations and warranties as originators who exhibit what the commenters referred to as ‘‘poor underwriting standards.’’ Finally, a few commenters requested that the agencies and the FDIC completely remove, or significantly reduce, capital requirements for representations and warranties. They argue that the market is able to regulate itself, as a banking organization will not be able to sell its loans in the secondary market if they are frequently put back by the buyers. The agencies considered these alternatives and have decided to finalize the proposed methodology for determining the capital requirement applied to representations and warranties without change. The agencies are concerned that buyback reserves could be inadequate, especially if the housing market enters another prolonged downturn. Robust and clear capital requirements, in addition to separate buyback reserves held by originators, better ensure that representation and warranty claims will be fulfilled in times of stress. Furthermore, capital requirements based upon originators’ historical representation and warranty claims are not only operationally difficult to implement and monitor, but they can also be misleading. Underwriting standards at firms are not static and can change over time. The agencies believe that capital requirements based on past performance of a particular underwriter do not always adequately capture the current risks faced by that firm. The agencies believe that the incorporation of the 120-day safe harbor in the final rule as discussed above addresses many of the commenters’ concerns. Some commenters requested clarification on the duration of the capital treatment for credit-enhancing representations and warranties. For instance, some commenters questioned VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 whether capital is required for creditenhancing representations and warranties after the contractual life of the representations and warranties has expired or whether capital has to be held for the life of the asset. Banking organizations are not required to hold capital for any credit-enhancing representation and warranty after the expiration of the representation or warranty, regardless of the maturity of the underlying loan. Additionally, commenters indicated that market practice for some representations and warranties for sold mortgages stipulates that originators only need to refund the buyer any servicing premiums and other earned fees in cases of early default, rather than requiring putback of the underlying loan to the seller. These commenters sought clarification as to whether the proposal would have required them to hold capital against the value of the underlying loan or only for the premium or fees that could be subject to a refund, as agreed upon in their contract with the buyer. For purposes of the final rule, a banking organization must hold capital only for the maximum contractual amount of the banking organization’s exposure under the representations and warranties. In the case described by the commenters, the banking organization would hold capital against the value of the servicing premium and other earned fees, rather than the value of the underlying loan, for the duration specified in the representations and warranties agreement. Some commenters also requested exemptions from the proposed treatment of representations and warranties for particular originators, types of transactions, or asset categories. In particular, many commenters asked for an exemption for community banking organizations, claiming that the proposed treatment would lessen credit availability and increase the costs of lending. One commenter argued that bona fide mortgage sale agreements should be exempt from capital requirements. Other commenters requested an exemption for the portion of any off-balance sheet asset that is subject to a risk retention requirement under section 941 of the Dodd-Frank Act and any regulations promulgated thereunder.145 Some commenters also requested that the agencies and the FDIC delay action on the proposal until the risk retention rule is finalized. Other commenters also requested exemptions for qualified mortgages (QM) and ‘‘prime’’ mortgage loans. 145 See PO 00000 15 U.S.C. 78o–11, et seq. Frm 00077 Fmt 4701 Sfmt 4700 62093 The agencies have decided not to adopt any of the specific exemptions suggested by the commenters. Although community banking organizations are critical to ensure the flow of credit to small businesses and individual borrowers, providing them with an exemption from the proposed treatment of credit-enhancing representations and warranties would be inconsistent with safety and soundness because the risks from these exposures to community banking organizations are no different than those to other banking organizations. The agencies also have not provided exemptions in this rulemaking to portions of off-balance sheet assets subject to risk retention, QM, and ‘‘prime loans.’’ The relevant agencies have not yet adopted a final rule implementing the risk retention provisions of section 941 of the DoddFrank Act, and the agencies, therefore, do not believe it is appropriate to provide an exemption relating to risk retention in this final rule. In addition, while the QM rulemaking is now final,146 the agencies believe it is appropriate to first evaluate how the QM designation affects the mortgage market before requiring less capital to be held against off-balance sheet assets that cover these loans. As noted above, the incorporation in the final rule of the 120-day safe harbor addresses many of the concerns about burden. The risk-based capital treatment for off-balance sheet items in this final rule is consistent with section 165(k) of the Dodd-Frank Act which provides that, in the case of a BHC with $50 billion or more in total consolidated assets, the computation of capital, for purposes of meeting capital requirements, shall take into account any off-balance-sheet activities of the company.147 The final rule complies with the requirements of section 165(k) of the Dodd-Frank Act by requiring a BHC to hold risk-based capital for its off-balance sheet exposures, as described in sections 31, 33, 34 and 35 of the final rule. 146 See 12 CFR part 1026. 165(k) of the Dodd-Frank Act (12 U.S.C. 5365(k)). This section defines an off-balance sheet activity as an existing liability of a company that is not currently a balance sheet liability, but may become one upon the happening of some future event. Such transactions may include direct credit substitutes in which a banking organization substitutes its own credit for a third party; irrevocable letters of credit; risk participations in bankers’ acceptances; sale and repurchase agreements; asset sales with recourse against the seller; interest rate swaps; credit swaps; commodities contracts; forward contracts; securities contracts; and such other activities or transactions as the Board may define through a rulemaking. 147 Section E:\FR\FM\11OCR2.SGM 11OCR2 62094 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 D. Over-the-Counter Derivative Contracts In the Standardized Approach NPR, the agencies and the FDIC proposed generally to retain the treatment of OTC derivatives provided under the general risk-based capital rules, which is similar to the current exposure method (CEM) for determining the exposure amount for OTC derivative contracts contained in the Basel II standardized framework.148 Proposed revisions to the treatment of the OTC derivative contracts included an updated definition of an OTC derivative contract, a revised conversion factor matrix for calculating the PFE, a revision of the criteria for recognizing the netting benefits of qualifying master netting agreements and of financial collateral, and the removal of the 50 percent risk weight cap for OTC derivative contracts. The agencies and the FDIC received a number of comments on the proposed CEM relating to OTC derivatives. These comments generally focused on the revised conversion factor matrix, the proposed removal of the 50 percent cap on risk weights for OTC derivative transactions in the general risk-based capital rules, and commenters’ view that there is a lack of risk sensitivity in the calculation of the exposure amount of OTC derivatives and netting benefits. A specific discussion of the comments on particular aspects of the proposal follows. One commenter asserted that the proposed conversion factors for common interest rate and foreign exchange contracts, and risk participation agreements (a simplified form of credit default swaps) (set forth in Table 19 below), combined with the removal of the 50 percent risk weight cap, would drive up banking organizations’ capital requirements associated with these routine transactions and result in much higher transaction costs for small businesses. Another commenter asserted that the zero percent conversion factor assigned to interest rate derivatives with a remaining maturity of one year or less is not appropriate as the PFE incorrectly assumes all interest rate derivatives always can be covered by taking a position in a liquid market. 148 The general risk-based capital rules for savings associations regarding the calculation of credit equivalent amounts for derivative contracts differ from the rules for other banking organizations. (See 12 CFR 167(a)(2) (Federal savings associations) and 12 CFR 390.466(a)(2) (state savings associations)). The savings association rules address only interest rate and foreign exchange rate contracts and include certain other differences. Accordingly, the description of the general risk-based capital rules in this preamble primarily reflects the rules applicable to state and national banks and BHCs. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 The agencies acknowledge that the standardized matrix of conversion factors may be too simplified for some banking organizations. The agencies believe, however, that the matrix approach appropriately balances the policy goals of simplicity and risksensitivity, and that the conversion factors themselves have been appropriately calibrated for the products to which they relate. Some commenters supported retention of the 50 percent risk weight cap for derivative exposures under the general risk-based capital rules. Specifically, one commenter argued that the methodology for calculating the exposure amount without the 50 percent risk weight cap would result in inappropriately high capital charge unless the methodology were amended to recognize the use of netting and collateral. Accordingly, the commenter encouraged the agencies and the FDIC to retain the 50 percent risk weight cap until the BCBS enhances the CEM to improve risk-sensitivity. The agencies believe that as the market for derivatives has developed, the types of counterparties acceptable to participants have expanded to include counterparties that merit a risk weight greater than 50 percent. In addition, the agencies are aware of the ongoing work of the BCBS to improve the current exposure method and expect to consider any necessary changes to update the exposure amount calculation when the BCBS work is completed. Some commenters suggested that the agencies and the FDIC allow the use of internal models approved by the primary Federal supervisor as an alternative to the proposal, consistent with Basel III. The agencies chose not to incorporate all of the methodologies included in the Basel II standardized framework in the final rule. The agencies believe that, given the range of banking organizations that are subject to the final rule in the United States, it is more appropriate to permit only the proposed non-models based methodology for calculating OTC derivatives exposure amounts under the standardized approach. For larger and more complex banking organizations, the use of the internal model methodology and other models-based methodologies is permitted under the advanced approaches rule. One commenter asked the agencies and the FDIC to provide a definition for ‘‘netting,’’ as the meaning of this term differs widely under various master netting agreements used in industry practice. Another commenter asserted that net exposures are likely to understate actual exposures and the risk PO 00000 Frm 00078 Fmt 4701 Sfmt 4700 of early close-out posed to banking organizations facing financial difficulties, that the conversion factors for PFE are inappropriate, and that a better measure of risk tied to gross exposure is needed. With respect to the definition of netting, the agencies note that the definition of ‘‘qualifying master netting agreement’’ provides a functional definition of netting. With respect to the use of net exposure for purposes of determining PFE, the agencies believe that, in light of the existing international framework to enforce netting arrangements together with the conditions for recognizing netting that are included in this final rule, the use of net exposure is appropriate in the context of a riskbased counterparty credit risk charge that is specifically intended to address default risk. The final rule also continues to limit full recognition of netting for purposes of calculating PFE for counterparty credit risk under the standardized approach.149 Other commenters suggested adopting broader recognition of netting under the PFE calculation for netting sets, using a factor of 85 percent rather than 60 percent in the formula for recognizing netting effects to be consistent with the BCBS CCP interim framework (which is defined and discussed in section VIII.E of this preamble, below). Another commenter suggested implementing a 15 percent haircut on the calculated exposure amount for failure to recognize risk mitigants and portfolio diversification. With respect to the commenters’ request for greater recognition of netting in the calculation of PFE, the agencies note that the BCBS CCP interim framework’s use of 85 percent recognition of netting was limited to the calculation of the hypothetical capital requirement of the QCCP for purposes of determining a clearing member banking organization’s risk-weighted asset amount for its default fund contribution. As such, the final rule retains the proposed formula for recognizing netting effects for OTC derivative contracts that was set out in the proposal. The agencies expect to consider whether it would be necessary to propose any changes to the CEM once BCBS discussions on this topic are complete. The proposed rule placed a cap on the PFE of sold credit protection, equal to the net present value of the amount of unpaid premiums. One commenter questioned the appropriateness of the proposed cap, and suggested that a seller’s exposure be measured as the gross exposure amount of the credit 149 See E:\FR\FM\11OCR2.SGM section 34(a)(2) of the final rule. 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations protection provided on the name referenced in the credit derivative contract. The agencies believe that the proposed approach is appropriate for measuring counterparty credit risk because it reflects the amount a banking organization may lose on its exposure to the counterparty that purchased protection. The exposure amount on a sold credit derivative would be calculated separately under section 34(a). Another commenter asserted that current credit exposure (netted and unnetted) understates or ignores the risk that the mark is inaccurate. Generally, the agencies expect a banking organization to have in place policies and procedures regarding the valuation of positions, and that those processes would be reviewed in connection with routine and periodic supervisory examinations of a banking organization. The final rule generally adopts the proposed treatment for OTC derivatives without change. Under the final rule, as under the general risk-based capital rules, a banking organization is required to hold risk-based capital for counterparty credit risk for an OTC derivative contract. As defined in the rule, a derivative contract is a financial contract whose value is derived from the values of one or more underlying assets, reference rates, or indices of asset values or reference rates. A derivative contract includes an interest rate, exchange rate, equity, or a commodity derivative contract, a credit derivative, and any other instrument that poses similar counterparty credit risks. Derivative contracts also include unsettled securities, commodities, and foreign exchange transactions with a contractual settlement or delivery lag that is longer than the lesser of the market standard for the particular instrument or five business days. This applies, for example, to mortgagebacked securities (MBS) transactions that the GSEs conduct in the To-BeAnnounced market. Under the final rule, an OTC derivative contract does not include a derivative contract that is a cleared transaction, which is subject to a specific treatment as described in section VIII.E of this preamble. However, an OTC derivative contract includes an exposure of a banking organization that is a clearing member banking organization to its clearing member client where the clearing member banking organization is either acting as a financial intermediary and enters into an offsetting transaction with a CCP or where the clearing member banking organization provides a guarantee to the CCP on the performance of the client. The rationale for this treatment is the banking organization’s continued exposure directly to the risk of the clearing member client. In recognition of the 62095 shorter close-out period for these transactions, however, the final rule permits a banking organization to apply a scaling factor to recognize the shorter holding period as discussed in section VIII.E of this preamble. To determine the risk-weighted asset amount for an OTC derivative contract under the final rule, a banking organization must first determine its exposure amount for the contract and then apply to that amount a risk weight based on the counterparty, eligible guarantor, or recognized collateral. For a single OTC derivative contract that is not subject to a qualifying master netting agreement (as defined further below in this section), the rule requires the exposure amount to be the sum of (1) the banking organization’s current credit exposure, which is the greater of the fair value or zero, and (2) PFE, which is calculated by multiplying the notional principal amount of the OTC derivative contract by the appropriate conversion factor, in accordance with Table 19 below. Under the final rule, the conversion factor matrix includes the additional categories of OTC derivative contracts as illustrated in Table 19. For an OTC derivative contract that does not fall within one of the specified categories in Table 19, the final rule requires PFE to be calculated using the ‘‘other’’ conversion factor. TABLE 19—CONVERSION FACTOR MATRIX FOR OTC DERIVATIVE CONTRACTS 150 Remaining maturity 151 Interest rate wreier-aviles on DSK5TPTVN1PROD with RULES2 One year or less .......... Greater than one year and less than or equal to five years .... Greater than five years Foreign exchange rate and gold 13:14 Oct 10, 2013 Credit (noninvestmentgrade reference asset) Precious metals (except gold) Equity Other 0.00 0.01 0.05 0.10 0.06 0.07 0.10 0.005 0.015 0.05 0.075 0.05 0.05 0.10 0.10 0.08 0.10 0.07 0.08 0.12 0.15 For multiple OTC derivative contracts subject to a qualifying master netting agreement, a banking organization must calculate the exposure amount by adding the net current credit exposure and the adjusted sum of the PFE amounts for all OTC derivative contracts subject to the qualifying master netting agreement. Under the final rule, the net current credit exposure is the greater of zero and the net sum of all positive and negative fair values of the individual OTC derivative contracts subject to the qualifying master netting agreement. The adjusted sum of the PFE amounts must be calculated as described in section 34(a)(2)(ii) of the final rule. VerDate Mar<15>2010 Credit (investmentgrade reference asset) 152 Jkt 232001 Under the final rule, to recognize the netting benefit of multiple OTC 150 For a derivative contract with multiple exchanges of principal, the conversion factor is multiplied by the number of remaining payments in the derivative contract. 151 For a derivative contract that is structured such that on specified dates any outstanding exposure is settled and the terms are reset so that the market value of the contract is zero, the remaining maturity equals the time until the next reset date. For an interest rate derivative contract with a remaining maturity of greater than one year that meets these criteria, the minimum conversion factor is 0.005. 152 A banking organization must use the column labeled ‘‘Credit (investment-grade reference asset)’’ for a credit derivative whose reference asset is an outstanding unsecured long-term debt security PO 00000 Frm 00079 Fmt 4701 Sfmt 4700 derivative contracts, the contracts must be subject to a qualifying master netting agreement; however, unlike under the general risk-based capital rules, under the final rule for most transactions, a banking organization may rely on sufficient legal review instead of an opinion on the enforceability of the netting agreement as described below.153 The final rule defines a without credit enhancement that is investment grade. A banking organization must use the column labeled ‘‘Credit (non-investment-grade reference asset)’’ for all other credit derivatives. 153 Under the general risk-based capital rules, to recognize netting benefits a banking organization E:\FR\FM\11OCR2.SGM Continued 11OCR2 62096 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 qualifying master netting agreement as any written, legally enforceable netting agreement that creates a single legal obligation for all individual transactions covered by the agreement upon an event of default (including receivership, insolvency, liquidation, or similar proceeding) provided that certain conditions set forth in section 3 of the final rule are met.154 These conditions include requirements with respect to the banking organization’s right to terminate the contract and liquidate collateral and meeting certain standards with respect to legal review of the agreement to ensure its meets the criteria in the definition. The legal review must be sufficient so that the banking organization may conclude with a well-founded basis that, among other things, the contract would be found legal, binding, and enforceable under the law of the relevant jurisdiction and that the contract meets the other requirements of the definition. In some cases, the legal review requirement could be met by reasoned reliance on a commissioned legal opinion or an in-house counsel analysis. In other cases, for example, those involving certain new derivative transactions or derivative counterparties in jurisdictions where a banking organization has little experience, the banking organization would be expected to obtain an explicit, written legal opinion from external or internal legal counsel addressing the particular situation. Under the final rule, if an OTC derivative contract is collateralized by financial collateral, a banking organization must first determine the exposure amount of the OTC derivative contract as described in this section of the preamble. Next, to recognize the credit risk mitigation benefits of the financial collateral, a banking organization could use the simple approach for collateralized transactions as described in section 37(b) of the final rule. Alternatively, if the financial collateral is marked-to-market on a daily basis and subject to a daily margin maintenance requirement, a banking must enter into a bilateral master netting agreement with its counterparty and obtain a written and wellreasoned legal opinion of the enforceability of the netting agreement for each of its netting agreements that cover OTC derivative contracts. 154 The final rule adds a new section 3: Operational requirements for counterparty credit risk. This section organizes substantive requirements related to cleared transactions, eligible margin loans, qualifying cross-product master netting agreements, qualifying master netting agreements, and repo-style transactions in a central place to assist banking organizations in determining their legal responsibilities. These substantive requirements are consistent with those included in the proposal. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 organization could adjust the exposure amount of the contract using the collateral haircut approach described in section 37(c) of the final rule. Similarly, if a banking organization purchases a credit derivative that is recognized under section 36 of the final rule as a credit risk mitigant for an exposure that is not a covered position under subpart F, it is not required to compute a separate counterparty credit risk capital requirement for the credit derivative, provided it does so consistently for all such credit derivative contracts. Further, where these credit derivative contracts are subject to a qualifying master netting agreement, the banking organization must either include them all or exclude them all from any measure used to determine the counterparty credit risk exposure to all relevant counterparties for risk-based capital purposes. Under the final rule, a banking organization must treat an equity derivative contract as an equity exposure and compute its risk-weighted asset amount according to the simple risk-weight approach (SRWA) described in section 52 (unless the contract is a covered position under the market risk rule). If the banking organization risk weights a contract under the SRWA described in section 52, it may choose not to hold risk-based capital against the counterparty risk of the equity contract, so long as it does so for all such contracts. Where the OTC equity contracts are subject to a qualified master netting agreement, a banking organization either includes or excludes all of the contracts from any measure used to determine counterparty credit risk exposures. If the banking organization is treating an OTC equity derivative contract as a covered position under subpart F, it also must calculate a risk-based capital requirement for counterparty credit risk of the contract under this section. In addition, if a banking organization provides protection through a credit derivative that is not a covered position under subpart F of the final rule, it must treat the credit derivative as an exposure to the underlying reference asset and compute a risk-weighted asset amount for the credit derivative under section 32 of the final rule. The banking organization is not required to compute a counterparty credit risk capital requirement for the credit derivative, as long as it does so consistently for all such OTC credit derivative contracts. Further, where these credit derivative contracts are subject to a qualifying master netting agreement, the banking organization must either include all or exclude all such credit derivatives from PO 00000 Frm 00080 Fmt 4701 Sfmt 4700 any measure used to determine counterparty credit risk exposure to all relevant counterparties for risk-based capital purposes. Where the banking organization provides protection through a credit derivative treated as a covered position under subpart F, it must compute a supplemental counterparty credit risk capital requirement using an amount determined under section 34 for OTC credit derivative contracts or section 35 for credit derivatives that are cleared transactions. In either case, the PFE of the protection provider would be capped at the net present value of the amount of unpaid premiums. Under the final rule, the risk weight for OTC derivative transactions is not subject to any specific ceiling, consistent with the Basel capital framework. Although the agencies generally adopted the proposal without change, the final rule has been revised to add a provision regarding the treatment of a clearing member banking organization’s exposure to a clearing member client (as described below under ‘‘Cleared Transactions,’’ a transaction between a clearing member banking organization and a client is treated as an OTC derivative exposure). However, the final rule recognizes the shorter close-out period for cleared transactions that are derivative contracts, such that a clearing member banking organization can reduce its exposure amount to its client by multiplying the exposure amount by a scaling factor of no less than 0.71. See section VIII.E of this preamble, below, for additional discussion. E. Cleared Transactions The BCBS and the agencies support incentives designed to encourage clearing of derivative and repo-style transactions 155 through a CCP wherever possible in order to promote transparency, multilateral netting, and robust risk-management practices. Although there are some risks associated with CCPs, as discussed below, the agencies believe that CCPs generally help improve the safety and soundness of the derivatives and repostyle transactions markets through the multilateral netting of exposures, establishment and enforcement of collateral requirements, and the promotion of market transparency. As discussed in the proposal, when developing Basel III, the BCBS recognized that as more transactions move to central clearing, the potential for risk concentration and systemic risk 155 See section 2 of the final rule for the definition of a repo-style transaction. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations increases. To address these concerns, in the period preceding the proposal, the BCBS sought comment on a more risksensitive approach for determining capital requirements for banking organizations’ exposures to CCPs.156 In addition, to encourage CCPs to maintain strong risk-management procedures, the BCBS sought comment on a proposal for lower risk-based capital requirements for derivative and repo-style transaction exposures to CCPs that meet the standards established by the Committee on Payment and Settlement Systems (CPSS) and International Organization of Securities Commissions (IOSCO).157 Exposures to such entities, termed QCCPs in the final rule, would be subject to lower risk weights than exposures to CCPs that did not meet those criteria. Consistent with the BCBS proposals and the CPSS–IOSCO standards, the agencies and the FDIC sought comment on specific risk-based capital requirements for cleared derivative and repo-style transactions that are designed to incentivize the use of CCPs, help reduce counterparty credit risk, and promote strong risk management of CCPs to mitigate their potential for systemic risk. In contrast to the general risk-based capital rules, which permit a banking organization to exclude certain derivative contracts traded on an exchange from the risk-based capital calculation, the proposal would have required a banking organization to hold risk-based capital for an outstanding derivative contract or a repo-style transaction that has been cleared through a CCP, including an exchange. The proposal also included a capital requirement for default fund contributions to CCPs. In the case of non-qualifying CCPs (that is, CCPs that do not meet the risk-management, supervision, and other standards for QCCPs outlined in the proposal), the risk-weighted asset amount for default fund contributions to such CCPs would be equal to the sum of the banking organization’s default fund contributions to the CCPs multiplied by 1,250 percent. In the case of QCCPs, the risk-weighted asset amount would be calculated according to a formula based on the hypothetical capital requirement for a QCCP, consistent with the Basel capital framework. The proposal included a formula with inputs including the exposure amount of 156 See ‘‘Capitalisation of Banking Organization Exposures to Central Counterparties’’ (November 2011) (CCP consultative release), available at https:// www.bis.org/publ/bcbs206.pdf. 157 See CPSS–IOSCO, ‘‘Recommendations for Central Counterparties’’ (November 2004), available at https://www.bis.org/publ/cpss64.pdf?noframes=1. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 transactions cleared through the QCCP, collateral amounts, the number of members of the QCCP, and default fund contributions. Following issuance of the proposal, the BCBS issued an interim framework for the capital treatment of bank exposures to CCPs (BCBS CCP interim framework).158 The BCBS CCP interim framework reflects several key changes from the CCP consultative release, including: (1) A provision to allow a clearing member banking organization to apply a scalar when using the CEM (as described below) in the calculation of its exposure amount to a client (or use a reduced margin period of risk when using the internal models methodology (IMM) to calculate exposure at default (EAD) under the advanced approaches rule); (2) revisions to the risk weights applicable to a clearing member banking organization’s exposures when such clearing member banking organization guarantees QCCP performance; (3) a provision to permit clearing member banking organizations to choose from one of two formulaic methodologies for determining the capital requirement for default fund contributions; and (4) revisions to the CEM formula to recognize netting to a greater extent for purposes of calculating the capital requirement for default fund contributions. The agencies and the FDIC received a number of comments on the proposal relating to cleared transactions. Commenters also encouraged the agencies and the FDIC to revise certain aspects of the proposal in a manner consistent with the BCBS CCP interim framework. Some commenters asserted that the definition of QCCP should be revised, specifically by including a definitive list of QCCPs rather than requiring each banking organization to demonstrate that a CCP meets certain qualifying criteria. The agencies believe that a static list of QCCPs would not reflect the potentially dynamic nature of a CCP, and that banking organizations are situated to make this determination on an ongoing basis. Some commenters recommended explicitly including derivatives clearing organizations (DCOs) and securitiesbased swap clearing agencies in the definition of a QCCP. Commenters also suggested including in the definition of QCCP any CCP that the CFTC or SEC exempts from registration because it is deemed by the CFTC or SEC to be subject to ‘‘comparable, comprehensive 158 See ‘‘Capital requirements for bank exposures to central counterparties’’ (July 2012), available at https://www.bis.org/publ/bcbs227.pdf. PO 00000 Frm 00081 Fmt 4701 Sfmt 4700 62097 supervision’’ by another regulator. The agencies note that such registration (or exemption from registration based on being subject to ‘‘comparable, comprehensive supervision’’) does not necessarily mean that the CCP is subject to, or in compliance with, the standards established by the CPSS and IOSCO. In contrast, a designated FMU, which is included in the definition of QCCP, is subject to regulation that corresponds to such standards. Another commenter asserted that, consistent with the BCBS CCP interim framework, the final rule should provide for the designation of a QCCP by the agencies in the absence of a national regime for authorization and licensing of CCPs. The final rule has not been amended to include this aspect of the BCBS CCP interim framework because the agencies believe a national regime for authorizing and licensing CCPs is a critical mechanism to ensure the compliance and ongoing monitoring of a CCP’s adherence to internationally recognized risk-management standards. Another commenter requested that a three-month grace period apply for CCPs that cease to be QCCPs. The agencies note that such a grace period was included in the proposed rule, and the final rule retains the proposed definition without substantive change.159 With respect to the proposed definition of cleared transaction, some commenters asserted that the definition should recognize omnibus accounts because their collateral is bankruptcyremote. The agencies agree with these commenters and have revised the operational requirements for cleared transactions to include an explicit reference to such accounts. The BCBS CCP interim framework requires trade portability to be ‘‘highly likely,’’ as a condition of whether a trade satisfies the definition of cleared transaction. One commenter who encouraged the agencies and the FDIC to adopt the standards set forth in the BCBS CCP interim framework sought clarification of the meaning of ‘‘highly likely’’ in this context. The agencies clarify that, consistent with the BCBS CCP interim framework, if there is clear precedent for transactions to be transferred to a non-defaulting clearing member upon the default of another clearing member (commonly referred to as ‘‘portability’’) and there are no indications that such practice will not continue, then these factors should be considered, when assessing whether client positions are portable. The 159 This provision is located in sections 35 and 133 of the final rule. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62098 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations definition of ‘‘cleared transaction’’ in the final rule is discussed in further detail below. Another commenter sought clarification on whether reasonable reliance on a commissioned legal opinion for foreign financial jurisdictions could satisfy the ‘‘sufficient legal review’’ requirement for bankruptcy remoteness of client positions. The agencies believe that reasonable reliance on a commissioned legal opinion could satisfy this requirement. Another commenter expressed concern that the proposed framework for cleared transactions would capture securities clearinghouses, and encouraged the agencies to clarify their intent with respect to such entities for purposes of the final rule. The agencies note that the definition of ‘‘cleared transaction’’ refers only to OTC derivatives and repo-style transactions. As a result, securities clearinghouses are not within the scope of the cleared transactions framework. One commenter asserted that the agencies and the FDIC should recognize varying close-out period conventions for specific cleared products, specifically exchange-traded derivatives. This commenter also asserted that the agencies and the FDIC should adjust the holding period assumptions or allow CCPs to use alternative methods to compute the appropriate haircut for cleared transactions. For purposes of this final rule, the agencies retained a standard close-out period in the interest of avoiding unnecessary complexity, and note that cleared transactions with QCCPs attract extremely low risk weights (generally, 2 or 4 percent), which, in part, is in recognition of the shorter close-out period involved in cleared transactions. Another commenter requested confirmation that the risk weight applicable to the trade exposure amount for a cleared credit default swap (CDS) could be substituted for the risk weight assigned to an exposure that was hedged by the cleared CDS, that is, the substitution treatment described in sections 36 and 134 would apply. The agencies confirm that under the final rule, a banking organization may apply the substitution treatment of sections 36 or 134 to recognize the credit risk mitigation benefits of a cleared CDS as long as the CDS is an eligible credit derivative and meets the other criteria for recognition. Thus, if a banking organization purchases an eligible credit derivative as a hedge of an exposure and the eligible credit derivative qualifies as a cleared transaction, the banking organization may substitute the risk weight applicable to the cleared VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 transaction under sections 35 or 133 of the final rule (instead of using the risk weight associated with the protection provider).160 Furthermore, the agencies have modified the definition of eligible guarantor to include a QCCP. Another commenter asserted that the final rule should decouple the risk weights applied to collateral exposure and those assigned to other components of trade exposure to recognize the separate components of risk. The agencies note that, if collateral is bankruptcy remote, then it would not be included in the trade exposure amount calculation (see sections 35(b)(2) and 133(b)(2) of the final rule). The agencies also note that such collateral must be risk weighted in accordance with other sections of the final rule as appropriate, to the extent that the posted collateral remains an asset on a banking organization’s balance sheet. A number of commenters addressed the use of the CEM for purposes of calculating a capital requirement for a default fund contribution to a CCP (Kccp).161 Some commenters asserted that the CEM is not appropriate for determining the hypothetical capital requirement for a QCCP (Kccp) under the proposed formula because it lacks risk sensitivity and sophistication, and was not developed for centrally-cleared transactions. Another commenter asserted that the use of CEM should be clarified in the clearing context, specifically, whether the modified CEM approach would permit the netting of offsetting positions booked under different ‘‘desk IDs’’ or ‘‘hub accounts’’ for a given clearing member banking organization. Another commenter encouraged the agencies and the FDIC to allow banking organizations to use the IMM to calculate Kccp. Another commenter encouraged the agencies and the FDIC to continue to work with the BCBS to harmonize international and domestic capital rules for cleared transactions. Although the agencies recognize that the CEM has certain limitations, the agencies consider the CEM, as modified for cleared transactions, to be a reasonable approach that would produce consistent results across banking organizations. Regarding the commenter’s request for clarification of netting positions across ‘‘desk IDs’’ or ‘‘hub accounts,’’ the CEM would recognize netting across such 160 See ‘‘Basel III counterparty credit risk and exposures to central counterparties—Frequently asked questions’’ (December 2012 (update of FAQs published in November 2012)), available at https:// www.bis.org/publ/bcbs237.pdf. 161 See section VIII.D of this preamble for a description of the CEM. PO 00000 Frm 00082 Fmt 4701 Sfmt 4700 transactions if such netting is legally enforceable upon a CCP’s default. Moreover, the agencies believe that the use of models either by the CCP, whose model would not be subject to review and approval by the agencies, or by the banking organizations, whose models may vary significantly, likely would produce inconsistent results that would not serve as a basis for comparison across banking organizations. The agencies recognize that additional work is being performed by the BCBS to revise the CCP capital framework and the CEM. The agencies expect to modify the final rule to incorporate the BCBS improvements to the CCP capital framework and CEM through the normal rulemaking process. Other commenters suggested that the agencies and the FDIC not allow preferential treatment for clearinghouses, which they asserted are systemically critical institutions. In addition, some of these commenters argued that the agency clearing model should receive a more favorable capital requirement because the agency relationship facilitates protection and portability of client positions in the event of a clearing member default, compared to the back-to-back principal model. As noted above, the agencies acknowledge that as more transactions move to central clearing, the potential for risk concentration and systemic risk increases. As noted in the proposal, the risk weights applicable to cleared transactions with QCCPs (generally 2 or 4 percent) represent an increase for many cleared transactions as compared to the general risk-based capital rules (which exclude from the risk-based ratio calculations exchange rate contracts with an original maturity of fourteen or fewer calendar days and derivative contracts traded on exchanges that require daily receipt and payment of cash variation margin),162 in part to reflect the increased concentration and systemic risk inherent in such transactions. In regards to the agency clearing model, the agencies note that a clearing member banking organization that acts as an agent for a client and that guarantees the client’s performance to the QCCP would have no exposure to the QCCP to risk weight. The exposure arising from the guarantee would be treated as an OTC derivative with a reduced holding period, as discussed below. 162 See 12 CFR part 3, appendix A, section 3(b)(7)(iv) (national banks) and 12 CFR 167.6(a)(2)(iv)(E) (Federal savings associations) (OCC); 12 CFR part 208, appendix A paragraph III.E.1.e; 12 CFR part 225, appendix A paragraph III.E.1.e (Board). E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations Another commenter suggested that the final rule address the treatment of unfunded default fund contribution amounts and potential future contributions to QCCPs, noting that the treatment of these potential exposures is not addressed in the BCBS CCP interim framework. The agencies have clarified in the final rule that if a banking organization’s unfunded default fund contribution to a CCP is unlimited, the banking organization’s primary Federal supervisor will determine the riskweighted asset amount for such default fund contribution based on factors such as the size, structure, and membership of the CCP and the riskiness of its transactions. The final rule does not contemplate unlimited default fund contributions to QCCPs because defined default fund contribution amounts are a prerequisite to being a QCCP. Another commenter asserted that it is unworkable to require securities lending transactions to be conducted through a CCP, and that it would be easier and more sensible to make the appropriate adjustments in the final rule to ensure a capital treatment for securities lending transactions that is proportional to their actual risks. The agencies note that the proposed rule would not have required securities lending transactions to be cleared. The agencies also acknowledge that clearing may not be widely available for securities lending transactions, and believe that the collateral haircut approach (sections 37(c) and 132(b) of the final rule) and for advanced approaches banking organizations, the simple value-at-risk (VaR) and internal models methodologies (sections 132(b)(3) and (d) of the final rule) are an appropriately risk-sensitive exposure measure for noncleared securities lending exposures. One commenter asserted that end users and client-cleared trades would be disadvantaged by the proposal. Although there may be increased transaction costs associated with the introduction of the CCP framework, the agencies believe that the overall risk mitigation that should result from the capital requirements generated by the framework will help promote financial stability, and that the measures the agencies have taken in the final rule to incentivize client clearing are aimed at addressing the commenters’ concerns. Several commenters suggested that the proposed rule created a disincentive for client clearing because of the clearing member banking organization’s exposure to the client. The agencies agree with the need to mitigate disincentives for client clearing in the methodology, and have amended the final rule to reflect a lower margin VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 period of risk, or holding period, as applicable, as discussed further below. Commenters suggested delaying implementation of a cleared transactions framework in the final rule until the BCBS CCP interim framework is finalized, implementing the BCBS CCP interim framework in the final rule pending finalization of the BCBS interim framework, or providing a transition period for banking organizations to be able to comply with some of the requirements. A number of commenters urged the agencies and the FDIC to incorporate all substantive changes of the BCBS CCP interim framework, ranging from minor adjustments to more material modifications. After considering the comments and reviewing the standards in the BCBS CCP interim framework, the agencies believe that the modifications to capital standards for cleared transactions in the BCBS CCP interim framework are appropriate and believe that they would result in modifications that address many commenters’ concerns. Furthermore, the agencies believe that it is prudent to implement the BCBS CCP interim framework, rather than wait for the final framework, because the changes in the BCBS CCP interim framework represent a sound approach to mitigating the risks associated with cleared transactions. Accordingly, the agencies have incorporated the material elements of the BCBS CCP interim framework into the final rule. In addition, given the delayed effective date of the final rule, the agencies believe that an additional transition period, as suggested by some commenters, is not necessary. The material changes to the proposed rule to incorporate the CCP interim rule are described below. Other than these changes, the final rule retains the capital requirements for cleared transaction exposures generally as proposed by the agencies and the FDIC. As noted in the proposal, the international discussions are ongoing on these issues, and the agencies will revisit this issue once the Basel capital framework is revised. 1. Definition of Cleared Transaction The final rule defines a cleared transaction as an exposure associated with an outstanding derivative contract or repo-style transaction that a banking organization or clearing member has entered into with a CCP (that is, a transaction that a CCP has accepted).163 163 For example, the agencies expect that a transaction with a derivatives clearing organization (DCO) would meet the criteria for a cleared transaction. A DCO is a clearinghouse, clearing PO 00000 Frm 00083 Fmt 4701 Sfmt 4700 62099 Cleared transactions include the following: (1) A transaction between a CCP and a clearing member banking organization for the banking organization’s own account; (2) a transaction between a CCP and a clearing member banking organization acting as a financial intermediary on behalf of its clearing member client; (3) a transaction between a client banking organization and a clearing member where the clearing member acts on behalf of the client banking organization and enters into an offsetting transaction with a CCP; and (4) a transaction between a clearing member client and a CCP where a clearing member banking organization guarantees the performance of the clearing member client to the CCP. Such transactions must also satisfy additional criteria provided in section 3 of the final rule, including bankruptcy remoteness of collateral, transferability criteria, and portability of the clearing member client’s position. As explained above, the agencies have modified the definition in the final rule to specify that regulated omnibus accounts to meet the requirement for bankruptcy remoteness. A banking organization is required to calculate risk-weighted assets for all of its cleared transactions, whether the banking organization acts as a clearing member (defined as a member of, or direct participant in, a CCP that is entitled to enter into transactions with the CCP) or a clearing member client (defined as a party to a cleared transaction associated with a CCP in which a clearing member acts either as a financial intermediary with respect to the party or guarantees the performance of the party to the CCP). Derivative transactions that are not cleared transactions because they do not meet all the criteria, are OTC derivative transactions. For example, if a transaction submitted to the CCP is not accepted by the CCP because the terms of the transaction submitted by the clearing members do not match or because other operational issues are identified by the CCP, the transaction does not meet the definition of a cleared transaction and is an OTC derivative transaction. If the counterparties to the transaction resolve the issues and association, clearing corporation, or similar entity that enables each party to an agreement, contract, or transaction to substitute, through novation or otherwise, the credit of the DCO for the credit of the parties; arranges or provides, on a multilateral basis, for the settlement or netting of obligations; or otherwise provides clearing services or arrangements that mutualize or transfer credit risk among participants. To qualify as a DCO, an entity must be registered with the U.S. Commodity Futures Trading Commission and comply with all relevant laws and procedures. E:\FR\FM\11OCR2.SGM 11OCR2 62100 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 resubmit the transaction and it is accepted, the transaction would then be a cleared transaction. A cleared transaction does not include an exposure of a banking organization that is a clearing member to its clearing member client where the banking organization is either acting as a financial intermediary and enters into an offsetting transaction with a CCP or where the banking organization provides a guarantee to the CCP on the performance of the client. Under the standardized approach, as discussed below, such a transaction is an OTC derivative transaction with the exposure amount calculated according to section 34(e) of the final rule or a repo-style transaction with the exposure amount calculated according to section 37(c) of the final rule. Under the advanced approaches rule, such a transaction is treated as either an OTC derivative transaction with the exposure amount calculated according to sections 132(c)(8) or (d)(5)(iii)(C) of the final rule or a repo-style transaction with the exposure amount calculated according to sections 132(b) or (d) of the final rule. 2. Exposure Amount Scalar for Calculating for Client Exposures Under the proposal, a transaction between a clearing member banking organization and a client was treated as an OTC derivative exposure, with the exposure amount calculated according to sections 34 or 132 of the proposal. The agencies acknowledged in the proposal that this treatment could have created disincentives for banking organizations to facilitate client clearing. Commenters’ feedback and the BCBS CCP interim framework’s treatment on this subject provided alternatives to address the incentive concern. Consistent with comments and the BCBS CCP interim framework, under the final rule, a clearing member banking organization must treat its counterparty credit risk exposure to clients as an OTC derivative contract, irrespective of whether the clearing member banking organization guarantees the transaction or acts as an intermediary between the client and the QCCP. Consistent with the BCBS CCP interim framework, to recognize the shorter close-out period for cleared transactions, under the standardized approach a clearing member banking organization may calculate its exposure amount to a client by multiplying the exposure amount, calculated using the CEM, by a scaling factor of no less than 0.71, which represents a five-day holding period. A clearing member banking organization must use a longer VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 holding period and apply a larger scaling factor to its exposure amount in accordance with Table 20 if it determines that a holding period longer than five days is appropriate. A banking organization’s primary Federal supervisor may require a clearing member banking organization to set a longer holding period if the primary Federal supervisor determines that a longer period is commensurate with the risks associated with the transaction. The agencies believe that the recognition of a shorter close-out period appropriately captures the risk associated with such transactions while furthering the policy goal of promoting central clearing. TABLE 20—HOLDING PERIODS AND SCALING FACTORS Holding period (days) Scaling factor 5 6 7 8 9 10 0.71 0.77 0.84 0.89 0.95 1.00 3. Risk Weighting for Cleared Transactions Under the final rule, to determine the risk-weighted asset amount for a cleared transaction, a clearing member client banking organization or a clearing member banking organization must multiply the trade exposure amount for the cleared transaction by the appropriate risk weight, determined as described below. The trade exposure amount is calculated as follows: (1) For a cleared transaction that is a derivative contract or a netting set of derivatives contracts, the trade exposure amount is equal to the exposure amount for the derivative contract or netting set of derivative contracts, calculated using the CEM for OTC derivative contracts (described in sections 34 or 132(c) of the final rule) or for advanced approaches banking organizations that use the IMM, under section 132(d) of the final rule), plus the fair value of the collateral posted by the clearing member client banking organization and held by the CCP or clearing member in a manner that is not bankruptcy remote; and (2) For a cleared transaction that is a repo-style transaction or a netting set of repo-style transactions, the trade exposure amount is equal to the exposure amount calculated under the collateral haircut approach used for financial collateral (described in section 37(c) and 132(b) of the final rule) (or for advanced approaches banking organizations the IMM under section PO 00000 Frm 00084 Fmt 4701 Sfmt 4700 132(d) of the final rule) plus the fair value of the collateral posted by the clearing member client banking organization that is held by the CCP or clearing member in a manner that is not bankruptcy remote. The trade exposure amount does not include any collateral posted by a clearing member client banking organization or clearing member banking organization that is held by a custodian in a manner that is bankruptcy remote 164 from the CCP, clearing member, other counterparties of the clearing member, and the custodian itself. In addition to the capital requirement for the cleared transaction, the banking organization remains subject to a capital requirement for any collateral provided to a CCP, a clearing member, or a custodian in connection with a cleared transaction in accordance with section 32 or 131 of the final rule. Consistent with the BCBS CCP interim framework, the risk weight for a cleared transaction depends on whether the CCP is a QCCP. Central counterparties that are designated FMUs and foreign entities regulated and supervised in a manner equivalent to designated FMUs are QCCPs. In addition, a CCP could be a QCCP under the final rule if it is in sound financial condition and meets certain standards that are consistent with BCBS expectations for QCCPs, as set forth in the QCCP definition. A clearing member banking organization must apply a 2 percent risk weight to its trade exposure amount to a QCCP. A banking organization that is a clearing member client may apply a 2 percent risk weight to the trade exposure amount only if: (1) The collateral posted by the clearing member client banking organization to the QCCP or clearing member is subject to an arrangement that prevents any losses to the clearing member client due to the joint default or a concurrent insolvency, liquidation, or receivership proceeding of the clearing member and any other clearing member clients of the clearing member, and (2) The clearing member client banking organization has conducted sufficient legal review to conclude with a well-founded basis (and maintains sufficient written documentation of that legal review) that in the event of a legal challenge (including one resulting from default or a liquidation, insolvency, or receivership proceeding) the relevant court and administrative authorities 164 Under the final rule, bankruptcy remote, with respect to an entity or asset, means that the entity or asset would be excluded from an insolvent entity’s estate in a receivership, insolvency or similar proceeding. E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 would find the arrangements to be legal, valid, binding, and enforceable under the law of the relevant jurisdiction. If the criteria above are not met, a clearing member client banking organization must apply a risk weight of 4 percent to the trade exposure amount. Under the final rule, as under the proposal, for a cleared transaction with a CCP that is not a QCCP, a clearing member banking organization and a clearing member client banking organization must risk weight the trade exposure amount to the CCP according to the risk weight applicable to the CCP under section 32 of the final rule (generally, 100 percent). Collateral posted by a clearing member banking organization that is held by a custodian in a manner that is bankruptcy remote from the CCP is not subject to a capital requirement for counterparty credit risk. Similarly, collateral posted by a clearing member client that is held by a custodian in a manner that is bankruptcy remote from the CCP, VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 clearing member, and other clearing member clients of the clearing member is not be subject to a capital requirement for counterparty credit risk. The proposed rule was silent on the risk weight that would apply where a clearing member banking organization acts for its own account or guarantees a QCCP’s performance to a client. Consistent with the BCBS CCP interim framework, the final rule provides additional specificity regarding the riskweighting methodologies for certain exposures of clearing member banking organizations. The final rule provides that a clearing member banking organization that (i) acts for its own account, (ii) is acting as a financial intermediary (with an offsetting transaction or a guarantee of the client’s performance to a QCCP), or (iii) guarantees a QCCP’s performance to a client would apply a two percent risk weight to the banking organization’s exposure to the QCCP. The diagrams below demonstrate the various potential PO 00000 Frm 00085 Fmt 4701 Sfmt 4700 62101 transactions and exposure treatment in the final rule. Table 21 sets out how the transactions illustrated in the diagrams below are risk-weighted under the final rule. In the diagram, ‘‘T’’ refers to a transaction, and the arrow indicates the direction of the exposure. The diagram describes the appropriate risk weight treatment for exposures from the perspective of a clearing member banking organization entering into cleared transactions for its own account (T1), a clearing member banking organization entering into cleared transactions on behalf of a client (T2 through T7), and a banking organization entering into cleared transactions as a client of a clearing member (T8 and T9). Table 21 shows for each trade whom the exposure is to, a description of the type of trade, and the risk weight that would apply based on the risk of the counterparty. BILLING CODE 4810–33–P E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations BILLING CODE 4810–33–C VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00086 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.001</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 62102 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 62103 TABLE 21—RISK WEIGHTS FOR VARIOUS CLEARED TRANSACTIONS Exposure to Description ...................... ...................... ...................... ...................... ...................... ...................... ...................... ...................... QCCP ............... Client ................ QCCP ............... Client ................ QCCP ............... Client ................ QCCP ............... CM .................... T9 ...................... QCCP ............... Own account ............................................................. Financial intermediary with offsetting trade to QCCP Financial intermediary with offsetting trade to QCCP Agent with guarantee of client performance ............. Agent with guarantee of client performance ............. Guarantee of QCCP performance ............................ Guarantee of QCCP performance ............................ CM financial intermediary with offsetting trade to QCCP. CM agent with guarantee of client performance ....... T1 T2 T3 T4 T5 T6 T7 T8 wreier-aviles on DSK5TPTVN1PROD with RULES2 4. Default Fund Contribution Exposures There are several risk mitigants available when a party clears a transaction through a CCP rather than on a bilateral basis: The protection provided to the CCP clearing members by the margin requirements imposed by the CCP; the CCP members’ default fund contributions; and the CCP’s own capital and contribution to the default fund, which are an important source of collateral in case of counterparty default.165 CCPs independently determine default fund contributions that are required from members. The BCBS therefore established, and the final rule adopts, a risk-sensitive approach for risk weighting a banking organization’s exposure to a default fund. Under the proposed rule, there was only one method that a clearing member banking organization could use to calculate its risk-weighted asset amount for default fund contributions. The BCBS CCP interim framework added a second method to better reflect the lower risks associated with exposures to those clearinghouses that have relatively large default funds with a significant amount unfunded. Commenters requested that the final rule adopt both methods contained in the BCBS CCP interim framework. Accordingly, under the final rule, a banking organization that is a clearing member of a CCP must calculate the risk-weighted asset amount for its default fund contributions at least quarterly or more frequently if there is a material change, in the opinion of the banking organization or the primary Federal supervisor, in the financial condition of the CCP. A default fund contribution means the funds contributed or commitments made by a clearing member to a CCP’s mutualized loss-sharing arrangement. If the CCP is not a QCCP, the banking organization’s risk-weighted asset amount for its 165 Default funds are also known as clearing deposits or guaranty funds. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 Risk-weighting treatment under the final rule 2% risk weight on trade exposure amount. OTC derivative with CEM scalar.** 2% risk weight on trade exposure amount. OTC derivative with CEM scalar.** No exposure. OTC derivative with CEM scalar.** 2% risk weight on trade exposure amount. 2% or 4%* risk weight on trade exposure amount. 2% or 4%* risk weight on trade exposure amount. default fund contribution is either the sum of the default fund contributions multiplied by 1,250 percent, or in cases where the default fund contributions may be unlimited, an amount as determined by the banking organization’s primary Federal supervisor based on factors described above. Consistent with the BCBS CCP interim framework, the final rule requires a banking organization to calculate a risk-weighted asset amount for its default fund contribution using one of two methods. Method one requires a clearing member banking organization to use a three-step process. The first step is for the clearing member banking organization to calculate the QCCP’s hypothetical capital requirement (KCCP), unless the QCCP has already disclosed it, in which case the banking organization must rely on that disclosed figure, unless the banking organization determines that a higher figure is appropriate based on the nature, structure, or characteristics of the QCCP. KCCP is defined as the capital that a QCCP is required to hold if it were a banking organization, and is calculated using the CEM for OTC derivatives or the collateral haircut approach for repo-style transactions, recognizing the risk-mitigating effects of collateral posted by and default fund contributions received from the QCCP clearing members. The final rule provides several modifications to the calculation of KCCP to adjust for certain features that are unique to QCCPs. Namely, the modifications permit: (1) A clearing member to offset its exposure to a QCCP with actual default fund contributions, and (2) greater recognition of netting when using the CEM to calculate KCCP described below. Additionally, the risk weight of all clearing members is set at 20 percent, except when a banking organization’s primary Federal supervisor has determined that a higher risk weight is appropriate based on the specific characteristics of the QCCP and PO 00000 Frm 00087 Fmt 4701 Sfmt 4700 its clearing members. Finally, for derivative contracts that are options, the PFE amount calculation is adjusted by multiplying the notional principal amount of the derivative contract by the appropriate conversion factor and the absolute value of the option’s delta (that is, the ratio of the change in the value of the derivative contract to the corresponding change in the price of the underlying asset). In the second step of method one, the final rule requires a banking organization to compare KCCP to the funded portion of the default fund of a QCCP, and to calculate the total of all the clearing members’ capital requirements (K*cm). If the total funded default fund of a QCCP is less than KCCP, the final rule requires additional capital to be assessed against the shortfall because of the small size of the funded portion of the default fund relative to KCCP. If the total funded default fund of a QCCP is greater than KCCP, but the QCCP’s own funded contributions to the default fund are less than KCCP (so that the clearing members’ default fund contributions are required to achieve KCCP), the clearing members’ default fund contributions up to KCCP are risk-weighted at 100 percent and a decreasing capital factor, between 1.6 percent and 0.16 percent, is applied to the clearing members’ funded default fund contributions above KCCP. If the QCCP’s own contribution to the default fund is greater than KCCP, then only the decreasing capital factor is applied to the clearing members’ default fund contributions. In the third step of method one, the final rule requires (K*cm) to be allocated back to each individual clearing member. This allocation is proportional to each clearing member’s contribution to the default fund but adjusted to reflect the impact of two average-size clearing members defaulting as well as to account for the concentration of exposures among clearing members. A clearing member banking organization multiplies its allocated capital E:\FR\FM\11OCR2.SGM 11OCR2 62104 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 requirement by 12.5 to determine its risk-weighted asset amount for its default fund contribution to the QCCP. As the alternative, a banking organization is permitted to use method two, which is a simplified method under which the risk-weighted asset amount for its default fund contribution to a QCCP equals 1,250 percent multiplied by the default fund contribution, subject to an overall cap. The cap is based on a banking organization’s trade exposure amount for all of its transactions with a QCCP. A banking organization’s risk-weighted asset amount for its default fund contribution to a QCCP is either a 1,250 percent risk weight applied to its default fund contribution to that QCCP or 18 percent of its trade exposure amount to that QCCP. Method two subjects a banking organization to an overall cap on the risk-weighted assets from all its exposures to the CCP equal to 20 percent times the trade exposures to the CCP. This 20 percent cap is arrived at as the sum of the 2 percent capital requirement for trade exposure plus 18 percent for the default fund portion of a banking organization’s exposure to a QCCP. To address commenter concerns that the CEM underestimates the multilateral netting benefits arising from a QCCP, the final rule recognizes the larger diversification benefits inherent in a multilateral netting arrangement for purposes of measuring the QCCP’s potential future exposure associated with derivative contracts. Consistent with the BCBS CCP interim framework, and as mentioned above, the final rule replaces the proposed factors (0.3 and 0.7) in the formula to calculate Anet with 0.15 and 0.85, in sections 35(d)(3)(i)(A)(1) and 133(d)(3)(i)(A)(1) of the final rule, respectively. F. Credit Risk Mitigation Banking organizations use a number of techniques to mitigate credit risks. For example, a banking organization may collateralize exposures with cash or securities; a third party may guarantee an exposure; a banking organization may buy a credit derivative to offset an exposure’s credit risk; or a banking organization may net exposures with a counterparty under a netting agreement. The general risk-based capital rules recognize these techniques to some extent. This section of the preamble describes how the final rule allows banking organizations to recognize the risk-mitigation effects of guarantees, credit derivatives, and collateral for risk-based capital purposes. In general, the final rule provides for a greater variety of credit risk mitigation VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 techniques than the general risk-based capital rules. Similar to the general risk-based capital rules, under the final rule a banking organization generally may use a substitution approach to recognize the credit risk mitigation effect of an eligible guarantee from an eligible guarantor and the simple approach to recognize the effect of collateral. To recognize credit risk mitigants, all banking organizations must have operational procedures and risk-management processes that ensure that all documentation used in collateralizing or guaranteeing a transaction is legal, valid, binding, and enforceable under applicable law in the relevant jurisdictions. A banking organization should conduct sufficient legal review to reach a well-founded conclusion that the documentation meets this standard as well as conduct additional reviews as necessary to ensure continuing enforceability. Although the use of credit risk mitigants may reduce or transfer credit risk, it simultaneously may increase other risks, including operational, liquidity, or market risk. Accordingly, a banking organization should employ robust procedures and processes to control risks, including roll-off and concentration risks, and monitor and manage the implications of using credit risk mitigants for the banking organization’s overall credit risk profile. 1. Guarantees and Credit Derivatives a. Eligibility Requirements Consistent with the Basel capital framework, the agencies and the FDIC proposed to recognize a wider range of eligible guarantors than permitted under the general risk-based capital rules, including sovereigns, the Bank for International Settlements, the International Monetary Fund, the European Central Bank, the European Commission, Federal Home Loan Banks (FHLB), Federal Agricultural Mortgage Corporation (Farmer Mac), MDBs, depository institutions, BHCs, SLHCs, credit unions, and foreign banks. Eligible guarantors would also include entities that are not special purpose entities that have issued and outstanding unsecured debt securities without credit enhancement that are investment grade and that meet certain other requirements.166 166 Under the proposed and final rule, an exposure is ‘‘investment grade’’ if the entity to which the banking organization is exposed through a loan or security, or the reference entity with respect to a credit derivative, has adequate capacity to meet financial commitments for the projected life of the asset or exposure. Such an entity or reference entity has adequate capacity to meet financial commitments if the risk of its default is low and the PO 00000 Frm 00088 Fmt 4701 Sfmt 4700 Some commenters suggested modifying the proposed definition of eligible guarantor to remove the investment-grade requirement. Commenters also suggested that the agencies and the FDIC potentially include as eligible guarantors other entities, such as financial guaranty and private mortgage insurers. The agencies believe that guarantees issued by these types of entities can exhibit significant wrong-way risk and modifying the definition of eligible guarantor to accommodate these entities or entities that are not investment grade would be contrary to one of the key objectives of the capital framework, which is to mitigate interconnectedness and systemic vulnerabilities within the financial system. Therefore, the agencies have not included the recommended entities in the final rule’s definition of ‘‘eligible guarantor.’’ The agencies have, however, amended the definition of eligible guarantor in the final rule to include QCCPs to accommodate use of the substitution approach for credit derivatives that are cleared transactions. The agencies believe that QCCPs, as supervised entities subject to specific risk-management standards, are appropriately included as eligible guarantors under the final rule.167 In addition, the agencies clarify one commenter’s concern and confirm that re-insurers that are engaged predominantly in the business of providing credit protection do not qualify as an eligible guarantor under the final rule. Under the final rule, guarantees and credit derivatives are required to meet specific eligibility requirements to be recognized for credit risk mitigation purposes. Consistent with the proposal, under the final rule, an eligible guarantee is defined as a guarantee from an eligible guarantor that is written and meets certain standards and conditions, including with respect to its enforceability. An eligible credit derivative is defined as a credit derivative in the form of a CDS, nth-todefault swap, total return swap, or any other form of credit derivative approved by the primary Federal supervisor, provided that the instrument meets the standards and conditions set forth in the definition. See the definitions of ‘‘eligible guarantee’’ and ‘‘eligible credit derivative’’ in section 2 of the final rule. Under the proposal, a banking organization would have been permitted to recognize the credit risk mitigation full and timely repayment of principal and interest is expected. 167 See the definition of ‘‘eligible guarantor’’ in section 2 of the final rule. E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 benefits of an eligible credit derivative that hedges an exposure that is different from the credit derivative’s reference exposure used for determining the derivative’s cash settlement value, deliverable obligation, or occurrence of a credit event if (1) the reference exposure ranks pari passu with or is subordinated to the hedged exposure; (2) the reference exposure and the hedged exposure are to the same legal entity; and (3) legally-enforceable crossdefault or cross-acceleration clauses are in place to assure payments under the credit derivative are triggered when the issuer fails to pay under the terms of the hedged exposure. In addition to these two exceptions, one commenter encouraged the agencies and the FDIC to revise the final rule to recognize a proxy hedge as an eligible credit derivative even though such a transaction hedges an exposure that differs from the credit derivative’s reference exposure. A proxy hedge was characterized by the commenter as a hedge of an exposure supported by a sovereign using a credit derivative on that sovereign. The agencies do not believe there is sufficient justification to include proxy hedges in the definition of eligible credit derivative because they have concerns regarding the ability of the hedge to sufficiently mitigate the risk of the underlying exposure. The agencies have, therefore, adopted the definition of eligible credit derivative as proposed. In addition, under the final rule, consistent with the proposal, when a banking organization has a group of hedged exposures with different residual maturities that are covered by a single eligible guarantee or eligible credit derivative, it must treat each hedged exposure as if it were fully covered by a separate eligible guarantee or eligible credit derivative. b. Substitution Approach The agencies are adopting the substitution approach for eligible guarantees and eligible credit derivatives in the final rule without change. Under the substitution approach, if the protection amount (as defined below) of an eligible guarantee or eligible credit derivative is greater than or equal to the exposure amount of the hedged exposure, a banking organization substitutes the risk weight applicable to the guarantor or credit derivative protection provider for the risk weight applicable to the hedged exposure. If the protection amount of the eligible guarantee or eligible credit derivative is less than the exposure amount of the hedged exposure, a VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 banking organization must treat the hedged exposure as two separate exposures (protected and unprotected) to recognize the credit risk mitigation benefit of the guarantee or credit derivative. In such cases, a banking organization calculates the riskweighted asset amount for the protected exposure under section 36 of the final rule (using a risk weight applicable to the guarantor or credit derivative protection provider and an exposure amount equal to the protection amount of the guarantee or credit derivative). The banking organization calculates its risk-weighted asset amount for the unprotected exposure under section 32 of the final rule (using the risk weight assigned to the exposure and an exposure amount equal to the exposure amount of the original hedged exposure minus the protection amount of the guarantee or credit derivative). Under the final rule, the protection amount of an eligible guarantee or eligible credit derivative means the effective notional amount of the guarantee or credit derivative reduced to reflect any, maturity mismatch, lack of restructuring coverage, or currency mismatch as described below. The effective notional amount for an eligible guarantee or eligible credit derivative is the lesser of the contractual notional amount of the credit risk mitigant and the exposure amount of the hedged exposure, multiplied by the percentage coverage of the credit risk mitigant. For example, the effective notional amount of a guarantee that covers, on a pro rata basis, 40 percent of any losses on a $100 bond is $40. c. Maturity Mismatch Haircut The agencies are adopting the proposed haircut for maturity mismatch in the final rule without change. Under the final rule, the agencies have adopted the requirement that a banking organization that recognizes an eligible guarantee or eligible credit derivative must adjust the effective notional amount of the credit risk mitigant to reflect any maturity mismatch between the hedged exposure and the credit risk mitigant. A maturity mismatch occurs when the residual maturity of a credit risk mitigant is less than that of the hedged exposure(s).168 168 As noted above, when a banking organization has a group of hedged exposures with different residual maturities that are covered by a single eligible guarantee or eligible credit derivative, a banking organization treats each hedged exposure as if it were fully covered by a separate eligible guarantee or eligible credit derivative. To determine whether any of the hedged exposures has a maturity mismatch with the eligible guarantee or credit derivative, the banking organization assesses whether the residual maturity of the eligible PO 00000 Frm 00089 Fmt 4701 Sfmt 4700 62105 The residual maturity of a hedged exposure is the longest possible remaining time before the obligated party of the hedged exposure is scheduled to fulfil its obligation on the hedged exposure. A banking organization is required to take into account any embedded options that may reduce the term of the credit risk mitigant so that the shortest possible residual maturity for the credit risk mitigant is used to determine the potential maturity mismatch. If a call is at the discretion of the protection provider, the residual maturity of the credit risk mitigant is at the first call date. If the call is at the discretion of the banking organization purchasing the protection, but the terms of the arrangement at origination of the credit risk mitigant contain a positive incentive for the banking organization to call the transaction before contractual maturity, the remaining time to the first call date is the residual maturity of the credit risk mitigant. A banking organization is permitted, under the final rule, to recognize a credit risk mitigant with a maturity mismatch only if its original maturity is greater than or equal to one year and the residual maturity is greater than three months. Assuming that the credit risk mitigant may be recognized, a banking organization is required to apply the following adjustment to reduce the effective notional amount of the credit risk mitigant to recognize the maturity mismatch: Pm = E × [(t¥0.25)/(T¥0.25)], where: (1) Pm = effective notional amount of the credit risk mitigant, adjusted for maturity mismatch; (2) E = effective notional amount of the credit risk mitigant; (3) t = the lesser of T or residual maturity of the credit risk mitigant, expressed in years; and (4) T = the lesser of five or the residual maturity of the hedged exposure, expressed in years. d. Adjustment for Credit Derivatives Without Restructuring as a Credit Event The agencies are adopting in the final rule the proposed adjustment for credit derivatives without restructuring as a credit event. Consistent with the proposal, under the final rule, a banking organization that seeks to recognize an eligible credit derivative that does not include a restructuring of the hedged exposure as a credit event under the derivative must reduce the effective notional amount of the credit derivative guarantee or eligible credit derivative is less than that of the hedged exposure. E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations recognized for credit risk mitigation purposes by 40 percent. For purposes of the credit risk mitigation framework, a restructuring may involve forgiveness or postponement of principal, interest, or fees that result in a credit loss event (that is, a charge-off, specific provision, or other similar debit to the profit and loss account). In these instances, the banking organization is required to apply the following adjustment to reduce the effective notional amount of the credit derivative: Pr = Pm × 0.60, where: (1) Pr = effective notional amount of the credit risk mitigant, adjusted for lack of a restructuring event (and maturity mismatch, if applicable); and (2) Pm = effective notional amount of the credit risk mitigant (adjusted for maturity mismatch, if applicable). e. Currency Mismatch Adjustment Consistent with the proposal, under the final rule, if a banking organization recognizes an eligible guarantee or eligible credit derivative that is denominated in a currency different from that in which the hedged exposure is denominated, the banking organization must apply the following formula to the effective notional amount of the guarantee or credit derivative: PC = Pr × (1¥HFX), wreier-aviles on DSK5TPTVN1PROD with RULES2 where: (1) Pc = effective notional amount of the credit risk mitigant, adjusted for currency mismatch (and maturity mismatch and lack of restructuring event, if applicable); (2) Pr = effective notional amount of the credit risk mitigant (adjusted for maturity mismatch and lack of restructuring event, if applicable); and (3) HFX = haircut appropriate for the currency mismatch between the credit risk mitigant and the hedged exposure. A banking organization is required to use a standard supervisory haircut of 8 percent for HFX (based on a tenbusiness-day holding period and daily marking-to-market and remargining). Alternatively, a banking organization has the option to use internally estimated haircuts of HFX based on a ten-business-day holding period and daily marking-to-market if the banking organization qualifies to use the ownestimates of haircuts in section 37(c)(4) of the final rule. In either case, the banking organization is required to scale the haircuts up using the square root of time formula if the banking organization revalues the guarantee or credit derivative less frequently than once every 10 business days. The applicable haircut (HM) is calculated using the following square root of time formula: VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 where: TM = equals the greater of 10 or the number of days between revaluation. f. Multiple Credit Risk Mitigants Consistent with the proposal, under the final rule, if multiple credit risk mitigants cover a single exposure, a banking organization may disaggregate the exposure into portions covered by each credit risk mitigant (for example, the portion covered by each guarantee) and calculate separately a risk-based capital requirement for each portion, consistent with the Basel capital framework. In addition, when a single credit risk mitigant covers multiple exposures, a banking organization must treat each hedged exposure as covered by a single credit risk mitigant and must calculate separate risk-weighted asset amounts for each exposure using the substitution approach described in section 36(c) of the final rule. 2. Collateralized Transactions a. Eligible Collateral Under the proposal, the agencies and the FDIC would recognize an expanded range of financial collateral as credit risk mitigants that may reduce the riskbased capital requirements associated with a collateralized transaction, consistent with the Basel capital framework. The agencies and the FDIC proposed that a banking organization could recognize the risk-mitigating effects of financial collateral using the ‘‘simple approach’’ for any exposure provided that the collateral meets certain requirements. For repo-style transactions, eligible margin loans, collateralized derivative contracts, and single-product netting sets of such transactions, a banking organization could alternatively use the collateral haircut approach. The proposal required a banking organization to use the same approach for similar exposures or transactions. The commenters generally agreed with this aspect of the proposal; however, a few commenters encouraged the agencies and the FDIC to expand the definition of financial collateral to include precious metals and certain residential mortgages that collateralize warehouse lines of credit. Several commenters asserted that the final rule should recognize as financial collateral conforming residential mortgages (or at least those collateralizing warehouse lines of credit) and/or those insured by the FHA or VA. They noted that by not including conforming residential PO 00000 Frm 00090 Fmt 4701 Sfmt 4700 mortgages in the definition of financial collateral, the proposed rule would require banking organizations providing warehouse lines to treat warehouse facilities as commercial loan exposures, thus preventing such entities from looking through to the underlying collateral in calculating the appropriate risk weighting. Others argued that a ‘‘look through’’ approach for a repostyle structure to the financial collateral held therein should be allowed. Another commenter argued that the final rule should allow recognition of intangible assets as financial collateral because they have real value. The agencies believe that the collateral types suggested by the commenters are not appropriate forms of financial collateral because they exhibit increased variation and credit risk, and are relatively more speculative than the recognized forms of financial collateral under the proposal. For example, residential mortgages can be highly idiosyncratic in regards to payment features, interest rate provisions, lien seniority, and maturities. The agencies believe that the proposed definition of financial collateral, which is broader than the collateral recognized under the general risk-based capital rules, included those collateral types of sufficient liquidity and asset quality to recognize as credit risk mitigants for risk-based capital purposes. As a result, the agencies have retained the definition of financial collateral as proposed. Therefore, consistent with the proposal, the final rule defines financial collateral as collateral in the form of: (1) Cash on deposit with the banking organization (including cash held for the banking organization by a third-party custodian or trustee); (2) gold bullion; (3) shortand long-term debt securities that are not resecuritization exposures and that are investment grade; (4) equity securities that are publicly-traded; (5) convertible bonds that are publiclytraded; or (6) money market fund shares and other mutual fund shares if a price for the shares is publicly quoted daily. With the exception of cash on deposit, the banking organization is also required to have a perfected, firstpriority security interest or, outside of the United States, the legal equivalent thereof, notwithstanding the prior security interest of any custodial agent. Even if a banking organization has the legal right, it still must ensure it monitors or has a freeze on the account to prevent a customer from withdrawing cash on deposit prior to defaulting. A banking organization is permitted to recognize partial collateralization of an exposure. E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.002</GPH> 62106 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 Under the final rule, the agencies require that a banking organization could recognize the risk-mitigating effects of financial collateral using the simple approach described below, where: The collateral is subject to a collateral agreement for at least the life of the exposure; the collateral is revalued at least every six months; and the collateral (other than gold) and the exposure is denominated in the same currency. For repo-style transactions, eligible margin loans, collateralized derivative contracts, and single-product netting sets of such transactions, a banking organization could alternatively use the collateral haircut approach described below. The final rule, like the proposal, requires a banking organization to use the same approach for similar exposures or transactions. b. Risk-Management Guidance for Recognizing Collateral Before a banking organization recognizes collateral for credit risk mitigation purposes, it should: (1) Conduct sufficient legal review to ensure, at the inception of the collateralized transaction and on an ongoing basis, that all documentation used in the transaction is binding on all parties and legally enforceable in all relevant jurisdictions; (2) consider the correlation between risk of the underlying direct exposure and collateral in the transaction; and (3) fully take into account the time and cost needed to realize the liquidation proceeds and the potential for a decline in collateral value over this time period. A banking organization also should ensure that the legal mechanism under which the collateral is pledged or transferred ensures that the banking organization has the right to liquidate or take legal possession of the collateral in a timely manner in the event of the default, insolvency, or bankruptcy (or other defined credit event) of the counterparty and, where applicable, the custodian holding the collateral. In addition, a banking organization should ensure that it (1) has taken all steps necessary to fulfill any legal requirements to secure its interest in the collateral so that it has and maintains an enforceable security interest; (2) has set up clear and robust procedures to ensure satisfaction of any legal conditions required for declaring the default of the borrower and prompt liquidation of the collateral in the event of default; (3) has established procedures and practices for conservatively estimating, on a regular ongoing basis, the fair value of the collateral, taking into account factors that could affect that value (for example, VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 the liquidity of the market for the collateral and obsolescence or deterioration of the collateral); and (4) has in place systems for promptly requesting and receiving additional collateral for transactions whose terms require maintenance of collateral values at specified thresholds. c. Simple Approach The agencies are adopting the simple approach without change for purposes of the final rule. Under the final rule, the collateralized portion of the exposure receives the risk weight applicable to the collateral. The collateral is required to meet the definition of financial collateral. For repurchase agreements, reverse repurchase agreements, and securities lending and borrowing transactions, the collateral would be the instruments, gold, and cash that a banking organization has borrowed, purchased subject to resale, or taken as collateral from the counterparty under the transaction. As noted above, in all cases, (1) the collateral must be subject to a collateral agreement for at least the life of the exposure; (2) the banking organization must revalue the collateral at least every six months; and (3) the collateral (other than gold) and the exposure must be denominated in the same currency. Generally, the risk weight assigned to the collateralized portion of the exposure must be no less than 20 percent. However, the collateralized portion of an exposure may be assigned a risk weight of less than 20 percent for the following exposures. OTC derivative contracts that are marked to fair value on a daily basis and subject to a daily margin maintenance agreement, may receive (1) a zero percent risk weight to the extent that contracts are collateralized by cash on deposit, or (2) a 10 percent risk weight to the extent that the contracts are collateralized by an exposure to a sovereign that qualifies for a zero percent risk weight under section 32 of the final rule. In addition, a banking organization may assign a zero percent risk weight to the collateralized portion of an exposure where the financial collateral is cash on deposit; or the financial collateral is an exposure to a sovereign that qualifies for a zero percent risk weight under section 32 of the final rule, and the banking organization has discounted the fair value of the collateral by 20 percent. d. Collateral Haircut Approach Consistent with the proposal, in the final rule, a banking organization may use the collateral haircut approach to recognize the credit risk mitigation PO 00000 Frm 00091 Fmt 4701 Sfmt 4700 62107 benefits of financial collateral that secures an eligible margin loan, repostyle transaction, collateralized derivative contract, or single-product netting set of such transactions. In addition, the banking organization may use the collateral haircut approach with respect to any collateral that secures a repo-style transaction that is included in the banking organization’s VaR-based measure under subpart F of the final rule, even if the collateral does not meet the definition of financial collateral. To apply the collateral haircut approach, a banking organization must determine the exposure amount and the relevant risk weight for the counterparty or guarantor. The exposure amount for an eligible margin loan, repo-style transaction, collateralized derivative contract, or a netting set of such transactions is equal to the greater of zero and the sum of the following three quantities: (1) The value of the exposure less the value of the collateral. For eligible margin loans, repo-style transactions and netting sets thereof, the value of the exposure is the sum of the current market values of all instruments, gold, and cash the banking organization has lent, sold subject to repurchase, or posted as collateral to the counterparty under the transaction or netting set. For collateralized OTC derivative contracts and netting sets thereof, the value of the exposure is the exposure amount that is calculated under section 34 of the final rule. The value of the collateral equals the sum of the current market values of all instruments, gold and cash the banking organization has borrowed, purchased subject to resale, or taken as collateral from the counterparty under the transaction or netting set; (2) The absolute value of the net position in a given instrument or in gold (where the net position in a given instrument or in gold equals the sum of the current market values of the instrument or gold the banking organization has lent, sold subject to repurchase, or posted as collateral to the counterparty minus the sum of the current market values of that same instrument or gold that the banking organization has borrowed, purchased subject to resale, or taken as collateral from the counterparty) multiplied by the market price volatility haircut appropriate to the instrument or gold; and (3) The absolute value of the net position of instruments and cash in a currency that is different from the settlement currency (where the net position in a given currency equals the sum of the current market values of any instruments or cash in the currency the E:\FR\FM\11OCR2.SGM 11OCR2 62108 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations banking organization has lent, sold subject to repurchase, or posted as collateral to the counterparty minus the sum of the current market values of any instruments or cash in the currency the banking organization has borrowed, purchased subject to resale, or taken as collateral from the counterparty) multiplied by the haircut appropriate to the currency mismatch. For purposes of the collateral haircut approach, a given instrument includes, for example, all securities with a single Committee on Uniform Securities Identification Procedures (CUSIP) number and would not include securities with different CUSIP numbers, even if issued by the same issuer with the same maturity date. e. Standard Supervisory Haircuts When determining the exposure amount, the banking organization must apply a haircut for price market volatility and foreign exchange rates, determined either using standard supervisory market price volatility haircuts and a standard haircut for exchange rates or, with prior approval of the agency, a banking organization’s own estimates of volatilities of market prices and foreign exchange rates. The standard supervisory market price volatility haircuts set a specified market price volatility haircut for various categories of financial collateral. These standard haircuts are based on the ten-business-day holding period for eligible margin loans and derivative contracts. For repo-style transactions, a banking organization may multiply the standard supervisory haircuts by the square root of 1⁄2 to scale them for a holding period of five business days. Several commenters argued that the proposed haircuts were too conservative and insufficiently risk-sensitive, and that banking organizations should be allowed to compute their own haircuts. Some commenters proposed limiting the maximum haircut for non-sovereign issuers that receive a 100 percent risk weight to 12 percent and, more specifically, assigning a lower haircut than 25 percent for financial collateral in the form of an investment-grade corporate debt security that has a shorter residual maturity. The commenters asserted that these haircuts conservatively correspond to the existing rating categories and result in greater alignment with the Basel framework. In the final rule, the agencies have revised from 25.0 percent the standard supervisory market price volatility haircuts for financial collateral issued by non-sovereign issuers with a risk weight of 100 percent to 4.0 percent for maturities of less than one year, 8.0 percent for maturities greater than one year but less than or equal to five years, and 16.0 percent for maturities greater than five years, consistent with Table 22 below. The agencies believe that the revised haircuts better reflect the collateral’s credit quality and an appropriate differentiation based on the collateral’s residual maturity. A banking organization using the standard currency mismatch haircut is required to use an 8 percent haircut for each currency mismatch for transactions subject to a 10 day holding period, as adjusted for different required holding periods. One commenter asserted that the proposed adjustment for currency mismatch was unwarranted because in securities lending transactions, the parties typically require a higher collateral margin than in transactions where there is no mismatch. In the alternative, the commenter argued that the agencies and the FDIC should align the currency mismatch haircut more closely with a given currency combination and suggested those currencies of countries with a more favorable CRC from the OECD should receive a smaller haircut. The agencies have decided to adopt this aspect of the proposal without change in the final rule. The agencies believe that the own internal estimates for haircuts methodology described below allows banking organizations appropriate flexibility to more granularly reflect individual currency combinations, provided they meet certain criteria. TABLE 22—STANDARD SUPERVISORY MARKET PRICE VOLATILITY HAIRCUTS 1 Haircut (in percent) assigned based on: Sovereign issuers risk weight under § l.32 2 Residual maturity Zero Less than or equal to 1 year ..................... Greater than 1 year and less than or equal to 5 years ..................................... Greater than 5 years .................................. 20 or 50 Non-sovereign issuers risk weight under § l.32 100 20 50 Investment-grade securitization exposures (in percent) 100 0.5 1.0 15.0 1.0 2.0 4.0 4.0 2.0 4.0 3.0 6.0 15.0 15.0 4.0 8.0 6.0 12.0 8.0 16.0 12.0 24.0 Main index equities (including convertible bonds) and gold ....................................... 15.0 Other publicly-traded equities (including convertible bonds) ....................................... 25.0 Mutual funds ................................................................................................................ Highest haircut applicable to any security in which the fund can invest. Cash collateral held ..................................................................................................... Zero Other exposure types .................................................................................................. 25.0 wreier-aviles on DSK5TPTVN1PROD with RULES2 1 The market price volatility haircuts in Table 22 are based on a 10 business-day holding period. 2 Includes a foreign PSE that receives a zero percent risk weight. The final rule requires that a banking organization increase the standard supervisory haircut for transactions involving large netting sets. As noted in the proposed rule, during the recent financial crisis, many financial VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 institutions experienced significant delays in settling or closing-out collateralized transactions, such as repostyle transactions and collateralized OTC derivatives. The assumed holding period for collateral in the collateral PO 00000 Frm 00092 Fmt 4701 Sfmt 4700 haircut approach under Basel II proved to be inadequate for certain transactions and netting sets and did not reflect the difficulties and delays that institutions had when settling or liquidating E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations collateral during a period of financial stress. Thus, consistent with the proposed rule, for netting sets where: (1) The number of trades exceeds 5,000 at any time during the quarter; (2) one or more trades involves illiquid collateral posted by the counterparty; or (3) the netting set includes any OTC derivatives that cannot be easily replaced, the final rule requires a banking organization to assume a holding period of 20 business days for the collateral under the collateral haircut approach. The formula and methodology for increasing the haircut to reflect the longer holding period is described in section 37(c) of the final rule. Consistent with the Basel capital framework, a banking organization is not required to adjust the holding period upward for cleared transactions. When determining whether collateral is illiquid or whether an OTC derivative cannot be easily replaced for these purposes, a banking organization should assess whether, during a period of stressed market conditions, it could obtain multiple price quotes within two days or less for the collateral or OTC derivative that would not move the market or represent a market discount (in the case of collateral) or a premium (in the case of an OTC derivative). One commenter requested the agencies and the FDIC clarify whether the 5,000-trade threshold applies on a counterparty-by-counterparty (rather than aggregate) basis, and only will be triggered in the event there are 5,000 open trades with a single counterparty within a single netting set in a given quarter. Commenters also asked whether the threshold would be calculated on an average basis or whether a de minimis number of breaches could be permitted without triggering the increased holding period or margin period of risk. One commenter suggested eliminating the threshold because it is ineffective as a measure of risk, and combined with other features of the proposals (for example, collateral haircuts, margin disputes), could create a disincentive for banking organizations to apply sound practices such as risk diversification. The agencies note that the 5,000-trade threshold applies to a netting set, which by definition means a group of transactions with a single counterparty that are subject to a qualifying master netting agreement. The 5,000 trade calculation threshold was proposed as an indicator that a set of transactions may be more complex, or require a lengthy period, to close out in the event of a default of a counterparty. The agencies continue to believe that the threshold of 5,000 is a reasonable VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 indicator of the complexity of a closeout. Therefore, the final rule retains the 5,000 trade threshold as proposed, without any de minimis exception. One commenter asked the agencies to clarify how trades would be counted in the context of an indemnified agency securities lending relationship. In such transactions, an agent banking organization acts as an intermediary for, potentially, multiple borrowers and lenders. The banking organization is acting as an agent with no exposure to either the securities lenders or borrowers except for an indemnification to the securities lenders in the event of a borrower default. The indemnification creates an exposure to the securities borrower, as the agent banking organization could suffer a loss upon the default of a borrower. In these cases, each transaction between the agent and a borrower would count as a trade. The agencies note that a trade in this instance consists of an order by the borrower, and not the number of securities lenders providing shares to fulfil the order or the number of shares underlying such order.169 The commenters also addressed the longer holding period for trades involving illiquid collateral posted by the counterparty. Some commenters asserted that one illiquid exposure or one illiquid piece of collateral should not taint the entire netting set. Other commenters recommended applying a materiality threshold (for example, 1 percent) below which one or more illiquid exposures would not trigger the longer holding period, or allowing banking organizations to define ‘‘materiality’’ based on experience. Regarding the potential for an illiquid exposure to ‘‘taint’’ an entire netting set, the final rule does not require a banking organization to recognize any piece of collateral as a risk mitigant. Accordingly, if a banking organization elects to exclude the illiquid collateral from the netting set for purposes of calculating risk-weighted assets, then such illiquid collateral does not result in an increased holding period for the netting set. With respect to a derivative that may not be easily replaced, a banking organization could create a separate netting set that would preserve the holding period for the original netting set of easily replaced transactions. Accordingly, the final rule 169 In the event that the agent banking organization reinvests the cash collateral proceeds on behalf of the lender and provides an explicit or implicit guarantee of the value of the collateral in such pool, the banking organization should hold capital, as appropriate, against the risk of loss of value of the collateral pool. PO 00000 Frm 00093 Fmt 4701 Sfmt 4700 62109 adopts this aspect of the proposal without change. One commenter asserted that the final rule should not require a banking organization to determine whether an instrument is liquid on a daily basis, but rather should base the timing of such determination by product category and on long-term liquidity data. According to the commenter, such an approach would avoid potential confusion, volatility and destabilization of the funding markets. For purposes of determining whether collateral is illiquid or an OTC derivative contract is easily replaceable under the final rule, a banking organization may assess whether, during a period of stressed market conditions, it could obtain multiple price quotes within two days or less for the collateral or OTC derivative that would not move the market or represent a market discount (in the case of collateral) or a premium (in the case of an OTC derivative). A banking organization is not required to make a daily determination of liquidity under the final rule; rather, banking organizations should have policies and procedures in place to evaluate the liquidity of their collateral as frequently as warranted. Under the proposed rule, a banking organization would increase the holding period for a netting set if over the two previous quarters more than two margin disputes on a netting set have occurred that lasted longer than the holding period. However, consistent with the Basel capital framework, a banking organization would not be required to adjust the holding period upward for cleared transactions. Several commenters requested further clarification on the meaning of ‘‘margin disputes.’’ Some of these commenters suggested restricting ‘‘margin disputes’’ to formal legal action. Commenters also suggested restricting ‘‘margin disputes’’ to disputes resulting in the creation of an exposure that exceeded any available overcollateralization, or establishing a materiality threshold. One commenter suggested that margin disputes were not an indicator of an increased risk and, therefore, should not trigger a longer holding period. The agencies continue to believe that an increased holding period is appropriate regardless of whether the dispute exceeds applicable collateral requirements and regardless of whether the disputes exceed a materiality threshold. The agencies expect that the determination as to whether a dispute constitutes a margin dispute for purposes of the final rule will depend solely on the timing of the resolution. That is to say, if collateral is not E:\FR\FM\11OCR2.SGM 11OCR2 62110 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations delivered within the time period required under an agreement, and such failure to deliver is not resolved in a timely manner, then such failure would count toward the two-margin-dispute limit. For the purpose of the final rule, where a dispute is subject to a recognized industry dispute resolution protocol, the agencies expect to consider the dispute period to begin after a thirdparty dispute resolution mechanism has failed. For comments and concerns that are specific to the parallel provisions in the advanced approaches rule, reference section XII.A of this preamble. wreier-aviles on DSK5TPTVN1PROD with RULES2 f. Own Estimates of Haircuts Under the final rule, consistent with the proposal, banking organizations may calculate market price volatility and foreign exchange volatility using own internal estimates with prior written approval of the banking organization’s primary Federal supervisor. To receive approval to calculate haircuts using its own internal estimates, a banking organization must meet certain minimum qualitative and quantitative standards set forth in the final rule, including the requirements that a banking organization: (1) Uses a 99th percentile one-tailed confidence interval and a minimum five-business-day holding period for repo-style transactions and a minimum tenbusiness-day holding period for all other transactions; (2) adjusts holding periods upward where and as appropriate to take into account the illiquidity of an instrument; (3) selects a historical observation period that reflects a continuous 12-month period of significant financial stress appropriate to the banking organization’s current portfolio; and (4) updates its data sets and compute haircuts no less frequently than quarterly, as well as any time market prices change materially. A banking organization estimates the volatilities of exposures, the collateral, and foreign exchange rates and should not take into account the correlations between them. The final rule provides a formula for converting own-estimates of haircuts based on a holding period different from the minimum holding period under the rule to haircuts consistent with the rule’s minimum holding periods. The minimum holding periods for netting sets with more than 5,000 trades, netting sets involving illiquid collateral or an OTC derivative that cannot easily be replaced, and netting sets involving more than two margin disputes over the previous two quarters described above also apply for own-estimates of haircuts. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 Under the final rule, a banking organization is required to have policies and procedures that describe how it determines the period of significant financial stress used to calculate the banking organization’s own internal estimates, and to be able to provide empirical support for the period used. These policies and procedures must address (1) how the banking organization links the period of significant financial stress used to calculate the own internal estimates to the composition and directional bias of the banking organization’s current portfolio; and (2) the banking organization’s process for selecting, reviewing, and updating the period of significant financial stress used to calculate the own internal estimates and for monitoring the appropriateness of the 12-month period in light of the banking organization’s current portfolio. The banking organization is required to obtain the prior approval of its primary Federal supervisor for these policies and procedures and notify its primary Federal supervisor if the banking organization makes any material changes to them. A banking organization’s primary Federal supervisor may require it to use a different period of significant financial stress in the calculation of the banking organization’s own internal estimates. Under the final rule, a banking organization is allowed to calculate internally estimated haircuts for categories of debt securities that are investment-grade exposures. The haircut for a category of securities must be representative of the internal volatility estimates for securities in that category that the banking organization has lent, sold subject to repurchase, posted as collateral, borrowed, purchased subject to resale, or taken as collateral. In determining relevant categories, the banking organization must, at a minimum, take into account (1) the type of issuer of the security; (2) the credit quality of the security; (3) the maturity of the security; and (4) the interest rate sensitivity of the security. A banking organization must calculate a separate internally estimated haircut for each individual non-investmentgrade debt security and for each individual equity security. In addition, a banking organization must estimate a separate currency mismatch haircut for its net position in each mismatched currency based on estimated volatilities for foreign exchange rates between the mismatched currency and the settlement currency where an exposure or collateral (whether in the form of cash or securities) is denominated in a PO 00000 Frm 00094 Fmt 4701 Sfmt 4700 currency that differs from the settlement currency. g. Simple Value-at-Risk and Internal Models Methodology In the NPR, the agencies and the FDIC did not propose a simple VaR approach to calculate exposure amounts for eligible margin loans and repo-style transactions or IMM to calculate the exposure amount for the counterparty credit exposure for OTC derivatives, eligible margin loans, and repo-style transactions. These methodologies are included in the advanced approaches rule. The agencies and the FDIC sought comment on whether to implement the simple VaR approach and IMM in the standardized approach. Several commenters asserted that the IMM and simple VaR approach should be implemented in the final rule to better capture the risk of counterparty credit exposures. The agencies have considered these comments and, have concluded that the increased complexity and limited applicability of these models-based approaches is inconsistent with the agencies’ overall focus in the standardized approach on simplicity, comparability, and broad applicability of methodologies for U.S. banking organizations. Therefore, consistent with the proposal, the final rule does not include the simple VaR approach or the IMM in the standardized approach. G. Unsettled Transactions Under the proposed rule, a banking organization would be required to hold capital against the risk of certain unsettled transactions. One commenter expressed opposition to assigning a risk weight to unsettled transactions where previously none existed, because it would require a significant and burdensome tracking process without commensurate benefit. The agencies believe that it is important for a banking organization to have procedures to identify and track a delayed or unsettled transaction of the types specified in the rule. Such procedures capture the resulting risks associated with such delay. As a result, the agencies are adopting the risk-weighting requirements as proposed. Consistent with the proposal, the final rule provides for a separate risk-based capital requirement for transactions involving securities, foreign exchange instruments, and commodities that have a risk of delayed settlement or delivery. Under the final rule, the capital requirement does not, however, apply to certain types of transactions, including: (1) Cleared transactions that are markedto-market daily and subject to daily E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations receipt and payment of variation margin; (2) repo-style transactions, including unsettled repo-style transactions; (3) one-way cash payments on OTC derivative contracts; or (4) transactions with a contractual settlement period that is longer than the normal settlement period (which the proposal defined as the lesser of the market standard for the particular instrument or five business days).170 In the case of a system-wide failure of a settlement, clearing system, or central counterparty, the banking organization’s primary Federal supervisor may waive risk-based capital requirements for unsettled and failed transactions until the situation is rectified. The final rule provides separate treatments for delivery-versus-payment (DvP) and payment-versus-payment (PvP) transactions with a normal settlement period, and non-DvP/nonPvP transactions with a normal settlement period. A DvP transaction refers to a securities or commodities transaction in which the buyer is obligated to make payment only if the seller has made delivery of the securities or commodities and the seller is obligated to deliver the securities or commodities only if the buyer has made payment. A PvP transaction means a foreign exchange transaction in which each counterparty is obligated to make a final transfer of one or more currencies only if the other counterparty has made a final transfer of one or more currencies. A transaction is considered to have a normal settlement period if the contractual settlement period for the transaction is equal to or less than the market standard for the instrument underlying the transaction and equal to or less than five business days. Consistent with the proposal, under the final rule, a banking organization is required to hold risk-based capital against a DvP or PvP transaction with a normal settlement period if the banking organization’s counterparty has not made delivery or payment within five business days after the settlement date. The banking organization determines its risk-weighted asset amount for such a transaction by multiplying the positive current exposure of the transaction for the banking organization by the appropriate risk weight in Table 23. The positive current exposure from an unsettled transaction of a banking organization is the difference between the transaction value at the agreed settlement price and the current market price of the transaction, if the difference 170 Such transactions are treated as derivative contracts as provided in section 34 or section 35 of the final rule. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 62111 results in a credit exposure of the banking organization to the counterparty. rule.171 They would have replaced both the ratings-based approach and an approach that permits banking organizations to use supervisorapproved internal systems to replicate TABLE 23—RISK WEIGHTS FOR UNSETTLED DVP AND PVP TRANS- external ratings processes for certain unrated exposures in the general riskACTIONS based capital rules. In addition, the agencies and the FDIC Risk weight to be proposed to update the terminology for Number of business days applied to after contractual positive current the securitization framework, include a settlement date exposure definition of securitization exposure (in percent) that encompasses a wider range of From 5 to 15 ..................... 100.0 exposures with similar risk From 16 to 30 ................... 625.0 characteristics, and implement new due From 31 to 45 ................... 937.5 diligence requirements for securitization 46 or more ........................ 1,250.0 exposures. A banking organization must hold risk-based capital against any non-DvP/ non-PvP transaction with a normal settlement period if the banking organization delivered cash, securities, commodities, or currencies to its counterparty but has not received its corresponding deliverables by the end of the same business day. The banking organization must continue to hold riskbased capital against the transaction until it has received the corresponding deliverables. From the business day after the banking organization has made its delivery until five business days after the counterparty delivery is due, the banking organization must calculate the risk-weighted asset amount for the transaction by risk weighting the current fair value of the deliverables owed to the banking organization, using the risk weight appropriate for an exposure to the counterparty in accordance with section 32. If a banking organization has not received its deliverables by the fifth business day after the counterparty delivery due date, the banking organization must assign a 1,250 percent risk weight to the current market value of the deliverables owed. H. Risk-Weighted Assets for Securitization Exposures In the proposal, the agencies and the FDIC proposed to significantly revise the risk-based capital framework for securitization exposures. These proposed revisions included removing references to and reliance on credit ratings to determine risk weights for these exposures and using alternative standards of creditworthiness, as required by section 939A of the DoddFrank Act. These alternative standards were designed to produce capital requirements that generally would be consistent with those under the BCBS securitization framework and were consistent with those incorporated into the agencies’ and the FDIC’s market risk PO 00000 Frm 00095 Fmt 4701 Sfmt 4700 1. Overview of the Securitization Framework and Definitions The proposed securitization framework was designed to address the credit risk of exposures that involve the tranching of credit risk of one or more underlying financial exposures. Consistent with the proposal, the final rule defines a securitization exposure as an on- or off-balance sheet credit exposure (including credit-enhancing representations and warranties) that arises from a traditional or synthetic securitization (including a resecuritization), or an exposure that directly or indirectly references a securitization exposure. Commenters expressed concerns that the proposed scope of the securitization framework was overly broad and requested that the definition of securitizations be narrowed to exposures that tranche the credit risk associated with a pool of assets. However, the agencies believe that limiting the securitization framework to exposures backed by a pool of assets would exclude tranched credit risk exposures that are appropriately captured under the securitization framework, such as certain first loss or other tranched guarantees provided to a single underlying exposure. In the proposal a traditional securitization was defined, in part, as a transaction in which credit risk of one or more underlying exposures has been transferred to one or more third parties (other than through the use of credit derivatives or guarantees), where the credit risk associated with the underlying exposures has been separated into at least two tranches reflecting different levels of seniority. The definition included certain other conditions, such as requiring all or substantially all of the underlying exposures to be financial exposures. The agencies have decided to finalize the 171 77 E:\FR\FM\11OCR2.SGM FR 53060 (August 30, 2012). 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62112 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations definition of traditional securitization largely as proposed, with some revisions (as discussed below), that reflect certain comments regarding exclusions under the framework and other modifications to the final rule. Both the designation of exposures as securitization exposures (or resecuritization exposures, as described below) and the calculation of risk-based capital requirements for securitization exposures under the final rule are guided by the economic substance of a transaction rather than its legal form. Provided there is tranching of credit risk, securitization exposures could include, among other things, ABS and MBS, loans, lines of credit, liquidity facilities, financial standby letters of credit, credit derivatives and guarantees, loan servicing assets, servicer cash advance facilities, reserve accounts, credit-enhancing representations and warranties, and CEIOs. Securitization exposures also include assets sold with retained tranches. The agencies believe that requiring all or substantially all of the underlying exposures of a securitization to be financial exposures creates an important boundary between the general credit risk framework and the securitization framework. Examples of financial exposures include loans, commitments, credit derivatives, guarantees, receivables, asset-backed securities, mortgage-backed securities, other debt securities, or equity securities. Based on their cash flow characteristics, the agencies also consider asset classes such as lease residuals and entertainment royalties to be financial assets. The securitization framework is not designed, however, to apply to tranched credit exposures to commercial or industrial companies or nonfinancial assets or to amounts deducted from capital under section 22 of the final rule. Accordingly, a specialized loan to finance the construction or acquisition of large-scale projects (for example, airports or power plants), objects (for example, ships, aircraft, or satellites), or commodities (for example, reserves, inventories, precious metals, oil, or natural gas) generally would not be a securitization exposure because the assets backing the loan typically are nonfinancial assets (the facility, object, or commodity being financed). Consistent with the proposal, under the final rule, an operating company does not fall under the definition of a traditional securitization (even if substantially all of its assets are financial exposures). Operating companies generally refer to companies that are established to conduct business with clients with the intention of VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 earning a profit in their own right and generally produce goods or provide services beyond the business of investing, reinvesting, holding, or trading in financial assets. Accordingly, an equity investment in an operating company generally would be an equity exposure. Under the final rule, banking organizations are operating companies and do not fall under the definition of a traditional securitization. However, investment firms that generally do not produce goods or provide services beyond the business of investing, reinvesting, holding, or trading in financial assets, would not be operating companies under the final rule and would not qualify for this general exclusion from the definition of traditional securitization. Under the proposed rule, paragraph (10) of the definition of traditional securitization specifically excluded exposures to investment funds (as defined in the proposal) and collective investment and pension funds (as defined in relevant regulations and set forth in the proposed definition of ‘‘traditional securitization’’). These specific exemptions served to narrow the potential scope of the securitization framework. Investment funds, collective investment funds, pension funds regulated under ERISA and their foreign equivalents, and transactions registered with the SEC under the Investment Company Act of 1940 and their foreign equivalents would be exempted from the definition because these entities and transactions are regulated and subject to strict leverage requirements. The proposal defined an investment fund as a company (1) where all or substantially all of the assets of the fund are financial assets; and (2) that has no material liabilities. In addition, the agencies explained in the proposal that the capital requirements for an extension of credit to, or an equity holding in, these transactions are more appropriately calculated under the rules for corporate and equity exposures, and that the securitization framework was not intended to apply to such transactions. Commenters generally agreed with the proposed exemptions from the definition of traditional securitization and requested that the agencies and the FDIC provide exemptions for exposures to a broader set of investment firms, such as pension funds operated by state and local governments. In view of the comments regarding pension funds, the final rule provides an additional exclusion from the definition of traditional securitization for a ‘‘governmental plan’’ (as defined in 29 U.S.C. 1002(32)) that complies with the tax deferral qualification requirements PO 00000 Frm 00096 Fmt 4701 Sfmt 4700 provided in the Internal Revenue Code. The agencies believe that an exemption for such government plans is appropriate because they are subject to substantial regulation. Commenters also requested that the agencies and the FDIC provide exclusions for certain products provided to investment firms, such as extensions of short-term credit that support day-to-day investmentrelated activities. The agencies believe that exposures that meet the definition of traditional securitization, regardless of product type or maturity, would fall under the securitization framework. Accordingly, the agencies have not provided for any such exemptions under the final rule.172 To address the treatment of investment firms that are not specifically excluded from the securitization framework, the proposed rule provided discretion to the primary Federal supervisor of a banking organization to exclude from the definition of a traditional securitization those transactions in which the underlying exposures are owned by an investment firm that exercises substantially unfettered control over the size and composition of its assets, liabilities, and off-balance sheet exposures. While the commenters supported the agencies’ and the FDIC’s recognition that certain investment firms may warrant an exemption from the securitization framework, some expressed concern that the process for making such a determination may present significant implementation burden. To maintain sufficient flexibility to provide an exclusion for certain investment firms from the securitization framework, the agencies have retained this discretionary provision in the final rule without change. In determining whether to exclude an investment firm from the securitization framework, the agencies will consider a number of factors, including the assessment of the transaction’s leverage, risk profile, and economic substance. This supervisory exclusion gives the primary Federal supervisor discretion to distinguish structured finance transactions, to which the securitization framework is designed to apply, from those of flexible investment firms, such as certain hedge funds and private equity funds. Only investment firms that can easily change the size and composition of their capital structure, as well as the size and composition of their assets and off172 The final rule also clarifies that the portion of a synthetic exposure to the capital of a financial institution that is deducted from capital is not a traditional securitization. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations balance sheet exposures, are eligible for the exclusion from the definition of traditional securitization under this provision. The agencies do not consider managed collateralized debt obligation vehicles, structured investment vehicles, and similar structures, which allow considerable management discretion regarding asset composition but are subject to substantial restrictions regarding capital structure, to have substantially unfettered control. Thus, such transactions meet the definition of traditional securitization under the final rule. The line between securitization exposures and non-securitization exposures may be difficult to identify in some circumstances. In addition to the supervisory exclusion from the definition of traditional securitization described above, the primary Federal supervisor may expand the scope of the securitization framework to include other transactions if doing so is justified by the economics of the transaction. Similar to the analysis for excluding an investment firm from treatment as a traditional securitization, the agencies will consider the economic substance, leverage, and risk profile of a transaction to ensure that an appropriate risk-based capital treatment is applied. The agencies will consider a number of factors when assessing the economic substance of a transaction including, for example, the amount of equity in the structure, overall leverage (whether onor off-balance sheet), whether redemption rights attach to the equity investor, and the ability of the junior tranches to absorb losses without interrupting contractual payments to more senior tranches. Under the proposal, a synthetic securitization was defined as a transaction in which: (1) All or a portion of the credit risk of one or more underlying exposures is transferred to one or more third parties through the use of one or more credit derivatives or guarantees (other than a guarantee that transfers only the credit risk of an individual retail exposure); (2) the credit risk associated with the underlying exposures has been separated into at least two tranches reflecting different levels of seniority; (3) performance of the securitization exposures depends upon the performance of the underlying exposures; and (4) all or substantially all of the underlying exposures are financial exposures (such as loans, commitments, credit derivatives, guarantees, receivables, asset-backed securities, mortgage-backed securities, other debt securities, or equity securities). The agencies have decided VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 to finalize the definition of synthetic securitization largely as proposed, but have also clarified in the final rule that transactions in which a portion of credit risk has been retained, not just transferred, through the use of credit derivatives is subject to the securitization framework. In response to the proposal, commenters requested that the agencies and the FDIC provide an exemption for guarantees that tranche credit risk under certain mortgage partnership finance programs, such as certain programs provided by the FHLBs, whereby participating member banking organizations provide credit enhancement to a pool of residential mortgage loans that have been delivered to the FHLB. The agencies believe that these exposures that tranche credit risk meet the definition of a synthetic securitization and that the risk of such exposures would be appropriately captured under the securitization framework. In contrast, mortgage-backed pass-through securities (for example, those guaranteed by FHLMC or FNMA) that feature various maturities but do not involve tranching of credit risk do not meet the definition of a securitization exposure. Only those MBS that involve tranching of credit risk are considered to be securitization exposures. Consistent with the 2009 Enhancements, the proposed rule defined a resecuritization exposure as an on- or off-balance sheet exposure to a resecuritization; or an exposure that directly or indirectly references a resecuritization exposure. A resecuritization would have meant a securitization in which one or more of the underlying exposures is a securitization exposure. An exposure to an asset-backed commercial paper (ABCP) program would not have been a resecuritization exposure if either: (1) The program-wide credit enhancement does not meet the definition of a resecuritization exposure; or (2) the entity sponsoring the program fully supports the commercial paper through the provision of liquidity so that the commercial paper holders effectively are exposed to the default risk of the sponsor instead of the underlying exposures. Commenters asked the agencies and the FDIC to narrow the definition of resecuritization by exempting resecuritizations in which a minimal amount of underlying assets are securitization exposures. According to commenters, the proposed definition would have a detrimental effect on certain collateralized loan obligation exposures, which typically include a PO 00000 Frm 00097 Fmt 4701 Sfmt 4700 62113 small amount of securitization exposures as part of the underlying pool of assets in a securitization. Specifically, the commenters requested that resecuritizations be defined as a securitization in which five percent or more of the underlying exposures are securitizations. Commenters also asked the agencies and the FDIC to consider employing a pro rata treatment by only applying a higher capital surcharge to the portion of a securitization exposure that is backed by underlying securitization exposures. The agencies believe that the introduction of securitization exposures into a pool of securitized exposures significantly increases the complexity and correlation risk of the exposures backing the securities issued in the transaction, and that the resecuritization framework is appropriate for applying risk-based capital requirements to exposures to pools that contain securitization exposures. Commenters sought clarification as to whether the proposed definition of resecuritization would include a single exposure that has been retranched, such as a resecuritization of a real estate mortgage investment conduit (ReREMIC). The agencies believe that the increased capital surcharge, or p factor, for resecuritizations was meant to address the increased correlation risk and complexity resulting from retranching of multiple underlying exposures and was not intended to apply to the retranching of a single underlying exposure. As a result, the definition of resecuritization in the final rule has been refined to clarify that resecuritizations do not include exposures comprised of a single asset that has been retranched. The agencies note that for purposes of the final rule, a resecuritization does not include passthrough securities that have been pooled together and effectively re-issued as tranched securities. This is because the pass-through securities do not tranche credit protection and, as a result, are not considered securitization exposures under the final rule. Under the final rule, if a transaction involves a traditional multi-seller ABCP conduit, a banking organization must determine whether the transaction should be considered a resecuritization exposure. For example, assume that an ABCP conduit acquires securitization exposures where the underlying assets consist of wholesale loans and no securitization exposures. As is typically the case in multi-seller ABCP conduits, each seller provides first-loss protection by over-collateralizing the conduit to which it sells loans. To ensure that the commercial paper issued by each E:\FR\FM\11OCR2.SGM 11OCR2 62114 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations conduit is highly-rated, a banking organization sponsor provides either a pool-specific liquidity facility or a program-wide credit enhancement such as a guarantee to cover a portion of the losses above the seller-provided protection. The pool-specific liquidity facility generally is not a resecuritization exposure under the final rule because the pool-specific liquidity facility represents a tranche of a single asset pool (that is, the applicable pool of wholesale exposures), which contains no securitization exposures. However, a sponsor’s program-wide credit enhancement that does not cover all losses above the seller-provided credit enhancement across the various pools generally constitutes tranching of risk of a pool of multiple assets containing at least one securitization exposure, and, therefore, is a resecuritization exposure. In addition, if the conduit in this example funds itself entirely with a single class of commercial paper, then the commercial paper generally is not a resecuritization exposure if, as noted above, either (1) the program-wide credit enhancement does not meet the definition of a resecuritization exposure or (2) the commercial paper is fully supported by the sponsoring banking organization. When the sponsoring banking organization fully supports the commercial paper, the commercial paper holders effectively are exposed to default risk of the sponsor instead of the underlying exposures, and the external rating of the commercial paper is expected to be based primarily on the credit quality of the banking organization sponsor, thus ensuring that the commercial paper does not represent a tranched risk position. 2. Operational Requirements wreier-aviles on DSK5TPTVN1PROD with RULES2 a. Due Diligence Requirements During the recent financial crisis, it became apparent that many banking organizations relied exclusively on ratings issued by Nationally Recognized Statistical Rating Organizations (NRSROs) and did not perform internal credit analysis of their securitization exposures. Consistent with the Basel capital framework and the agencies’ general expectations for investment analysis, the proposal required banking organizations to satisfy specific due diligence requirements for securitization exposures. Specifically, under the proposal a banking organization would be required to demonstrate, to the satisfaction of its primary Federal supervisor, a comprehensive understanding of the features of a securitization exposure that would VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 materially affect its performance. The banking organization’s analysis would have to be commensurate with the complexity of the exposure and the materiality of the exposure in relation to capital of the banking organization. On an ongoing basis (no less frequently than quarterly), the banking organization must evaluate, review, and update as appropriate the analysis required under section 41(c)(1) of the proposed rule for each securitization exposure. The analysis of the risk characteristics of the exposure prior to acquisition, and periodically thereafter, would have to consider: (1) Structural features of the securitization that materially impact the performance of the exposure, for example, the contractual cash-flow waterfall, waterfall-related triggers, credit enhancements, liquidity enhancements, market value triggers, the performance of organizations that service the position, and deal-specific definitions of default; (2) Relevant information regarding the performance of the underlying credit exposure(s), for example, the percentage of loans 30, 60, and 90 days past due; default rates; prepayment rates; loans in foreclosure; property types; occupancy; average credit score or other measures of creditworthiness; average LTV ratio; and industry and geographic diversification data on the underlying exposure(s); (3) Relevant market data of the securitization, for example, bid-ask spread, most recent sales price and historical price volatility, trading volume, implied market rating, and size, depth and concentration level of the market for the securitization; and (4) For resecuritization exposures, performance information on the underlying securitization exposures, for example, the issuer name and credit quality, and the characteristics and performance of the exposures underlying the securitization exposures. Commenters expressed concern that many banking organizations would be unable to perform the due diligence necessary to meet the requirements and, as a result, would no longer purchase privately-issued securitization exposures and would increase their holdings of GSE-guaranteed securities, thereby increasing the size of the GSEs. Commenters also expressed concerns regarding banking organizations’ ability to obtain relevant market data for certain exposures, such as foreign exposures and exposures that are traded in markets that are typically illiquid, as well as their ability to obtain market data during periods of general market illiquidity. Commenters also stated concerns that uneven application of the PO 00000 Frm 00098 Fmt 4701 Sfmt 4700 requirements by supervisors may result in disparate treatment for the same exposure held at different banking organizations due to perceived management deficiencies. For these reasons, many commenters requested that the agencies and the FDIC consider removing the market data requirement from the due diligence requirements. In addition, some commenters suggested that the due diligence requirements be waived provided that all of the underlying loans meet certain underwriting standards. The agencies note that the proposed due diligence requirements are generally consistent with the goal of the agencies’ investment permissibility requirements, which provide that banking organizations must be able to determine the risk of loss is low, even under adverse economic conditions. The agencies acknowledge potential restrictions on data availability and believe that the standards provide sufficient flexibility so that the due diligence requirements, such as relevant market data requirements, would be implemented as applicable. In addition, the agencies note that, where appropriate, pool-level data could be used to meet certain of the due diligence requirements. As a result, the agencies are adopting the due diligence requirements as proposed. Under the proposal, if a banking organization is not able to meet these due diligence requirements and demonstrate a comprehensive understanding of a securitization exposure to the satisfaction of its primary Federal supervisor, the banking organization would be required to assign a risk weight of 1,250 percent to the exposure. Commenters requested that the agencies and the FDIC adopt a more flexible approach to due diligence requirements rather than requiring a banking organization to assign a risk weight of 1,250 percent for violation of those requirements. For example, some commenters recommended that the agencies and the FDIC assign progressively increasing risk weights based on the severity and duration of infringements of due diligence requirements, to allow the agencies and the FDIC to differentiate between minor gaps in due diligence requirements and more serious violations. The agencies believe that the requirement to assign a 1,250 percent risk weight, rather than applying a lower risk weight, to exposures for violation of these requirements is appropriate given that such information is required to monitor appropriately the risk of the underlying assets. The agencies recognize the importance of E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations consistent and uniform application of the standards across banking organizations and will endeavor to ensure that supervisors consistently review banking organizations’ due diligence on securitization exposures. The agencies believe that these efforts will mitigate concerns that the 1,250 percent risk weight will be applied inappropriately to banking organizations’ failure to meet the due diligence requirements. At the same time, the agencies believe that the requirement that a banking organization’s analysis be commensurate with the complexity and materiality of the securitization exposure provides the banking organization with sufficient flexibility to mitigate the potential for undue burden. As a result, the agencies are adopting the risk weight requirements related to due diligence requirements as proposed. b. Operational Requirements for Traditional Securitizations wreier-aviles on DSK5TPTVN1PROD with RULES2 The proposal outlined certain operational requirements for traditional securitizations that had to be met in order to apply the securitization framework. The agencies are adopting these operational requirements as proposed. In a traditional securitization, an originating banking organization typically transfers a portion of the credit risk of exposures to third parties by selling them to a securitization special purpose entity (SPE).173 Consistent with the proposal, the final rule defines a banking organization to be an originating banking organization with respect to a securitization if it (1) directly or indirectly originated or securitized the underlying exposures included in the securitization; or (2) serves as an ABCP program sponsor to the securitization. Under the final rule, consistent with the proposal, a banking organization that transfers exposures it has originated or purchased to a securitization SPE or other third party in connection with a traditional securitization can exclude the underlying exposures from the calculation of risk-weighted assets only if each of the following conditions are met: (1) The exposures are not reported on the banking organization’s consolidated balance sheet under 173 The final rule defines a securitization SPE as a corporation, trust, or other entity organized for the specific purpose of holding underlying exposures of a securitization, the activities of which are limited to those appropriate to accomplish this purpose, and the structure of which is intended to isolate the underlying exposures held by the entity from the credit risk of the seller of the underlying exposures to the entity. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 GAAP; (2) the banking organization has transferred to one or more third parties credit risk associated with the underlying exposures; and (3) any clean-up calls relating to the securitization are eligible clean-up calls (as discussed below).174 An originating banking organization that meets these conditions must hold risk-based capital against any credit risk it retains or acquires in connection with the securitization. An originating banking organization that fails to meet these conditions is required to hold riskbased capital against the transferred exposures as if they had not been securitized and must deduct from common equity tier 1 capital any aftertax gain-on-sale resulting from the transaction. In addition, if a securitization (1) includes one or more underlying exposures in which the borrower is permitted to vary the drawn amount within an agreed limit under a line of credit, and (2) contains an early amortization provision, the originating banking organization is required to hold risk-based capital against the transferred exposures as if they had not been securitized and deduct from common equity tier 1 capital any after-tax gainon-sale resulting from the transaction.175 The agencies believe that this treatment is appropriate given the 174 Commenters asked the agencies and the FDIC to consider the interaction between the proposed non-consolidation condition and the agencies’ and the FDIC’s proposed rules implementing section 941 of the Dodd-Frank Act regarding risk retention, given concerns that satisfaction of certain of the proposed risk retention requirements would affect the accounting treatment for certain transactions. The agencies acknowledge these concerns and will take into consideration any effects on the securitization framework as they continue to develop the risk retention rules. 175 Many securitizations of revolving credit facilities (for example, credit card receivables) contain provisions that require the securitization to be wound down and investors to be repaid if the excess spread falls below a certain threshold. This decrease in excess spread may, in some cases, be caused by deterioration in the credit quality of the underlying exposures. An early amortization event can increase a banking organization’s capital needs if new draws on the revolving credit facilities need to be financed by the banking organization using on-balance sheet sources of funding. The payment allocations used to distribute principal and finance charge collections during the amortization phase of these transactions also can expose a banking organization to a greater risk of loss than in other securitization transactions. The final rule defines an early amortization provision as a provision in a securitization’s governing documentation that, when triggered, causes investors in the securitization exposures to be repaid before the original stated maturity of the securitization exposure, unless the provision (1) is solely triggered by events not related to the performance of the underlying exposures or the originating banking organization (such as material changes in tax laws or regulations), or (2) leaves investors fully exposed to future draws by borrowers on the underlying exposures even after the provision is triggered. PO 00000 Frm 00099 Fmt 4701 Sfmt 4700 62115 lack of risk transference in securitizations of revolving underlying exposures with early amortization provisions. c. Operational Requirements for Synthetic Securitizations In general, the proposed operational requirements for synthetic securitizations were similar to those proposed for traditional securitizations. The operational requirements for synthetic securitizations, however, were more detailed to ensure that the originating banking organization has truly transferred credit risk of the underlying exposures to one or more third parties. Under the proposal, an originating banking organization would have been able to recognize for riskbased capital purposes the use of a credit risk mitigant to hedge underlying exposures only if each of the conditions in the proposed definition of ‘‘synthetic securitization’’ was satisfied. The agencies are adopting the operational requirements largely as proposed. However, to ensure that synthetic securitizations created through tranched guarantees and credit derivatives are properly included in the framework, in the final rule the agencies have amended the operational requirements to recognize guarantees that meet all of the criteria set forth in the definition of eligible guarantee except the criterion under paragraph (3) of the definition. Additionally, the operational criteria recognize a credit derivative provided that the credit derivative meets all of the criteria set forth in the definition of eligible credit derivative except for paragraph 3 of the definition of eligible guarantee. As a result, a guarantee or credit derivative that provides a tranched guarantee would not be excluded by the operational requirements for synthetic securitizations. Failure to meet these operational requirements for a synthetic securitization prevents a banking organization that has purchased tranched credit protection referencing one or more of its exposures from using the securitization framework with respect to the reference exposures and requires the banking organization to hold risk-based capital against the underlying exposures as if they had not been synthetically securitized. A banking organization that holds a synthetic securitization as a result of purchasing credit protection may use the securitization framework to determine the risk-based capital requirement for its exposure. Alternatively, it may instead choose to disregard the credit protection and use E:\FR\FM\11OCR2.SGM 11OCR2 62116 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 the general credit risk framework. A banking organization that provides tranched credit protection in the form of a synthetic securitization or credit protection to a synthetic securitization must use the securitization framework to compute risk-based capital requirements for its exposures to the synthetic securitization even if the originating banking organization fails to meet one or more of the operational requirements for a synthetic securitization. d. Clean-Up Calls Under the proposal, to satisfy the operational requirements for securitizations and enable an originating banking organization to exclude the underlying exposures from the calculation of its risk-based capital requirements, any clean-up call associated with a securitization would need to be an eligible clean-up call. The proposed rule defined a clean-up call as a contractual provision that permits an originating banking organization or servicer to call securitization exposures before their stated maturity or call date. In the case of a traditional securitization, a clean-up call generally is accomplished by repurchasing the remaining securitization exposures once the amount of underlying exposures or outstanding securitization exposures falls below a specified level. In the case of a synthetic securitization, the cleanup call may take the form of a clause that extinguishes the credit protection once the amount of underlying exposures has fallen below a specified level. The final rule retains the proposed treatment for clean-up calls, and defines an eligible clean-up call as a clean-up call that (1) is exercisable solely at the discretion of the originating banking organization or servicer; (2) is not structured to avoid allocating losses to securitization exposures held by investors or otherwise structured to provide credit enhancement to the securitization (for example, to purchase non-performing underlying exposures); and (3) for a traditional securitization, is only exercisable when 10 percent or less of the principal amount of the underlying exposures or securitization exposures (determined as of the inception of the securitization) is outstanding; or, for a synthetic securitization, is only exercisable when 10 percent or less of the principal amount of the reference portfolio of underlying exposures (determined as of the inception of the securitization) is outstanding. Where a securitization SPE is structured as a master trust, a cleanup call with respect to a particular VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 series or tranche issued by the master trust meets criteria (3) of the definition of ‘‘eligible clean-up call’’ as long as the outstanding principal amount in that series or tranche was 10 percent or less of its original amount at the inception of the series. 3. Risk-Weighted Asset Amounts for Securitization Exposures The proposed framework for assigning risk-based capital requirements to securitization exposures required banking organizations generally to calculate a risk-weighted asset amount for a securitization exposure by applying either (i) the simplified supervisory formula approach (SSFA), described in section VIII.H of the preamble, or (ii) if the banking organization is not subject to the market risk rule, a gross-up approach similar to an approach provided under the general risk-based capital rules. A banking organization would be required to apply either the SSFA or the gross-up approach consistently across all of its securitization exposures. However, a banking organization could choose to assign a 1,250 percent risk weight to any securitization exposure. Commenters expressed concerns regarding the potential differences in risk weights for similar exposures when using the gross-up approach compared to the SSFA, and the potential for capital arbitrage depending on the outcome of capital treatment under the framework. The agencies acknowledge these concerns and, to reduce arbitrage opportunities, have required that a banking organization apply either the gross-up approach or the SSFA consistently across all of its securitization exposures. Commenters also asked the agencies and the FDIC to clarify how often and under what circumstances a banking organization is allowed to switch between the SSFA and the gross-up approach. While the agencies are not placing restrictions on the ability of banking organizations to switch from the SSFA to the gross-up approach, the agencies do not anticipate there should be a need for frequent changes in methodology by a banking organization absent significant change in the nature of the banking organization’s securitization activities, and expect banking organizations to be able to provide a rationale for changing methodologies to their primary Federal supervisors if requested. Citing potential disadvantages of the proposed securitization framework as compared to standards to be applied to international competitors that rely on the use of credit ratings, some commenters requested that banking PO 00000 Frm 00100 Fmt 4701 Sfmt 4700 organizations be able to continue to implement a ratings-based approach to allow the agencies and the FDIC more time to calibrate the SSFA in accordance with international standards that rely on ratings. The agencies again observe that in accordance with section 939A of the Dodd-Frank Act, they are required to remove any references to, or reliance on, ratings in regulations. Accordingly, the final rule does not include any references to, or reliance on, credit ratings. The agencies have determined that the SSFA is an appropriate substitute standard to credit ratings that can be used to measure riskbased capital requirements and may be implemented uniformly across institutions. Under the proposed securitization framework, banking organizations would have been required or could choose to assign a risk weight of 1,250 percent to certain securitization exposures. Commenters stated that the 1,250 percent risk weight required under certain circumstances in the securitization framework would penalize banking organizations that hold capital above the total risk-based capital minimum and could require a banking organization to hold more capital against the exposure than the actual exposure amount at risk. As a result, commenters requested that the amount of risk-based capital required to be held against a banking organization’s exposure be capped at the exposure amount. The agencies have decided to retain the proposed 1,250 percent risk weight in the final rule, consistent with their overall goals of simplicity and comparability, to provide for comparability in risk-weighted asset amounts for the same exposure across institutions. Consistent with the proposal, the final rule provides for alternative treatment of securitization exposures to ABCP programs and certain gains-on-sale and CEIO exposures. Specifically, similar to the general risk-based capital rules, the final rule includes a minimum 100 percent risk weight for interest-only mortgage-backed securities and exceptions to the securitization framework for certain small-business loans and certain derivatives as described below. A banking organization may use the securitization credit risk mitigation rules to adjust the capital requirement under the securitization framework for an exposure to reflect certain collateral, credit derivatives, and guarantees, as described in more detail below. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations a. Exposure Amount of a Securitization Exposure Under the final rule, the exposure amount of an on-balance sheet securitization exposure that is not a repo-style transaction, eligible margin loan, OTC derivative contract or derivative that is a cleared transaction is generally the banking organization’s carrying value of the exposure. The final rule modifies the proposed treatment for determining exposure amounts under the securitization framework to reflect the ability of a banking organization not subject to the advanced approaches rule to make an AOCI opt-out election. As a result, the exposure amount of an onbalance sheet securitization exposure that is an available-for-sale debt security or an available-for-sale debt security transferred to held-to-maturity held by a banking organization that has made an AOCI opt-out election is the banking organization’s carrying value (including net accrued but unpaid interest and fees), less any net unrealized gains on the exposure and plus any net unrealized losses on the exposure. The exposure amount of an offbalance sheet securitization exposure that is not an eligible ABCP liquidity facility, a repo-style transaction, eligible margin loan, an OTC derivative contract (other than a credit derivative), or a derivative that is a cleared transaction (other than a credit derivative) is the notional amount of the exposure. The treatment for OTC credit derivatives is described in more detail below. For purposes of calculating the exposure amount of an off-balance sheet exposure to an ABCP securitization exposure, such as a liquidity facility, consistent with the proposed rule, the notional amount may be reduced to the maximum potential amount that the banking organization could be required to fund given the ABCP program’s current underlying assets (calculated without regard to the current credit quality of those assets). Thus, if $100 is the maximum amount that could be drawn given the current volume and current credit quality of the program’s assets, but the maximum potential draw against these same assets could increase to as much as $200 under some scenarios if their credit quality were to improve, then the exposure amount is $200. An ABCP program is defined as a program established primarily for the purpose of issuing commercial paper that is investment grade and backed by underlying exposures held in a securitization SPE. An eligible ABCP liquidity facility is defined as a liquidity facility supporting ABCP, in form or in substance, which is subject to an asset VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 quality test at the time of draw that precludes funding against assets that are 90 days or more past due or in default. Notwithstanding these eligibility requirements, a liquidity facility is an eligible ABCP liquidity facility if the assets or exposures funded under the liquidity facility that do not meet the eligibility requirements are guaranteed by a sovereign that qualifies for a 20 percent risk weight or lower. Commenters, citing accounting changes that require certain ABCP securitization exposures to be consolidated on banking organizations balance sheets, asked the agencies and the FDIC to consider capping the amount of an off-balance sheet securitization exposure to the maximum potential amount that the banking organization could be required to fund given the securitization SPE’s current underlying assets. These commenters stated that the downward adjustment of the notional amount of a banking organization’s off-balance sheet securitization exposure to the amount of the available asset pool generally should be permitted regardless of whether the exposure to a customer SPE is made directly through a credit commitment by the banking organization to the SPE or indirectly through a funding commitment that the banking organization makes to an ABCP conduit. The agencies believe that the requirement to hold risk-based capital against the full amount that may be drawn more accurately reflects the risks of potential draws under these exposures and have decided not to provide a separate provision for offbalance sheet exposures to customersponsored SPEs that are not ABCP conduits. Under the final rule, consistent with the proposal, the exposure amount of an eligible ABCP liquidity facility that is subject to the SSFA equals the notional amount of the exposure multiplied by a 100 percent CCF. The exposure amount of an eligible ABCP liquidity facility that is not subject to the SSFA is the notional amount of the exposure multiplied by a 50 percent CCF. The exposure amount of a securitization exposure that is a repo-style transaction, eligible margin loan, an OTC derivative contract (other than a purchased credit derivative), or derivative that is a cleared transaction (other than a purchased credit derivative) is the exposure amount of the transaction as calculated under section 34 or section 37 of the final rule, as applicable. PO 00000 Frm 00101 Fmt 4701 Sfmt 4700 62117 b. Gains-On-Sale and Credit-Enhancing Interest-Only Strips Consistent with the proposal, under the final rule a banking organization must deduct from common equity tier 1 capital any after-tax gain-on-sale resulting from a securitization and must apply a 1,250 percent risk weight to the portion of a CEIO that does not constitute an after-tax gain-on-sale. The agencies believe this treatment is appropriate given historical supervisory concerns with the subjectivity involved in valuations of gains-on-sale and CEIOs. Furthermore, although the treatments for gains-on-sale and CEIOs can increase an originating banking organization’s risk-based capital requirement following a securitization, the agencies believe that such anomalies are rare where a securitization transfers significant credit risk from the originating banking organization to third parties. c. Exceptions Under the Securitization Framework Commenters stated concerns that the proposal would inhibit demand for private label securitization by making it more difficult for banking organizations, especially community banking organizations, to purchase private label mortgage-backed securities. Instead of implementing the SSFA and the grossup approach, commenters suggested allowing banking organizations to assign a 20 percent risk weight to securitization exposures that are backed by mortgage exposures that would be ‘‘qualified mortgages’’ under the Truth in Lending Act and implementing regulations issued by the CFPB.176 The agencies believe that the proposed securitization approaches would be more appropriate in capturing the risks provided by structured transactions, including those backed by QM. The final rule does not provide an exclusion for such exposures. Under the final rule, consistent with the proposal, there are several exceptions to the general provisions in the securitization framework that parallel the general risk-based capital rules. First, a banking organization is required to assign a risk weight of at least 100 percent to an interest-only MBS. The agencies believe that a minimum risk weight of 100 percent is prudent in light of the uncertainty implied by the substantial price volatility of these securities. Second, as required by federal statute, a special set of rules continues to apply to securitizations of small-business loans 176 78 E:\FR\FM\11OCR2.SGM FR 6408 (Jan. 30, 2013). 11OCR2 62118 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations and leases on personal property transferred with retained contractual exposure by well-capitalized depository institutions.177 Finally, if a securitization exposure is an OTC derivative contract or derivative contract that is a cleared transaction (other than a credit derivative) that has a first priority claim on the cash flows from the underlying exposures (notwithstanding amounts due under interest rate or currency derivative contracts, fees due, or other similar payments), a banking organization may choose to set the risk-weighted asset amount of the exposure equal to the amount of the exposure. d. Overlapping Exposures Consistent with the proposal, the final rule includes provisions to limit the double counting of risks in situations involving overlapping securitization exposures. If a banking organization has multiple securitization exposures that provide duplicative coverage to the underlying exposures of a securitization (such as when a banking organization provides a program-wide credit enhancement and multiple pool-specific liquidity facilities to an ABCP program), the banking organization is not required to hold duplicative risk-based capital against the overlapping position. Instead, the banking organization must apply to the overlapping position the applicable risk-based capital treatment under the securitization framework that results in the highest risk-based capital requirement. wreier-aviles on DSK5TPTVN1PROD with RULES2 e. Servicer Cash Advances A traditional securitization typically employs a servicing banking organization that, on a day-to-day basis, collects principal, interest, and other payments from the underlying exposures of the securitization and forwards such payments to the securitization SPE or to investors in the securitization. Servicing banking organizations often provide a facility to the securitization under which the servicing banking organization may advance cash to ensure an uninterrupted flow of payments to investors in the securitization, including advances made to cover foreclosure costs or other expenses to facilitate the 177 See 12 U.S.C. 1835. This provision places a cap on the risk-based capital requirement applicable to a well-capitalized depository institution that transfers small-business loans with recourse. The final rule does not expressly provide that the agencies may permit adequately-capitalized banking organizations to use the small business recourse rule on a case-by-case basis because the agencies may make such a determination under the general reservation of authority in section 1 of the final rule. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 timely collection of the underlying exposures. These servicer cash advance facilities are securitization exposures. Consistent with the proposal, under the final rule a banking organization must apply the SSFA or the gross-up approach, as described below, or a 1,250 percent risk weight to a servicer cash advance facility. The treatment of the undrawn portion of the facility depends on whether the facility is an eligible servicer cash advance facility. An eligible servicer cash advance facility is a servicer cash advance facility in which: (1) The servicer is entitled to full reimbursement of advances, except that a servicer may be obligated to make non-reimbursable advances for a particular underlying exposure if any such advance is contractually limited to an insignificant amount of the outstanding principal balance of that exposure; (2) the servicer’s right to reimbursement is senior in right of payment to all other claims on the cash flows from the underlying exposures of the securitization; and (3) the servicer has no legal obligation to, and does not make, advances to the securitization if the servicer concludes the advances are unlikely to be repaid. Under the proposal, a banking organization that is a servicer under an eligible servicer cash advance facility is not required to hold risk-based capital against potential future cash advanced payments that it may be required to provide under the contract governing the facility. A banking organization that provides a non-eligible servicer cash advance facility would determine its risk-based capital requirement for the notional amount of the undrawn portion of the facility in the same manner as the banking organization would determine its risk-based capital requirement for other off-balance sheet securitization exposures. The agencies are clarifying the terminology in the final rule to specify that a banking organization that is a servicer under a non-eligible servicer cash advance facility must hold risk-based capital against the amount of all potential future cash advance payments that it may be contractually required to provide during the subsequent 12-month period under the contract governing the facility. f. Implicit Support Consistent with the proposed rule, the final rule requires a banking organization that provides support to a securitization in excess of its predetermined contractual obligation (implicit support) to include in riskweighted assets all of the underlying exposures associated with the securitization as if the exposures had PO 00000 Frm 00102 Fmt 4701 Sfmt 4700 not been securitized, and deduct from common equity tier 1 capital any aftertax gain-on-sale resulting from the securitization.178 In addition, the banking organization must disclose publicly (i) that it has provided implicit support to the securitization, and (ii) the risk-based capital impact to the banking organization of providing such implicit support. The agencies note that under the reservations of authority set forth in the final rule, the banking organization’s primary Federal supervisor also could require the banking organization to hold risk-based capital against all the underlying exposures associated with some or all the banking organization’s other securitizations as if the underlying exposures had not been securitized, and to deduct from common equity tier 1 capital any after-tax gain-on-sale resulting from such securitizations. 4. Simplified Supervisory Formula Approach The proposed rule incorporated the SSFA, a simplified version of the supervisory formula approach (SFA) in the advanced approaches rule, to assign risk weights to securitization exposures. Many of the commenters focused on the burden of implementing the SSFA given the complexity of the approach in relation to the proposed treatment of mortgages exposures. Commenters also stated concerns that implementation of the SSFA would generally restrict credit growth and create competitive equity concerns with other jurisdictions implementing ratings-based approaches. The agencies acknowledge that there may be differences in capital requirements under the SSFA and the ratings-based approach in the Basel capital framework. As explained previously, section 939A of the DoddFrank Act requires the agencies to use alternative standards of creditworthiness and prohibits the agencies from including references to, or reliance upon, credit ratings in their regulations. Any alternative standard developed by the agencies may not generate the same result as a ratingsbased capital framework under every circumstance. However, the agencies have designed the SSFA to result in generally comparable capital requirements to those that would be required under the Basel ratings-based approach without undue complexity. The agencies will monitor implementation of the SSFA and, based 178 The final rule is consistent with longstanding guidance on the treatment of implicit support, entitled, ‘‘Interagency Guidance on Implicit Recourse in Asset Securitizations,’’ (May 23, 2002). See OCC Bulletin 2002–20 (national banks) (OCC); and SR letter 02–15 (Board). E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations on supervisory experience, consider what modifications, if any, may be necessary to improve the SSFA in the future. The agencies have adopted the proposed SSFA largely as proposed, with a revision to the delinquency parameter (parameter W) that will increase the risk sensitivity of the approach and clarify the operation of the formula when the contractual terms of the exposures underlying a securitization permit borrowers to defer payments of principal and interest, as described below. To limit potential burden of implementing the SSFA, banking organizations that are not subject to the market risk rule may also choose to use as an alternative the grossup approach described in section VIII.H.5 below, provided that they apply the gross-up approach to all of their securitization exposures. Similar to the SFA under the advanced approaches rule, the SSFA is a formula that starts with a baseline derived from the capital requirements that apply to all exposures underlying the securitization and then assigns risk weights based on the subordination level of an exposure. The agencies designed the SSFA to apply relatively higher capital requirements to the more risky junior tranches of a securitization that are the first to absorb losses, and relatively lower requirements to the most senior exposures. The SSFA applies a 1,250 percent risk weight to securitization exposures that absorb losses up to the amount of capital that is required for the underlying exposures under subpart D of the final rule had those exposures been held directly by a banking organization. In addition, the agencies are implementing a supervisory riskweight floor or minimum risk weight for a given securitization of 20 percent. While some commenters requested that the floor be lowered for certain low-risk securitization exposures, the agencies believe that a 20 percent floor is prudent given the performance of many securitization exposures during the recent crisis. At the inception of a securitization, the SSFA requires more capital on a transaction-wide basis than would be required if the underlying assets had not been securitized. That is, if the banking organization held every tranche of a securitization, its overall capital requirement would be greater than if the banking organization held the underlying assets in portfolio. The agencies believe this overall outcome is important in reducing the likelihood of regulatory capital arbitrage through securitizations. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 The proposed rule required banking organizations to use data to assign the SSFA parameters that are not more than 91 days old. Commenters requested that the data requirement be amended to account for securitizations of underlying assets with longer payment periods, such as transactions featuring annual or biannual payments. In response, the agencies amended this requirement in the final rule so that data used to determine SSFA parameters must be the most currently available data. However, for exposures that feature payments on a monthly or quarterly basis, the final rule requires the data to be no more than 91 calendar days old. Under the final rule, to use the SSFA, a banking organization must obtain or determine the weighted-average risk weight of the underlying exposures (KG), as well as the attachment and detachment points for the banking organization’s position within the securitization structure. ‘‘KG,’’ is calculated using the risk-weighted asset amounts in the standardized approach and is expressed as a decimal value between zero and 1 (that is, an average risk weight of 100 percent means that KG would equal 0.08). The banking organization may recognize the relative seniority of the exposure, as well as all cash funded enhancements, in determining attachment and detachment points. In addition, a banking organization must be able to determine the credit performance of the underlying exposures. The commenters expressed concerns that certain types of data that would be required to calculate KG may not be readily available, particularly data necessary to calculate the weightedaverage capital requirement of residential mortgages according to the proposed rule’s standardized approach for residential mortgages. Some commenters therefore asked to be able to use the risk weights under the general risk-based capital rules for residential mortgages in the calculation of KG. Commenters also requested the use of alternative estimates or conservative proxy data to implement the SSFA when a parameter is not readily available, especially for securitizations of mortgage exposures. As previously discussed, the agencies are retaining in the final rule the existing mortgage treatment under the general risk-based capital rules. Accordingly, the agencies believe that banking organizations should generally have access to the data necessary to calculate the SSFA parameters for mortgage exposures. Commenters characterized the KG parameter as not sufficiently risk sensitive and asked the agencies and the PO 00000 Frm 00103 Fmt 4701 Sfmt 4700 62119 FDIC to provide more recognition under the SSFA with respect to the credit quality of the underlying assets. Some commenters observed that the SSFA did not take into account sequential pay structures. As a result, some commenters requested that banking organizations be allowed to implement cash-flow models to increase risk sensitivity, especially given that the SSFA does not recognize the various types of cash-flow waterfalls for different transactions. In developing the final rule, the agencies considered the trade-offs between added risk sensitivity, increased complexity that would result from reliance on cash-flow models, and consistency with standardized approach risk weights. The agencies believe it is important to calibrate capital requirements under the securitization framework in a manner that is consistent with the calibration used for the underlying assets of the securitization to reduce complexity and best align capital requirements under the securitization framework with requirements for credit exposures under the standardized approach. As a result, the agencies have decided to finalize the KG parameter as proposed. To make the SSFA more risk-sensitive and forward-looking, the parameter KG is modified based on delinquencies among the underlying assets of the securitization. The resulting adjusted parameter is labeled KA. KA is set equal to the weighted average of the KG value and a fixed parameter equal to 0.5. KA = (1 ¥ W) · KG + (0.5 · W) Under the proposal, the W parameter equaled the ratio of the sum of the dollar amounts of any underlying exposures of the securitization that are 90 days or more past due, subject to a bankruptcy or insolvency proceeding, in the process of foreclosure, held as real estate owned, in default, or have contractually deferred interest for 90 days or more divided by the ending balance, measured in dollars, of the underlying exposures. Commenters expressed concern that the proposal would require additional capital for payment deferrals that are unrelated to the creditworthiness of the borrower, and encouraged the agencies and the FDIC to amend the proposal so that the numerator of the W parameter would not include deferrals of interest that are unrelated to the performance of the loan or the borrower, as is the case for certain federally-guaranteed student loans or certain consumer credit facilities that allow the borrower to defer principal and interest payments for the first 12 months following the purchase of a E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations funds are disbursed that provide for period(s) of deferral that are not initiated based on changes in the creditworthiness of the borrower. The agencies believe that the SSFA appropriately reflects partial government guarantees because such guarantees are reflected in KG in the same manner that they are reflected in capital requirements for loans held on balance sheet. For clarity, the agencies have eliminated the term ‘‘securitized pool’’ from the final rule. The calculation of parameter W includes all underlying exposures of a securitization transaction. The agencies believe that, with the parameter W calibration set equal to 0.5, the overall capital requirement produced by the SSFA is sufficiently The values A of and D denote the attachment and detachment points, respectively, for the tranche. Specifically, A is the attachment point for the tranche that contains the securitization exposure and represents the threshold at which credit losses will first be allocated to the exposure. This input is the ratio, as expressed as a decimal value between zero and one, of the dollar amount of the securitization exposures that are subordinated to the tranche that contains the securitization exposure held by the banking organization to the current dollar amount of all underlying exposures. Commenters requested that the agencies and the FDIC recognize unfunded forms of credit support, such as excess spread, in the calculation of A. Commenters also stated that where the carrying value of an exposure is less than its par value, the discount to par for a particular exposure should be recognized as additional credit protection. However, the agencies believe it is prudent to recognize only funded credit enhancements, such as overcollateralization or reserve accounts funded by accumulated cash flows, in the calculation of parameter A. Discounts and write-downs can be related to credit risk or due to other factors such as interest rate movements or liquidity. As a result, the agencies do not believe that discounts or writedowns should be factored into the SSFA as credit enhancement. Parameter D is the detachment point for the tranche that contains the securitization exposure and represents the threshold at which credit losses allocated to the securitization exposure would result in a total loss of principal. This input, which is a decimal value between zero and one, equals the value of parameter A plus the ratio of the current dollar amount of the securitization exposures that are pari passu with the banking organization’s securitization exposure (that is, have equal seniority with respect to credit risk) to the current dollar amount of all underlying exposures. The SSFA VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00104 Fmt 4701 Sfmt 4725 responsive and prudent to ensure sufficient capital for pools that demonstrate credit weakness. The entire specification of the SSFA in the final rule is as follows: KSSFA is the risk-based capital requirement for the securitization exposure and is a function of three variables, labeled a, u, and l. The constant e is the base of the natural logarithms (which equals 2.71828). The variables a, u, and l have the following definitions: specification is completed by the constant term p, which is set equal to 0.5 for securitization exposures that are not resecuritizations, or 1.5 for resecuritization exposures, and the variable KA, which is described above. When parameter D for a securitization exposure is less than or equal to KA, the exposure must be assigned a risk weight of 1,250 percent. When A for a securitization exposure is greater than or equal to KA, the risk weight of the exposure, expressed as a percent, would equal KSSFA times 1,250. When A is less than KA and D is greater than KA, the applicable risk weight is a weighted average of 1,250 percent and 1,250 percent times KSSFA. As suggested by commenters, in order to make the description of the SSFA formula clearer, the term ‘‘l’’ has been redefined to be the maximum of 0 and A–KA, instead of the proposed A–KA. The risk weight would be determined according to the following formula: E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.004</GPH> ER11OC13.005</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 product or service. Some commenters also asserted that the proposed SSFA would not accurately calibrate capital requirements for those student loans with a partial government guarantee. Another commenter also asked for clarification on which exposures are in the securitized pool. In response to these concerns, the agencies have decided to explicitly exclude from the numerator of parameter W loans with deferral of principal or interest for (1) federallyguaranteed student loans, in accordance with the terms of those programs, or (2) for consumer loans, including nonfederally-guaranteed student loans, provided that such payments are deferred pursuant to provisions included in the contract at the time ER11OC13.003</GPH> 62120 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations For resecuritizations, banking organizations must use the SSFA to measure the underlying securitization exposure’s contribution to KG. For example, consider a hypothetical securitization tranche that has an attachment point at 0.06 and a detachment point at 0.07. Then assume that 90 percent of the underlying pool of assets were mortgage loans that qualified for a 50 percent risk weight and that the remaining 10 percent of the pool was a tranche of a separate securitization (where the underlying exposures consisted of mortgages that also qualified for a 50 percent weight). An exposure to this hypothetical tranche would meet the definition of a resecuritization exposure. Next, assume that the attachment point A of the underlying securitization that is the 10 percent share of the pool is 0.06 and the detachment point is 0.08. Finally, assume that none of the underlying mortgage exposures of either the hypothetical tranche or the underlying securitization exposure meet the final rule definition of ‘‘delinquent.’’ The value of KG for the resecuritization exposure equals the weighted average of the two distinct KG values. For the mortgages that qualify for the 50 percent risk weight and represent 90 percent of the resecuritization, KG equals 0.04 (that is, 50 percent of the 8 percent risk-based capital standard). KG,re-securitization = (0.9 · 0.04) + (0.1 · KG,securitizaiton) To calculate the value of KG,securitization a banking organization would use the attachment and detachment points of 0.06 and 0.08, respectively. Applying those input parameters to the SSFA (together with p = 0.5 and KG = 0.04) results in a KG,securitization equal to 0.2325. Substituting this value into the equation yields: KG,re-securitization = (0.9 · 0.04) + (0.1 · 0.2325) = 0.05925 This value of 0.05925 for KG,re-securitization, would then be used in the calculation of the risk-based capital requirement for the tranche of the resecuritization (where A = 0.06, B = 0.07, and p = 1.5). The result is a risk weight of 1,172 percent for the tranche that runs from 0.06 to 0.07. Given that the attachment point is very close to the value of KG,re-securitization, the capital charge is nearly equal to the maximum risk weight of 1,250 percent. To apply the securitization framework to a single tranched exposure that has been re-tranched, such as some ReREMICs, a banking organization must apply the SSFA or gross-up approach to the retranched exposure as if it were VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 still part of the structure of the original securitization transaction. Therefore, a banking organization implementing the SSFA or the gross-up approach would calculate parameters for those approaches that would treat the retranched exposure as if it were still embedded in the original structure of the transaction while still recognizing any added credit enhancement provided by retranching. For example, under the SSFA a banking organization would calculate the approach using hypothetical attachment and detachment points that reflect the seniority of the retranched exposure within the original deal structure, as well as any additional credit enhancement provided by retranching of the exposure. Parameters that depend on pool-level characteristics, such as the W parameter under the SSFA, would be calculated based on the characteristics of the total underlying exposures of the initial securitization transaction, not just the retranched exposure. 5. Gross-Up Approach Under the final rule, consistent with the proposal, banking organizations that are not subject to the market risk rule may assign risk-weighted asset amounts to securitization exposures by implementing the gross-up approach described in section 43 of the final rule, which is similar to an existing approach provided under the general risk-based capital rules. If the banking organization chooses to apply the gross-up approach, it is required to apply this approach to all of its securitization exposures, except as otherwise provided for certain securitization exposures under sections 44 and 45 of the final rule. The gross-up approach assigns riskweighted asset amounts based on the full amount of the credit-enhanced assets for which the banking organization directly or indirectly assumes credit risk. To calculate riskweighted assets under the gross-up approach, a banking organization determines four inputs: The pro rata share, the exposure amount, the enhanced amount, and the applicable risk weight. The pro rata share is the par value of the banking organization’s exposure as a percentage of the par value of the tranche in which the securitization exposure resides. The enhanced amount is the par value of all the tranches that are more senior to the tranche in which the exposure resides. The applicable risk weight is the weighted-average risk weight of the underlying exposures in the securitization as calculated under the standardized approach. PO 00000 Frm 00105 Fmt 4701 Sfmt 4700 62121 Under the gross-up approach, a banking organization is required to calculate the credit equivalent amount, which equals the sum of (1) the exposure of the banking organization’s securitization exposure and (2) the pro rata share multiplied by the enhanced amount. To calculate risk-weighted assets for a securitization exposure under the gross-up approach, a banking organization is required to assign the applicable risk weight to the gross-up credit equivalent amount. As noted above, in all cases, the minimum risk weight for securitization exposures is 20 percent. As discussed above, the agencies recognize that different capital requirements are likely to result from the application of the gross-up approach as compared to the SSFA. However, the agencies believe allowing smaller, less complex banking organizations not subject to the market risk rule to use the gross up approach (consistent with past practice under the existing general riskbased capital rules) is appropriate and should reduce operational burden for many banking organizations. 6. Alternative Treatments for Certain Types of Securitization Exposures Under the proposal, a banking organization generally would assign a 1,250 percent risk weight to any securitization exposure to which the banking organization does not apply the SSFA or the gross-up approach. However, the proposal provided alternative treatments for certain types of securitization exposures described below, provided that the banking organization knows the composition of the underlying exposures at all times. a. Eligible Asset-Backed Commercial Paper Liquidity Facilities Under the final rule, consistent with the proposal and the Basel capital framework, a banking organization is permitted to determine the riskweighted asset amount of an eligible ABCP liquidity facility by multiplying the exposure amount by the highest risk weight applicable to any of the individual underlying exposures covered by the facility. b. A Securitization Exposure in a Second-Loss Position or Better to an Asset-Backed Commercial Paper Program Under the final rule and consistent with the proposal, a banking organization may determine the riskweighted asset amount of a securitization exposure that is in a second-loss position or better to an ABCP program by multiplying the E:\FR\FM\11OCR2.SGM 11OCR2 62122 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 exposure amount by the higher of 100 percent and the highest risk weight applicable to any of the individual underlying exposures of the ABCP program, provided the exposure meets the following criteria: (1) The exposure is not an eligible ABCP liquidity facility; (2) The exposure is economically in a second-loss position or better, and the first-loss position provides significant credit protection to the second-loss position; (3) The exposure qualifies as investment grade; and (4) The banking organization holding the exposure does not retain or provide protection for the first-loss position. The agencies believe that this approach, which is consistent with the Basel capital framework, appropriately and conservatively assesses the credit risk of non-first-loss exposures to ABCP programs. The agencies are adopting this aspect of the proposal, without change, for purposes of the final rule. 7. Credit Risk Mitigation for Securitization Exposures Under the final rule, and consistent with the proposal, the treatment of credit risk mitigation for securitization exposures would differ slightly from the treatment for other exposures. To recognize the risk mitigating effects of financial collateral or an eligible guarantee or an eligible credit derivative from an eligible guarantor, a banking organization that purchases credit protection uses the approaches for collateralized transactions under section 37 of the final rule or the substitution treatment for guarantees and credit derivatives described in section 36 of the final rule. In cases of maturity or currency mismatches, or, if applicable, lack of a restructuring event trigger, the banking organization must make any applicable adjustments to the protection amount of an eligible guarantee or credit derivative as required by section 36 for any hedged securitization exposure. In addition, for synthetic securitizations, when an eligible guarantee or eligible credit derivative covers multiple hedged exposures that have different residual maturities, the banking organization is required to use the longest residual maturity of any of the hedged exposures as the residual maturity of all the hedged exposures. In the final rule, the agencies are clarifying that a banking organization is not required to compute a counterparty credit risk capital requirement for the credit derivative provided that this treatment is applied consistently for all of its OTC credit derivatives. However, a banking organization must calculate VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 counterparty credit risk if the OTC credit derivative is a covered position under the market risk rule. Consistent with the proposal, a banking organization that purchases an OTC credit derivative (other than an nthto-default credit derivative) that is recognized as a credit risk mitigant for a securitization exposure that is not a covered position under the market risk rule is not required to compute a separate counterparty credit risk capital requirement provided that the banking organization does so consistently for all such credit derivatives. The banking organization must either include all or exclude all such credit derivatives that are subject to a qualifying master netting agreement from any measure used to determine counterparty credit risk exposure to all relevant counterparties for risk-based capital purposes. If a banking organization cannot, or chooses not to, recognize a credit derivative that is a securitization exposure as a credit risk mitigant, the banking organization must determine the exposure amount of the credit derivative under the treatment for OTC derivatives in section 34. In the final rule, the agencies are clarifying that if the banking organization purchases the credit protection from a counterparty that is a securitization, the banking organization must determine the risk weight for counterparty credit risk according to the securitization framework. If the banking organization purchases credit protection from a counterparty that is not a securitization, the banking organization must determine the risk weight for counterparty credit risk according to general risk weights under section 32. A banking organization that provides protection in the form of a guarantee or credit derivative (other than an nth-todefault credit derivative) that covers the full amount or a pro rata share of a securitization exposure’s principal and interest must risk weight the guarantee or credit derivative as if it holds the portion of the reference exposure covered by the guarantee or credit derivative. 8. Nth-to-Default Credit Derivatives Under the final rule and consistent with the proposal, the capital requirement for credit protection provided through an nth-to-default credit derivative is determined either by using the SSFA, or applying a 1,250 percent risk weight. A banking organization providing credit protection must determine its exposure to an nth-to-default credit derivative as the largest notional amount of all the underlying exposures. When applying the SSFA, the PO 00000 Frm 00106 Fmt 4701 Sfmt 4700 attachment point (parameter A) is the ratio of the sum of the notional amounts of all underlying exposures that are subordinated to the banking organization’s exposure to the total notional amount of all underlying exposures. In the case of a first-todefault credit derivative, there are no underlying exposures that are subordinated to the banking organization’s exposure. In the case of a second-or-subsequent-to default credit derivative, the smallest (n-1) underlying exposure(s) are subordinated to the banking organization’s exposure. Under the SSFA, the detachment point (parameter D) is the sum of the attachment point and the ratio of the notional amount of the banking organization’s exposure to the total notional amount of the underlying exposures. A banking organization that does not use the SSFA to calculate a risk weight for an nth-to-default credit derivative would assign a risk weight of 1,250 percent to the exposure. For protection purchased through a first-to-default derivative, a banking organization that obtains credit protection on a group of underlying exposures through a first-to-default credit derivative that meets the rules of recognition for guarantees and credit derivatives under section 36(b) of the final rule must determine its risk-based capital requirement for the underlying exposures as if the banking organization synthetically securitized the underlying exposure with the smallest riskweighted asset amount and had obtained no credit risk mitigant on the other underlying exposures. A banking organization must calculate a risk-based capital requirement for counterparty credit risk according to section 34 of the final rule for a first-to-default credit derivative that does not meet the rules of recognition of section 36(b). For second-or-subsequent-to-default credit derivatives, a banking organization that obtains credit protection on a group of underlying exposures through a nth-to-default credit derivative that meets the rules of recognition of section 36(b) of the final rule (other than a first-to-default credit derivative) may recognize the credit risk mitigation benefits of the derivative only if the banking organization also has obtained credit protection on the same underlying exposures in the form of first-through-(n-1)-to-default credit derivatives; or if n-1 of the underlying exposures have already defaulted. If a banking organization satisfies these requirements, the banking organization determines its risk-based capital requirement for the underlying exposures as if the banking organization E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations had only synthetically securitized the underlying exposure with the nth smallest risk-weighted asset amount and had obtained no credit risk mitigant on the other underlying exposures. For a nth-to-default credit derivative that does not meet the rules of recognition of section 36(b), a banking organization must calculate a risk-based capital requirement for counterparty credit risk according to the treatment of OTC derivatives under section 34 of the final rule. The agencies are adopting this aspect of the proposal without change for purposes of the final rule. IX. Equity Exposures The proposal significantly revised the general risk-based capital rules’ treatment for equity exposures. To improve risk sensitivity, the final rule generally follows the same approach to equity exposures as the proposal, while providing clarification on investments in a separate account as detailed below. In particular, the final rule requires a banking organization to apply the SRWA for equity exposures that are not exposures to an investment fund and apply certain look-through approaches to assign risk-weighted asset amounts to equity exposures to an investment fund. These approaches are discussed in greater detail below. A. Definition of Equity Exposure and Exposure Measurement wreier-aviles on DSK5TPTVN1PROD with RULES2 The agencies are adopting the proposed definition of equity exposures, without change, for purposes of the final rule.179 Under the final rule, a banking organization is required to determine the adjusted carrying value for each equity exposure based on the approaches described below. For the onbalance sheet component of an equity exposure, other than an equity exposure that is classified as AFS where the banking organization has made an AOCI opt-out election under section 22(b)(2) of the final rule, the adjusted carrying value is a banking organization’s carrying value of the exposure. For the on-balance sheet component of an equity exposure that is classified as AFS where the banking organization has 179 See the definition of ‘‘equity exposure’’ in section 2 of the final rule. However, as described above in section VIII.A of this preamble, the agencies have adjusted the definition of ‘‘exposure amount’’ in line with certain requirements necessary for banking organizations that make an AOCI opt-out election. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 made an AOCI opt-out election under section 22(b)(2) of the final rule, the adjusted carrying value of the exposure is the banking organization’s carrying value of the exposure less any net gains on the exposure that are reflected in the carrying value but excluded from the banking organization’s regulatory capital components. For a commitment to acquire an equity exposure that is unconditional, the adjusted carrying value is the effective notional principal amount of the exposure multiplied by a 100 percent conversion factor. For a commitment to acquire an equity exposure that is conditional, the adjusted carrying value is the effective notional principal amount of the commitment multiplied by (1) a 20 percent conversion factor, for a commitment with an original maturity of one year or less or (2) a 50 percent conversion factor, for a commitment with an original maturity of over one year. For the off-balance sheet component of an equity exposure that is not an equity commitment, the adjusted carrying value is the effective notional principal amount of the exposure, the size of which is equivalent to a hypothetical on-balance sheet position in the underlying equity instrument that would evidence the same change in fair value (measured in dollars) for a given small change in the price of the underlying equity instrument, minus the adjusted carrying value of the onbalance sheet component of the exposure. The agencies included the concept of the effective notional principal amount of the off-balance sheet portion of an equity exposure to provide a uniform method for banking organizations to measure the on-balance sheet equivalent of an off-balance sheet exposure. For example, if the value of a derivative contract referencing the common stock of company X changes the same amount as the value of 150 shares of common stock of company X, for a small change (for example, 1.0 percent) in the value of the common stock of company X, the effective notional principal amount of the derivative contract is the current value of 150 shares of common stock of company X, regardless of the number of shares the derivative contract references. The adjusted carrying value of the off-balance sheet component of the derivative is the current value of 150 shares of common stock of company X minus the adjusted carrying value of PO 00000 Frm 00107 Fmt 4701 Sfmt 4700 62123 any on-balance sheet amount associated with the derivative. B. Equity Exposure Risk Weights The proposal set forth a SRWA for equity exposures, which the agencies have adopted without change in the final rule. Therefore, under the final rule, a banking organization determines the risk-weighted asset amount for each equity exposure, other than an equity exposure to an investment fund, by multiplying the adjusted carrying value of the equity exposure, or the effective portion and ineffective portion of a hedge pair as described below, by the lowest applicable risk weight in section 52 of the final rule. A banking organization determines the riskweighted asset amount for an equity exposure to an investment fund under section 53 of the final rule. A banking organization sums risk-weighted asset amounts for all of its equity exposures to calculate its aggregate risk-weighted asset amount for its equity exposures. Some commenters asserted that mutual banking organizations, which are more highly exposed to equity exposures than traditional depository institutions, should be permitted to assign a 100 percent risk weight to their equity exposures rather than the proposed 300 percent risk weight for publicly-traded equity exposures or 400 percent risk weight for non-publicly traded equity exposures. Some commenters also argued that a banking organization’s equity investment in a banker’s bank should get special treatment, for instance, exemption from the 400 percent risk weight or deduction as an investment in the capital of an unconsolidated financial institution. The agencies have decided to retain the proposed risk weights in the final rule because they do not believe there is sufficient justification for a lower risk weight solely based on the nature of the institution (for example, mutual banking organization) holding the exposure. In addition, the agencies believe that a 100 percent risk weight does not reflect the inherent risk for equity exposures that fall under the proposed 300 percent and 400 percent risk-weight categories or that are subject to deduction as investments in unconsolidated financial institutions. The agencies have agreed to finalize the SRWA risk weights as proposed, which are summarized below in Table 24. E:\FR\FM\11OCR2.SGM 11OCR2 62124 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations TABLE 24—SIMPLE RISK-WEIGHT APPROACH Risk weight (in percent) Equity exposure 0 ...................... An equity exposure to a sovereign, the Bank for International Settlements, the European Central Bank, the European Commission, the International Monetary Fund, an MDB, and any other entity whose credit exposures receive a zero percent risk weight under section 32 of the final rule. An equity exposure to a PSE, Federal Home Loan Bank or Farmer Mac. • Community development equity exposures.180 • The effective portion of a hedge pair. • Non-significant equity exposures to the extent that the aggregate adjusted carrying value of the exposures does not exceed 10 percent of tier 1 capital plus tier 2 capital A significant investment in the capital of an unconsolidated financial institution in the form of common stock that is not deducted under section 22 of the final rule. A publicly-traded equity exposure (other than an equity exposure that receives a 600 percent risk weight and including the ineffective portion of a hedge pair). An equity exposure that is not publicly-traded (other than an equity exposure that receives a 600 percent risk weight). An equity exposure to an investment firm that (i) would meet the definition of a traditional securitization were it not for the primary Federal supervisor’s application of paragraph (8) of that definition and (ii) has greater than immaterial leverage. 20 .................... 100 .................. 250 .................. 300 .................. 400 .................. 600 .................. Consistent with the proposal, the final rule defines publicly traded as traded on: (1) Any exchange registered with the SEC as a national securities exchange under section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f); or (2) any non-U.S.-based securities exchange that is registered with, or approved by, a national securities regulatory authority and that provides a liquid, two-way market for the instrument in question. A two-way market refers to a market where there are independent bona fide offers to buy and sell so that a price reasonably related to the last sales price or current bona fide competitive bid and offer quotations can be determined within one day and settled at that price within a relatively short time frame conforming to trade custom. wreier-aviles on DSK5TPTVN1PROD with RULES2 C. Non-significant Equity Exposures Under the final rule, and as proposed, a banking organization may apply a 100 percent risk weight to certain equity 180 The final rule generally defines these exposures as exposures that qualify as community development investments under 12 U.S.C. 24 (Eleventh), excluding equity exposures to an unconsolidated small business investment company and equity exposures held through a consolidated small business investment company described in section 302 of the Small Business Investment Act of 1958 (15 U.S.C. 682). Under the proposal, a savings association’s community development equity exposure investments was defined to mean an equity exposure that are designed primarily to promote community welfare, including the welfare of low- and moderate-income communities or families, such as by providing services or jobs, and excluding equity exposures to an unconsolidated small business investment company and equity exposures held through a consolidated small business investment company described in section 302 of the Small Business Investment Act of 1958 (15 U.S.C. 682). The agencies have determined that a separate definition for a savings association’s community development equity exposure is not necessary and, therefore, the final rule applies one definition of community development equity exposure to all types of covered banking organizations. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 exposures deemed non-significant. Nonsignificant equity exposures means an equity exposure to the extent that the aggregate adjusted carrying value of the exposures does not exceed 10 percent of the banking organization’s total capital.181 To compute the aggregate adjusted carrying value of a banking organization’s equity exposures for determining their non-significance, the banking organization may exclude (1) equity exposures that receive less than a 300 percent risk weight under the SRWA (other than equity exposures determined to be non-significant); (2) the equity exposure in a hedge pair with the smaller adjusted carrying value; and (3) a proportion of each equity exposure to an investment fund equal to the proportion of the assets of the investment fund that are not equity exposures. If a banking organization does not know the actual holdings of the investment fund, the banking organization may calculate the proportion of the assets of the fund that are not equity exposures based on the terms of the prospectus, partnership agreement, or similar contract that defines the fund’s permissible investments. If the sum of the investment limits for all exposure classes within the fund exceeds 100 percent, the banking organization must assume that the investment fund invests to the maximum extent possible in equity exposures. To determine which of a banking organization’s equity exposures qualify for a 100 percent risk weight based on non-significance, the banking organization first must include equity 181 The definition excludes exposures to an investment firm that (1) meet the definition of traditional securitization were it not for the primary Federal regulator’s application of paragraph (8) of the definition of a traditional securitization and (2) has greater than immaterial leverage. PO 00000 Frm 00108 Fmt 4701 Sfmt 4700 exposures to unconsolidated smallbusiness investment companies, or those held through consolidated smallbusiness investment companies described in section 302 of the Small Business Investment Act of 1958. Next, it must include publicly-traded equity exposures (including those held indirectly through investment funds), and then it must include non-publiclytraded equity exposures (including those held indirectly through investment funds).182 One commenter proposed that certain exposures, including those to smallbusiness investment companies, should not be subject to the 10 percent capital limitation for non-significant equity exposures and should receive a 100 percent risk weight, consistent with the treatment of community development investments. The agencies reflected upon this comment and determined to retain the proposed 10 percent limit on a banking organization’s total capital in the final rule given the inherent credit and concentration risks associated with these exposures. D. Hedged Transactions Under the proposal, to determine riskweighted assets under the SRWA, a banking organization could identify hedge pairs, which would be defined as two equity exposures that form an effective hedge, as long as each equity exposure is publicly traded or has a return that is primarily based on a publicly traded equity exposure. A banking organization would risk-weight only the effective and ineffective portions of a hedge pair rather than the entire adjusted carrying value of each exposure that makes up the pair. A few commenters requested that non-publicly traded equities be recognized in a 182 See E:\FR\FM\11OCR2.SGM 15 U.S.C. 682. 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 62125 The exposures either have the same remaining maturity or each has a remaining maturity of at least three months; the hedge relationship is formally documented in a prospective manner (that is, before the banking organization acquires at least one of the equity exposures); the documentation specifies the measure of effectiveness (E) the banking organization uses for the hedge relationship throughout the life of the transaction; and the hedge relationship has an E greater than or equal to 0.8. A banking organization measures E at least quarterly and uses one of three measures of E described in the next section: The dollar-offset method, the variability-reduction method, or the regression method. It is possible that only part of a banking organization’s exposure to a particular equity instrument is part of a hedge pair. For example, assume a banking organization has equity exposure A with a $300 adjusted carrying value and chooses to hedge a portion of that exposure with equity exposure B with an adjusted carrying value of $100. Also assume that the combination of equity exposure B and $100 of the adjusted carrying value of equity exposure A form an effective hedge with an E of 0.8. In this situation, the banking organization treats $100 of equity exposure A and $100 of equity exposure B as a hedge pair, and the remaining $200 of its equity exposure A as a separate, stand-alone equity position. The effective portion of a hedge pair is calculated as E multiplied by the greater of the adjusted carrying values of the equity exposures forming the hedge pair. The ineffective portion of a hedge pair is calculated as (1–E) multiplied by the greater of the adjusted carrying values of the equity exposures forming the hedge pair. In the above example, the effective portion of the hedge pair is 0.8 × $100 = $80, and the ineffective portion of the hedge pair is (1 ¥ 0.8) × $100 = $20. The value of t ranges from zero to T, where T is the length of the observation period for the values of A and B, and is comprised of shorter values each labeled t. The regression method of measuring effectiveness is based on a regression in which the change in value of one VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00109 Fmt 4701 Sfmt 4700 E. Measures of Hedge Effectiveness As stated above, a banking organization could determine effectiveness using any one of three methods: The dollar-offset method, the variability-reduction method, or the regression method. Under the dollaroffset method, a banking organization determines the ratio of the cumulative sum of the changes in value of one equity exposure to the cumulative sum of the changes in value of the other equity exposure, termed the ratio of value change (RVC). If the changes in the values of the two exposures perfectly offset each other, the RVC is –1. If RVC is positive, implying that the values of the two equity exposures move in the same direction, the hedge is not effective and E equals 0. If RVC is negative and greater than or equal to –1 (that is, between zero and –1), then E equals the absolute value of RVC. If RVC is negative and less than –1, then E equals 2 plus RVC. The variability-reduction method of measuring effectiveness compares changes in the value of the combined position of the two equity exposures in the hedge pair (labeled X in the equation below) to changes in the value of one exposure as though that one exposure were not hedged (labeled A). This measure of E expresses the timeseries variability in X as a proportion of the variability of A. As the variability described by the numerator becomes small relative to the variability described by the denominator, the measure of effectiveness improves, but is bounded from above by a value of one. E is computed as: E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.007</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 hedged transaction under the rule. Equities that are not publicly traded are subject to considerable valuation uncertainty due to a lack of transparency and are generally far less liquid than publicly traded equities. The agencies have therefore determined that given the potential increased risk associated with equities that are not publicly traded, recognition of these instruments as hedges under the rule is not appropriate. One commenter indicated that the test of hedge effectiveness used in the calculation of publicly traded equities should be more risk sensitive in evaluating all components of the transaction to better determine the appropriate risk weight. The examples the commenter highlighted indicated dissatisfaction with the assignment of a 100 percent risk weight to the effective portion of all hedge pairs. As described further below, the proposed rule contained three methodologies for identifying the measure of effectiveness of an equity hedge relationship, methodologies which recognize less-than-perfect hedges. The proposal assigns a 100 percent risk weight to the effective portion of a hedge pair because some hedge pairs involve residual risks. In developing the standardized approach, the agencies and the FDIC sought to balance complexity and risk sensitivity, which limits the degree of granularity in hedge recognition. On balance, the agencies believe that it is more reflective of a banking organization’s risk profile to recognize a broader range of hedge pairs and assign all hedge pairs a 100 percent risk weight than to recognize only perfect hedges and assign a lower risk weight. Accordingly, the agencies are adopting the proposed treatment without change. Under the final rule, two equity exposures form an effective hedge if: 62126 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations exposure in a hedge pair is the dependent variable and the change in value of the other exposure in the hedge pair is the independent variable. E equals the coefficient of determination of this regression, which is the proportion of the variation in the dependent variable explained by variation in the independent variable. However, if the estimated regression coefficient is positive, then the value of E is zero. Accordingly, E is higher when the relationship between the values of the two exposures is closer. wreier-aviles on DSK5TPTVN1PROD with RULES2 F. Equity Exposures to Investment Funds Under the general risk-based capital rules, exposures to investments funds are captured through one of two methods. These methods are similar to the alternative modified look-through approach and the simple modified lookthrough approach described below. The proposal included an additional option, referred to in the NPR as the full lookthrough approach. The agencies and the FDIC proposed this separate treatment for equity exposures to an investment fund to ensure that the regulatory capital treatment for these exposures is commensurate with the risk. Thus, the risk-based capital requirement for equity exposures to investment funds that hold only low-risk assets would be relatively low, whereas high-risk exposures held through investment funds would be subject to a higher capital requirement. The final rule implements these three approaches as proposed and clarifies that the risk-weight for any equity exposure to an investment fund must be no less than 20 percent. In addition, the final rule clarifies, generally consistent with prior agency guidance, that a banking organization must treat an investment in a separate account, such as bank-owned life insurance, as if it were an equity exposure to an investment fund.183 A banking organization must use one of the look-through approaches provided in section 53 and, if applicable, section 154 of the final rule to determine the risk-weighted asset amount for such investments. A banking organization that purchases stable value protection on its investment in a separate account must treat the portion of the carrying value of its investment in the separate account attributable to the stable value protection as an exposure to the provider of the protection and the remaining portion as an equity exposure 183 Interagency Statement on the Purchase and Risk Management of Life Insurance, pp. 19–20, https://www.federalreserve.gov/boarddocs/srletters/ 2004/SR0419a1.pdf. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 to an investment fund. Stable value protection means a contract where the provider of the contract pays to the policy owner of the separate account an amount equal to the shortfall between the fair value and cost basis of the separate account when the policy owner of the separate account surrenders the policy. It also includes a contract where the provider of the contract pays to the beneficiary an amount equal to the shortfall between the fair value and book value of a specified portfolio of assets. A banking organization that provides stable value protection, such as through a stable value wrap that has provisions and conditions that minimize the wrap’s exposure to credit risk of the underlying assets in the fund, must treat the exposure as if it were an equity derivative on an investment fund and determine the adjusted carrying value of the exposure as the sum of the adjusted carrying values of any on-balance sheet asset component determined according to section 51(b)(1) and the off-balance sheet component determined according to section 51(b)(3). That is, the adjusted carrying value is the effective notional principal amount of the exposure, the size of which is equivalent to a hypothetical on-balance sheet position in the underlying equity instrument that would evidence the same change in fair value (measured in dollars) given a small change in the price of the underlying equity instrument without subtracting the adjusted carrying value of the on-balance sheet component of the exposure as calculated under the same paragraph. Risk-weighted assets for such an exposure is determined by applying one of the three look-through approaches as provided in section 53 and, if applicable, section 154 of the final rule. As discussed further below, under the final rule, a banking organization determines the risk-weighted asset amount for equity exposures to investment funds using one of three approaches: The full look-through approach, the simple modified lookthrough approach, or the alternative modified look-through approach, unless the equity exposure to an investment fund is a community development equity exposure. The risk-weighted asset amount for such community development equity exposures is the exposure’s adjusted carrying value. If a banking organization does not use the full look-through approach, and an equity exposure to an investment fund is part of a hedge pair, a banking organization must use the ineffective portion of the hedge pair as the adjusted carrying value for the equity exposure to PO 00000 Frm 00110 Fmt 4701 Sfmt 4700 the investment fund. The risk-weighted asset amount of the effective portion of the hedge pair is equal to its adjusted carrying value. A banking organization could choose which approach to apply for each equity exposure to an investment fund. 1. Full Look-Through Approach A banking organization may use the full look-through approach only if the banking organization is able to calculate a risk-weighted asset amount for each of the exposures held by the investment fund. Under the final rule, a banking organization using the full look-through approach is required to calculate the risk-weighted asset amount for its proportionate ownership share of each of the exposures held by the investment fund (as calculated under subpart D of the final rule) as if the proportionate ownership share of the adjusted carrying value of each exposures were held directly by the banking organization. The banking organization’s risk-weighted asset amount for the exposure to the fund is equal to (1) the aggregate risk-weighted asset amount of the exposures held by the fund as if they were held directly by the banking organization multiplied by (2) the banking organization’s proportional ownership share of the fund. 2. Simple Modified Look-Through Approach Under the simple modified lookthrough approach, a banking organization sets the risk-weighted asset amount for its equity exposure to an investment fund equal to the adjusted carrying value of the equity exposure multiplied by the highest applicable risk weight under subpart D of the final rule to any exposure the fund is permitted to hold under the prospectus, partnership agreement, or similar agreement that defines the fund’s permissible investments. The banking organization may exclude derivative contracts held by the fund that are used for hedging, rather than for speculative purposes, and do not constitute a material portion of the fund’s exposures. 3. Alternative Modified Look-Through Approach Under the alternative modified lookthrough approach, a banking organization may assign the adjusted carrying value of an equity exposure to an investment fund on a pro rata basis to different risk weight categories under subpart D of the final rule based on the investment limits in the fund’s prospectus, partnership agreement, or E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations similar contract that defines the fund’s permissible investments. The risk-weighted asset amount for the banking organization’s equity exposure to the investment fund is equal to the sum of each portion of the adjusted carrying value assigned to an exposure type multiplied by the applicable risk weight. If the sum of the investment limits for all permissible investments within the fund exceeds 100 percent, the banking organization must assume that the fund invests to the maximum extent permitted under its investment limits in the exposure type with the highest applicable risk weight under subpart D and continues to make investments in the order of the exposure category with the next highest risk weight until the maximum total investment level is reached. If more than one exposure category applies to an exposure, the banking organization must use the highest applicable risk weight. A banking organization may exclude derivative contracts held by the fund that are used for hedging, rather than for speculative purposes, and do not constitute a material portion of the fund’s exposures. Commenters expressed concerns regarding the application of the lookthrough approaches where an investment fund holds securitization exposures. Specifically, the commenters indicated a banking organization would be forced to apply a 1,250 percent risk weight to investment funds that hold securitization exposures if the banking organization does not have the information required to use one of the two applicable methods under subpart D to calculate the risk weight applicable to a securitization exposure: Gross-up treatment or the SSFA. According to the commenters, such an outcome would be overly punitive and inconsistent with the generally diversified composition of investment funds. The agencies acknowledge that a banking organization may have some difficulty obtaining all the information needed to use the gross-up treatment or SSFA, but believe that the proposed approach provides strong incentives for banking organizations to obtain such information. As a result, the agencies are adopting the treatment as proposed. wreier-aviles on DSK5TPTVN1PROD with RULES2 X. Insurance-Related Activities The Board proposed to apply consolidated regulatory capital requirements to SLHCs, consistent with the transfer of supervisory responsibilities to the Board under Title III of the Dodd-Frank Act, as well as the requirements in section 171 of the Dodd-Frank Act. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 Under the proposal, the consolidated regulatory capital requirements for SLHCs would be generally the same as those proposed for BHCs.184 In addition, the proposed regulatory capital requirements would be based on GAAP consolidated financial statements. Through this approach, the Board sought to take into consideration the unique characteristics, risks, and activities of SLHCs, while ensuring compliance with the requirements of the Dodd-Frank Act. Further, as explained in the proposal, a uniform approach for all holding companies was intended to help mitigate potential competitive equity issues, limit opportunities for regulatory arbitrage, and facilitate comparable treatment of similar risks across depository institution holding companies. The proposal included special provisions related to the determination of risk-weighted assets for nonbanking exposures unique to insurance underwriting activities. The NPR extended the approach the agencies and the FDIC implemented in 2011 in the general risk-based capital rules for depository institutions, whereby certain low-risk exposures that are generally not held by depository institutions may receive the capital treatment applicable under the capital guidelines for BHCs under limited circumstances.185 This approach is consistent with section 171 of the Dodd-Frank Act, which requires that BHCs be subject to capital requirements that are no less stringent than those applied to insured depository institutions. The agencies and the FDIC solicited comments on all aspects of the proposed rule, including the treatment of insurance underwriting activities. As described above, the final rule does not apply to SLHCs that are not covered SLHCs because the Board will give further consideration to a framework for consolidated regulatory capital requirements for SLHCs that are not covered SLHCs due to the scope of their insurance underwriting and commercial activities. Some BHCs and covered SLHCs currently conduct insurance underwriting activities, however, and the final rule for depository institution holding companies provides a more risksensitive approach to policy loans, nonguaranteed separate accounts, and insurance underwriting risk than that explicitly provided in the standardized 184 See also the Notice of Intent published by the Board in April, 2011, 76 FR 22662 (April 22, 2011), in which the Board discussed the possibility of applying the same consolidated regulatory capital requirements to savings and holding companies as those proposed for bank holding companies. 185 See 76 FR 37620 (June 28, 2011). PO 00000 Frm 00111 Fmt 4701 Sfmt 4700 62127 approach for depository institutions. The insurance-specific provisions of the proposed and final rules and related comments are discussed below. A. Policy Loans The proposal defined a policy loan as a loan to policyholders under the provisions of an insurance contract that is secured by the cash surrender value or collateral assignment of the related policy or contract. Under the proposal, a policy loan would include: (1) A cash loan, including a loan resulting from early payment or accelerated payment benefits, on an insurance contract when the terms of contract specify that the payment is a policy loan secured by the policy; and (2) an automatic premium loan, which is a loan made in accordance with policy provisions that provide that delinquent premium payments are automatically paid from the cash value at the end of the established grace period for premium payments. The proposal assigned a risk weight of 20 percent to policy loans. Several commenters suggested that a policy loan should be assigned a zero percent risk weight because an insurance company that provides a loan generally retains a right of setoff for the value of the principal and interest payments of the policy loan against the related policy benefits. The Board does not believe that a zero percent risk weight is appropriate for policy loans and continues to believe they should be treated in a similar manner to a loan secured by cash collateral, which is assigned a 20 percent risk weight. The Board believes assigning a preferential but non-zero risk weight to a policy loan is appropriate in light of the fact that should a borrower default, the resulting loss to the insurance company is mitigated by the right to access the cash surrender value or collateral assignment of the related policy. Therefore, the final rule adopts the proposed treatment without change. B. Separate Accounts The proposal provided a specific treatment for non-guaranteed separate accounts. Separate accounts are legally segregated pools of assets owned and held by an insurance company and maintained separately from its general account assets for the benefit of an individual contract holder, subject to certain conditions. Under the proposal, to qualify as a separate account, the following conditions would have to be met: (1) The account must be legally recognized under applicable law; (2) the assets in the account must be insulated from general liabilities of the insurance company under applicable law and E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62128 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations protected from the insurance company’s general creditors in the event of the insurer’s insolvency; (3) the insurance company must invest the funds within the account as directed by the contract holder in designated investment alternatives or in accordance with specific investment objectives or policies; and (4) all investment performance, net of contract fees and assessments, must be passed through to the contract holder, provided that contracts may specify conditions under which there may be a minimum guarantee, but not a ceiling. The proposal distinguished between guaranteed and non-guaranteed separate accounts. Under the proposal, to qualify as a non-guaranteed separate account, the insurance company could not contractually guarantee a minimum return or account value to the contract holder, and the insurance company must not be required to hold reserves for these separate account assets pursuant to its contractual obligations on an associated policy. The proposal provided for a zero percent risk weight for assets held in non-guaranteed separate accounts where all the losses are passed on to the contract holders and the insurance company does not bear the risk of the assets. The proposal provided that assets held in a separate account that does not qualify as a nonguaranteed separate account (that is, a guaranteed separate account) would be assigned risk weights in the same manner as other on-balance sheet assets. The NPR requested comments on this proposal, including the interaction of the proposed definition of a separate account with the state laws and the nature of the implications of any differences. A number of commenters stated that the proposed definition of a nonguaranteed separate account, including the proposed criterion that an insurance company would not be required to hold reserves for separate account assets pursuant to its contractual obligations on an associated policy, is too broad because, as commenters asserted, state laws require insurance companies to hold general account reserves for all contractual commitments. Accordingly, the commenters suggested that the capital requirement for guaranteed separate accounts should be based on the value of the guarantee, and not on the value of the underlying assets, because of what they characterized as an inverse relationship between the value of the underlying assets and the potential risk of a guarantee being realized. The Board continues to believe that it is appropriate to provide a preferential VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 risk-based capital treatment to assets held in non-guaranteed separate accounts and is adopting the treatment of these accounts as proposed. The criteria for non-guaranteed separate accounts ensure that a zero percent risk weight is applied only to those assets for which contract holders, and not the consolidated banking organization, would bear all the losses. Consistent with the proposal and with the general risk-based capital rules, the Board is not at this time providing a preferential treatment to assets held in guaranteed separate accounts. The Board believes that it is consistent with safety and soundness and with the risk profiles of banking organizations subject to the final rule to provide preferential capital treatment to non-guaranteed separate accounts while it considers whether and how to provide a unique treatment to guaranteed separate accounts. The Board notes that SLHCs that are not subject to the final rule because they meet the exclusion criteria in the definition of ‘‘covered SLHC’’ typically have the most material concentrations of guaranteed separate accounts of all depository institution holding companies. C. Additional Deductions—Insurance Underwriting Subsidiaries Consistent with the treatment under the advanced approaches rule, the Basel III NPR provided that bank holding companies and SLHCs would consolidate and deduct the minimum regulatory capital requirement of insurance underwriting subsidiaries (generally 200 percent of the subsidiary’s authorized control level as established by the appropriate state insurance regulator) from total capital to reflect the capital needed to cover insurance risks. The proposed deduction would be 50 percent from tier 1 capital and 50 percent from tier 2 capital. A number of commenters stated that the proposed deduction is not appropriate for holding companies that are predominantly engaged in insurance activities where insurance underwriting companies contribute the predominant amount of regulatory capital and assets. In addition, the commenters asserted that the insurance risk-based capital requirements are designed to measure several specific categories of risk and that the proposed deduction should not include asset-specific risks to avoid double-counting of regulatory capital. Accordingly, commenters suggested that the proposed deduction be eliminated or modified to include only insurance regulatory capital for non-asset risks, such as insurance risk and business risk PO 00000 Frm 00112 Fmt 4701 Sfmt 4700 for life insurers and underwriting risk for casualty and property insurers. Further, the commenters stated that the proposal did not impose a similar deduction for other wholly-owned subsidiaries that are subject to capital requirements by functional regulators, such as insured depository institutions or broker-dealers. In response to these comments, the Board has modified the deduction required for insurance activities to more closely address insurance underwriting risk. Specifically, the final rule requires a banking organization to deduct an amount equal to the regulatory capital requirement for insurance underwriting risks established by the regulator of any insurance underwriting activities of the company 50 percent from tier 1 capital and 50 percent from tier 2 capital. Accordingly, banking organizations that calculate their regulatory capital for insurance underwriting activities using the National Association of Insurance Commissioners’ risk-based capital formulas are required to deduct regulatory capital attributable to the categories of the insurance risk-based capital that do not measure assetspecific risks. For example, for companies using the life risk-based capital formula, banking organizations must deduct the regulatory capital requirement related to insurance risk and business risk. For companies using the property and casualty risk-based formula, banking organizations must deduct the regulatory capital requirement related to underwriting risk—reserves and underwriting risk— net written premiums. For companies using the health risk-based formula, banking organizations must deduct the regulatory capital requirement related to underwriting risk and business risk. In no case may a banking organization reduce the capital requirement for underwriting risk to reflect any diversification with other risks. XI. Market Discipline and Disclosure Requirements A. Proposed Disclosure Requirements The agencies have long supported meaningful public disclosure by banking organizations with the objective of improving market discipline and encouraging sound risk-management practices. The BCBS introduced public disclosure requirements under Pillar 3 of Basel II, which is designed to complement the minimum capital requirements and the supervisory review process by encouraging market discipline through enhanced and E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 meaningful public disclosure.186 The BCBS introduced additional disclosure requirements in Basel III, which, under the final rule, apply to banking organizations as discussed herein.187 The agencies and the FDIC received a limited number of comments on the proposed disclosure requirements. The commenters expressed some concern that the proposed requirements would be extended to apply to smaller banking organizations. As discussed further below, the agencies and the FDIC proposed the disclosure requirements for banking organizations with $50 billion or more in assets and believe they are most appropriate for these companies. The agencies believe that the proposed disclosure requirements strike the appropriate balance between the market benefits of disclosure and the additional burden to a banking organization that provides the disclosures, and therefore have adopted the requirements as proposed, with minor clarification with regard to timing of disclosures as discussed further below. The public disclosure requirements under section 62 of the final rule apply only to banking organizations with total consolidated assets of $50 billion or more that are not a consolidated subsidiary of a BHC, covered SLHC, or depository institution that is subject to these disclosure requirements or a subsidiary of a non-U.S. banking organization that is subject to comparable public disclosure requirements in its home jurisdiction or an advanced approaches banking organization making public disclosures pursuant to section 172 of the final rule. An advanced approaches banking organization that meets the $50 billion asset threshold, but that has not received approval from its primary Federal supervisor to exit parallel run, must make the disclosures described in sections 62 and 63 of the final rule. The agencies note that the asset threshold of $50 billion is consistent with the threshold established by section 165 of the Dodd-Frank Act relating to enhanced supervision and prudential standards for certain banking organizations.188 A banking 186 The agencies and the FDIC incorporated the BCBS disclosure requirements into the advanced approaches rule in 2007. See 72 FR 69288, 69432 (December 7, 2007). 187 In June 2012, the BCBS adopted Pillar 3 disclosure requirements in a paper titled ‘‘Composition of Capital Disclosure Requirements,’’ available at https://www.bis.org/publ/bcbs221.pdf. The agencies anticipate incorporating these disclosure requirements through a separate notice and comment period. 188 See section 165(a) of the Dodd-Frank Act (12 U.S.C. 5365(a)). The Dodd-Frank Act provides that VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 62129 organization may be able to fulfill some of the disclosure requirements by relying on similar disclosures made in accordance with federal securities law requirements. In addition, a banking organization may use information provided in regulatory reports to fulfill certain disclosure requirements. In these situations, a banking organization is required to explain any material differences between the accounting or other disclosures and the disclosures required under the final rule. A banking organization’s exposure to risks and the techniques that it uses to identify, measure, monitor, and control those risks are important factors that market participants consider in their assessment of the banking organization. Accordingly, a banking organization must have a formal disclosure policy approved by its board of directors that addresses the banking organization’s approach for determining the disclosures it should make. The policy should address the associated internal controls, disclosure controls, and procedures. The board of directors and senior management should ensure the appropriate review of the disclosures and that effective internal controls, disclosure controls, and procedures are maintained. One or more senior officers of the banking organization must attest that the disclosures meet the requirements of this final rule. A banking organization must decide the relevant disclosures based on a materiality concept. Information is regarded as material for purposes of the disclosure requirements in the final rule if the information’s omission or misstatement could change or influence the assessment or decision of a user relying on that information for the purpose of making investment decisions. fourth calendar quarter, provided any significant changes are disclosed in the interim. The agencies acknowledge that the timing of disclosures under the federal banking laws may not always coincide with the timing of disclosures required under other federal laws, including disclosures required under the federal securities laws and their implementing regulations by the SEC. For calendar quarters that do not correspond to fiscal year end, the agencies consider those disclosures that are made within 45 days of the end of the calendar quarter (or within 60 days for the limited purpose of the banking organization’s first reporting period in which it is subject to the rule’s disclosure requirements) as timely. In general, where a banking organization’s fiscal year-end coincides with the end of a calendar quarter, the agencies consider qualitative and quantitative disclosures to be timely if they are made no later than the applicable SEC disclosure deadline for the corresponding Form 10–K annual report. In cases where an institution’s fiscal year end does not coincide with the end of a calendar quarter, the primary Federal supervisor would consider the timeliness of disclosures on a case-by-case basis. In some cases, management may determine that a significant change has occurred, such that the most recent reported amounts do not reflect the banking organization’s capital adequacy and risk profile. In those cases, a banking organization needs to disclose the general nature of these changes and briefly describe how they are likely to affect public disclosures going forward. A banking organization should make these interim disclosures as soon as practicable after the determination that a significant change has occurred. B. Frequency of Disclosures Consistent with the agencies’ longstanding requirements for robust quarterly disclosures in regulatory reports, and considering the potential for rapid changes in risk profiles, the final rule requires that a banking organization provide timely public disclosures after each calendar quarter. However, qualitative disclosures that provide a general summary of a banking organization’s risk-management objectives and policies, reporting system, and definitions may be disclosed annually after the end of the C. Location of Disclosures and Audit Requirements the Board may, upon the recommendation of the Financial Stability Oversight Council, increase the $50 billion asset threshold for the application of the resolution plan, concentration limit, and credit exposure report requirements. See 12 U.S.C. 5365(a)(2)(B). PO 00000 Frm 00113 Fmt 4701 Sfmt 4700 The disclosures required under the final rule must be publicly available (for example, included on a public Web site) for each of the last three years or such shorter time period beginning when the banking organization became subject to the disclosure requirements. For example, a banking organization that begins to make public disclosures in the first quarter of 2015 must make all of its required disclosures publicly available until the first quarter of 2018, after which it must make its required disclosures for the previous three years publicly available. Except as discussed below, management has some discretion to determine the appropriate medium and location of the disclosure. Furthermore, a banking organization has E:\FR\FM\11OCR2.SGM 11OCR2 62130 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 flexibility in formatting its public disclosures. The agencies encourage management to provide all of the required disclosures in one place on the entity’s public Web site and the agencies anticipate that the public Web site address would be reported in a banking organization’s regulatory report. However, a banking organization may provide the disclosures in more than one public financial report or other regulatory reports (for example, in Management’s Discussion and Analysis included in SEC filings), provided that the banking organization publicly provides a summary table specifically indicating the location(s) of all such disclosures (for example, regulatory report schedules, page numbers in annual reports). The agencies expect that disclosures of common equity tier 1, tier 1, and total capital ratios would be tested by external auditors as part of the financial statement audit. D. Proprietary and Confidential Information The agencies believe that the disclosure requirements strike an appropriate balance between the need for meaningful disclosure and the protection of proprietary and confidential information.189 Accordingly, the agencies believe that banking organizations would be able to provide all of these disclosures without revealing proprietary and confidential information. Only in rare circumstances might disclosure of certain items of information required by the final rule compel a banking organization to reveal confidential and proprietary information. In these unusual situations, if a banking organization believes that disclosure of specific commercial or financial information would compromise its position by making public information that is either proprietary or confidential in nature, the banking organization will not be required to disclose those specific items under the rule’s periodic disclosure requirement. Instead, the banking organization must disclose more general information about the subject matter of the requirement, together with the fact that, and the reason why, the specific items of information have not been disclosed. This provision applies only to those disclosures included in this 189 Proprietary information encompasses information that, if shared with competitors, would render a banking organization’s investment in these products/systems less valuable, and, hence, could undermine its competitive position. Information about customers is often confidential, in that it is provided under the terms of a legal agreement or counterparty relationship. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 final rule and does not apply to disclosure requirements imposed by accounting standards, other regulatory agencies, or under other requirements of the agencies. E. Specific Public Disclosure Requirements The public disclosure requirements are designed to provide important information to market participants on the scope of application, capital, risk exposures, risk assessment processes, and, thus, the capital adequacy of the institution. The agencies note that the substantive content of the tables is the focus of the disclosure requirements, not the tables themselves. The table numbers below refer to the table numbers in section 63 of the final rule. A banking organization must make the disclosures described in Tables 1 through 10.190 Table 1 disclosures, ‘‘Scope of Application,’’ name the top corporate entity in the group to which subpart D of the final rule applies and include a brief description of the differences in the basis for consolidating entities for accounting and regulatory purposes, as well as a description of any restrictions, or other major impediments, on transfer of funds or total capital within the group. These disclosures provide the basic context underlying regulatory capital calculations. Table 2 disclosures, ‘‘Capital Structure,’’ provide summary information on the terms and conditions of the main features of regulatory capital instruments, which allow for an evaluation of the quality of the capital available to absorb losses within a banking organization. A banking organization also must disclose the total amount of common equity tier 1, tier 1 and total capital, with separate disclosures for deductions and adjustments to capital. The agencies expect that many of these disclosure requirements would be captured in revised regulatory reports. Table 3 disclosures, ‘‘Capital Adequacy,’’ provide information on a banking organization’s approach for categorizing and risk weighting its exposures, as well as the amount of total risk-weighted assets. The Table also includes common equity tier 1, and tier 1 and total risk-based capital ratios for the top consolidated group, and for each depository institution subsidiary. Table 4 disclosures, ‘‘Capital Conservation Buffer,’’ require a banking 190 Other public disclosure requirements would continue to apply, such as federal securities law, and regulatory reporting requirements for banking organizations. PO 00000 Frm 00114 Fmt 4701 Sfmt 4700 organization to disclose the capital conservation buffer, the eligible retained income and any limitations on capital distributions and certain discretionary bonus payments, as applicable. Disclosures in Tables 5, ‘‘Credit Risk: General Disclosures,’’ 6, ‘‘General Disclosure for Counterparty Credit RiskRelated Exposures,’’ and 7, ‘‘Credit Risk Mitigation,’’ relate to credit risk, counterparty credit risk and credit risk mitigation, respectively, and provide market participants with insight into different types and concentrations of credit risk to which a banking organization is exposed and the techniques it uses to measure, monitor, and mitigate those risks. These disclosures are intended to enable market participants to assess the credit risk exposures of the banking organization without revealing proprietary information. Table 8 disclosures, ‘‘Securitization,’’ provide information to market participants on the amount of credit risk transferred and retained by a banking organization through securitization transactions, the types of products securitized by the organization, the risks inherent in the organization’s securitized assets, the organization’s policies regarding credit risk mitigation, and the names of any entities that provide external credit assessments of a securitization. These disclosures provide a better understanding of how securitization transactions impact the credit risk of a banking organization. For purposes of these disclosures, ‘‘exposures securitized’’ include underlying exposures transferred into a securitization by a banking organization, whether originated by the banking organization or purchased from third parties, and third-party exposures included in sponsored programs. Securitization transactions in which the originating banking organization does not retain any securitization exposure are shown separately and are only reported for the year of inception of the transaction. Table 9 disclosures, ‘‘Equities Not Subject to Subpart F of this Part,’’ provide market participants with an understanding of the types of equity securities held by the banking organization and how they are valued. These disclosures also provide information on the capital allocated to different equity products and the amount of unrealized gains and losses. Table 10 disclosures, ‘‘Interest Rate Risk for Non-trading Activities,’’ require a banking organization to provide certain quantitative and qualitative disclosures regarding the banking E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 organization’s management of interest rate risks. XII. Risk-weighted Assets— Modifications to the Advanced Approaches In the Advanced Approaches NPR, the agencies and the FDIC proposed revisions to the advanced approaches rule to incorporate certain aspects of Basel III, as well as the requirements introduced by the BCBS in the 2009 Enhancements 191 and subsequent consultative papers. In accordance with Basel III, the proposal sought to require advanced approaches banking organizations to hold more appropriate levels of capital for counterparty credit risk, CVA, and wrong-way risk. Consistent with the 2009 Enhancements, the agencies and the FDIC proposed to strengthen the riskbased capital requirements for certain securitization exposures by requiring banking organizations that are subject to the advanced approaches rule to conduct more rigorous credit analysis of securitization exposures and to enhance the disclosure requirements related to those exposures. The agencies and the FDIC also proposed revisions to the advanced approaches rule that are consistent with the requirements of section 939A of the Dodd-Frank Act.192 The agencies and the FDIC proposed to remove references to ratings from certain defined terms under the advanced approaches rule, as well as the ratings-based approach for securitization exposures, and replace these provisions with alternative standards of creditworthiness. The proposed rule also contained a number of proposed technical amendments to clarify or adjust existing requirements under the advanced approaches rule. The Board also proposed to apply the advanced approaches rule and the market risk rule to SLHCs, and the FDIC and OCC proposed to apply the market risk rule to state and Federal savings associations, respectively. This section of the preamble describes the proposals in the Advanced Approaches NPR, comments received on those proposals, and the revisions to the advanced approaches rule reflected in the final rule. In many cases, the comments received on the Standardized Approach NPR were also relevant to the proposed changes to the advanced approaches framework. The agencies generally took a consistent approach towards 191 See ‘‘Enhancements to the Basel II framework’’ (July 2009), available at https://www.bis.org/publ/ bcbs157.htm. 192 See section 939A of Dodd-Frank Act (15 U.S.C. 78o–7 note). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 addressing the comments with respect to the standardized approach and the advanced approaches rule. Banking organizations that are or would be subject to the advanced approaches rule should refer to the relevant sections of the discussion of the standardized approach for further discussion of these comments. One commenter raised concerns about the use of models in determining regulatory capital requirements and encouraged the agencies and the FDIC to conduct periodic validation of banking organizations’ models for capital adequacy and require modification if necessary. Consistent with the current advanced approaches rule, the final rule requires a banking organization to validate its models used to determine regulatory capital requirements on an ongoing basis. This validation must include an evaluation of conceptual soundness; an ongoing monitoring process that includes verification of processes and benchmarking; and an outcomes analysis process that includes backtesting. Under section 123 of the final rule, a banking organization’s primary Federal supervisor may require the banking organization to calculate its advanced approaches risk-weighted assets according to modifications provided by the supervisor if the supervisor determines that the banking organization’s advanced approaches total risk-weighted assets are not commensurate with its credit, market, operational or other risks. Other commenters suggested that the agencies and the FDIC interpret section 171 of the Dodd-Frank Act narrowly with regard to the advanced approaches framework. The agencies have adopted the approach taken in the proposed rule because they believe that the approach provides clear, consistent minimum requirements across institutions that comply with the requirements of section 171. A. Counterparty Credit Risk The recent financial crisis highlighted certain aspects of the treatment of counterparty credit risk under the Basel II framework that were inadequate, and of banking organizations’ risk management of counterparty credit risk that were insufficient. The Basel III revisions were intended to address both areas of weakness by ensuring that all material on- and off-balance sheet counterparty risks, including those associated with derivative-related exposures, are appropriately incorporated into banking organizations’ risk-based capital ratios. In addition, new risk-management requirements in Basel III strengthen the oversight of PO 00000 Frm 00115 Fmt 4701 Sfmt 4700 62131 counterparty credit risk exposures. The proposed rule included counterparty credit risk revisions in a manner generally consistent with the Basel III revisions to international standards, modified to incorporate alternative standards to the use of credit ratings. The discussion below highlights the proposed revisions, industry comments, and outcome of the final rule. 1. Recognition of Financial Collateral a. Financial Collateral The EAD adjustment approach under section 132 of the proposed rules permitted a banking organization to recognize the credit risk mitigation benefits of financial collateral by adjusting the EAD rather than the loss given default (LGD) of the exposure for repo-style transactions, eligible margin loans and OTC derivative contracts. The permitted methodologies for recognizing such benefits included the collateral haircut approach, simple VaR approach and the IMM. Consistent with Basel III, the Advanced Approaches NPR proposed certain modifications to the definition of financial collateral. For example, the definition of financial collateral was modified so that resecuritizations would no longer qualify as financial collateral.193 Thus, resecuritization collateral could not be used to adjust the EAD of an exposure. The agencies believe that this treatment is appropriate because resecuritizations have been shown to have more market value volatility than other types of financial collateral. The proposed rule also removed conforming residential mortgages from the definition of financial collateral. As a result, a banking organization would no longer be able to recognize the credit risk mitigation benefit of such instruments through an adjustment to EAD. Consistent with the Basel III framework, the agencies and the FDIC proposed to exclude all debt securities that are not investment grade from the definition of financial collateral. As discussed in section VII.F of this preamble, the proposed rule revised the definition of ‘‘investment grade’’ for the advanced approaches rule and proposed conforming changes to the market risk rule. As discussed in section VIII.F of the preamble, the agencies believe that the 193 Under the proposed rule, a securitization in which one or more of the underlying exposures is a securitization position would be a resecuritization. A resecuritization position under the proposal meant an on- or off-balance sheet exposure to a resecuritization, or an exposure that directly or indirectly references a securitization exposure. E:\FR\FM\11OCR2.SGM 11OCR2 62132 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations additional collateral types suggested by commenters are not appropriate forms of financial collateral because they exhibit increased variation and credit risk, and are relatively more speculative than the recognized forms of financial collateral under the proposal. In some cases, the assets suggested by commenters for eligibility as financial collateral were precisely the types of assets that became illiquid during the recent financial crisis. As a result, the agencies have retained the definition of financial collateral as proposed. b. Revised Supervisory Haircuts Securitization exposures have increased levels of volatility relative to other types of financial collateral. To address this issue, consistent with Basel III, the proposal incorporated new standardized supervisory haircuts for securitization exposures in the EAD adjustment approach based on the credit quality of the exposure. Consistent with section 939A of the Dodd-Frank Act, the proposed rule set out an alternative approach to assigning standard one year, 8.0 percent for maturities greater than one year but less than or equal to five years, and 16.0 percent for maturities greater than five years, consistent with Table 25 below. The agencies believe that the revised haircuts better reflect the collateral’s credit quality and an appropriate differentiation based on the collateral’s residual maturity. Consistent with the proposal, under the final rule, supervisory haircuts for exposures to sovereigns, GSEs, public sector entities, depository institutions, foreign banks, credit unions, and corporate issuers are calculated based upon the risk weights for such exposures described under section 32 of the final rule. The final rule also clarifies that if a banking organization lends instruments that do not meet the definition of financial collateral, such as non-investment-grade corporate debt securities or resecuritization exposures, the haircut applied to the exposure must be 25 percent. supervisory haircuts for securitization exposures, and amended the standard supervisory haircuts for other types of financial collateral to remove the references to credit ratings. Some commenters proposed limiting the maximum haircut for non-sovereign issuers that receive a 100 percent risk weight to 12 percent, and more specifically assigning a lower haircut than 25 percent for financial collateral in the form of an investment-grade corporate debt security that has a shorter residual maturity. The commenters asserted that these haircuts conservatively correspond to the existing rating categories and result in greater alignment with the Basel framework. As discussed in section VIII.F of the preamble, in the final rule, the agencies have revised the standard supervisory market price volatility haircuts for financial collateral issued by non-sovereign issuers with a risk weight of 100 percent from 25.0 percent to 4.0 percent for maturities of less than TABLE 25—STANDARD SUPERVISORY MARKET PRICE VOLATILITY HAIRCUTS 1 Haircut (in percent) assigned based on: Sovereign issuers risk weight under section 32 2 (in percent) Residual maturity Zero Less than or equal to 1 year ....................... Greater than 1 year and less than or equal to 5 years ................................................. Greater than 5 years .................................... 20 or 50 Investment-grade securitization exposures (in percent) Non-sovereign issuers risk weight under section 32 (in percent) 100 20 50 100 0.5 1.0 15.0 1.0 2.0 4.0 4.0 2.0 4.0 3.0 6.0 15.0 15.0 4.0 8.0 6.0 12.0 8.0 16.0 12.0 24.0 Main index equities (including convertible bonds) and gold ......................................... 15.0 Other publicly traded equities (including convertible bonds) ......................................... 25.0 Mutual funds .................................................................................................................. Highest haircut applicable to any security in which the fund can invest. Cash collateral held ....................................................................................................... Zero Other exposure types .................................................................................................... 25.0 1 The market price volatility haircuts in Table 25 are based on a 10 business-day holding period. 2 Includes a foreign PSE that receives a zero percent risk weight. wreier-aviles on DSK5TPTVN1PROD with RULES2 2. Holding Periods and the Margin Period of Risk As noted in the proposal, during the recent financial crisis, many financial institutions experienced significant delays in settling or closing out collateralized transactions, such as repostyle transactions and collateralized OTC derivative contracts. The assumed holding period for collateral in the collateral haircut and simple VaR approaches and the margin period of risk in the IMM proved to be inadequate for certain transactions and netting VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 sets.194 It also did not reflect the difficulties and delays experienced by institutions when settling or liquidating 194 Under the advanced approaches rule, the margin period of risk means, with respect to a netting set subject to a collateral agreement, the time period from the most recent exchange of collateral with a counterparty until the next required exchange of collateral plus the period of time required to sell and realize the proceeds of the least liquid collateral that can be delivered under the terms of the collateral agreement and, where applicable, the period of time required to re-hedge the resulting market risk, upon the default of the counterparty. PO 00000 Frm 00116 Fmt 4701 Sfmt 4700 collateral during a period of financial stress. Consistent with Basel III, the proposed rule would have amended the advanced approaches rule to incorporate adjustments to the holding period in the collateral haircut and simple VaR approaches, and to the margin period of risk in the IMM that a banking organization may use to determine its capital requirement for repo-style transactions, OTC derivative transactions, and eligible margin loans, with respect to large netting sets, netting sets involving illiquid collateral or E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 including OTC derivatives that could not easily be replaced, or two margin disputes within a netting set over the previous two quarters that last for a certain length of time. For cleared transactions, which are discussed below, the agencies and the FDIC proposed not to require a banking organization to adjust the holding period or margin period of risk upward when determining the capital requirement for its counterparty credit risk exposures to the CCP, which is also consistent with Basel III. One commenter asserted that the proposed triggers for the increased margin period of risk were not in the spirit of the advanced approaches rule, which is intended to be more risk sensitive than the general risk-based capital rules. Another commenter asserted that banking organizations should be permitted to increase the holding period or margin period of risk by one or more business days, but not be required to increase it to the full period required under the proposal (20 business days or at least double the margin period of risk). The agencies believe the triggers set forth in the proposed rule, as well as the increased holding period or margin period of risk are empirical indicators of increased risk of delay or failure of close-out on the default of a counterparty. The goal of risk sensitivity would suggest that modifying these indicators is not warranted and could lead to increased risks to the banking system. Accordingly, the final rule adopts these features as proposed. 3. Internal Models Methodology Consistent with Basel III, the proposed rule would have amended the advanced approaches rule so that the capital requirement for IMM exposures is equal to the larger of the capital requirement for those exposures calculated using data from the most recent three-year period and data from a three-year period that contains a period of stress reflected in the credit default spreads of the banking organization’s counterparties. The proposed rule defined an IMM exposure as a repo-style transaction, eligible margin loan, or OTC derivative contract for which a banking organization calculates EAD using the IMM. The proposed rule would have required a banking organization to demonstrate to the satisfaction of the banking organization’s primary Federal supervisor at least quarterly that the stress period it uses for the IMM coincides with increased CDS or other credit spreads of its counterparties and to have procedures in place to evaluate VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 the effectiveness of its stress calibration. These procedures would have been required to include a process for using benchmark portfolios that are vulnerable to the same risk factors as the banking organization’s portfolio. In addition, under the proposal, the primary Federal supervisor could require a banking organization to modify its stress calibration if the primary Federal supervisor believes that another calibration better reflects the actual historic losses of the portfolio. Consistent with Basel III and the current advanced approaches rule, the proposed rule would have required a banking organization to establish a process for initial validation and annual review of its internal models. As part of the process, the proposed rule would have required a banking organization to have a backtesting program for its model that includes a process by which unacceptable model performance is identified and remedied. In addition, a banking organization would have been required to multiply the expected positive exposure (EPE) of a netting set by the default scaling factor alpha (set equal to 1.4) in calculating EAD. The primary Federal supervisor could require the banking organization to set a higher default scaling factor based on the past performance of the banking organization’s internal model. The proposed rule would have required a banking organization to have policies for the measurement, management, and control of collateral, including the reuse of collateral and margin amounts, as a condition of using the IMM. Under the proposal, a banking organization would have been required to have a comprehensive stress testing program for the IMM that captures all credit exposures to counterparties and incorporates stress testing of principal market risk factors and the creditworthiness of its counterparties. Basel III provided that a banking organization could capture within its internal model the effect on EAD of a collateral agreement that requires receipt of collateral when the exposure to the counterparty increases. Basel II also contained a ‘‘shortcut’’ method to provide a banking organization whose internal model did not capture the effects of collateral agreements with a method to recognize some benefit from the collateral agreement. Basel III modifies the ‘‘shortcut’’ method for capturing the effects of collateral agreements by setting effective EPE to a counterparty as the lesser of the following two exposure calculations: (1) The exposure without any held or posted margining collateral, plus any collateral posted to the counterparty PO 00000 Frm 00117 Fmt 4701 Sfmt 4700 62133 independent of the daily valuation and margining process or current exposure, or (2) an add-on that reflects the potential increase of exposure over the margin period of risk plus the larger of (i) the current exposure of the netting set reflecting all collateral received or posted by the banking organization excluding any collateral called or in dispute; or (ii) the largest net exposure (including all collateral held or posted under the margin agreement) that would not trigger a collateral call. The add-on would be computed as the largest expected increase in the netting set’s exposure over any margin period of risk in the next year. The proposed rule included the Basel III modification of the ‘‘shortcut’’ method. The final rule adopts all the proposed requirements discussed above with two modifications. With respect to the proposed requirement that a banking organization must demonstrate on a quarterly basis to its primary Federal supervisor the appropriateness of its stress period, under the final rule, the banking organization must instead demonstrate at least quarterly that the stress period coincides with increased CDS or other credit spreads of the banking organization’s counterparties, and must maintain documentation of such demonstration. In addition, the formula for the ‘‘shortcut’’ method has been modified to clarify that the add-on is computed as the expected increase in the netting set’s exposure over the margin period of risk. a. Recognition of Wrong-Way Risk The recent financial crisis highlighted the interconnectedness of large financial institutions through an array of complex transactions. In recognition of this interconnectedness and to mitigate the risk of contagion from the banking sector to the broader financial system and the general economy, Basel III includes enhanced requirements for the recognition and treatment of wrong-way risk in the IMM. The proposed rule defined wrong-way risk as the risk that arises when an exposure to a particular counterparty is positively correlated with the probability of default of that counterparty. The proposed rule provided enhancements to the advanced approaches rule that require banking organizations’ risk-management procedures to identify, monitor, and control wrong-way risk throughout the life of an exposure. The proposed rule required these risk-management procedures to include the use of stress testing and scenario analysis. In addition, where a banking organization has identified an IMM exposure with E:\FR\FM\11OCR2.SGM 11OCR2 62134 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 specific wrong-way risk, the banking organization would be required to treat that transaction as its own netting set. The proposed rule defined specific wrong-way risk as a type of wrong-way risk that arises when either the counterparty and issuer of the collateral supporting the transaction, or the counterparty and the reference asset of the transaction, are affiliates or are the same entity. In addition, under the proposal, where a banking organization has identified an OTC derivative transaction, repo-style transaction, or eligible margin loan with specific wrong-way risk for which the banking organization otherwise applies the IMM, the banking organization would set the probability of default (PD) of the counterparty and a LGD equal to 100 percent. The banking organization would then enter these parameters into the appropriate risk-based capital formula specified in Table 1 of section 131 of the proposed rule, and multiply the output of the formula (K) by an alternative EAD based on the transaction type, as follows: (1) For a purchased credit derivative, EAD would be the fair value of the underlying reference asset of the credit derivative contract; (2) For an OTC equity derivative,195 EAD would be the maximum amount that the banking organization could lose if the fair value of the underlying reference asset decreased to zero; (3) For an OTC bond derivative (that is, a bond option, bond future, or any other instrument linked to a bond that gives rise to similar counterparty credit risks), EAD would be the smaller of the notional amount of the underlying reference asset and the maximum amount that the banking organization could lose if the fair value of the underlying reference asset decreased to zero; and (4) For repo-style transactions and eligible margin loans, EAD would be calculated using the formula in the collateral haircut approach of section 132 of the final rule and with the estimated value of the collateral substituted for the parameter C in the equation. The final rule adopts the proposed requirements regarding wrong-way risk discussed above. b. Increased Asset Value Correlation Factor To recognize the correlation of financial institutions’ creditworthiness 195 Under the final rule, equity derivatives that are call options are not be subject to a counterparty credit risk capital requirement for specific wrongway risk. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 attributable to similar sensitivities to common risk factors, the agencies and the FDIC proposed to incorporate the Basel III increase in the correlation factor used in the formulas provided in Table 1 of section 131 of the proposed rule for certain wholesale exposures. Under the proposed rule, banking organizations would apply a multiplier of 1.25 to the correlation factor for wholesale exposures to unregulated financial institutions that generate a majority of their revenue from financial activities, regardless of asset size. This category would include highly leveraged entities, such as hedge funds and financial guarantors. The proposal also included a definition of ‘‘regulated financial institution,’’ meaning a financial institution subject to consolidated supervision and regulation comparable to that imposed on certain U.S. financial institutions, namely depository institutions, depository institution holding companies, nonbank financial companies supervised by the Board, designated FMUs, securities broker-dealers, credit unions, or insurance companies. Banking organizations would apply a multiplier of 1.25 to the correlation factor for wholesale exposures to regulated financial institutions with consolidated assets of greater than or equal to $100 billion. Several commenters pointed out that in the proposed formulas for wholesale exposures to unregulated and regulated financial institutions, the 0.18 multiplier should be revised to 0.12 in order to be consistent with Basel III. The agencies have corrected this aspect of both formulas in the final rule. Another comment asserted that the 1.25 multiplier for the correlation factor for wholesale exposures to unregulated financial institutions or regulated financial institutions with more than $100 billion in assets is an overly blunt tool and is not necessary as single counterparty credit limits already address interconnectivity risk. Consistent with the concerns about systemic risk and interconnectedness surrounding these classes of institutions, the agencies continue to believe that the 1.25 multiplier appropriately reflects the associated additional risk. Therefore, the final rule retains the 1.25 multiplier. In addition, the final rule also adopts the definition of ‘‘regulated financial institution’’ without change from the proposal. As discussed in section V.B, above, the agencies and the FDIC received significant comment on the definition of ‘‘financial institution’’ in the context of deductions of investments in the capital of unconsolidated financial institutions. PO 00000 Frm 00118 Fmt 4701 Sfmt 4700 That definition also, under the proposal, defined the universe of ‘‘unregulated’’ financial institutions as companies meeting the definition of ‘‘financial institution’’ that were not regulated financial institutions. For the reasons discussed in section V.B of the preamble, the agencies have modified the definition of ‘‘financial institution,’’ including by introducing an ownership interest threshold to the ‘‘predominantly engaged’’ test to determine if a banking organization must subject a particular unconsolidated investment in a company that may be a financial institution to the relevant deduction thresholds under subpart C of the final rule. While commenters stated that it would be burdensome to determine whether an entity falls within the definition of financial institution using the predominantly engaged test, the agencies believe that advanced approaches banking organizations should have the systems and resources to identify the activities of their wholesale counterparties. Accordingly, under the final rule, the agencies have adopted a definition of ‘‘unregulated financial institution’’ that does not include the ownership interest threshold test but otherwise incorporates revisions to the definition of ‘‘financial institution.’’ Under the final rule, an ‘‘unregulated financial institution’’ is a financial institution that is not a regulated financial institution and that meets the definition of ‘‘financial institution’’ under the final rule without regard to the ownership interest thresholds set forth in paragraph (4)(i) of that definition. The agencies believe the ‘‘unregulated financial institution’’ definition is necessary to maintain an appropriate scope for the 1.25 multiplier consistent with the proposal and Basel III. 4. Credit Valuation Adjustments After the recent financial crisis, the BCBS reviewed the treatment of counterparty credit risk and found that roughly two-thirds of counterparty credit risk losses during the crisis were due to fair value losses from CVA (that is, the fair value adjustment to reflect counterparty credit risk in the valuation of an OTC derivative contract), whereas one-third of counterparty credit risk losses resulted from actual defaults. The internal ratings-based approach in Basel II addressed counterparty credit risk as a combination of default risk and credit migration risk. Credit migration risk accounts for fair value losses resulting from deterioration of counterparties’ credit quality short of default and is addressed in Basel II via the maturity adjustment multiplier. However, the E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations maturity adjustment multiplier in Basel II was calibrated for loan portfolios and may not be suitable for addressing CVA risk. Basel III therefore includes an explicit capital requirement for CVA risk. Accordingly, consistent with Basel III and the proposal, the final rule requires banking organizations to calculate risk-weighted assets for CVA risk. Consistent with the Basel III CVA capital requirement and the proposal, the final rule reflects in risk-weighted assets a potential increase of the firmwide CVA due to changes in counterparties’ credit spreads, assuming fixed expected exposure (EE) profiles. The proposed and final rules provide two approaches for calculating the CVA capital requirement: The simple approach and the advanced CVA approach. However, unlike Basel III, they do not include references to credit ratings. Consistent with the proposal and Basel III, the simple CVA approach in the final rule permits calculation of the CVA capital requirement (KCVA) based on a formula described in more detail below, with a modification consistent with section 939A of the Dodd-Frank Act. Under the advanced CVA approach in the final rule, consistent with the proposal, a banking organization would use the VaR model that it uses to calculate specific risk under section 207(b) of subpart F or another model that meets the quantitative requirements of sections 205(b) and 207(b)(1) of subpart F to calculate its CVA capital requirement for its entire portfolio of OTC derivatives that are subject to the CVA capital requirement 196 by modeling the impact of changes in the counterparties’ credit spreads, together with any recognized CVA hedges on the CVA for the counterparties. To convert the CVA capital requirement to a riskweighted asset amount, a banking organization must multiply its CVA capital requirement by 12.5. The CVA risk-weighted asset amount is not a component of credit risk-weighted assets and therefore is not subject to the 1.06 multiplier for credit risk-weighted assets under the final rule. Consistent with the proposal, the final rule provides that only a banking organization that is subject to the market risk rule and had obtained prior approval from its primary Federal 196 Certain CDS may be exempt from inclusion in the portfolio of OTC derivatives that are subject to the CVA capital requirement. For example, a CDS on a loan that is recognized as a credit risk mitigant and receives substitution treatment under section 134 would not be included in the portfolio of OTC derivatives that are subject to the CVA capital requirement. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 supervisor to calculate (1) the EAD for OTC derivative contracts using the IMM described in section 132, and (2) the specific risk add-on for debt positions using a specific risk model described in section 207(b) of subpart F is eligible to use the advanced CVA approach. A banking organization that receives such approval would be able to continue to use the advanced CVA approach until it notifies its primary Federal supervisor in writing that it expects to begin calculating its CVA capital requirement using the simple CVA approach. Such notice must include an explanation from the banking organization as to why it is choosing to use the simple CVA approach and the date when the banking organization would begin to calculate its CVA capital requirement using the simple CVA approach. Consistent with the proposal, under the final rule, when calculating a CVA capital requirement, a banking organization may recognize the hedging benefits of single name CDS, single name contingent CDS, any other equivalent hedging instrument that references the counterparty directly, and index CDS (CDSind), provided that the equivalent hedging instrument is managed as a CVA hedge in accordance with the banking organization’s hedging policies. A tranched or nth-to-default CDS would not qualify as a CVA hedge. In addition, any position that is recognized as a CVA hedge would not be a covered position under the market risk rule, except in the case where the banking organization is using the advanced CVA approach, the hedge is a CDSind, and the VaR model does not capture the basis between the spreads of the index that is used as the hedging instrument and the hedged counterparty exposure over various time periods, as discussed in further detail below. The agencies and the FDIC received several comments on the proposed CVA capital requirement. One commenter asserted that there was ambiguity in the ‘‘total CVA risk-weighted assets’’ definition which could be read as indicating that KCVA is calculated for each counterparty and then summed. The agencies agree that KCVA relates to a banking organization’s entire portfolio of OTC derivatives contracts, and the final rule reflects this clarification. A commenter asserted that the proposed CVA treatment should not apply to central banks, MDBs and other similar counterparties that have very low credit risk, such as the Bank for International Settlements and the European Central Bank, as well as U.S. PSEs. Another commenter pointed out that the proposal in the European Union to implement Basel III excludes PO 00000 Frm 00119 Fmt 4701 Sfmt 4700 62135 sovereign, pension fund, and corporate counterparties from the proposed CVA treatment. Another commenter argued that the proposed CVA treatment should not apply to transactions executed with end-users when hedging business risk because the resulting increase in pricing will disproportionately impact smalland medium-sized businesses. The final rule does not exempt the entities suggested by commenters. However, the agencies anticipate that a counterparty that is exempt from the 0.03 percent PD floor under § l.131(d)(2) and receives a zero percent risk weight under § l.32 (that is, central banks, MDBs, the Bank for International Settlements and European Central Bank) likely would attract a minimal CVA requirement because the credit spreads associated with these counterparties have very little variability. Regarding the other entities mentioned by commenters (U.S. public sector entities, pension funds and corporate end-users), the agencies believe it is appropriate for CVA to apply as these counterparty types exhibit varying degrees of credit risk. Some commenters asked that the agencies and the FDIC clarify that interest rate hedges of CVA are not covered positions as defined in subpart F and, therefore, not subject to a market risk capital requirement. In addition, some commenters asserted that the overall capital requirements for CVA are more appropriately addressed as a trading book issue in the context of the BCBS Fundamental Review of the Trading Book.197 Another commenter asserted that CVA rates hedges (to the extent they might be covered positions) should be excluded from the market-risk rule capital requirements until supervisors are ready to approve allowing CVA rates sensitivities to be incorporated into a banking organization’s general market risk VaR. The agencies recognize that CVA is not a covered position under the market risk rule. Hence, as elaborated in the market risk rule, hedges of non-covered positions that are not themselves trading positions also are not eligible to be a covered position under the market risk rule. Therefore, the agencies clarify that non-credit risk hedges (market risk hedges or exposure hedges) of CVA generally are not covered positions under the market risk rule, but rather are assigned risk-weighted asset amounts under subparts D and E of the 197 See ‘‘Fundamental review of the trading book’’ (May 2012) available at https://www.bis.org/publ/ bcbs219.pdf. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62136 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations final rule.198 Once the BCBS Fundamental Review of the Trading Book is complete, the agencies will review the BCBS findings and consider whether they are appropriate for U.S. banking organizations. One commenter asserted that observable LGDs for credit derivatives do not represent the best estimation of LGD for calculating CVA under the advanced CVA approach, and that the final rule should instead consider a number of parameters, including market observable recovery rates on unsecured bonds and structural components of the derivative. Another commenter argued that banking organizations should be permitted greater flexibility in determining market-implied loss given default (LGDMKT) and credit spread factors for VaR. Consistent with the BCBS’s frequently asked question (BCBS FAQ) on this topic,199 the agencies recognize that while there is often limited market information of LGDMKT (or equivalently the market implied recovery rate), the agencies consider the use of LGDMKT to be the most appropriate approach to quantify CVA. It is also the market convention to use a fixed recovery rate for CDS pricing purposes; banking organizations may use that information for purposes of the CVA capital requirement in the absence of other information. In cases where a netting set of OTC derivative contracts has a different seniority than those derivative contracts that trade in the market from which LGDMKT is inferred, a banking organization may adjust LGDMKT to reflect this difference in seniority. Where no market information is available to determine LGDMKT, a banking organization may propose a method for determining LGDMKT based upon data collected by the banking organization that would be subject to approval by its primary Federal supervisor. The final rule has been amended to include this alternative. Regarding the proposed CVA EAD calculation assumptions in the advanced CVA approach, one commenter asserted that EE constant treatment is inappropriate, and that it is more appropriate to use the weighted average maturity of the portfolio rather than the netting set. Another commenter asserted that maturity should equal the weighted average maturity of all transactions in the netting set, rather than the greater of the notional weighted average maturity and the maximum of half of the longest maturity occurring in the netting set. The agencies note that this issue is relevant only where a banking organization utilized the current exposure method or the ‘‘shortcut’’ method, rather than IMM, for any immaterial portfolios of OTC derivatives contracts. As a result, the final rule retains the requirement to use the greater of the notional weighted average maturity (WAM) and the maximum of half of the longest maturity in the netting set when calculating EE constant treatment in the advanced CVA approach. One commenter asked the agencies and the FDIC to clarify that section 132(c)(3) would exempt the purchased CDS from the proposed CVA capital requirements in section 132(e) of the final rule. Consistent with the BCBS FAQ on this topic, the agencies agree that purchased credit derivative protection against a wholesale exposure that is subject to the double default framework or the PD substitution approach and where the wholesale exposure itself is not subject to the CVA capital requirement, will not be subject to the CVA capital requirement in the final rule. Also consistent with the BCBS FAQ, the purchased credit derivative protection may not be recognized as a hedge for any other exposure under the final rule. Another commenter asserted that single-name proxy CDS trades should be allowed as hedges in the advanced CVA approach CVA VaR calculation. Under the final rule, a banking organization is permitted to recognize the hedging benefits of single name CDS, single name contingent CDS, any other equivalent hedging instrument that references the counterparty directly, and CDSind, provided that the hedging instrument is managed as a CVA hedge in accordance with the banking organization’s hedging policies. The final rule does not permit the use of single-name proxy CDS. The agencies believe this is an important limitation because of the significant basis risk that could arise from the use of a singlename proxy. Additionally, the final rule reflects several clarifying amendments to the proposed rule. First, the final rule divides the Advanced CVA formulas in the proposed rule into two parts: Formula 3 and Formula 3a. The agencies believe that this clarification is important to reflect the different purposes of the two formulas: The first formula (Formula 3) is for the CVA VaR calculation, whereas the second formula (Formula 3a) is for calculating CVA for each credit spread simulation scenario. The final rule includes a description that clarifies each formula’s purpose. In addition, the notations in proposed Formula 3 have been changed from CVAstressedVaR and CVAunstressedVaR to VaRCVAstressed and VaRCVAunstressed. The definitions of these terms have not changed in the final rule. Finally, the subscript ‘‘j’’ in Formula 3a has been defined as referring either to stressed or unstressed calibrations. These formulas are discussed in the final rule description below. 198 The agencies believe that a banking organization needs to demonstrate rigorous risk management and the efficacy of its CVA hedges and should follow the risk management principles of the Interagency Supervisory Guidance on Counterparty Credit Risk Management (2011) and identification of covered positions as in the agencies’ market risk rule, see 77 FR 53060 (August 30, 2012). 199 See ‘‘Basel III counterparty credit risk and exposures to central counterparties—Frequently asked questions (December 2012 (update of FAQs published November 2012)) at https://www.bis.org/ publ/bcbs237.pdf. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00120 Fmt 4701 Sfmt 4700 a. Simple Credit Valuation Adjustment Approach Under the final rule, a banking organization without approval to use the advanced CVA approach must use formula 1 to calculate its CVA capital requirement for its entire portfolio of OTC derivative contracts. The simple CVA approach is based on an analytical approximation derived from a general CVA VaR formulation under a set of simplifying assumptions: (1) All credit spreads have a flat term structure; (2) All credit spreads at the time horizon have a lognormal distribution; (3) Each single name credit spread is driven by the combination of a single systematic factor and an idiosyncratic factor; (4) The correlation between any single name credit spread and the systematic factor is equal to 0.5; (5) All credit indices are driven by the single systematic factor; and (6) The time horizon is short (the square root of time scaling to 1 year is applied). The approximation is based on the linearization of the dependence of both CVA and CDS hedges on credit spreads. Given the assumptions listed above, a measure of CVA VaR has a closed-form analytical solution. The formula of the simple CVA approach is obtained by applying certain standardizations, conservative adjustments, and scaling to the analytical CVA VaR result. A banking organization calculates KCVA, where: E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations Internal PD (in percent) Weight wi (in percent) 0.00–0.07 .......................... >0.07–0.15 ........................ >0.15–0.40 ........................ >0.4–2.00 .......................... >2.0–6.00 .......................... >6.0 ................................... 0.70 0.80 1.00 2.00 3.00 10.00 described in section 132(c) of the final rule, as adjusted by Formula 2 or the IMM described in section 132(d) of the final rule. When the banking organization calculates EAD using the IMM, EADitotal equals EADunstressed. EADitotal in Formula 1 refers to the sum of the EAD for all netting sets of for hedging, a banking organization is allowed to treat the notional amount in an index attributable to that counterparty as a single name hedge of counterparty i (Bi,) when calculating KCVA and subtract the notional amount of Bi from the notional amount of the CDSind. The CDSind hedge with the notional amount reduced by Bi can still be treated as a CVA index hedge. b. Advanced Credit Valuation Adjustment Approach The final rule requires that the VaR model incorporate only changes in the counterparties’ credit spreads, not changes in other risk factors; it does not require a banking organization to capture jump-to-default risk in its VaR model. In order for a banking organization to receive approval to use the advanced CVA approach under the final rule, the banking organization needs to have the systems capability to calculate the CVA capital requirement on a daily basis but is not expected or required to calculate the CVA capital requirement on a daily basis. The CVA capital requirement under the advanced CVA approach is equal to the general market risk capital requirement of the CVA exposure using the ten-business-day time horizon of the market risk rule. The capital requirement does not include the incremental risk requirement of subpart F. If a banking organization uses the current exposure methodology to calculate the EAD of any immaterial OTC derivative portfolio, under the final rule the banking organization must use this EAD as a constant EE in the formula for the calculation of CVA. Also, the banking organization must set the maturity equal to the greater of half of the longest maturity occurring in the netting set and the notional weighted average maturity of all transactions in the netting set. 200 These weights represent the assumed values of the product of a counterparties’ current credit spread and the volatility of that credit spread. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00121 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.009</GPH> The term ‘‘exp’’ is the exponential function. Quantity Mi in Formulas 1 and 2 refers to the EAD-weighted average of the effective maturity of each netting set with counterparty i (where each netting set’s M cannot be smaller than one). Quantity Mihedge in Formula 1 refers to the notional weighted average maturity of the hedge instrument. Quantity Mind in Formula 1 equals the maturity of the CDSind or the notional weighted average maturity of any CDSind purchased to hedge CVA risk of counterparty i. Quantity Bi in Formula 1 refers to the sum of the notional amounts of any purchased single name CDS referencing counterparty i that is used to hedge CVA risk to counterparty i multiplied by (1exp(¥0.05 × Mi hedge))/(0.05 × Mihedge). Quantity B ind in Formula 1 refers to the notional amount of one or more CDSind purchased as protection to hedge CVA risk for counterparty i multiplied by (1exp(¥0.05 × Mind))/(0.05 × Mind). If counterparty i is part of an index used OTC derivative contracts with TABLE 26—ASSIGNMENT OF COUNTERPARTY WEIGHT UNDER THE counterparty i calculated using the current exposure methodology SIMPLE CVA ER11OC13.008</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 In Formula 1, wi refers to the weight applicable to counterparty i assigned according to Table 26 below.200 In Basel III, the BCBS assigned wi based on the external rating of the counterparty. However, consistent with the proposal and section 939A of the Dodd-Frank Act, the final rule assigns wi based on the relevant PD of the counterparty, as assigned by the banking organization. Quantity wind in Formula 1 refers to the weight applicable to the CDSind based on the average weight under Table 26 of the underlying reference names that comprise the index. 62137 62138 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations advanced CVA approach to calculate KCVA as follows: VaRJ is the 99 percent VaR reflecting changes of CVAj and fair value of eligible hedges (aggregated across all counterparties and eligible hedges) resulting from simulated changes of credit spreads over a ten-day time publicly traded debt instrument of the counterparty, or, where a publicly traded debt instrument spread is not available, a proxy spread based on the credit quality, industry and region of the counterparty. (E) EEi = the sum of the expected exposures for all netting sets with the counterparty at revaluation time ti calculated using the IMM. (F) Di = the risk-free discount factor at time ti, where D0 = 1. (G) The function exp is the exponential function. (H) The subscript j refers either to a stressed or an unstressed calibration as 201 For purposes of this formula, the subscript ‘‘ ’’ j refers either to a stressed or unstressed calibration as described in section 133(e)(6)(iv) and (v) of the final rule. wreier-aviles on DSK5TPTVN1PROD with RULES2 In Formula 3a: VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00122 Fmt 4701 Sfmt 4700 described in section 132(e)(6)(iv) and (v) of the final rule. Under the final rule, if a banking organization’s VaR model is not based on full repricing, the banking organization must use either Formula 4 or Formula 5 to calculate credit spread sensitivities. If the VaR model is based on credit spread sensitivities for specific tenors, the banking organization must calculate each credit spread sensitivity according to Formula 4: E:\FR\FM\11OCR2.SGM ER11OC13.011</GPH> (A) ti = the time of the i-th revaluation time bucket starting from t0 = 0. (B) tT = the longest contractual maturity across the OTC derivative contracts with the counterparty. (C) si = the CDS spread for the counterparty at tenor ti used to calculate the CVA for the counterparty. If a CDS spread is not available, the banking organization must use a proxy spread based on the credit quality, industry and region of the counterparty. (D) LGDMKT = the loss given default of the counterparty based on the spread of a horizon.201 CVAj for a given counterparty must be calculated according to 11OCR2 ER11OC13.010</GPH> The final rule requires a banking organization to use the formula for the Under the final rule, a banking organization must calculate VaRCVAunstressed using CVAUnstressed and VaRCVAstressed using CVAStressed. To calculate the CVAUnstressed measure in Formula 3a, a banking organization must use the EE for a counterparty calculated using current market data to compute current exposures and estimate model parameters using the historical observation period required under section 205(b)(2) of subpart F. However, if a banking organization uses the ‘‘shortcut’’ method described in section 132(d)(5) of the final rule to capture the effect of a collateral agreement when estimating EAD using the IMM, the banking organization must calculate the EE for the counterparty using that method and keep that EE constant with the maturity equal to the maximum of half of the longest maturity occurring in the netting set, and the notional weighted average maturity of all transactions in the netting set. To calculate the CVAStressed measure in Formula 3a, the final rule requires a banking organization to use the EE for a counterparty calculated using the stress calibration of the IMM. However, if a banking organization uses the ‘‘shortcut’’ method described in section 132(d)(5) of the final rule to capture the effect of a collateral agreement when VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 estimating EAD using the IMM, the banking organization must calculate the EE for the counterparty using that method and keep that EE constant with the maturity equal to the greater of half of the longest maturity occurring in the netting set with the notional amount equal to the weighted average maturity of all transactions in the netting set. Consistent with Basel III, the final rule requires a banking organization to calibrate the VaR model inputs to historical data from the most severe twelve-month stress period contained within the three-year stress period used to calculate EE. However, the agencies retain the flexibility to require a banking organization to use a different period of significant financial stress in the calculation of the CVAStressed measure that better reflects actual historic losses of the portfolio. Under the final rule, a banking organization’s VaR model is required to capture the basis between the spreads of the index that is used as the hedging instrument and the hedged counterparty exposure over various time periods, including benign and stressed environments. If the VaR model does not capture that basis, the banking organization is permitted to reflect only 50 percent of the notional amount of the CDSind hedge in the VaR model. PO 00000 Frm 00123 Fmt 4701 Sfmt 4700 62139 5. Cleared Transactions (Central Counterparties) As discussed more fully in section VIII.E of this preamble on cleared transactions under the standardized approach, CCPs help improve the safety and soundness of the derivatives and repo-style transaction markets through the multilateral netting of exposures, establishment and enforcement of collateral requirements, and market transparency. Similar to the changes to the cleared transaction treatment in the subpart D of the final rule, the requirements regarding the cleared transaction framework in the subpart E has been revised to reflect the material changes from the BCBS CCP interim framework. Key changes from the CCP interim framework, include: (1) Allowing a clearing member banking organization to use a reduced margin period of risk when using the IMM or a scaling factor of no less than 0.71 202 when using the CEM in the calculation of its EAD for client-facing derivative trades; (2) updating the risk weights applicable to a clearing member banking organization’s exposures when the 202 See Table 20 in section VIII.E of this preamble. Consistent with the scaling factor for the CEM in Table 20, an advanced approaches banking organization may reduce the margin period of risk when using the IMM to no shorter than 5 days. E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.012</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 62140 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations clearing member banking organization guarantees QCCP performance; (3) permitting clearing member banking organizations to choose from one of two approaches for determining the capital requirement for exposures to default fund contributions; and (4) updating the CEM formula to recognize netting to a greater extent for purposes of calculating its risk-weighted asset amount for default fund contributions. Additionally, changes in response to comments received on the proposal, as discussed in detail in section VIII.E of this preamble with respect to cleared transactions in the standardized approach, are also reflected in the final rule for advanced approaches. Banking organizations seeking more information on the changes relating to the material elements of the BCBS CCP interim framework and the comments received should refer to section VIII.E of this preamble. wreier-aviles on DSK5TPTVN1PROD with RULES2 6. Stress Period for Own Estimates During the recent financial crisis, increased volatility in the value of collateral led to higher counterparty exposures than estimated by banking organizations. Under the collateral haircut approach in the advanced approaches final rule, consistent with the proposal, a banking organization that receives prior approval from its primary Federal supervisor may calculate market price and foreign exchange volatility using own internal estimates. In response to the increased volatility experienced during the crisis, however, the final rule modifies the quantitative standards for approval by requiring banking organizations to base own internal estimates of haircuts on a historical observation period that reflects a continuous 12-month period of significant financial stress appropriate to the security or category of securities. As described in section VIII.F of this preamble with respect to the standardized approach, a banking organization is also required to have policies and procedures that describe how it determines the period of significant financial stress used to calculate the banking organization’s own internal estimates, and must be able to provide empirical support for the period used. To ensure an appropriate level of conservativeness, in certain circumstances a primary Federal supervisor may require a banking organization to use a different period of significant financial stress in the calculation of own internal estimates for haircuts. The agencies are adopting this aspect of the proposal without change. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 B. Removal of Credit Ratings 1. Eligible Guarantor Consistent with the proposed rule and section 939A of the Dodd-Frank Act, the final rule includes a number of changes to definitions in the advanced approaches rule that currently reference credit ratings.203 These changes are consistent with the alternative standards included in the Standardized Approach and alternative standards that already have been implemented in the agencies’ market risk rule. In addition, the final rule includes necessary changes to the hierarchy for risk weighting securitization exposures necessitated by the removal of the ratings-based approach, as described further below. In certain instances, the final rule uses an ‘‘investment grade’’ standard that does not rely on credit ratings. Under the final rule and consistent with the market risk rule, investment grade means that the entity to which the banking organization is exposed through a loan or security, or the reference entity with respect to a credit derivative, has adequate capacity to meet financial commitments for the projected life of the asset or exposure. Such an entity or reference entity has adequate capacity to meet financial commitments if the risk of its default is low and the full and timely repayment of principal and interest is expected. The agencies are largely adopting the proposed alternatives to ratings as proposed. Consistent with the proposal, the agencies are retaining the standards used to calculate the PFE for derivative contracts (as set forth in Table 2 of the final rule), which are based in part on whether the counterparty satisfies the definition of investment grade under the final rule. The agencies are also adopting as proposed the term ‘‘eligible double default guarantor,’’ which is used for purposes of determining whether a banking organization may recognize a guarantee or credit derivative under the credit risk mitigation framework. In addition, the agencies are adopting the proposed requirements for qualifying operational risk mitigants, which among other criteria, must be provided by an unaffiliated company that the banking organization deems to have strong capacity to meet its claims payment obligations and the obligor rating category to which the banking organization assigns the company is assigned a PD equal to or less than 10 basis points. Previously, to be an eligible securitization guarantor under the advanced approaches rule, a guarantor was required to meet a number of criteria. For example, the guarantor must have issued and outstanding an unsecured long-term debt security without credit enhancement that has a long-term applicable external rating in one of the three highest investmentgrade rating categories. The final rule replaces the term ‘‘eligible securitization guarantor’’ with the term ‘‘eligible guarantor,’’ which includes certain entities that have issued and outstanding unsecured debt securities without credit enhancement that are investment grade. Comments and modifications to the definition of eligible guarantor are discussed below and in section VIII.F of this preamble. 203 See PO 00000 76 FR 79380 (Dec. 21, 2011). Frm 00124 Fmt 4701 Sfmt 4700 2. Money Market Fund Approach Previously, under the money market fund approach in the advanced approaches rule, banking organizations were permitted to assign a 7 percent risk weight to exposures to money market funds that were subject to SEC rule 2a– 7 and that had an applicable external rating in the highest investment grade rating category. The proposed rule eliminated the money market fund approach. Commenters stated that the elimination of the existing 7 percent risk weight for equity exposures to money market funds would result in an overly stringent treatment for those exposures under the remaining look-through approaches. However, during the recent financial crisis, several money market funds demonstrated elevated credit risk that is not consistent with a low 7 percent risk weight. Accordingly, the agencies believe it is appropriate to eliminate the preferential risk weight for money market fund investments. As a result of the changes, a banking organization must use one of the three alternative approaches under section 154 of the final rule to determine the risk weight for its exposures to a money market fund. 3. Modified Look-Through Approaches for Equity Exposures to Investment Funds Under the proposal, risk weights for equity exposures under the simple modified look-through approach would have been based on the highest risk weight assigned to the exposure under the standardized approach (subpart D) based on the investment limits in the fund’s prospectus, partnership agreement, or similar contract that defines the fund’s permissible E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations investments. As discussed in the preamble regarding the standardized approach, commenters expressed concerns regarding their ability to implement the look-through approaches for investment funds that hold securitization exposures. However, the agencies believe that banking organizations should be aware of the nature of the investments in a fund in which the organization invests. To the extent that information is not available, the treatment in the final rule will create incentives for banking organizations to obtain the information necessary to compute risk-based capital requirements under the approach. These incentives are consistent with the agencies’ supervisory aim that banking organizations have sufficient understanding of the characteristics and risks of their investments. wreier-aviles on DSK5TPTVN1PROD with RULES2 C. Revisions to the Treatment of Securitization Exposures 1. Definitions As discussed in section VIII.H of this preamble with respect to the standardized approach, the proposal introduced a new definition for resecuritization exposures consistent with the 2009 Enhancements and broadened the definition of a securitization exposure. In addition, the agencies and the FDIC proposed to amend the existing definition of traditional securitization in order to exclude certain types of investment firms from treatment under the securitization framework. Consistent with the approach taken with respect to the standardized approach, the proposed definitions under the securitization framework in the advanced approach are largely finalized as proposed, except for changes described below. Banking organizations should refer to part VIII.H of this preamble for further discussion of these comments. In response to the proposed definition of traditional securitization, commenters generally agreed with the proposed exemptions from the definition and requested that the agencies and the FDIC provide exemptions for exposures to a broader set of investment firms, such as pension funds operated by state and local governments. In view of the comments regarding pension funds, the final rule, as described in part VIII.H of this preamble, excludes from the definition of traditional securitization a ‘‘governmental plan’’ (as defined in 29 U.S.C. 1002(32)) that complies with the tax deferral qualification requirements provided in the Internal Revenue Code. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 In response to the proposed definition of resecuritization, commenters requested clarification regarding its potential scope of application to exposures that they believed should not be considered resecuritizations. In response, the agencies have amended the definition of resecuritization by excluding securitizations that feature retranching of a single exposure. In addition, the agencies note that for purposes of the final rule, a resecuritization does not include passthrough securities that have been pooled together and effectively re-issued as tranched securities. This is because the pass-through securities do not tranche credit protection and, as a result, are not considered securitization exposures under the final rule. Previously, under the advanced approaches rule issued in 2007, the definition of eligible securitization guarantor included, among other entities, any entity (other than a securitization SPE) that has issued and has outstanding an unsecured long-term debt security without credit enhancement that has a long-term applicable external rating in one of the three highest investment-grade rating categories, or has a PD assigned by the banking organization that is lower than or equal to the PD associated with a long-term external rating in the third highest investment-grade category. The final rule removes the existing references to ratings from the definition of an eligible guarantor (the new term for an eligible securitization guarantor) and finalizes the requirements as proposed, as described in section VIII.F of this preamble. During the recent financial crisis, certain guarantors of securitization exposures had difficulty honoring those guarantees as the financial condition of the guarantors deteriorated at the same time as the guaranteed exposures experienced losses. Consistent with the proposal, a guarantor is not an eligible guarantor under the final rule if the guarantor’s creditworthiness is positively correlated with the credit risk of the exposures for which it has provided guarantees. In addition, insurance companies engaged predominately in the business of providing credit protection are not eligible guarantors. Further discussion can be found in section VIII.F of this preamble. 2. Operational Criteria for Recognizing Risk Transference in Traditional Securitizations The proposal outlined certain operational requirements for traditional securitizations that had to be met in PO 00000 Frm 00125 Fmt 4701 Sfmt 4700 62141 order to apply the securitization framework. Consistent with the standardized approach as discussed in section VIII.H of this preamble, the agencies are adopting the operational criteria for recognizing risk transference in traditional securitizations largely as proposed. 3. The Hierarchy of Approaches Consistent with section 939A of the Dodd-Frank Act, the proposed rule removed the ratings-based approach (RBA) and internal assessment approach for securitization exposures. The agencies are adopting the hierarchy largely as proposed. Under the final rule, the hierarchy for securitization exposures is as follows: (1) A banking organization is required to deduct from common equity tier 1 capital any after-tax gain-on-sale resulting from a securitization and apply a 1,250 percent risk weight to the portion of a CEIO that does not constitute after-tax gain-on-sale. (2) If a securitization exposure does not require deduction, a banking organization is required to assign a risk weight to the securitization exposure using the SFA. The agencies expect banking organizations to use the SFA rather than the SSFA in all instances where data to calculate the SFA is available. (3) If the banking organization cannot apply the SFA because not all the relevant qualification criteria are met, it is allowed to apply the SSFA. A banking organization should be able to explain and justify (for example, based on data availability) to its primary Federal supervisor any instances in which the banking organization uses the SSFA rather than the SFA for its securitization exposures. The SSFA, described in detail in part VIII.H of this preamble, is similar in construct and function to the SFA. A banking organization needs several inputs to calculate the SSFA. The first input is the weighted-average capital requirement calculated under the standardized approach that applies to the underlying exposures as if they are held directly by the banking organization. The second and third inputs indicate the position’s level of subordination and relative size within the securitization. The fourth input is the level of delinquencies experienced on the underlying exposures. A banking organization must apply the hierarchy of approaches in section 142 of this final rule to determine which approach it applies to a securitization exposure. The SSFA has been finalized as proposed, with the exception of some modifications to the delinquency E:\FR\FM\11OCR2.SGM 11OCR2 62142 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 parameter, as discussed in part VIII.H of this preamble. 4. Guarantees and Credit Derivatives Referencing a Securitization Exposure The current advanced approaches rule includes methods for calculating riskweighted assets for nth-to-default credit derivatives, including first-to-default credit derivatives and second-orsubsequent-to-default credit derivatives.204 The current advanced approaches rule, however, does not specify how to treat guarantees or credit derivatives (other than nth-to-default credit derivatives) purchased or sold that reference a securitization exposure. Accordingly, the proposal included specific treatment for credit protection purchased or provided in the form of a guarantee or credit derivative (other than an nth-to-default credit derivative) that references a securitization exposure. For a guarantee or credit derivative (other than an nth-to-default credit derivative) where the banking organization has provided protection, the final rule requires a banking organization providing credit protection to determine the risk-based capital requirement for the guarantee or credit derivative as if it directly holds the portion of the reference exposure covered by the guarantee or credit derivative. The banking organization calculates its risk-based capital requirement for the guarantee or credit derivative by applying either (1) the SFA as provided in section 143 of the final rule to the reference exposure if the banking organization and the reference exposure qualify for the SFA; or (2) the SSFA as provided in section 144 of the final rule. If the guarantee or credit derivative and the reference securitization exposure do not qualify for the SFA, or the SSFA, the banking organization is required to assign a 1,250 percent risk weight to the notional amount of protection provided under the guarantee or credit derivative. The final rule also clarifies how a banking organization may recognize a guarantee or credit derivative (other than an nth-to-default credit derivative) purchased as a credit risk mitigant for a securitization exposure held by the banking organization. A banking organization that purchases an OTC credit derivative (other than an nth-to204 Nth-to-default credit derivative means a credit derivative that provides credit protection only for the nth-defaulting reference exposure in a group of reference exposures. See 12 CFR part 3, appendix C, section 42(l) (national banks) and 12 CFR part 167, appendix C, section 42(l) (Federal savings associations) (OCC); 12 CFR part 208, appendix F, and 12 CFR part 225, appendix G (Board). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 default credit derivative) that is recognized as a credit risk mitigant for a securitization exposure that is not a covered position under the market risk rule is not required to compute a separate counterparty credit risk capital requirement provided that the banking organization does so consistently for all such credit derivatives. The banking organization must either include all or exclude all such credit derivatives that are subject to a qualifying master netting agreement from any measure used to determine counterparty credit risk exposure to all relevant counterparties for risk-based capital purposes. If a banking organization cannot, or chooses not to, recognize a credit derivative that is a securitization exposure as a credit risk mitigant, the bank must determine the exposure amount of the credit derivative under the treatment for OTC derivatives in section 132. If the banking organization purchases the credit protection from a counterparty that is a securitization, the banking must determine the risk weight for counterparty credit risk according to the securitization framework. If the banking organization purchases credit protection from a counterparty that is not a securitization, the banking organization must determine the risk weight for counterparty credit risk according to general risk weights under section 131. 5. Due Diligence Requirements for Securitization Exposures As the recent financial crisis unfolded, weaknesses in exposures underlying securitizations became apparent and resulted in NRSROs downgrading many securitization exposures held by banking organizations. The agencies found that many banking organizations relied on NRSRO ratings as a proxy for the credit quality of securitization exposures they purchased and held without conducting their own sufficient independent credit analysis. As a result, some banking organizations did not have sufficient capital to absorb the losses attributable to these exposures. Accordingly, consistent with the 2009 Enhancements, the proposed rule introduced due diligence requirements that banking organizations would be required to undertake to use the SFA or SSFA. Comments received regarding the proposed due diligence requirements and the rationale for adopting the proposed treatment in the final rule are discussed in part VIII of the preamble. 6. Nth-to-Default Credit Derivatives Consistent with the proposal, the final rule provides that a banking organization that provides credit PO 00000 Frm 00126 Fmt 4701 Sfmt 4700 protection through an nth-to-default derivative must assign a risk weight to the derivative using the SFA or the SSFA. In the case of credit protection sold, a banking organization must determine its exposure in the nth-todefault credit derivative as the largest notional dollar amount of all the underlying exposures. When applying the SSFA to protection provided in the form of an nth-to-default credit derivative, the attachment point (parameter A) is the ratio of the sum of the notional amounts of all underlying exposures that are subordinated to the banking organization’s exposure to the total notional amount of all underlying exposures. For purposes of applying the SFA, parameter A is set equal to the credit enhancement level (L) used in the SFA formula. In the case of a first-todefault credit derivative, there are no underlying exposures that are subordinated to the banking organization’s exposure. In the case of a second-or-subsequent-to default credit derivative, the smallest (n-1) underlying exposure(s) are subordinated to the banking organization’s exposure. Under the SSFA, the detachment point (parameter D) is the sum of the attachment point and the ratio of the notional amount of the banking organization’s exposure to the total notional amount of the underlying exposures. Under the SFA, Parameter D is set to equal L plus the thickness of the tranche (T) under the SFA formula. A banking organization that does not use the SFA or SSFA to calculate a risk weight for an nth-to-default credit derivative must assign a risk weight of 1,250 percent to the exposure. For the treatment of protection purchased through a first-to-default credit derivative, a banking organization must determine its risk-based capital requirement for the underlying exposures as if the banking organization had synthetically securitized the underlying exposure with the lowest risk-based capital requirement and had obtained no credit risk mitigant on the other underlying exposures. A banking organization must calculate a risk-based capital requirement for counterparty credit risk according to section 132 of the final rule for a first-to-default credit derivative that does not meet the rules of recognition for guarantees and credit derivatives under section 134(b). For second-or-subsequent-to default credit derivatives, a banking organization that obtains credit protection on a group of underlying exposures through a nth-to-default credit derivative that meets the rules of recognition of section 134(b) of the final E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 rule (other than a first-to-default credit derivative) is permitted to recognize the credit risk mitigation benefits of the derivative only if the banking organization also has obtained credit protection on the same underlying exposures in the form of first-through(n-1)-to-default credit derivatives; or if n-1 of the underlying exposures have already defaulted. If a banking organization satisfies these requirements, the banking organization determines its risk-based capital requirement for the underlying exposures as if the banking organization had only synthetically securitized the underlying exposure with the nth smallest risk-based capital requirement and had obtained no credit risk mitigant on the other underlying exposures. A banking organization that does not fulfill these requirements must calculate a risk-based capital requirement for counterparty credit risk according to section 132 of the final rule for a nth-todefault credit derivative that does not meet the rules of recognition of section 134(b) of the final rule. D. Treatment of Exposures Subject to Deduction Under the current advanced approaches rule, a banking organization is required to deduct certain exposures from total capital, including securitization exposures such as CEIOs, low-rated securitization exposures, and high-risk securitization exposures subject to the SFA; eligible credit reserves shortfall; and certain failed capital markets transactions. Consistent with Basel III, the proposed rule required a banking organization to assign a 1,250 percent risk weight to many exposures that previously were deducted from capital, except for deductions from total capital of insurance underwriting subsidiaries of BHCs. In the proposal, the agencies and the FDIC noted that such treatment would not be equivalent to a deduction from tier 1 capital, as the effect of a 1,250 percent risk weight would depend on an individual banking organization’s current risk-based capital ratios. Specifically, when a risk-based capital ratio (either tier 1 or total risk-based capital) exceeds 8.0 percent, the effect on that risk-based capital ratio of assigning an exposure a 1,250 percent risk weight would be more conservative than a deduction from total capital. The more a risk-based capital ratio exceeds 8.0 percent, the harsher is the effect of a 1,250 percent risk weight on riskbased capital ratios. Commenters acknowledged these points and asked the agencies and the FDIC to replace the VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 1,250 percent risk weight with the maximum risk weight that would correspond with deduction. Commenters also stated that the agencies and the FDIC should consider the effect of the 1,250 percent risk weight given that the Basel III proposals, over time, would require banking organizations to maintain a total riskbased capital ratio of at least 10.5 percent to meet the minimum required capital ratio plus the capital conservation buffer. The agencies are adopting the requirements as proposed, in order to provide for comparability in riskweighted asset measurements across institutions. The agencies and the FDIC did not propose to apply a 1,250 percent risk weight to those exposures currently deducted from tier 1 capital under the advanced approaches rule. For example, the agencies and the FDIC proposed that an after-tax gain-on-sale that is deducted from tier 1 under the advanced approaches rule be deducted from common equity tier 1 under the proposed rule. In this regard, the agencies and the FDIC also clarified that any asset deducted from common equity tier 1, tier 1, or tier 2 capital under the advanced approaches rule would not be included in the measure of riskweighted assets under the advanced approaches rule. The agencies have finalized these requirements as proposed. E. Technical Amendments to the Advanced Approaches Rule In the proposed rule, the agencies and the FDIC introduced a number of amendments to the advanced approaches rule that were designed to refine and clarify certain aspects of the rule’s implementation. The agencies are adopting each of these technical amendments as proposed. Additionally, in the final rule, the agencies are amending the treatment of defaulted exposures that are covered by government guarantees. Each of these revisions is described below. 1. Eligible Guarantees and Contingent U.S. Government Guarantees In order to be recognized as an eligible guarantee under the advanced approaches rule, the guarantee, among other criteria, must be unconditional. The agencies note that this definition would exclude certain guarantees provided by the U.S. Government or its agencies that would require some action on the part of the banking organization or some other third party. However, based on their risk characteristics, the agencies believe that these guarantees should be recognized as eligible PO 00000 Frm 00127 Fmt 4701 Sfmt 4700 62143 guarantees. Therefore, the agencies are amending the definition of eligible guarantee so that it explicitly includes a contingent obligation of the U.S. Government or an agency of the U.S. Government, the validity of which is dependent on some affirmative action on the part of the beneficiary or a third party (for example, servicing requirements) irrespective of whether such contingent obligation is otherwise considered a conditional guarantee. Related to the change to the eligible guarantee definition, the agencies have amended the provision in the advanced approaches rule pertaining to the 10 percent floor on the LGD for residential mortgage exposures. Currently, the rule provides that the LGD for each segment of residential mortgage exposures (other than segments of residential mortgage exposures for which all or substantially all of the principal of each exposure is directly and unconditionally guaranteed by the full faith and credit of a sovereign entity) may not be less than 10 percent. The provision would therefore require a 10 percent LGD floor on segments of residential mortgage exposures for which all or substantially of the principal are conditionally guaranteed by the U.S. government. The agencies have amended the final rule to allow an exception from the 10 percent floor in such cases. 2. Calculation of Foreign Exposures for Applicability of the Advanced Approaches—Insurance Underwriting Subsidiaries A banking organization is subject to the advanced approaches rule if it has consolidated assets greater than or equal to $250 billion, or if it has total consolidated on-balance sheet foreign exposures of at least $10 billion.205 For bank holding companies, in particular, the advanced approaches rule provides that the $250 billion threshold criterion excludes assets held by an insurance underwriting subsidiary. However, a similar provision does not exist for the $10 billion foreign-exposure threshold criterion. Therefore, for bank holding companies and covered SLHCs, the Board is excluding assets held by insurance underwriting subsidiaries from the $10 billion in total foreign exposures threshold. The Board believes such a parallel provision results in a more appropriate scope of application for the advanced approaches rule. 205 See 12 CFR part 3, appendix C (national banks) and 12 CFR part 167, appendix C (Federal savings associations) (OCC); 12 CFR part 208, appendix F, and 12 CFR part 225, appendix G (Board). E:\FR\FM\11OCR2.SGM 11OCR2 62144 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 3. Calculation of Foreign Exposures for Applicability of the Advanced Approaches—Changes to Federal Financial Institutions Economic Council 009 The agencies are revising the advanced approaches rule to comport with changes to the FFIEC’s Country Exposure Report (FFIEC 009) that occurred after the issuance of the advanced approaches rule in 2007. Specifically, the FFIEC 009 replaced the term ‘‘local country claims’’ with the term ‘‘foreign-office claims.’’ Accordingly, the agencies have made a similar change under section 100, the section of the final rule that makes the rules applicable to a banking organization that has consolidated total on-balance sheet foreign exposures equal to $10 billion or more. As a result, to determine total on-balance sheet foreign exposure, a banking organization sums its adjusted cross-border claims, local country claims, and cross-border revaluation gains calculated in accordance with FFIEC 009. Adjusted cross-border claims equal total crossborder claims less claims with the head office or guarantor located in another country, plus redistributed guaranteed amounts to the country of the head office or guarantor. wreier-aviles on DSK5TPTVN1PROD with RULES2 4. Applicability of the Final Rule The agencies believe that once a banking organization reaches the asset size or level of foreign activity that causes it to become subject to the advanced approaches, that it should remain subject to the advanced approaches rule even if it subsequently drops below the asset or foreign exposure threshold. The agencies believe that it is appropriate for the primary Federal supervisor to evaluate whether a banking organization’s business or risk exposure has changed after dropping below the thresholds in a manner that it would no longer be appropriate for the banking organization to be subject to the advanced approaches. As a result, consistent with the proposal, the final rule clarifies that once a banking organization is subject to the advanced approaches rule under subpart E, it remains subject to subpart E until its primary Federal supervisor determines that application of the rule would not be appropriate in light of the banking organization’s asset size, level of complexity, risk profile, or scope of operations. In connection with the consideration of a banking organization’s level of complexity, risk profile, and scope of operations, the agencies also may consider a banking VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 organization’s interconnectedness and other relevant risk-related factors. 5. Change to the Definition of Probability of Default Related to Seasoning The advanced approaches rule requires an upward adjustment to estimated PD for segments of retail exposures for which seasoning effects are material. The rationale underlying this requirement was the seasoning pattern displayed by some types of retail exposures—that is, the exposures have very low default rates in their first year, rising default rates in the next few years, and declining default rates for the remainder of their terms. Because of the one-year internal ratings-based (IRB) default horizon, capital based on the very low PDs for newly originated, or ‘‘unseasoned,’’ loans would be insufficient to cover the elevated risk in subsequent years. The upward seasoning adjustment to PD was designed to ensure that banking organizations would have sufficient capital when default rates for such segments rose predictably beginning in year two. Since the issuance of the advanced approaches rule, the agencies have found the seasoning provision to be problematic. First, it is difficult to ensure consistency across institutions, given that there is no guidance or criteria for determining when seasoning is ‘‘material’’ or what magnitude of upward adjustment to PD is ‘‘appropriate.’’ Second, the advanced approaches rule lacks flexibility by requiring an upward PD adjustment whenever there is a significant relationship between a segment’s default rate and its age (since origination). For example, the upward PD adjustment may be inappropriate in cases where (1) the outstanding balance of a segment is falling faster over time (due to defaults and prepayments) than the default rate is rising; (2) the age (since origination) distribution of a portfolio is stable over time; or (3) where the loans in a segment are intended, with a high degree of certainty, to be sold or securitized within a short time period. Therefore, consistent with the proposal, the agencies are deleting the regulatory seasoning provision and will instead consider seasoning when evaluating a firm’s assessment of its capital adequacy from a supervisory perspective. In addition to the difficulties in applying the advanced approaches rule’s seasoning requirements discussed above, the agencies believe that seasoning is more appropriately considered from a PO 00000 Frm 00128 Fmt 4701 Sfmt 4700 supervisory perspective. First, seasoning involves the determination of minimum required capital for a period in excess of the 12-month time horizon implicit in the advanced approaches risk-based capital ratio calculations. It thus falls more appropriately under longer-term capital planning and capital adequacy, which are major focal points of the internal capital adequacy assessment process. Second, seasoning is a major issue only where a banking organization has a concentration of unseasoned loans. The risk-based capital ratios do not take concentrations of any kind into account; however, they are an explicit factor in the internal capital adequacy assessment process. 6. Cash Items in Process of Collection Under the current advanced approaches rule, cash items in the process of collection are not assigned a risk-based capital treatment and, as a result, are subject to a 100 percent risk weight. Under the final rule, consistent with the proposal, the agencies are revising the advanced approaches rule to risk weight cash items in the process of collection at 20 percent of the carrying value, as the agencies believe that this treatment is more commensurate with the risk of these exposures. A corresponding provision is included in section 32 of the final rule. 7. Change to the Definition of Qualifying Revolving Exposure The agencies and the FDIC proposed modifying the definition of qualifying revolving exposure (QRE) such that certain unsecured and unconditionally cancellable exposures where a banking organization consistently imposes in practice an upper exposure limit of $100,000 and requires payment in full every cycle would qualify as QRE. Under the previous definition in the advanced approaches rule, only unsecured and unconditionally cancellable revolving exposures with a pre-established maximum exposure amount of $100,000 or less (such as credit cards) were classified as QRE. Unsecured, unconditionally cancellable exposures that require payment in full and have no communicated maximum exposure amount (often referred to as ‘‘charge cards’’) were instead classified as ‘‘other retail.’’ For risk-based capital purposes, this classification was material and generally results in substantially higher minimum required capital to the extent that the exposure’s asset value correlation (AVC) would differ if classified as QRE (where it is assigned an AVC of 4 percent) or other retail (where AVC varies inversely with through-the-cycle PD estimated at the E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 segment level and can go as high as almost 16 percent for very low PD segments). Under the proposed definition, certain charge card products would qualify as QRE. Charge card exposures may be viewed as revolving in that there is an ability to borrow despite a requirement to pay in full. Commenters agreed that charge cards should be included as QRE because, compared to credit cards, they generally exhibit lower loss rates and loss volatility. Where a banking organization consistently imposes in practice an upper exposure limit of $100,000 the agencies believe that charge cards are more closely aligned from a risk perspective with credit cards than with any type of ‘‘other retail’’ exposure and are therefore amending the definition of QRE in order to more appropriately capture such products under the definition of QRE. With respect to a product with a balance that the borrower is required to pay in full every month, the exposure would qualify as QRE under the final rule as long as its balance does not in practice exceed $100,000. If the balance of an exposure were to exceed that amount, it would represent evidence that such a limit is not maintained in practice for the segment of exposures in which that exposure is placed for risk parameter estimation purposes. As a result, that segment of exposures would not qualify as QRE over the next 24 month period. In addition, the agencies believe that the definition of QRE should be sufficiently flexible to encompass products with new features that were not envisioned at the time of adopting the advanced approaches rule, provided, however, that the banking organization can demonstrate to the satisfaction of the primary Federal supervisor that the performance and risk characteristics (in particular the volatility of loss rates over time) of the new product are consistent with the definition and requirements of QRE portfolios. 8. Trade-Related Letters of Credit In 2011, the BCBS revised the Basel II advanced internal ratings-based approach to remove the one-year maturity floor for trade finance instruments. Consistent with this revision, the proposed rule specified that an exposure’s effective maturity must be no greater than five years and no less than one year, except that an exposure’s effective maturity must be no less than one day if the exposure is a trade-related letter of credit, or if the exposure has an original maturity of less than one year and is not part of a banking organization’s ongoing VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 financing of the obligor. Commenters requested clarification on whether short-term self-liquidating trade finance instruments would be considered exempt from the one-year maturity floor, as they do not constitute an ongoing financing of the obligor. In addition, commenters stated that applying the proposed framework for AVCs to trade-related letters of credit would result in banking organizations maintaining overly conservative capital requirements in relation to the risk of trade finance exposures, which could reduce the availability of trade finance and increase the cost of providing trade finance for businesses globally. As a result, commenters requested that trade finance exposures be assigned a separate AVC that would better reflect the product’s low default rates and low correlation. The agencies believe that, in light of the removal of the one-year maturity floor, the proposed requirements for trade-related letters of credit are appropriate without a separate AVC. In the final rule, the agencies are adopting the treatment of trade-related letters of credit as proposed. Under the final rule, trade finance exposures that meet the stated requirements above may be assigned a maturity lower than one year. Section 32 of the final rule includes a provision that similarly recognizes the low default rates of these exposures. 9. Defaulted Exposures That Are Guaranteed by the U.S. Government Under the current advanced approaches rule, a banking organization is required to apply an 8.0 percent capital requirement to the EAD for each wholesale exposure to a defaulted obligor and for each segment of defaulted retail exposures. The advanced approaches rule does not recognize yet-to-be paid protection in the form of guarantees or insurance on defaulted exposures. For example, under certain programs, a U.S. government agency that provides a guarantee or insurance is not required to pay on claims on exposures to defaulted obligors or segments of defaulted retail exposures until the collateral is sold. The time period from default to sale of collateral can be significant and the exposure amount covered by such U.S. sovereign guarantees or insurance can be substantial. In order to make the treatment for exposures to defaulted obligors and segments of defaulted retail exposures more risk sensitive, the agencies have decided to amend the advanced approaches rule by assigning a 1.6 percent capital requirement to the portion of the EAD for each wholesale PO 00000 Frm 00129 Fmt 4701 Sfmt 4700 62145 exposure to a defaulted obligor and each segment of defaulted retail exposures that is covered by an eligible guarantee from the U.S. government. The portion of the exposure amount for each wholesale exposure to a defaulted obligor and each segment of defaulted retail exposures not covered by an eligible guarantee from the U.S. government continues to be assigned an 8.0 percent capital requirement. 10. Stable Value Wraps The agencies are clarifying that a banking organization that provides stable value protection, such as through a stable value wrap that has provisions and conditions that minimize the wrap’s exposure to credit risk of the underlying assets in the fund, must treat the exposure as if it were an equity derivative on an investment fund and determine the adjusted carrying value of the exposure as the sum of the adjusted carrying values of any on-balance sheet asset component determined according to section 151(b)(1) and the off-balance sheet component determined according to section 151(b)(2). That is, the adjusted carrying value is the effective notional principal amount of the exposure, the size of which is equivalent to a hypothetical on-balance sheet position in the underlying equity instrument that would evidence the same change in fair value (measured in dollars) given a small change in the price of the underlying equity instrument without subtracting the adjusted carrying value of the onbalance sheet component of the exposure as calculated under the same paragraph. Risk-weighted assets for such an exposure is determined by applying one of the three look-through approaches as provided in section 154 of the final rule. 11. Treatment of Pre-Sold Construction Loans and Multi-Family Residential Loans The final rule assigns either a 50 percent or a 100 percent risk weight to certain one-to-four family residential pre-sold construction loans under the advanced approaches rule, consistent with provisions of the RTCRRI Act.206 This treatment is consistent with the treatment under the general risk-based capital rules and under the standardized approach. F. Pillar 3 Disclosures 1. Frequency and Timeliness of Disclosures For purposes of the final rule, a banking organization is required to 206 See E:\FR\FM\11OCR2.SGM 12 U.S.C. 1831n, note. 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62146 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations provide certain qualitative and quantitative public disclosures on a quarterly, or in some cases, annual basis, and these disclosures must be ‘‘timely.’’ Qualitative disclosures that provide a general summary of a banking organization’s risk-management objectives and policies, reporting system, and definitions may be disclosed annually after the end of the fourth calendar quarter, provided any significant changes are disclosed in the interim. In the preamble to the advanced approaches rule, the agencies indicated that quarterly disclosures would be timely if they were provided within 45 days after calendar quarterend. The preamble did not specify expectations regarding annual disclosures. The agencies acknowledge that timing of disclosures required under the federal banking laws may not always coincide with the timing of disclosures under other federal laws, including federal securities laws and their implementing regulations by the SEC. The agencies also indicated that a banking organization may use disclosures made pursuant to SEC, regulatory reporting, and other disclosure requirements to help meet its public disclosure requirements under the advanced approaches rule. For calendar quarters that do not correspond to fiscal year end, the agencies consider those disclosures that are made within 45 days of the end of the calendar quarter (or within 60 days for the limited purpose of the banking organization’s first reporting period in which it is subject to the public disclosure requirements) as timely. In general, where a banking organization’s fiscal year-end coincides with the end of a calendar quarter, the agencies consider qualitative and quantitative disclosures to be timely if they are made no later than the applicable SEC disclosure deadline for the corresponding Form 10–K annual report. In cases where an institution’s fiscal year end does not coincide with the end of a calendar quarter, the primary Federal supervisor would consider the timeliness of disclosures on a case-by-case basis. In some cases, management may determine that a significant change has occurred, such that the most recent reported amounts do not reflect the banking organization’s capital adequacy and risk profile. In those cases, a banking organization needs to disclose the general nature of these changes and briefly describe how they are likely to affect public disclosures going forward. A banking organization should make these interim disclosures as soon as VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 practicable after the determination that a significant change has occurred. 2. Enhanced Securitization Disclosure Requirements In view of the significant market uncertainty during the recent financial crisis caused by the lack of disclosures regarding banking organizations’ securitization-related exposures, the agencies believe that enhanced disclosure requirements are appropriate. Consistent with the disclosures introduced by the 2009 Enhancements, the proposal amended the qualitative section for Table 9 disclosures (Securitization) under section 173 to include the following: D The nature of the risks inherent in a banking organization’s securitized assets, D A description of the policies that monitor changes in the credit and market risk of a banking organization’s securitization exposures, D A description of a banking organization’s policy regarding the use of credit risk mitigation for securitization exposures, D A list of the special purpose entities a banking organization uses to securitize exposures and the affiliated entities that a bank manages or advises and that invest in securitization exposures or the referenced SPEs, and D A summary of the banking organization’s accounting policies for securitization activities. To the extent possible, the agencies are implementing the disclosure requirements included in the 2009 Enhancements in the final rule. However, consistent with section 939A of the Dodd-Frank Act, the tables do not include those disclosure requirements that are tied to the use of ratings. 3. Equity Holdings That Are Not Covered Positions The current advanced approaches rule requires banking organizations to include in their public disclosures a discussion of ‘‘important policies covering the valuation of and accounting for equity holdings in the banking book.’’ Since ‘‘banking book’’ is not a defined term under the final rule, the agencies refer to such exposures as equity holdings that are not covered positions in the final rule. XIII. Market Risk Rule On August 30, 2012, the agencies and the FDIC revised their respective market risk rules to better capture positions subject to market risk, reduce procyclicality in market risk capital requirements, enhance the rule’s sensitivity to risks that were not PO 00000 Frm 00130 Fmt 4701 Sfmt 4700 adequately captured under the prior regulatory measurement methodologies, and increase transparency through enhanced disclosures.207 As noted in the introduction of this preamble, the agencies and the FDIC proposed to expand the scope of the market risk rule to include savings associations and SLHCs, and to codify the market risk rule in a manner similar to the other regulatory capital rules in the three proposals. In the final rule, consistent with the proposal, the agencies have also merged definitions and made appropriate technical changes. As a general matter, a banking organization that is subject to the market risk rule will continue to exclude covered positions (other than certain foreign exchange and commodities positions) when calculating its riskweighted assets under the other riskbased capital rules. Instead, the banking organization must determine an appropriate capital requirement for such positions using the methodologies set forth in the final market risk rule. The banking organization then must multiply its market risk capital requirement by 12.5 to determine a riskweighted asset amount for its market risk exposures and include that amount in its standardized approach riskweighted assets and for an advanced approaches banking organization’s advanced approaches risk-weighted assets. The market risk rule is designed to determine capital requirements for trading assets based on general and specific market risk associated with these assets. General market risk is the risk of loss in the market value of positions resulting from broad market movements, such as changes in the general level of interest rates, equity prices, foreign exchange rates, or commodity prices. Specific market risk is the risk of loss from changes in the fair value of a position due to factors other than broad market movements, including event risk (changes in market price due to unexpected events specific to a particular obligor or position) and default risk. The agencies and the FDIC proposed to apply the market risk rule to savings associations and SLHCs. Consistent with the proposal, the agencies in this final rule have expanded the scope of the market risk rule to savings associations and covered SLHCs that meet the stated thresholds. The market risk rule applies to any savings association or covered SLHC whose trading activity (the gross sum of its 207 See E:\FR\FM\11OCR2.SGM 77 FR 53060 (August 30, 2012). 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations trading assets and trading liabilities) is equal to 10 percent or more of its total assets or $1 billion or more. Each agency retains the authority to apply its respective market risk rule to any entity under its jurisdiction, regardless of whether it meets either of the thresholds described above, if the agency deems it necessary or appropriate for safe and sound banking practices. Application of the market risk rule to all banking organizations with material exposure to market risk is particularly important because of banking organizations’ increased exposure to traded credit products, such as CDSs, asset-backed securities and other structured products, as well as other less liquid products. In fact, many of the August 2012 revisions to the market risk rule were made in response to concerns that arose during the recent financial crisis when banking organizations holding certain trading assets suffered substantial losses. For example, in addition to a market risk capital requirement to account for general market risk, the revised rules apply more conservative standardized specific risk capital requirements to most securitization positions and implement an additional incremental risk capital requirement for a banking organization that models specific risk for one or more portfolios of debt or, if applicable, equity positions. Additionally, to address concerns about the appropriate treatment of traded positions that have limited price transparency, a banking organization subject to the market risk rule must have a well-defined valuation process for all covered positions. The agencies and the FDIC received comments on the market risk rule. One commenter asserted that the effective date for application of the market risk rule (and the advanced approaches rule) to SLHCs should be deferred until at least July 21, 2015. This commenter also asserted that SLHCs with substantial insurance operations should be exempt from the advanced approaches and market risk rules if their subsidiary bank or savings association comprised less than 5 percent or 10 percent of the total assets of the SLHC. As a general matter, savings associations and SLHCs do not engage in trading activity to a substantial degree. However, the agencies believe that any savings association or covered SLHC whose trading activity grows to the extent that it meets either of the thresholds should hold capital commensurate with the risk of the trading activity and should have in place the prudential risk-management systems and processes required under the market risk rule. Therefore, it is appropriate to expand the scope of the VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 market risk rule to apply to savings associations and covered SLHCs as of January 1, 2015. Another commenter asserted that the agencies and the FDIC should establish standardized capital requirements for trading operations rather than relying on risk modeling techniques because there is no way for regulators or market participants to judge whether bank calculations of market risk are meaningful. Regarding the use of standardized requirements for trading operations rather than reliance on risk modeling, banking organizations’ models are subject to initial approval and ongoing review under the market risk rule. The agencies are aware that the BCBS is considering, among other options, greater use of standardized approaches for market risk. The agencies would consider modifications to the international market risk framework when and if it is revised. One commenter asserted that regulations should increase the cost of excessive use of short-term borrowing to fund long maturity assets. The agencies are considering the implications of short-term funding from several perspectives outside of the regulatory capital framework. Specifically, the agencies expect short-term funding risks would be a potential area of focus in forthcoming Basel III liquidity and enhanced prudential standards regulations. The agencies also have adopted conforming changes to certain elements of the market risk rule to reflect changes that are being made to other aspects of the regulatory capital framework. These changes are designed to correspond to the changes to the CRC references and treatment of securitization exposures under subparts D and E of the final rule, which are discussed more fully in the standardized and advanced approaches sections. See sections VIII.B and XII.C of this preamble for a discussion of these changes. More specifically, the market risk rule is being amended to incorporate a revised definition of parameter W in the SSFA. As discussed above, the agencies and the FDIC received comment on the existing definition, which assessed a capital penalty if borrowers exercised contractual rights to defer payment of principal or interest for more than 90 days on exposures underlying a securitization. In response to commenters, the agencies are modifying this definition to exclude all loans issued under Federally-guaranteed student loan programs, and certain consumer loans (including nonFederally guaranteed student loans) PO 00000 Frm 00131 Fmt 4701 Sfmt 4700 62147 from being included in this component of parameter W. The agencies have made a technical amendment to the rule with respect to the covered position definition. Previously, the definition of covered position excluded equity positions that are not publicly traded. The agencies have refined this exception such that a covered position may include a position in a non-publicly traded investment company, as defined in and registered with the SEC under the Investment Company Act of 1940 (15 U.S.C. 80 a1 et seq.) (or its non-U.S. equivalent), provided that all the underlying equities held by the investment company are publicly traded. The agencies believe that a ‘‘look-through’’ approach is appropriate in these circumstances because of the of the liquidity of the underlying positions, so long as the other conditions of a covered position are satisfied. The agencies also have clarified where a banking organization subject to the market risk rule must make its required market risk disclosures and require that these disclosures be timely. The banking organization must provide its quantitative disclosures after each calendar quarter. In addition, the final rule clarifies that a banking organization must provide its qualitative disclosures at least annually, after the end of the fourth calendar quarter, provided any significant changes are disclosed in the interim. The agencies acknowledge that the timing of disclosures under the federal banking laws may not always coincide with the timing of disclosures required under other federal laws, including disclosures required under the federal securities laws and their implementing regulations by the SEC. For calendar quarters that do not correspond to fiscal year end, the agencies consider those disclosures that are made within 45 days of the end of the calendar quarter (or within 60 days for the limited purpose of the banking organization’s first reporting period in which it is subject to the rule) as timely. In general, where a banking organization’s fiscal year-end coincides with the end of a calendar quarter, the agencies consider qualitative and quantitative disclosures to be timely if they are made no later than the applicable SEC disclosure deadline for the corresponding Form 10–K annual report. In cases where an institution’s fiscal year end does not coincide with the end of a calendar quarter, the primary Federal supervisor would consider the timeliness of disclosures on a case-by-case basis. In some cases, management may determine that a significant change has occurred, E:\FR\FM\11OCR2.SGM 11OCR2 62148 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 such that the most recent reported amounts do not reflect the banking organization’s capital adequacy and risk profile. In those cases, a banking organization needs to disclose the general nature of these changes and briefly describe how they are likely to affect public disclosures going forward. A banking organization should make these interim disclosures as soon as practicable after the determination that a significant change has occurred. The final rule also clarifies that a banking organization’s management may provide all of the disclosures required by the market risk rule in one place on the banking organization’s public Web site or may provide the disclosures in more than one public financial report or other regulatory reports, provided that the banking organization publicly provides a summary table specifically indicating the location(s) of all such disclosures. The Board also is issuing a notice of proposed rulemaking concurrently with this final rule. The notice of proposed rulemaking would revise the current market risk rule in Appendix E to incorporate the changes to the CRC references and parameter W, as discussed above. XIV. Additional OCC Technical Amendments In addition to the changes described above, the OCC proposed to redesignate subpart C (Establishment of Minimum Capital Ratios for an Individual Bank), subpart D (Enforcement), and subpart E (Issuance of a Directive), as subparts H, I, and J, respectively. The OCC also proposed to redesignate section 3.100 (Capital and Surplus), as subpart K. The OCC proposed to carry over redesignated subpart K, which includes definitions of the terms ‘‘capital’’ and ‘‘surplus’’ and related definitions that are used for determining statutory limits applicable to national banks that are based on capital and surplus. In addition, the OCC proposed to remove appendices A, B, and C to part 3 because they would be replaced with the new proposed framework. Finally, as part of the integration of the rules governing national banks and Federal savings associations, the OCC proposed to make part 3 applicable to Federal savings associations, make other nonsubstantive, technical amendments, and rescind part 167 (including appendix C) (Capital). The OCC received no comments on these proposed changes and therefore is adopting the proposal as final, except for the following changes. The final rule retains the existing 12 CFR part 3, appendices A and B for national banks VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 and part 167 (excluding appendix C) for Federal savings associations. Because the impact of many of the deductions and adjustments to the revised definition of capital are phased in over several years, national banks and Federal savings associations will need to use the existing rules at 12 CFR part 3, appendix A and 12 CFR part 167 (excluding appendix C), respectively, pertaining to the definition of capital to determine certain baseline regulatory capital amounts. Additionally, because the standardized approach riskweighted asset calculations will not become effective until January 1, 2015, national banks and Federal savings associations that are not subject to the advanced approaches risk-based capital rules will be required to continue using the risk-weighted asset calculations set forth at 12 CFR part 3, appendix A and 12 CFR part 167 (excluding appendix C), respectively, from January 1, 2014, until December 31, 2014. National banks that are subject to the market risk rule (12 CFR part 3, appendix B), but not the advanced approaches risk-based capital rules, will need to use the 12 CFR part 3, appendix B, from January 1, 2014, until December 31, 2014. Finally, as noted earlier in this preamble, national banks and Federal savings associations that are subject to the advanced approaches risk-based rules must calculate their risk-based capital floor using the risk-weighted asset calculations set forth at 12 CFR part 3, appendix A, and 12 CFR part 167 (excluding appendix C), respectively, through December 31, 2014. Beginning on January 1, 2015, national banks and Federal savings associations subject to the advanced approaches risk-based capital rules will use the standardized approach risk-weighted asset calculations, set forth in new subpart D, when determining their risk-based capital floor. The final rule also removes existing 12 CFR part 167, appendix C (RiskBased Capital Requirements—InternalRatings-Based and Advanced Measurement Approaches) because it is being replaced with new subpart E. Finally, as described in section IV.H of this preamble, in 12 CFR 6.4(b)(5) and (c)(5) this final rule replaces the phrase ‘‘total adjusted assets’’ with the phrase ‘‘average total assets’’ in 12 CFR 6.4(b)(5) and (c)(5). The OCC may need to make additional technical and conforming amendments to other OCC rules, such as § 5.46, subordinated debt, which contains cross references to part 3 that are being changed pursuant to this final rule. The OCC intends to issue a separate rulemaking to amend other PO 00000 Frm 00132 Fmt 4701 Sfmt 4700 non-capital regulations that contain cross-references to provisions of the existing capital rules at 12 CFR part 3 and appendices A, B, or C (national banks) and 12 CFR part 167 and appendix C (Federal savings associations), as necessary, to reference the appropriate corresponding provisions of the revised rules. With the adoption of this final rule, as a result of the integration of the rules governing national banks and Federal savings association, all of part 3 will be applicable to Federal savings associations, except for subpart K (Interpretations). Thus, under the final rule, a Federal savings association will comply with redesignated subpart H (Establishment of minimum capital ratios for an individual bank or individual Federal savings association), subpart I (Enforcement), and subpart J (Issuance of a directive), rather than 12 CFR 167.3 (Individual minimum capital requirements) and 167.4 (Capital directives). The provisions of subparts H, I, and J are substantively the same as 12 CFR 167.3 and 167.4, with a few exceptions. Sections 3.402 (Applicability) and 167.3(b) (Appropriate considerations for establishing individual minimum capital requirements) both state that the OCC may require higher minimum capital ratios for an individual bank in view of its circumstances and provide examples of such circumstances. Likewise, both sections 3.403 (Standards for determining individual minimum capital ratios) and 167.3(c) (Standards for determination of appropriate minimum capital requirements) explain that the determination of the appropriate minimum capital level for an individual national bank or Federal savings association, respectively, is in part a subjective judgment based on agency expertise and these sections of the respective national bank and Federal savings association regulations provide a list factors that may be considered. The list of examples in sections 3.402 and 167.3(b) and in sections 3.403 and 167.3(c) are similar, but not identical in all respects; and consistent with the proposal, the final rule makes no change to the list of examples in sections 3.402 and 3.403. The OCC notes that, while the final rule omits some of the examples in sections 167.3(b) and (c), because the list of examples is illustrative and not exclusive, the OCC retains the ability to consider those omitted examples and all other relevant items when determining individual minimum capital requirements. The procedures in § 167.3(d) for responding to a notice of proposed E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations minimum capital ratios provide that the OCC may shorten the 30-day response period for good cause and limit good cause to three specific situations. A Federal savings association should be aware that, in addition to listing specific circumstances when the OCC may shorten the response time, the comparable provision in § 3.404(b)(1) of the final rule provides that the OCC, in its discretion, may shorten the 30-day response time. Thus, there may be additional circumstances in which the OCC may shorten the response time for a Federal savings association. Section 167.3(d)(3) (Decision) states that the OCC’s written decision on the individual minimum capital requirement with respect to a Federal savings association represents final agency action. Consistent with the proposal, § 3.404(c) (Decision) of the final rule does not include this statement. The OCC notes that inclusion of this statement is unnecessary because internal appeals of informal OCC enforcement actions, such as a decision on a Federal savings association’s minimum capital requirement, are reviewable by the OCC’s Ombudsman’s Office. Therefore, omitting this statement in § 3.404(c) will have no substantive effect. Sections 3.601 (Purpose and scope) and § 167.4(a) (Issuance of a capital directive), both of which address issuance of a capital directive, are very similar but not identical. The final rule adopts § 3.601 as proposed. In some cases § 167.4(a) includes more detail than § 3.601, and in some cases § 3.601 includes more detail than § 167.4(a). For example, § 3.601(b) states that violation of a directive may result in assessment of civil money penalties in accordance with 12 U.S.C. 3909(d), whereas § 167.4(a) does not include such a statement. However, because the International Lending Supervision Act (ILSA) applies to Federal savings associations and 12 U.S.C. 3909(d) states that the violation of any rule, regulation or order issued under the ILSA may result in a civil money penalty, the OCC has concluded that inclusion of this language in § 3.601 will have no substantive impact on Federal savings associations. Furthermore, the OCC has concluded that, notwithstanding any other minor differences between § 3.601 and § 167.4(a), those changes will have no substantive impact on Federal savings associations. XV. Abbreviations ABCP Asset-Backed Commercial Paper ADC Acquisition, Development, or Construction VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 AFS Available For Sale ALLL Allowance for Loan and Lease Losses AOCI Accumulated Other Comprehensive Income AVC Asset Value Correlation BCBS Basel Committee on Banking Supervision BCBS FAQ Basel Committee on Banking Supervision Frequently Asked Questions BHC Bank Holding Company CCF Credit Conversion Factor CCP Central Counterparty CDFI Community Development Financial Institution CDS Credit Default Swap CDSind Index Credit Default Swap CEIO Credit-Enhancing Interest-Only Strip CEM Current Exposure Method CFR Code of Federal Regulations CFPB Consumer Financial Protection Bureau CFTC Commodity Futures Trading Commission CPSS Committee on Payment and Settlement Systems CRC Country Risk Classifications CUSIP Committee on Uniform Securities Identification Procedures CVA Credit Valuation Adjustment DAC Deferred Acquisition Cost DCO Derivatives Clearing Organizations DTA Deferred Tax Asset DTL Deferred Tax Liability DvP Delivery-versus-Payment E Measure of Effectiveness EAD Exposure at Default ECL Expected Credit Loss EE Expected Exposure EPE Expected Positive Exposure ERISA Employee Retirement Income Security Act of 1974 ESOP Employee Stock Ownership Plan FDIC Federal Deposit Insurance Corporation FDICIA Federal Deposit Insurance Corporation Improvement Act of 1991 FFIEC Federal Financial Institutions Examination Council FHA Federal Housing Administration FHLB Federal Home Loan Bank FHLMC Federal Home Loan Mortgage Corporation FIRREA Financial Institutions, Reform, Recovery and Enforcement Act FMU Financial Market Utility FNMA Federal National Mortgage Association FRFA Final Regulatory Flexibility Act GAAP U.S. Generally Accepted Accounting Principles GNMA Government National Mortgage Association GSE Government-Sponsored Enterprise HAMP Home Affordable Mortgage Program HOLA Home Owners’ Loan Act HTM Held-To-Maturity HVCRE High-Volatility Commercial Real Estate IFRS International Financial Reporting Standards IMM Internal Models Methodology IOSCO International Organization of Securities Commissions IRB Internal Ratings-Based IRFA Initial Regulatory Flexibility Analysis LGD Loss Given Default PO 00000 Frm 00133 Fmt 4701 Sfmt 4700 62149 LTV Loan-to-Value Ratio M Effective Maturity MBS Mortgage-backed Security MDB Multilateral Development Bank MDI Minority Depository Institution MHC Mutual Holding Company MSA Mortgage Servicing Assets NPR Notice of Proposed Rulemaking NRSRO Nationally Recognized Statistical Rating Organization OCC Office of the Comptroller of the Currency OECD Organization for Economic Cooperation and Development OMB Office of Management and Budget OTC Over-the-Counter OTS Office of Thrift Supervision PCA Prompt Corrective Action PCCR Purchased Credit Card Relationship PD Probability of Default PFE Potential Future Exposure PMI Private Mortgage Insurance PMSR Purchased Mortgage Servicing Right PRA Paperwork Reduction Act of 1995 PSE Public Sector Entities PvP Payment-versus-Payment QCCP Qualifying Central Counterparty QIS Quantitative Impact Study QM Qualified Mortgages QRE Qualifying Revolving Exposure RBA Ratings-Based Approach RBC Risk-Based Capital REIT Real Estate Investment Trust Re-REMIC Resecuritization of Real Estate Mortgage Investment Conduit RFA Regulatory Flexibility Act RTCRRI Act Resolution Trust Corporation Refinancing, Restructuring, and Improvement Act of 1991 RVC Ratio of Value Change SAP Statutory Accounting Principles SEC U.S. Securities and Exchange Commission SFA Supervisory Formula Approach SLHC Savings and Loan Holding Company SPE Special Purpose Entity SR Supervision and Regulation Letter SRWA Simple Risk-Weight Approach SSFA Simplified Supervisory Formula Approach TruPS Trust Preferred Security TruPS CDO Trust Preferred Security Collateralized Debt Obligation UMRA Unfunded Mandates Reform Act of 1995 U.S.C. United States Code VA Veterans Administration VaR Value-at-Risk VOBA Value of Business Acquired WAM Weighted Average Maturity XVI. Regulatory Flexibility Act In general, section 4 of the Regulatory Flexibility Act (5 U.S.C. 604) (RFA) requires an agency to prepare a final regulatory flexibility analysis (FRFA), for a final rule unless the agency certifies that the rule will not, if promulgated, have a significant economic impact on a substantial number of small entities (defined as of July 2, 2013, for purposes of the RFA to include banking entities with total assets of $175 million or less, and beginning on July 22, 2013, to include E:\FR\FM\11OCR2.SGM 11OCR2 62150 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations banking entities with total assets of $500 million or less). Pursuant to the RFA, the agency must make the final regulatory flexibility analysis available to members of the public and must publish the final regulatory flexibility analysis, or a summary thereof, in the Federal Register. In accordance with section 4 of the RFA, the agencies are publishing the following summary of their final regulatory flexibility analyses.208 For purposes of their respective FRFAs, the OCC analyzed the potential economic impact of the final rule on the small entities it regulates, including small national banks and small Federal savings associations; and the Board analyzed the potential economic impact on the small entities it regulates including small state member banks, small bank holding companies and small savings and loan holding companies. As discussed in more detail in section E, below, this final rule may have a significant economic impact on a substantial number of the small entities under their respective jurisdictions. Accordingly, the agencies have prepared the following FRFA pursuant to the RFA. wreier-aviles on DSK5TPTVN1PROD with RULES2 A. Statement of the Need for, and Objectives of, the Final Rule As discussed in the SUPPLEMENTARY INFORMATION of the preamble to this final rule, the agencies are revising their regulatory capital requirements to promote safe and sound banking practices, implement Basel III and other aspects of the Basel capital framework, harmonize capital requirements across different types of insured depository institutions and depository institution holding companies, and codify capital requirements. Additionally, this final rule satisfies certain requirements under the Dodd208 Each agency published separate summaries of their initial regulatory flexibility analyses (IRFAs) with each of the proposed rules in the three NPRs in accordance with Section 3(a) of the Regulatory Flexibility Act, 5 U.S.C. 603. In the IRFAs provided in connection with the proposed rules, each agency requested comment on all aspects of the IRFAs, and, in particular, on any significant alternatives to the proposed rules applicable to covered small banking organizations that would minimize their impact on those entities. In the IRFAs provided by the OCC and the FDIC in connection with the advanced approach proposed rule, the OCC and the FDIC determined that there would not be a significant economic impact on a substantial number of small banking organizations and published a certification and a short explanatory statement pursuant to section 605(b) of the RFA. In the IRFA provided by the Board in connection with the advanced approach proposed rule, the Board provided the information required by section 603(a) of the RFA and concluded that there would not be a significant economic impact on a substantial number of small banking organizations. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 Frank Act by (1) revising regulatory capital requirements to remove all references to, and requirements of reliance on, credit ratings,209 and (2) imposing new or revised minimum capital requirements on certain insured depository institutions and depository institution holding companies.210 Under section 38(c)(1) of the Federal Deposit Insurance Act, the agencies are required to prescribe capital standards for insured depository institutions that they regulate.211 The agencies also must ‘‘cause banking institutions to achieve and maintain adequate capital by establishing minimum levels of capital for such banking institutions’’ under the International Lending Supervision Act.212 In addition, among other authorities, the Board may establish capital requirements for member banks under the Federal Reserve Act,213 for bank holding companies under the Bank Holding Company Act,214 and for savings and loan holding companies under the Home Owners Loan Act.215 B. Summary and Assessment of Significant Issues Raised by Public Comments in Response to the IRFAs, and a Statement of Changes Made as a Result of These Comments The agencies and the FDIC received three public comments directly addressing the initial regulatory flexibility analyses (IRFAs). One commenter questioned the FDIC’s assumption that risk-weighted assets would increase only 10 percent and questioned reliance on Call Report data for this assumption, as the commenter asserted that existing Call Report data does not contain the information required to accurately analyze the proposal’s impact on risk-weighted assets (for example, under the Standardized Approach NPR, an increase in the risk weights for 1–4 family residential mortgage exposures that are balloon mortgages). The commenters also expressed general concern that the agencies and the FDIC were underestimating the compliance cost of the proposed rules. For instance, one commenter questioned whether small banking organizations would have the information required to determine the applicable risk weights for residential mortgage exposures, and stated that the cost of applying the proposed standards to existing 209 See 15 U.S.C. 78o–7, note. 12 U.S.C. 5371. 211 See 12 U.S.C. 1831o(c). 212 See 12 U.S.C. 3907. 213 See 12 U.S.C. 321–338. 214 See 12 U.S.C. 1844. 215 See 12 U.S.C 1467a(g)(1). 210 See PO 00000 Frm 00134 Fmt 4701 Sfmt 4700 exposures was underestimated. Another commenter stated that the agencies and the FDIC did not adequately consider the additional costs relating to new reporting systems, assimilating data, and preparing reports required under the proposed rules. To measure the potential impact on small entities for the purposes of their respective IRFAs, the agencies used the most current regulatory reporting data available and, to address information gaps, they applied conservative assumptions. The agencies considered the comments they received on the potential impact of the proposed rules, and, as discussed in Item F, below, made significant revisions to the final rule in response to the concerns expressed regarding the potential burden on small banking organizations. Commenters expressed concern that the agencies and the FDIC did not use a uniform methodology for conducting their IRFAs and suggested that the agencies and the FDIC should have compared their analyses prior to publishing the proposed rules. The agencies and the FDIC coordinated closely in conducting the IRFAs to maximize consistency among the methodologies used for determining the potential impact on the entities regulated by each agency. However, the agencies and the FDIC prepared the individual analyses in recognition of the differences among the organizations that each agency supervises. In preparing their respective FRFAs, the agencies and the FDIC continued to coordinate closely in order to ensure maximum consistency and comparability. One commenter questioned the alternatives described in the IRFAs. This commenter asserted that the alternatives were counter-productive and added complexity to the capital framework without any meaningful benefit. As discussed throughout the preamble and in Item F, below, the agencies have responded to commenters’ concerns and sought to mitigate the potential compliance burden on community banking organizations throughout the final rule. The agencies and the FDIC also received a number of more general comments regarding the overall burden of the proposed rules. For example, many commenters expressed concern that the complexity and implementation cost of the proposed rules would exceed the expected benefit. According to these commenters, implementation of the proposed rules would require software upgrades for new internal reporting systems, increased employee training, and the hiring of additional employees for compliance purposes. E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 A few commenters also urged the agencies and the FDIC to recognize that compliance costs have increased significantly over recent years due to other regulatory changes. As discussed throughout the preamble and in Item F, below, the agencies recognize the potential compliance costs associated with the proposals. Accordingly, for purposes of the final rule the agencies modified certain requirements of the proposals, such as the proposed mortgage treatment, to help to reduce the compliance burden on small banking organizations. C. Response to Comments Filed by the Chief Counsel for Advocacy of the Small Business Administration, and Statement of Changes Made as a Result of the Comment The Chief Counsel for Advocacy of the Small Business Administration (CCA) filed a letter with the agencies and the FDIC providing comments on the proposed rules. The CCA generally commended the agencies and the FDIC for the IRFAs provided with the proposed rules, and specifically commended the agencies and the FDIC for considering the cumulative economic impact of the proposals on small banking organizations. The CCA acknowledged that the agencies and the FDIC provided lists of alternatives being considered, but encouraged the agencies and the FDIC to provide more detailed discussion of these alternatives and the potential burden reductions associated with the alternatives. The CCA acknowledged that the OCC and the FDIC had certified that the advanced approaches proposed rule would not have a significant economic impact on a substantial number of small banking organizations. The CCA noted that the Board did not provide such a certification for the advanced approaches proposed rule and suggested that the Board either provide the certification for the advanced approaches proposed rule or publish a more detailed IRFA, if public comments indicated that the advanced approaches proposed rule would have a significant economic impact on a substantial number of small banking organizations. The CCA encouraged ‘‘the agencies to allow small banks to continue under the current framework of Basel I.’’ The CCA also urged the agencies and the FDIC to give careful consideration to comments discussing the impact of the proposed rules on small financial institutions and to analyze possible alternatives to reduce this impact. The CCA expressed concern that aspects of the proposals could be problematic and onerous for small VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 62151 community banking organizations. The CCA stated that the proposed rules were designed for large, international banks and not adapted to the circumstances of community banking organizations. Specifically, the CCA expressed concern over higher risk weights for certain products, which, the CCA argued, could drive community banking organizations into products carrying additional risks. The CCA also noted heightened compliance and technology costs associated with implementing the proposed rules and raised the possibility that community banking organizations may exit the mortgage market. Although the new regulatory capital framework will carry costs, the supervisory interest in improved and uniform capital standards at the level of individual banking organizations, as well as the expected improvements in the safety and soundness of the U.S. banking system, should outweigh the increased burden on small banking organizations. The agencies carefully considered all comments received and, in particular, the comments that addressed the potential impact of the proposed rules on small banking organizations. As discussed throughout the preamble and in Item F below, the agencies have made significant revisions to the proposed rules that address the concerns raised in the CCA’s comment, including with respect to the treatment of AOCI, trust preferred securities issued by depository holding companies with less than $15 billion in total consolidated assets as of December 31, 2009, and mortgages. rule does not apply to small bank holding companies that are not engaged in significant nonbanking activities, do not conduct significant off-balance sheet activities, and do not have a material amount of debt or equity securities outstanding that are registered with the SEC. These small bank holding companies remain subject to the Board’s Small Bank Holding Company Policy Statement.218 Small state member banks and small savings and loan holding companies would be subject to the proposals in this rule. Under the $175 million threshold, as of December 31, 2012, the OCC regulates 737 small entities. Under the $500 million threshold, the OCC regulates 1,291 small entities.219 D. Description and Estimate of Small Entities Affected by the Final Rule December 31, 2012, there were approximately 2,259 small bank holding companies and approximately 145 small savings and loan holding companies. 218 See 12 CFR part 225, appendix C. Section 171 of the Dodd-Frank provides an exemption from its requirements for bank holding companies subject to the Small Bank Holding Company Policy Statement (as in effect on May 19, 2010). Section 171 does not provide a similar exemption for small savings and loan holding companies and they are therefore subject to the proposals. 12 U.S.C. 5371(b)(5)(C). 219 The OCC has calculated the number of small entities based on the SBA’s size thresholds for commercial banks and savings institutions, and trust companies. Consistent with the General Principles of Affiliation 13 CFR § 121.103(a), the OCC counts the assets of affiliated financial institutions when determining if the OCC should classify a bank the OCC supervises as a small entity. The OCC used December 31, 2012 to determine size because a ‘‘financial institution’s assets are determined by averaging the assets reported on its four quarterly financial statements for the preceding year.’’ See footnote 8 of the U.S. Small Business Administration’s Table of Size Standards. 220 Banking organizations subject to the advanced approaches rules also would be required in 2018 to achieve a minimum tier 1 capital to total leverage exposure ratio (the supplementary leverage ratio) of 3 percent. Advanced approaches banking organizations should refer to section 10 of subpart Under regulations issued by the Small Business Administration, a small entity includes a depository institution, bank holding company, or savings and loan holding company with total assets of $175 million or less and beginning July 22, 2013, total assets of $500 million or less (a small banking organization).216 As of March 31, 2013, the Board supervised approximately 636 small state member banks. As of December 31, 2012, there were approximately 3,802 small bank holding companies and approximately 290 small savings and loan holding companies.217 The final 216 See 13 CFR 121.201. Effective July 22, 2013, the Small Business Administration revised the size standards for banking organizations to $500 million in assets from $175 million in assets. 78 FR 37409 (June 20, 2013). 217 Under the prior Small Business Administration threshold of $175 million in assets, as of March 31, 2013 the Board supervised approximately 369 small state member banks. As of PO 00000 Frm 00135 Fmt 4701 Sfmt 4700 E. Projected Reporting, Recordkeeping, and Other Compliance Requirements The final rule may impact covered small banking organizations in several ways. The final rule affects covered small banking organizations’ regulatory capital requirements by changing the qualifying criteria for regulatory capital, including mandatory deductions and adjustments, and modifying the risk weight treatment for some exposures. The rule also requires covered small banking organizations to meet a new minimum common equity tier 1 to riskweighted assets ratio of 4.5 percent and an increased minimum tier 1 capital to risk-weighted assets risk-based capital ratio of 6 percent. Under the final rule, all banking organizations would remain subject to a minimum tier 1 leverage ratio of no more than 4 percent and an 8 percent total capital ratio.220 The rule E:\FR\FM\11OCR2.SGM Continued 11OCR2 62152 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations imposes limitations on capital distributions and discretionary bonus payments for covered small banking organizations that do not hold a buffer of common equity tier 1 capital above the minimum ratios. For those covered small banking organizations that do not engage in securitization activities, derivatives activities, and do not have exposure to foreign sovereigns or equities, there would be limited changes to the way these small banking organizations are required to calculate risk-weighted assets. For these organizations, the only two risk weights that would change are those that relate to past due exposures and acquisition and development real estate loans. The final rule includes other changes to the general risk-based capital requirements that address the calculation of risk-weighted assets: • Provides a more risk-sensitive approach to exposures to non-U.S. sovereigns and non-U.S. public sector entities; • Replaces references to credit ratings with new measures of creditworthiness; • Provides more comprehensive recognition of collateral and guarantees; and • Provides a more favorable capital treatment for transactions cleared through qualifying central counterparties.221 As a result of the new requirements, some covered small banking organizations may have to alter their capital structure (including by raising new capital or increasing retention of earnings) in order to achieve the new minimum capital requirements and avoid restrictions on distributions of capital and discretionary bonus payments. The agencies have excluded from this analysis any burden associated with changes to the Consolidated Reports of Income and Condition for banks (FFIEC 031 and 041; OMB Nos. 7100–0036, wreier-aviles on DSK5TPTVN1PROD with RULES2 B of the proposed rule and section II.B of the preamble for a more detailed discussion of the applicable minimum capital ratios. 221 Section 939A of the Dodd-Frank Act requires federal agencies to remove references to credit ratings from regulations and replace credit ratings with appropriate alternatives. The final rule introduces alternative measures of creditworthiness for foreign debt, securitization positions, and resecuritization positions. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 3064–0052, 1557–0081), the Financial Statements for Bank Holding Companies (FR Y–9; OMB No. 7100–0128), and the Capital Assessments and Stress Testing information collection (FR Y–14A/Q/M; OMB No. 7100–0341). The agencies are proposing information collection changes to reflect the requirements of the final rule, and are publishing separately for comment on the regulatory reporting requirements that will include associated estimates of burden. Further analysis of the projected reporting requirements imposed by the final rule is located in the Paperwork Reduction Act section, below. The agencies estimate that managerial/technical, senior management, legal counsel, and administrative/junior analyst skills will be necessary for the preparation of reports and records related to this final rule. Board To estimate the cost of capital needed to comply with the final rule, the Board estimated common equity tier 1, tier 1, and total risk-based capital as defined under the more stringent eligibility standards for capital instruments. The Board also adjusted risk-weighted assets for each banking organization to estimate the impact of compliance with the changes under final rule and then compared each banking organization’s risk-based capital ratios to the higher minimums required under the final rule. If a banking organization’s new measure of capital under the final rule would not meet the minimums required for ‘‘adequately-capitalized’’ under the final rule, the Board considered that difference to be a ‘‘shortfall’’, or the amount of capital that a banking organization would need to raise in order to comply with the rule.222 To estimate each small state member bank’s capital risk-based capital ratios under the final rule, the Board used currently available data from the 222 The Board’s analysis assumed that the changes included in the final rule were on a fully phasedin basis. In addition, for the purposes of this analysis, banking organizations that did not meet the minimum requirements (undercapitalized institutions) under the current rules were excluded in order to isolate the effect of the rule on institutions that were otherwise adequately or wellcapitalized. PO 00000 Frm 00136 Fmt 4701 Sfmt 4700 quarterly Call Reports. The Board arrived at estimates of the new numerators of the capital ratios by combining various regulatory reporting items to reflect definitional changes to common equity tier 1 capital, tier 1 capital, and total capital as described in the final rule. The capital ratio denominator, risk-weighted assets, will also change under the final rule. The uniqueness of each institution’s asset portfolio will cause the direction and extent of the change in the denominator to vary from institution to institution. The Board, however, was able to arrive at a reasonable proxy for risk-weighted assets under the standardized approach in the final rule by using information that is in the Call Reports. In particular, the Board adjusted foreign exposures, high volatility commercial real estate, past-due loans, and securitization exposures to account for new risk weights under the final rule. Using the estimates of the new capital levels and standardized risk-weighted assets under the final rule, the Board estimated the capital shortfall each banking organization would encounter if the rule was fully phased in, as discussed above. Table 27 shows the Board’s estimates of the number of state member banks that would not meet the minimum capital requirements according to Call Report data as of March 30, 2013. This table also shows the projected Basel III capital shortfall for those banking organizations were the final rule fully implemented. Because institutions must simultaneously meet all of the minimum capital requirements, the largest shortfall amount represents our estimate of the amount of capital Board-regulated banking organizations will need to accumulate to meet new minimum capital requirements under the final rule, fully implemented. Because SLHCs are not currently subject to regulatory capital reporting requirements, the Board is unable to use reporting information (as was done for small state member banks) to estimate capital and risk-weighted assets under the final rule for small SLHCs. Therefore, this analysis does not include an estimation of the capital shortfall for small SLHCs. E:\FR\FM\11OCR2.SGM 11OCR2 62153 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations TABLE 27—PROJECTED NUMBER OF SMALL STATE MEMBER BANKS WITH LESS THAN $500 MILLION IN TOTAL ASSETS A BASEL III CAPITAL SHORTFALL AND $ AMOUNT OF BASEL III CAPITAL SHORTFALL UNDER THE STANDARDIZED APPROACH, FULLY PHASED-IN Projected number of state member banks with Basel III capital shortfall (fully phased-in) Projected Basel III capital shortfall for state member banks (fully phased-in) 0 0 9 $0 0 11.3 Common Equity Tier 1 to Risk-weighted Assets ............................. Tier 1 to Risk-weighted Assets ........................................................ Minimum Total Capital + Conservation Buffer ................................ As shown in Table 27, the Board estimates that all small state member banks that meet the minimum requirements under the current rules will meet both the new common equity tier 1 minimum of 4.5 percent and the 6 percent minimum for tier 1 capital. The Board estimates that nine small state member banks will need to increase capital by a combined $11.3 million by January 1, 2019 in order to meet the minimum total capital, including conservation buffer.223 To estimate the cost to small state member banks of the new capital requirement, the Board examined the effect of this requirement on capital structure and the overall cost of capital.224 The cost of financing a bank or any firm is the weighted average cost of its various financing sources, which amounts to a weighted average cost of capital reflecting many different types of debt and equity financing. Because interest payments on debt are tax deductible, a more leveraged capital structure reduces corporate taxes, thereby lowering funding costs, and the weighted average cost of financing tends to decline as leverage increases. Thus, an increase in required equity capital would force a bank to deleverage and— all else equal—would increase the cost of capital for that bank. This increased cost in the most burdensome year would be tax benefits foregone: The capital requirement ($11.3 million), multiplied by the interest rate on the debt displaced and by the effective marginal tax rate for the banks affected by the final rule. The effective marginal corporate tax rate is affected not only by the statutory federal and state rates, but also by the probability of positive earnings and the offsetting effects of personal taxes on required bond yields. Graham (2000) considers these factors and estimates a median marginal tax benefit of $9.40 per $100 of interest. Using an estimated interest rate on debt of 6 percent, the Board estimated that the annual tax benefits foregone on $11.3 million of capital switching from debt to equity is approximately $6,391 per year ($1.08 million * 0.06 (interest rate) * 0.094 (median marginal tax savings)).225 On average, the cost is approximately $710 per small state member bank per year.226 As shown in Table 28, the Board also estimated that the cost of implementing the creditworthiness in the final rule will be approximately $27.3 million for small state member banks. For the nine small state member banks that also have to raise additional capital, the Board estimates that the cost of the final rule will be approximately $43,710. For all other small state member banks, the Board estimated the cost of the final rule as $43,000 per institution.227 TABLE 28—ESTIMATED COSTS OF CREDITWORTHINESS MEASUREMENT ACTIVITIES FOR STATE MEMBER BANKS WITH LESS THAN $500 MILLION IN TOTAL ASSETS Institution Number of institutions Estimated hours per institution Estimated cost per institution Estimated cost Small state member banks (assets < $500 million) ................ 636 505 $42,925 $27,300,300 wreier-aviles on DSK5TPTVN1PROD with RULES2 Because the Board has followed phased-in approach to reporting requirements for savings and loan holding companies, the Board does not possess the same detailed financial information on small savings and loan holding companies as it possesses regarding other small banking organizations. The Board, however, sought comment on the potential impact of the proposed requirements on small savings and loan holding companies. Several commenters expressed concern that the Federal Reserve’s Small Bank Holding Company Policy Statement does not apply to savings and loan holding companies with total consolidated assets less than $500 million. These commenters noted that small savings and loan holding companies presently do not have capital structures that would allow them to comply with the requirements of the Basel III proposal and requested that the Small Bank Holding Company Policy exemption be extended to small savings and loan holding companies. 223 The Board estimates that under the Small Business Administration’s prior $175 million asset threshold, all small state member banks that meet the minimum requirements under the current rules will meet both the new common equity tier 1 minimum of 4.5 percent and the 6 percent minimum for tier 1 capital. The Board estimates that two small state member banks will need to increase capital by a combined $1.08 million by January 1, 2019 in order to meet the minimum total capital, including conservation buffer. 224 See Merton H. Miller, (1995), ‘‘Do the M & M propositions apply to banks?’’ Journal of Banking & Finance, Vol. 19, pp. 483–489. 225 See John R. Graham, (2000), How Big Are the Tax Benefits of Debt?, Journal of Finance, Vol. 55, No. 5, pp. 1901–1941. Graham points out that ignoring the offsetting effects of personal taxes would increase the median marginal tax rate to $31.5 per $100 of interest. 226 The Board estimates that under the Small Business Administration’s prior $175 million asset threshold, that the annual tax benefits foregone on $1.08 million of capital switching from debt to equity is approximately $610 per year ($1.08 million * 0.06 (interest rate) * 0.094 (median marginal tax savings)). On average, the cost is approximately $305 per small state member bank per year under the $175 million threshold. 227 The Board estimates that under the Small Business Administration’s prior $175 million asset threshold, the cost of implementing the creditworthiness in the final rule will be approximately $15.8 million for small state member banks (369 institutions * $42,925 cost per institution). For the two small state member banks that also have to raise additional capital, the Board estimates that the cost of the final rule will be approximately $43,305. For all other small state member banks, the Board estimated the cost of the final rule as $43,000 per institution. VerDate Mar<15>2010 14:37 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00137 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 62154 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations For small savings and loan holding companies, the compliance burdens described above may be greater than for those of other covered small banking organizations. Small savings and loan holding companies previously have not been subject to regulatory capital requirements and reporting requirements tied regulatory capital requirements. Small savings and loan holding companies may therefore need to invest additional resources in establishing internal systems (including purchasing software or hiring new personnel or training existing personnel) or raising capital to achieve compliance with the new minimum capital requirements and avoid restrictions on distributions of capital and discretionary bonus payments the requirements of the final rule. Covered small banking organizations that would have to raise additional capital to comply with the requirements of the proposals may incur certain costs, including costs associated with issuance of regulatory capital instruments. The agencies have sought to minimize the burden of raising additional capital by providing for transitional arrangements that phase-in the new capital requirements over several years, allowing banking organizations time to accumulate additional capital through retained earnings as well as raising capital in the market. While the final rule establishes a narrower definition of regulatory capital—in the form of a minimum common equity tier 1 capital ratio, a higher minimum tier 1 capital ratio, and more stringent limitations on and deductions from capital—the vast majority of capital instruments currently held by small covered banking organizations, such as common stock and noncumulative perpetual preferred stock, would remain eligible as regulatory capital instruments under the proposed requirements. OCC To estimate the cost of capital needed to comply with the final rule, the OCC estimated common equity tier 1, tier 1, and total risk-based capital as defined under the more stringent eligibility standards for capital instruments. The OCC also adjusted risk-weighted assets for each banking organization to estimate the impact of compliance with the changes under final rule and then compared each banking organization’s risk-based capital ratios to the higher minimums required under the final rule. If a banking organization’s new measure of capital under the final rule would not meet the minimums required for ‘‘adequately-capitalized’’ under the final rule, the OCC considered that difference to be a ‘‘shortfall’’, or the amount of capital that a banking organization would need to raise in order to comply with the rule.228 To estimate each national bank or federal savings association’s capital riskbased capital ratios under the final rule, the OCC used currently available data from the quarterly Call Reports. The OCC arrived at estimates of the new numerators of the capital ratios by combining various regulatory reporting items to reflect definitional changes to common equity tier 1 capital, tier 1 capital, and total capital as described in the final rule. The capital ratio denominator, risk-weighted assets, will also change under the final rule. The uniqueness of each institution’s asset portfolio will cause the direction and extent of the change in the denominator to vary from institution to institution. The OCC, however, was able to arrive at a reasonable proxy for risk-weighted assets under the standardized approach in the final rule by using information that is in the Call Reports. In particular, the OCC adjusted foreign exposures, high volatility commercial real estate, past-due loans, and securitization exposures to account for new risk weights under the final rule. Using the estimates of the new capital levels and standardized risk-weighted assets under the final rule, the OCC estimated the capital shortfall each banking organization would encounter if the rule was fully phased in, as discussed above. Table 29 shows the OCC’s estimates of the number of small national banks and federal savings associations that would not meet the minimum capital requirements according to Call Report data as of March 31, 2013. Table 30, which also uses Call Report Data as of March 31, 2013, shows the projected Basel III capital shortfalls for those banking organizations during the final rule phase-in periods. Because institutions must simultaneously meet all of the minimum capital requirements, the largest shortfall amount represents our estimate of the amount of capital small OCC-regulated banking organizations will need to accumulate to meet new minimum capital requirements under the final rule, fully implemented. TABLE 29—PROJECTED CUMULATIVE NUMBER OF INSTITUTIONS SHORT OF BASEL III CAPITAL TRANSITION SCHEDULE, OCC-REGULATED INSTITUTIONS WITH CONSOLIDATED BANKING ASSETS OF $500 MILLION OR LESS, MARCH 31, 2013 Mar. 31, 2013 wreier-aviles on DSK5TPTVN1PROD with RULES2 Common Equity to Risk-Weighted Assets ................. Tier 1 to RiskWeighted Assets Minimum Total Capital + Conservation Buffer ........... Jan. 1, 2014 13:14 Oct 10, 2013 Jan. 1, 2016 (PCA) Jan. 1, 2017 Jan. 1, 2018 Jan. 1, 2019 3 8 13 22 22 22 22 7 14 17 31 31 31 31 23 ........................ ........................ 25 28 33 41 228 The OCC’s analysis assumed that the changes included in the final rule were on a fully phasedin basis. In addition, for the purposes of this VerDate Mar<15>2010 Jan. 1, 2015 Jkt 232001 analysis, the amount of additional capital necessary for a banking organization that is currently undercapitalized to meet the current requirements PO 00000 Frm 00138 Fmt 4701 Sfmt 4700 was excluded in order to isolate the effect of the final rule from the requirements of the current rules. E:\FR\FM\11OCR2.SGM 11OCR2 62155 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations TABLE 30—PROJECTED CUMULATIVE BASEL III CAPITAL SHORTFALL, OCC-REGULATED INSTITUTIONS WITH CONSOLIDATED BANKING ASSETS OF $500 MILLION OR LESS, ($ IN MILLIONS) MARCH 31, 2013 Mar. 31, 2013 Common Equity to Risk-Weighted Assets ................. Tier 1 to RiskWeighted Assets Minimum Total Capital + Conservation Buffer ........... Jan. 1, 2014 Jan. 1, 2015 Jan. 1, 2016 (PCA) Jan. 1, 2017 Jan. 1, 2018 Jan. 1, 2019 $13.0 $33.1 $40.0 $84.9 $84.9 $84.9 $84.9 20.9 45.5 56.5 114.9 114.9 114.9 114.9 67.3 ........................ ........................ 86.7 102.9 134.0 163.6 The OCC estimates that 41 small national banks and federal savings associations will need to increase capital by a combined $163.6 million by January 1, 2019 in order to meet the minimum total capital, including conservation buffer.229 To estimate the cost to small national banks and federal savings associations of the new capital requirement, the OCC examined the effect of this requirement on capital structure and the overall cost of capital.230 The cost of financing a bank or any firm is the weighted average cost of its various financing sources, which amounts to a weighted average cost of capital reflecting many different types of debt and equity financing. Because interest payments on debt are tax deductible, a more leveraged capital structure reduces corporate taxes, thereby lowering funding costs, and the weighted average cost of financing tends to decline as leverage increases. Thus, an increase in required equity capital would force a bank to deleverage and— all else equal—would increase the cost of capital for that bank. This increased cost in the most burdensome year would be tax benefits foregone: The capital requirement ($163.6 million), multiplied by the interest rate on the debt displaced and by the effective marginal tax rate for the banks affected by the final rule. The effective marginal corporate tax rate is affected not only by the statutory federal and state rates, but also by the probability of positive earnings and the offsetting effects of personal taxes on required bond yields. Graham (2000) considers these factors and estimates a median marginal tax benefit of $9.40 per $100 of interest. Using an estimated interest rate on debt of 6 percent, the OCC estimated that the annual tax benefits foregone on $163.6 million of capital switching from debt to equity is approximately $0.9 million per year ($163.6 million * 0.06 (interest rate) * 0.094 (median marginal tax savings)).231 On average, the cost is approximately $22,500 per small national bank and federal savings association per year.232 As shown in Table 31, the OCC also estimated that the cost of implementing the creditworthiness in the final rule will be approximately $55.4 million for small national banks and federal savings associations ($43,00 per small OCCregulated institution). For the 41 small state national banks and federal savings associations that also have to raise additional capital, the OCC estimates that the cost of the final rule will be approximately $65,500. For all other small national banks and federal savings associations, the OCC estimated the cost of the final rule as $43,000 per institution.233 TABLE 31—ESTIMATED COSTS OF CREDITWORTHINESS MEASUREMENT ACTIVITIES, OCC-REGULATED INSTITUTIONS WITH CONSOLIDATED BANKING ASSETS OF $500 MILLION OR LESS, MARCH 31, 2013 Institution Number of OCCregulated institutions Estimated hours per institution Estimated cost per institution Estimated cost Small national banks and federal savings associations .......... 1,291 505 $42,925 $55,416,175 wreier-aviles on DSK5TPTVN1PROD with RULES2 To determine if the final rule has a significant economic impact on small entities the OCC compared the estimated annual cost with annual noninterest expense and annual salaries and employee benefits for each OCC- regulated small entity. If the estimated annual cost is greater than or equal to 2.5 percent of total noninterest expense or 5 percent of annual salaries and employee benefits, the OCC classifies the impact as significant. The OCC estimates that the final rule will have a significant economic impact on 240 small OCC-regulated entities using the $500 million threshold. Following the same procedure, the final rule will have a significant economic impact on 219 229 The OCC estimates that under the Small Business Administration’s prior $175 million asset threshold, 21 small OCC-regulated institutions will need to increase capital by a combined $54.1 million by January 1, 2019, in order to meet the minimum total capital, including conservation buffer. 230 See Merton H. Miller, (1995), ‘‘Do the M & M propositions apply to banks?’’ Journal of Banking & Finance, Vol. 19, pp. 483–489. 231 See John R. Graham, (2000), How Big Are the Tax Benefits of Debt?, Journal of Finance, Vol. 55, No. 5, pp. 1901–1941. Graham points out that ignoring the offsetting effects of personal taxes would increase the median marginal tax rate to $31.5 per $100 of interest. 232 The OCC estimates that under the Small Business Administration’s prior $175 million asset threshold, 21 small OCC-regulated institutions will need to increase capital by a combined $54.1 million by January 1, 2019. The OCC estimates that the cost of lost tax benefits associated with increasing total capital by $54.1 million will be approximately $0.3 million per year ($54.1 million * 0.06 (interest rate) * 0.094 (median marginal tax savings)). On average, the cost is approximately $14,500 per institution per year under the $175 million threshold. 233 The OCC estimates that under the Small Business Administration’s prior $175 million asset threshold, the cost of implementing the creditworthiness in the final rule will be approximately $31.6 million for small national banks and federal savings associations (737 institutions * $42,925 cost per institution). For the 41 small national banks and federal savings associations that also have to raise additional capital, the OCC estimates that the cost of the final rule will be approximately $57,500. For all other small national banks and federal savings associations, the OCC estimated the cost of the final rule as $43,000 per institution. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00139 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 62156 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 small OCC-regulated entities using the $175 million threshold. Accordingly, using five percent as the threshold for a substantial number of small entities, the OCC finds that under either SBA size threshold, the final rule will have a significant economic impact on a substantial number of small entities. F. Steps Taken To Minimize the Economic Impact on Small Entities; Significant Alternatives In response to commenters’ concerns about the potential implementation burden on small banking organizations, the agencies have made several significant revisions to the proposals for purposes of the final rule, as discussed above. Under the final rule, nonadvanced approaches banking organizations will be permitted to elect to exclude amounts reported as AOCI when calculating regulatory capital, to the same extent currently permitted under the general risk-based capital rules.234 In addition, for purposes of calculating risk-weighted assets under the standardized approach, the agencies are not adopting the proposed treatment for 1–4 family residential mortgages, which would have required banking organizations to categorize residential mortgage loans into one of two categories based on certain underwriting standards and product features, and then risk weight each loan based on its loan-to-value ratio. The agencies also are retaining the 120-day safe harbor from recourse treatment for loans transferred pursuant to an early default provision. The agencies believe that these changes will meaningfully reduce the compliance burden of the final rule for small banking organizations. For instance, in contrast to the proposal, the final rule does not require banking organizations to review existing mortgage loan files, purchase new software to track loan-to-value ratios, train employees on the new risk-weight methodology, or hold more capital for exposures that would have been deemed category 2 under the proposed rule, removing the proposed distinction between risk weights for category 1 and 2 residential mortgage exposures. Similarly, the option to elect to retain the current treatment of AOCI will reduce the burden associated with managing the volatility in regulatory capital resulting from changes in the value of a banking organization’s AFS debt securities portfolio due to shifting 234 For most non-advanced approaches banking organizations, this will be a one-time only election. However, in certain limited circumstances, such as a merger of organizations that have made different elections, the primary Federal supervisory may permit the resultant entity to make a new election. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 interest rate environments. Additionally, the final rule grandfathers the regulatory capital treatment of trust preferred securities issued by certain small banking organizations prior to May 19, 2010, as permitted by section 171 of the Dodd-Frank Act, to reduce the amount of capital small banking organizations must raise to comply with the final rule. These modifications to the proposed rule should substantially reduce compliance burden for small banking organizations. This Supplementary Information section includes statements of factual, policy, and legal reasons for selecting alternatives adopted in this final rule and why each one of the other significant alternatives to the final rule considered by the agencies and which affect small entities was rejected. XVII. Paperwork Reduction Act In accordance with the requirements of the Paperwork Reduction Act (PRA) of 1995 (44 U.S.C. 3501–3521), the agencies may not conduct or sponsor, and the respondent is not required to respond to, an information collection unless it displays a currently valid Office of Management and Budget (OMB) control number. In conjunction with the proposed rules, the OCC and FDIC submitted the information collection requirements contained therein to OMB for review. In response, OMB filed comments with the OCC and FDIC in accordance with 5 CFR 1320.11(c) withholding PRA approval and instructing that the collection should be resubmitted to OMB at the final rule stage. As instructed by OMB, the information collection requirements contained in this final rule have been submitted by the OCC and FDIC to OMB for review under the PRA, under OMB Control Nos. 1557–0234 and 3064–0153. In accordance with the PRA (44 U.S.C. 3506; 5 CFR part 1320, Appendix A.1), the Board has reviewed the final rule under the authority delegated by OMB. The Board’s OMB Control No. is 7100– 0313. The final rule contains information collection requirements subject to the PRA. They are found in sections l.3, l.22, l.35, l.37, l.41, l.42, l.62, l.63 (including tables), l.121 through l.124, l.132, l.141, l.142, l.153, l.173 (including tables). The information collection requirements contained in sections l.203 through l.212 concerning market risk are approved by OMB under Control Nos. 1557–0247, 7100–0314, and 3064–0178. A total of nine comments were received concerning paperwork. Seven expressed concern regarding the PO 00000 Frm 00140 Fmt 4701 Sfmt 4700 increase in paperwork resulting from the rule. They addressed the concept of paperwork generally and not within the context of the PRA. One comment addressed cost, competitiveness, and qualitative impact statements, and noted the lack of cost estimates. It was unclear whether the commenter was referring to cost estimates for regulatory burden, which are included in the preamble to the rule, or cost estimates regarding the PRA burden, which are included in the submissions (information collection requests) made to OMB by the agencies regarding the final rule. All of the agencies’ submissions are publicly available at www.reginfo.gov. One commenter seemed to indicate that the agencies’ and the FDIC’s burden estimates are overstated. The commenter stated that, for their institution, the PRA burden will parallel that of interest rate risk (240 hours per year). The agencies’ estimates far exceed that figure, so no change to the estimates would be necessary. The agencies’ continue to believe that their estimates are reasonable averages that are not overstated. The agencies have an ongoing interest in your comments. Comments are invited on: (a) Whether the collection of information is necessary for the proper performance of the agencies’ functions, including whether the information has practical utility; (b) The accuracy of the estimates of the burden of the information collection, including the validity of the methodology and assumptions used; (c) Ways to enhance the quality, utility, and clarity of the information to be collected; (d) Ways to minimize the burden of the information collection on respondents, including through the use of automated collection techniques or other forms of information technology; and (e) Estimates of capital or start-up costs and costs of operation, maintenance, and purchase of services to provide information. XVIII. Plain Language Section 722 of the Gramm-LeachBliley Act requires the Federal banking agencies to use plain language in all proposed and rules published after January 1, 2000. The agencies have sought to present the proposed rule in a simple and straightforward manner and did not receive any comments on the use of plain language. E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations XIX. OCC Unfunded Mandates Reform Act of 1995 Determinations l.3 Section 202 of the Unfunded Mandates Reform Act of 1995 (UMRA) (2 U.S.C. 1532 et seq.) requires that an agency prepare a written statement before promulgating a rule that includes a Federal mandate that may result in the expenditure by State, local, and Tribal governments, in the aggregate, or by the private sector of $100 million or more (adjusted annually for inflation) in any one year. If a written statement is required, the UMRA (2 U.S.C. 1535) also requires an agency to identify and consider a reasonable number of regulatory alternatives before promulgating a rule and from those alternatives, either select the least costly, most cost-effective or least burdensome alternative that achieves the objectives of the rule, or provide a statement with the rule explaining why such an option was not chosen. Under this rule, the changes to minimum capital requirements include a new common equity tier 1 capital ratio, a higher minimum tier 1 capital ratio, a supplementary leverage ratio for advanced approaches banks, new thresholds for prompt corrective action purposes, a new capital conservation buffer, and a new countercyclical capital buffer for advanced approaches banks. To estimate the impact of this rule on bank capital needs, the OCC estimated the amount of capital banks will need to raise to meet the new minimum standards relative to the amount of capital they currently hold. To estimate new capital ratios and requirements, the OCC used currently available data from banks’ quarterly Consolidated Reports of Condition and Income (Call Reports) to approximate capital under the proposed rule. Most banks have raised their capital levels well above the existing minimum requirements and, after comparing existing levels with the proposed new requirements, the OCC has determined that its proposed rule will not result in expenditures by State, local, and Tribal governments, or by the private sector, of $100 million or more. Accordingly, the UMRA does not require that a written statement accompany this rule. Subpart B—Capital Ratio Requirements and Buffers l.10 Minimum capital requirements. l.11 Capital conservation buffer and countercyclical capital buffer amount. l.12 through l.19 [RESERVED] wreier-aviles on DSK5TPTVN1PROD with RULES2 Text of Common Rule Part [ll]—CAPITAL ADEQUACY OF [BANK]s Sec. Subpart A—General Provisions l.1 Purpose, applicability, reservations of authority, and timing. l.2 Definitions. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 Operational requirements for certain exposures. l.4 through l.9 [RESERVED] Subpart C—Definition of Capital l.20 Capital components and eligibility criteria for regulatory capital instruments. l.21 Minority interest. l.22 Regulatory capital adjustments and deductions. l.23 through l.29 [RESERVED] Subpart D—Risk-weighted Assets— Standardized Approach l.30 Applicability. Risk-Weighted Assets for General Credit Risk l.31 Mechanics for calculating riskweighted assets for general credit risk. l.32 General risk weights. l.33 Off-balance sheet exposures. l.34 OTC derivative contracts. l.35 Cleared transactions. l.36 Guarantees and credit derivatives: Substitution treatment. l.37 Collateralized transactions. Risk-Weighted Assets for Unsettled Transactions l.38 Unsettled transactions. l.39 through l.40 [RESERVED] Risk-Weighted Assets for Securitization Exposures l.41 Operational requirements for securitization exposures. l.42 Risk-weighted assets for securitization exposures. l.43 Simplified supervisory formula approach (SSFA) and the gross-up approach. l.44 Securitization exposures to which the SSFA and gross-up approach do not apply. l.45 Recognition of credit risk mitigants for securitization exposures. l.46 through l.50 [RESERVED] Risk-Weighted Assets for Equity Exposures l.51 Introduction and exposure measurement. l.52 Simple risk-weight approach (SRWA). l.53 Equity exposures to investment funds. l.54 through l.60 [RESERVED] Disclosures l.61 Purpose and scope. l.62 Disclosure requirements. l.63 Disclosures by [BANK]s described in § l.61. l.64 through l.99 [RESERVED] Subpart E—Risk-Weighted Assets—Internal Ratings-Based and Advanced Measurement Approaches l.100 Purpose, applicability, and principle of conservatism. PO 00000 Frm 00141 Fmt 4701 Sfmt 4700 l.101 Definitions. l.102 through l.120 62157 [RESERVED] Qualification l.121 Qualification process. l.122 Qualification requirements. l.123 Ongoing qualification. l.124 Merger and acquisition transitional arrangements. l.125 through l.130 [RESERVED] Risk-Weighted Assets For General Credit Risk l.131 Mechanics for calculating total wholesale and retail risk-weighted assets. l.132 Counterparty credit risk of repo-style transactions, eligible margin loans, and OTC derivative contracts. l.133 Cleared transactions. l.134 Guarantees and credit derivatives: PD substitution and LGD adjustment approaches. l.135 Guarantees and credit derivatives: Double default treatment. l.136 Unsettled transactions. l.137 through l.140 [RESERVED] Risk-Weighted Assets for Securitization Exposures l.141 Operational criteria for recognizing the transfer of risk. l.142 Risk-weighted assets for securitization exposures. l.143 Supervisory formula approach (SFA). l.144 Simplified supervisory formula approach (SSFA). l.145 Recognition of credit risk mitigants for securitization exposures. l.146 through l.150 [RESERVED] Risk-Weighted Assets For Equity Exposures l.151 Introduction and exposure measurement. l.152 Simple risk weight approach (SRWA). l.153 Internal models approach (IMA). l.154 Equity exposures to investment funds. l.155 Equity derivative contracts. l.166 through l.160 [RESERVED] Risk-Weighted Assets For Operational Risk l.161 Qualification requirements for incorporation of operational risk mitigants. l.162 Mechanics of risk-weighted asset calculation. l.163 through l.170 [RESERVED] Disclosures l.171 Purpose and scope. l.172 Disclosure requirements. l.173 Disclosures by certain advanced approaches [BANKS]. l.174 through l.200 [RESERVED] Subpart F—Risk-weighted Assets—Market Risk l.201 Purpose, applicability, and reservation of authority. l.202 Definitions. l.203 Requirements for application of this subpart F. l.204 Measure for market risk. l.205 VaR-based measure. E:\FR\FM\11OCR2.SGM 11OCR2 62158 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations l.206 Stressed VaR-based measure. l.207 Specific risk. l.208 Incremental risk. l.209 Comprehensive risk. l.210 Standardized measurement method for specific risk. l.211 Simplified supervisory formula approach (SSFA). l.212 Market risk disclosures. l.213 through l.299 [RESERVED] Subpart G—Transition Provisions l.300 Transitions. Subpart A—General Provisions wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.1 Purpose, applicability, reservations of authority, and timing. (a) Purpose. This [PART] establishes minimum capital requirements and overall capital adequacy standards for [BANK]s. This [PART] includes methodologies for calculating minimum capital requirements, public disclosure requirements related to the capital requirements, and transition provisions for the application of this [PART]. (b) Limitation of authority. Nothing in this [PART] shall be read to limit the authority of the [AGENCY] to take action under other provisions of law, including action to address unsafe or unsound practices or conditions, deficient capital levels, or violations of law or regulation, under section 8 of the Federal Deposit Insurance Act. (c) Applicability. Subject to the requirements in paragraphs (d) and (f) of this section: (1) Minimum capital requirements and overall capital adequacy standards. Each [BANK] must calculate its minimum capital requirements and meet the overall capital adequacy standards in subpart B of this part. (2) Regulatory capital. Each [BANK] must calculate its regulatory capital in accordance with subpart C of this part. (3) Risk-weighted assets. (i) Each [BANK] must use the methodologies in subpart D of this part (and subpart F of this part for a market risk [BANK]) to calculate standardized total riskweighted assets. (ii) Each advanced approaches [BANK] must use the methodologies in subpart E (and subpart F of this part for a market risk [BANK]) to calculate advanced approaches total riskweighted assets. (4) Disclosures. (i) Except for an advanced approaches [BANK] that is making public disclosures pursuant to the requirements in subpart E of this part, each [BANK] with total consolidated assets of $50 billion or more must make the public disclosures described in subpart D of this part. (ii) Each market risk [BANK] must make the public disclosures described in subpart F of this part. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (iii) Each advanced approaches [BANK] must make the public disclosures described in subpart E of this part. (d) Reservation of authority. (1) Additional capital in the aggregate. The [AGENCY] may require a [BANK] to hold an amount of regulatory capital greater than otherwise required under this part if the [AGENCY] determines that the [BANK]’s capital requirements under this part are not commensurate with the [BANK]’s credit, market, operational, or other risks. (2) Regulatory capital elements. (i) If the [AGENCY] determines that a particular common equity tier 1, additional tier 1, or tier 2 capital element has characteristics or terms that diminish its ability to absorb losses, or otherwise present safety and soundness concerns, the [AGENCY] may require the [BANK] to exclude all or a portion of such element from common equity tier 1 capital, additional tier 1 capital, or tier 2 capital, as appropriate. (ii) Notwithstanding the criteria for regulatory capital instruments set forth in subpart C of this part, the [AGENCY] may find that a capital element may be included in a [BANK]’s common equity tier 1 capital, additional tier 1 capital, or tier 2 capital on a permanent or temporary basis consistent with the loss absorption capacity of the element and in accordance with § l.20(e). (3) Risk-weighted asset amounts. If the [AGENCY] determines that the riskweighted asset amount calculated under this part by the [BANK] for one or more exposures is not commensurate with the risks associated with those exposures, the [AGENCY] may require the [BANK] to assign a different risk-weighted asset amount to the exposure(s) or to deduct the amount of the exposure(s) from its regulatory capital. (4) Total leverage. If the [AGENCY] determines that the leverage exposure amount, or the amount reflected in the [BANK]’s reported average total consolidated assets, for an on- or offbalance sheet exposure calculated by a [BANK] under § l.10 is inappropriate for the exposure(s) or the circumstances of the [BANK], the [AGENCY] may require the [BANK] to adjust this exposure amount in the numerator and the denominator for purposes of the leverage ratio calculations. (5) Consolidation of certain exposures. The [AGENCY] may determine that the risk-based capital treatment for an exposure or the treatment provided to an entity that is not consolidated on the [BANK]’s balance sheet is not commensurate with the risk of the exposure and the relationship of the [BANK] to the entity. PO 00000 Frm 00142 Fmt 4701 Sfmt 4700 Upon making this determination, the [AGENCY] may require the [BANK] to treat the exposure or entity as if it were consolidated on the balance sheet of the [BANK] for purposes of determining the [BANK]’s risk-based capital requirements and calculating the [BANK]’s risk-based capital ratios accordingly. The [AGENCY] will look to the substance of, and risk associated with, the transaction, as well as other relevant factors the [AGENCY] deems appropriate in determining whether to require such treatment. (6) Other reservation of authority. With respect to any deduction or limitation required under this part, the [AGENCY] may require a different deduction or limitation, provided that such alternative deduction or limitation is commensurate with the [BANK]’s risk and consistent with safety and soundness. (e) Notice and response procedures. In making a determination under this section, the [AGENCY] will apply notice and response procedures in the same manner as the notice and response procedures in [12 CFR 3.404, (OCC); 12 CFR 263.202 (Board)]. (f) Timing. (1) Subject to the transition provisions in subpart G of this part, an advanced approaches [BANK] that is not a savings and loan holding company must: (i) Except as described in paragraph (f)(1)(ii) of this section, beginning on January 1, 2014, calculate advanced approaches total risk-weighted assets in accordance with subpart E and, if applicable, subpart F of this part and, beginning on January 1, 2015, calculate standardized total risk-weighted assets in accordance with subpart D and, if applicable, subpart F of this part; (ii) From January 1, 2014 to December 31, 2014: (A) Calculate risk-weighted assets in accordance with the general risk-based capital rules under [12 CFR part 3, appendix A and, if applicable, appendix B (national banks), or 12 CFR part 167 (Federal savings associations) (OCC); 12 CFR parts 208 or 225, appendix A, and, if applicable, appendix E (state member banks or bank holding companies, respectively) (Board)] 1 and substitute 1 For the purpose of calculating its general riskbased capital ratios from January 1, 2014 to December 31, 2014, an advanced approaches [BANK] shall adjust, as appropriate, its riskweighted asset measure (as that amount is calculated under [12 CFR part 3, appendix A, Sec. 3 and, if applicable, 12 CFR part 3, appendix B (national banks), or 12 CFR part 167 (Federal savings associations) (OCC); 12 CFR parts 208 and 225, and, if applicable, appendix E (state member banks or bank holding companies, respectively) (Board)] in the general risk-based capital rules) by excluding those assets that are deducted from its regulatory capital under § l.22. E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 such risk-weighted assets for standardized total risk-weighted assets for purposes of § l.10; (B) If applicable, calculate general market risk equivalent assets in accordance with [12 CFR part 3, appendix B, section 4(a)(3) (national banks) (OCC); 12 CFR parts 208 or 225, appendix E, section 4(a)(3) (state member banks or bank holding companies, respectively) (Board); and 12 CFR part 325, appendix C, section 4(a)(3) (state nonmember banks and state savings associations)] and substitute such general market risk equivalent assets for standardized market risk-weighted assets for purposes of § l.20(d)(3); and (C) Substitute the corresponding provision or provisions of [12 CFR part 3, appendix A, and, if applicable, appendix B (national banks), or 12 CFR part 167 (Federal savings associations) (OCC)); 12 CFR parts 208 or 225, appendix A, and, if applicable, appendix E (state member banks or bank holding companies, respectively) (Board)] for any reference to subpart D of this part in: § l.121(c); § l.124(a) and (b); § l.144(b); § l.154(c) and (d); § l.202(b) (definition of covered position in paragraph (b)(3)(iv)); and § l.211(b);2 (iii) Beginning on January 1, 2014, calculate and maintain minimum capital ratios in accordance with subparts A, B, and C of this part, provided, however, that such [BANK] must: (A) From January 1, 2014 to December 31, 2014, maintain a minimum common equity tier 1 capital ratio of 4 percent, a minimum tier 1 capital ratio of 5.5 percent, a minimum total capital ratio of 8 percent, and a minimum leverage ratio of 4 percent; and (B) From January 1, 2015 to December 31, 2017, an advanced approaches [BANK]: (1) Is not required to maintain a supplementary leverage ratio; and (2) Must calculate a supplementary leverage ratio in accordance with § l.10(c), and must report the calculated supplementary leverage ratio on any applicable regulatory reports. 2 In addition, for purposes of § l.201(c)(3), from January 1, 2014 to December 31, 2014, for any circumstance in which the [AGENCY] may require a [BANK] to calculate risk-based capital requirements for specific positions or portfolios under subpart D of this part, the [AGENCY] will instead require the [BANK] to make such calculations according to [12 CFR part 3, appendix A, Sec. 3, appendix A, section 3 and, if applicable, 12 CFR part 3, appendix B (national banks), or 12 CFR part 167 (Federal savings associations) (OCC); 12 CFR parts 208 and 225, appendix A and, if applicable, appendix E (state member banks or bank holding companies, respectively) (Board)]. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (2) Subject to the transition provisions in subpart G of this part, a [BANK] that is not an advanced approaches [BANK] or a savings and loan holding company that is an advanced approaches [BANK] must: (i) Beginning on January 1, 2015, calculate standardized total riskweighted assets in accordance with subpart D, and if applicable, subpart F of this part; and (ii) Beginning on January 1, 2015, calculate and maintain minimum capital ratios in accordance with subparts A, B and C of this part, provided, however, that from January 1, 2015 to December 31, 2017, a savings and loan holding company that is an advanced approaches [BANK]: (A) Is not required to maintain a supplementary leverage ratio; and (B) Must calculate a supplementary leverage ratio in accordance with § l.10(c), and must report the calculated supplementary leverage ratio on any applicable regulatory reports. (3) Beginning on January 1, 2016, and subject to the transition provisions in subpart G of this part, a [BANK] is subject to limitations on distributions and discretionary bonus payments with respect to its capital conservation buffer and any applicable countercyclical capital buffer amount, in accordance with subpart B of this part. § l.2 Definitions. As used in this part: Additional tier 1 capital is defined in § l.20(c). Advanced approaches [BANK] means a [BANK] that is described in § l.100(b)(1). Advanced approaches total riskweighted assets means: (1) The sum of: (i) Credit-risk-weighted assets; (ii) Credit valuation adjustment (CVA) risk-weighted assets; (iii) Risk-weighted assets for operational risk; and (iv) For a market risk [BANK] only, advanced market risk-weighted assets; minus (2) Excess eligible credit reserves not included in the [BANK]’s tier 2 capital. Advanced market risk-weighted assets means the advanced measure for market risk calculated under § l.204 multiplied by 12.5. Affiliate with respect to a company, means any company that controls, is controlled by, or is under common control with, the company. Allocated transfer risk reserves means reserves that have been established in accordance with section 905(a) of the International Lending Supervision Act, against certain assets whose value U.S. PO 00000 Frm 00143 Fmt 4701 Sfmt 4700 62159 supervisory authorities have found to be significantly impaired by protracted transfer risk problems. Allowances for loan and lease losses (ALLL) means valuation allowances that have been established through a charge against earnings to cover estimated credit losses on loans, lease financing receivables or other extensions of credit as determined in accordance with GAAP. ALLL excludes ‘‘allocated transfer risk reserves.’’ For purposes of this part, ALLL includes allowances that have been established through a charge against earnings to cover estimated credit losses associated with off-balance sheet credit exposures as determined in accordance with GAAP. Asset-backed commercial paper (ABCP) program means a program established primarily for the purpose of issuing commercial paper that is investment grade and backed by underlying exposures held in a bankruptcy-remote special purpose entity (SPE). Asset-backed commercial paper (ABCP) program sponsor means a [BANK] that: (1) Establishes an ABCP program; (2) Approves the sellers permitted to participate in an ABCP program; (3) Approves the exposures to be purchased by an ABCP program; or (4) Administers the ABCP program by monitoring the underlying exposures, underwriting or otherwise arranging for the placement of debt or other obligations issued by the program, compiling monthly reports, or ensuring compliance with the program documents and with the program’s credit and investment policy. Bank holding company means a bank holding company as defined in section 2 of the Bank Holding Company Act. Bank Holding Company Act means the Bank Holding Company Act of 1956, as amended (12 U.S.C. 1841 et seq.). Bankruptcy remote means, with respect to an entity or asset, that the entity or asset would be excluded from an insolvent entity’s estate in receivership, insolvency, liquidation, or similar proceeding. Call Report means Consolidated Reports of Condition and Income. Carrying value means, with respect to an asset, the value of the asset on the balance sheet of the [BANK], determined in accordance with GAAP. Central counterparty (CCP) means a counterparty (for example, a clearing house) that facilitates trades between counterparties in one or more financial markets by either guaranteeing trades or novating contracts. CFTC means the U.S. Commodity Futures Trading Commission. E:\FR\FM\11OCR2.SGM 11OCR2 62160 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 Clean-up call means a contractual provision that permits an originating [BANK] or servicer to call securitization exposures before their stated maturity or call date. Cleared transaction means an exposure associated with an outstanding derivative contract or repo-style transaction that a [BANK] or clearing member has entered into with a central counterparty (that is, a transaction that a central counterparty has accepted). (1) The following transactions are cleared transactions: (i) A transaction between a CCP and a [BANK] that is a clearing member of the CCP where the [BANK] enters into the transaction with the CCP for the [BANK]’s own account; (ii) A transaction between a CCP and a [BANK] that is a clearing member of the CCP where the [BANK] is acting as a financial intermediary on behalf of a clearing member client and the transaction offsets another transaction that satisfies the requirements set forth in § l.3(a); (iii) A transaction between a clearing member client [BANK] and a clearing member where the clearing member acts as a financial intermediary on behalf of the clearing member client and enters into an offsetting transaction with a CCP, provided that the requirements set forth in § l.3(a) are met; or (iv) A transaction between a clearing member client [BANK] and a CCP where a clearing member guarantees the performance of the clearing member client [BANK] to the CCP and the transaction meets the requirements of § l.3(a)(2) and (3). (2) The exposure of a [BANK] that is a clearing member to its clearing member client is not a cleared transaction where the [BANK] is either acting as a financial intermediary and enters into an offsetting transaction with a CCP or where the [BANK] provides a guarantee to the CCP on the performance of the client.3 Clearing member means a member of, or direct participant in, a CCP that is entitled to enter into transactions with the CCP. Clearing member client means a party to a cleared transaction associated with a CCP in which a clearing member acts either as a financial intermediary with 3 For the standardized approach treatment of these exposures, see § l.34(e) (OTC derivative contracts) or § l.37(c) (repo-style transactions). For the advanced approaches treatment of these exposures, see §§ l.132(c)(8) and (d) (OTC derivative contracts) or §§ l.132(b) and § l.132(d) (repo-style transactions) and for calculation of the margin period of risk, see §§ l.132(d)(5)(iii)(C) (OTC derivative contracts) and § l.132(d)(5)(iii)(A) (repo-style transactions). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 respect to the party or guarantees the performance of the party to the CCP. Collateral agreement means a legal contract that specifies the time when, and circumstances under which, a counterparty is required to pledge collateral to a [BANK] for a single financial contract or for all financial contracts in a netting set and confers upon the [BANK] a perfected, firstpriority security interest (notwithstanding the prior security interest of any custodial agent), or the legal equivalent thereof, in the collateral posted by the counterparty under the agreement. This security interest must provide the [BANK] with a right to close out the financial positions and liquidate the collateral upon an event of default of, or failure to perform by, the counterparty under the collateral agreement. A contract would not satisfy this requirement if the [BANK]’s exercise of rights under the agreement may be stayed or avoided under applicable law in the relevant jurisdictions, other than in receivership, conservatorship, resolution under the Federal Deposit Insurance Act, Title II of the Dodd-Frank Act, or under any similar insolvency law applicable to GSEs. Commitment means any legally binding arrangement that obligates a [BANK] to extend credit or to purchase assets. Commodity derivative contract means a commodity-linked swap, purchased commodity-linked option, forward commodity-linked contract, or any other instrument linked to commodities that gives rise to similar counterparty credit risks. Commodity Exchange Act means the Commodity Exchange Act of 1936 (7 U.S.C. 1 et seq.) Common equity tier 1 capital is defined in § l.20(b). Common equity tier 1 minority interest means the common equity tier 1 capital of a depository institution or foreign bank that is: (1) A consolidated subsidiary of a [BANK]; and (2) Not owned by the [BANK]. Company means a corporation, partnership, limited liability company, depository institution, business trust, special purpose entity, association, or similar organization. Control. A person or company controls a company if it: (1) Owns, controls, or holds with power to vote 25 percent or more of a class of voting securities of the company; or (2) Consolidates the company for financial reporting purposes. PO 00000 Frm 00144 Fmt 4701 Sfmt 4700 Corporate exposure means an exposure to a company that is not: (1) An exposure to a sovereign, the Bank for International Settlements, the European Central Bank, the European Commission, the International Monetary Fund, a multi-lateral development bank (MDB), a depository institution, a foreign bank, a credit union, or a public sector entity (PSE); (2) An exposure to a GSE; (3) A residential mortgage exposure; (4) A pre-sold construction loan; (5) A statutory multifamily mortgage; (6) A high volatility commercial real estate (HVCRE) exposure; (7) A cleared transaction; (8) A default fund contribution; (9) A securitization exposure; (10) An equity exposure; or (11) An unsettled transaction. Country risk classification (CRC) with respect to a sovereign, means the most recent consensus CRC published by the Organization for Economic Cooperation and Development (OECD) as of December 31st of the prior calendar year that provides a view of the likelihood that the sovereign will service its external debt. Covered savings and loan holding company means a top-tier savings and loan holding company other than: (1) A top-tier savings and loan holding company that is: (i) A grandfathered unitary savings and loan holding company as defined in section 10(c)(9)(A) of HOLA; and (ii) As of June 30 of the previous calendar year, derived 50 percent or more of its total consolidated assets or 50 percent of its total revenues on an enterprise-wide basis (as calculated under GAAP) from activities that are not financial in nature under section 4(k) of the Bank Holding Company Act (12 U.S.C. 1842(k)); (2) A top-tier savings and loan holding company that is an insurance underwriting company; or (3)(i) A top-tier savings and loan holding company that, as of June 30 of the previous calendar year, held 25 percent or more of its total consolidated assets in subsidiaries that are insurance underwriting companies (other than assets associated with insurance for credit risk); and (ii) For purposes of paragraph (3)(i) of this definition, the company must calculate its total consolidated assets in accordance with GAAP, or if the company does not calculate its total consolidated assets under GAAP for any regulatory purpose (including compliance with applicable securities laws), the company may estimate its total consolidated assets, subject to review and adjustment by the Board. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations Credit derivative means a financial contract executed under standard industry credit derivative documentation that allows one party (the protection purchaser) to transfer the credit risk of one or more exposures (reference exposure(s)) to another party (the protection provider) for a certain period of time. Credit-enhancing interest-only strip (CEIO) means an on-balance sheet asset that, in form or in substance: (1) Represents a contractual right to receive some or all of the interest and no more than a minimal amount of principal due on the underlying exposures of a securitization; and (2) Exposes the holder of the CEIO to credit risk directly or indirectly associated with the underlying exposures that exceeds a pro rata share of the holder’s claim on the underlying exposures, whether through subordination provisions or other credit-enhancement techniques. Credit-enhancing representations and warranties means representations and warranties that are made or assumed in connection with a transfer of underlying exposures (including loan servicing assets) and that obligate a [BANK] to protect another party from losses arising from the credit risk of the underlying exposures. Credit-enhancing representations and warranties include provisions to protect a party from losses resulting from the default or nonperformance of the counterparties of the underlying exposures or from an insufficiency in the value of the collateral backing the underlying exposures. Credit-enhancing representations and warranties do not include: (1) Early default clauses and similar warranties that permit the return of, or premium refund clauses covering, 1–4 family residential first mortgage loans that qualify for a 50 percent risk weight for a period not to exceed 120 days from the date of transfer. These warranties may cover only those loans that were originated within 1 year of the date of transfer; (2) Premium refund clauses that cover assets guaranteed, in whole or in part, by the U.S. Government, a U.S. Government agency or a GSE, provided the premium refund clauses are for a period not to exceed 120 days from the date of transfer; or (3) Warranties that permit the return of underlying exposures in instances of misrepresentation, fraud, or incomplete documentation. Credit risk mitigant means collateral, a credit derivative, or a guarantee. Credit-risk-weighted assets means 1.06 multiplied by the sum of: VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (1) Total wholesale and retail riskweighted assets as calculated under § l.131; (2) Risk-weighted assets for securitization exposures as calculated under § l.142; and (3) Risk-weighted assets for equity exposures as calculated under § l.151. Credit union means an insured credit union as defined under the Federal Credit Union Act (12 U.S.C. 1752 et seq.). Current exposure means, with respect to a netting set, the larger of zero or the fair value of a transaction or portfolio of transactions within the netting set that would be lost upon default of the counterparty, assuming no recovery on the value of the transactions. Current exposure is also called replacement cost. Current exposure methodology means the method of calculating the exposure amount for over-the-counter derivative contracts in § l.34(a) and exposure at default (EAD) in § l.132(c)(5) or (6), as applicable. Custodian means a financial institution that has legal custody of collateral provided to a CCP. Default fund contribution means the funds contributed or commitments made by a clearing member to a CCP’s mutualized loss sharing arrangement. Depository institution means a depository institution as defined in section 3 of the Federal Deposit Insurance Act. Depository institution holding company means a bank holding company or savings and loan holding company. Derivative contract means a financial contract whose value is derived from the values of one or more underlying assets, reference rates, or indices of asset values or reference rates. Derivative contracts include interest rate derivative contracts, exchange rate derivative contracts, equity derivative contracts, commodity derivative contracts, credit derivative contracts, and any other instrument that poses similar counterparty credit risks. Derivative contracts also include unsettled securities, commodities, and foreign exchange transactions with a contractual settlement or delivery lag that is longer than the lesser of the market standard for the particular instrument or five business days. Discretionary bonus payment means a payment made to an executive officer of a [BANK], where: (1) The [BANK] retains discretion as to whether to make, and the amount of, the payment until the payment is awarded to the executive officer; PO 00000 Frm 00145 Fmt 4701 Sfmt 4700 62161 (2) The amount paid is determined by the [BANK] without prior promise to, or agreement with, the executive officer; and (3) The executive officer has no contractual right, whether express or implied, to the bonus payment. Distribution means: (1) A reduction of tier 1 capital through the repurchase of a tier 1 capital instrument or by other means, except when a [BANK], within the same quarter when the repurchase is announced, fully replaces a tier 1 capital instrument it has repurchased by issuing another capital instrument that meets the eligibility criteria for: (i) A common equity tier 1 capital instrument if the instrument being repurchased was part of the [BANK]’s common equity tier 1 capital, or (ii) A common equity tier 1 or additional tier 1 capital instrument if the instrument being repurchased was part of the [BANK]’s tier 1 capital; (2) A reduction of tier 2 capital through the repurchase, or redemption prior to maturity, of a tier 2 capital instrument or by other means, except when a [BANK], within the same quarter when the repurchase or redemption is announced, fully replaces a tier 2 capital instrument it has repurchased by issuing another capital instrument that meets the eligibility criteria for a tier 1 or tier 2 capital instrument; (3) A dividend declaration or payment on any tier 1 capital instrument; (4) A dividend declaration or interest payment on any tier 2 capital instrument if the [BANK] has full discretion to permanently or temporarily suspend such payments without triggering an event of default; or (5) Any similar transaction that the [AGENCY] determines to be in substance a distribution of capital. Dodd-Frank Act means the DoddFrank Wall Street Reform and Consumer Protection Act of 2010 (Pub. L. 111–203, 124 Stat. 1376). Early amortization provision means a provision in the documentation governing a securitization that, when triggered, causes investors in the securitization exposures to be repaid before the original stated maturity of the securitization exposures, unless the provision: (1) Is triggered solely by events not directly related to the performance of the underlying exposures or the originating [BANK] (such as material changes in tax laws or regulations); or (2) Leaves investors fully exposed to future draws by borrowers on the underlying exposures even after the provision is triggered. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62162 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations Effective notional amount means for an eligible guarantee or eligible credit derivative, the lesser of the contractual notional amount of the credit risk mitigant and the exposure amount (or EAD for purposes of subpart E of this part) of the hedged exposure, multiplied by the percentage coverage of the credit risk mitigant. Eligible ABCP liquidity facility means a liquidity facility supporting ABCP, in form or in substance, that is subject to an asset quality test at the time of draw that precludes funding against assets that are 90 days or more past due or in default. Notwithstanding the preceding sentence, a liquidity facility is an eligible ABCP liquidity facility if the assets or exposures funded under the liquidity facility that do not meet the eligibility requirements are guaranteed by a sovereign that qualifies for a 20 percent risk weight or lower. Eligible clean-up call means a cleanup call that: (1) Is exercisable solely at the discretion of the originating [BANK] or servicer; (2) Is not structured to avoid allocating losses to securitization exposures held by investors or otherwise structured to provide credit enhancement to the securitization; and (3)(i) For a traditional securitization, is only exercisable when 10 percent or less of the principal amount of the underlying exposures or securitization exposures (determined as of the inception of the securitization) is outstanding; or (ii) For a synthetic securitization, is only exercisable when 10 percent or less of the principal amount of the reference portfolio of underlying exposures (determined as of the inception of the securitization) is outstanding. Eligible credit derivative means a credit derivative in the form of a credit default swap, nth-to-default swap, total return swap, or any other form of credit derivative approved by the [AGENCY], provided that: (1) The contract meets the requirements of an eligible guarantee and has been confirmed by the protection purchaser and the protection provider; (2) Any assignment of the contract has been confirmed by all relevant parties; (3) If the credit derivative is a credit default swap or nth-to-default swap, the contract includes the following credit events: (i) Failure to pay any amount due under the terms of the reference exposure, subject to any applicable minimal payment threshold that is consistent with standard market practice and with a grace period that is VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 closely in line with the grace period of the reference exposure; and (ii) Receivership, insolvency, liquidation, conservatorship or inability of the reference exposure issuer to pay its debts, or its failure or admission in writing of its inability generally to pay its debts as they become due, and similar events; (4) The terms and conditions dictating the manner in which the contract is to be settled are incorporated into the contract; (5) If the contract allows for cash settlement, the contract incorporates a robust valuation process to estimate loss reliably and specifies a reasonable period for obtaining post-credit event valuations of the reference exposure; (6) If the contract requires the protection purchaser to transfer an exposure to the protection provider at settlement, the terms of at least one of the exposures that is permitted to be transferred under the contract provide that any required consent to transfer may not be unreasonably withheld; (7) If the credit derivative is a credit default swap or nth-to-default swap, the contract clearly identifies the parties responsible for determining whether a credit event has occurred, specifies that this determination is not the sole responsibility of the protection provider, and gives the protection purchaser the right to notify the protection provider of the occurrence of a credit event; and (8) If the credit derivative is a total return swap and the [BANK] records net payments received on the swap as net income, the [BANK] records offsetting deterioration in the value of the hedged exposure (either through reductions in fair value or by an addition to reserves). Eligible credit reserves means all general allowances that have been established through a charge against earnings to cover estimated credit losses associated with on- or off-balance sheet wholesale and retail exposures, including the ALLL associated with such exposures, but excluding allocated transfer risk reserves established pursuant to 12 U.S.C. 3904 and other specific reserves created against recognized losses. Eligible guarantee means a guarantee from an eligible guarantor that: (1) Is written; (2) Is either: (i) Unconditional, or (ii) A contingent obligation of the U.S. government or its agencies, the enforceability of which is dependent upon some affirmative action on the part of the beneficiary of the guarantee or a third party (for example, meeting servicing requirements); PO 00000 Frm 00146 Fmt 4701 Sfmt 4700 (3) Covers all or a pro rata portion of all contractual payments of the obligated party on the reference exposure; (4) Gives the beneficiary a direct claim against the protection provider; (5) Is not unilaterally cancelable by the protection provider for reasons other than the breach of the contract by the beneficiary; (6) Except for a guarantee by a sovereign, is legally enforceable against the protection provider in a jurisdiction where the protection provider has sufficient assets against which a judgment may be attached and enforced; (7) Requires the protection provider to make payment to the beneficiary on the occurrence of a default (as defined in the guarantee) of the obligated party on the reference exposure in a timely manner without the beneficiary first having to take legal actions to pursue the obligor for payment; (8) Does not increase the beneficiary’s cost of credit protection on the guarantee in response to deterioration in the credit quality of the reference exposure; and (9) Is not provided by an affiliate of the [BANK], unless the affiliate is an insured depository institution, foreign bank, securities broker or dealer, or insurance company that: (i) Does not control the [BANK]; and (ii) Is subject to consolidated supervision and regulation comparable to that imposed on depository institutions, U.S. securities brokerdealers, or U.S. insurance companies (as the case may be). Eligible guarantor means: (1) A sovereign, the Bank for International Settlements, the International Monetary Fund, the European Central Bank, the European Commission, a Federal Home Loan Bank, Federal Agricultural Mortgage Corporation (Farmer Mac), a multilateral development bank (MDB), a depository institution, a bank holding company, a savings and loan holding company, a credit union, a foreign bank, or a qualifying central counterparty; or (2) An entity (other than a special purpose entity): (i) That at the time the guarantee is issued or anytime thereafter, has issued and outstanding an unsecured debt security without credit enhancement that is investment grade; (ii) Whose creditworthiness is not positively correlated with the credit risk of the exposures for which it has provided guarantees; and (iii) That is not an insurance company engaged predominately in the business of providing credit protection (such as a monoline bond insurer or re-insurer). E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 Eligible margin loan means: (1) An extension of credit where: (i) The extension of credit is collateralized exclusively by liquid and readily marketable debt or equity securities, or gold; (ii) The collateral is marked-to-fair value daily, and the transaction is subject to daily margin maintenance requirements; and (iii) The extension of credit is conducted under an agreement that provides the [BANK] the right to accelerate and terminate the extension of credit and to liquidate or set-off collateral promptly upon an event of default, including upon an event of receivership, insolvency, liquidation, conservatorship, or similar proceeding, of the counterparty, provided that, in any such case, any exercise of rights under the agreement will not be stayed or avoided under applicable law in the relevant jurisdictions, other than in receivership, conservatorship, resolution under the Federal Deposit Insurance Act, Title II of the DoddFrank Act, or under any similar insolvency law applicable to GSEs.4 (2) In order to recognize an exposure as an eligible margin loan for purposes of this subpart, a [BANK] must comply with the requirements of § l.3(b) with respect to that exposure. Eligible servicer cash advance facility means a servicer cash advance facility in which: (1) The servicer is entitled to full reimbursement of advances, except that a servicer may be obligated to make non-reimbursable advances for a particular underlying exposure if any such advance is contractually limited to an insignificant amount of the outstanding principal balance of that exposure; (2) The servicer’s right to reimbursement is senior in right of payment to all other claims on the cash flows from the underlying exposures of the securitization; and (3) The servicer has no legal obligation to, and does not make advances to the securitization if the servicer concludes the advances are unlikely to be repaid. Employee stock ownership plan has the same meaning as in 29 CFR 2550.407d–6. 4 This requirement is met where all transactions under the agreement are (i) executed under U.S. law and (ii) constitute ‘‘securities contracts’’ under section 555 of the Bankruptcy Code (11 U.S.C. 555), qualified financial contracts under section 11(e)(8) of the Federal Deposit Insurance Act, or netting contracts between or among financial institutions under sections 401–407 of the Federal Deposit Insurance Corporation Improvement Act or the Federal Reserve Board’s Regulation EE (12 CFR part 231). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 Equity derivative contract means an equity-linked swap, purchased equitylinked option, forward equity-linked contract, or any other instrument linked to equities that gives rise to similar counterparty credit risks. Equity exposure means: (1) A security or instrument (whether voting or non-voting) that represents a direct or an indirect ownership interest in, and is a residual claim on, the assets and income of a company, unless: (i) The issuing company is consolidated with the [BANK] under GAAP; (ii) The [BANK] is required to deduct the ownership interest from tier 1 or tier 2 capital under this part; (iii) The ownership interest incorporates a payment or other similar obligation on the part of the issuing company (such as an obligation to make periodic payments); or (iv) The ownership interest is a securitization exposure; (2) A security or instrument that is mandatorily convertible into a security or instrument described in paragraph (1) of this definition; (3) An option or warrant that is exercisable for a security or instrument described in paragraph (1) of this definition; or (4) Any other security or instrument (other than a securitization exposure) to the extent the return on the security or instrument is based on the performance of a security or instrument described in paragraph (1) of this definition. ERISA means the Employee Retirement Income and Security Act of 1974 (29 U.S.C. 1001 et seq.). Exchange rate derivative contract means a cross-currency interest rate swap, forward foreign-exchange contract, currency option purchased, or any other instrument linked to exchange rates that gives rise to similar counterparty credit risks. Executive officer means a person who holds the title or, without regard to title, salary, or compensation, performs the function of one or more of the following positions: President, chief executive officer, executive chairman, chief operating officer, chief financial officer, chief investment officer, chief legal officer, chief lending officer, chief risk officer, or head of a major business line, and other staff that the board of directors of the [BANK] deems to have equivalent responsibility. Expected credit loss (ECL) means: (1) For a wholesale exposure to a nondefaulted obligor or segment of nondefaulted retail exposures that is carried at fair value with gains and losses flowing through earnings or that is classified as held-for-sale and is carried PO 00000 Frm 00147 Fmt 4701 Sfmt 4700 62163 at the lower of cost or fair value with losses flowing through earnings, zero. (2) For all other wholesale exposures to non-defaulted obligors or segments of non-defaulted retail exposures, the product of the probability of default (PD) times the loss given default (LGD) times the exposure at default (EAD) for the exposure or segment. (3) For a wholesale exposure to a defaulted obligor or segment of defaulted retail exposures, the [BANK]’s impairment estimate for allowance purposes for the exposure or segment. (4) Total ECL is the sum of expected credit losses for all wholesale and retail exposures other than exposures for which the [BANK] has applied the double default treatment in § l.135. Exposure amount means: (1) For the on-balance sheet component of an exposure (other than an available-for-sale or held-to-maturity security, if the [BANK] has made an AOCI opt-out election (as defined in § l.22(b)(2)); an OTC derivative contract; a repo-style transaction or an eligible margin loan for which the [BANK] determines the exposure amount under § l.37; a cleared transaction; a default fund contribution; or a securitization exposure), the [BANK]’s carrying value of the exposure. (2) For a security (that is not a securitization exposure, equity exposure, or preferred stock classified as an equity security under GAAP) classified as available-for-sale or heldto-maturity if the [BANK] has made an AOCI opt-out election (as defined in § l.22(b)(2)), the [BANK]’s carrying value (including net accrued but unpaid interest and fees) for the exposure less any net unrealized gains on the exposure and plus any net unrealized losses on the exposure. (3) For available-for-sale preferred stock classified as an equity security under GAAP if the [BANK] has made an AOCI opt-out election (as defined in § l.22(b)(2)), the [BANK]’s carrying value of the exposure less any net unrealized gains on the exposure that are reflected in such carrying value but excluded from the [BANK]’s regulatory capital components. (4) For the off-balance sheet component of an exposure (other than an OTC derivative contract; a repo-style transaction or an eligible margin loan for which the [BANK] calculates the exposure amount under § l.37; a cleared transaction; a default fund contribution; or a securitization exposure), the notional amount of the off-balance sheet component multiplied by the appropriate credit conversion factor (CCF) in § l.33. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62164 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (5) For an exposure that is an OTC derivative contract, the exposure amount determined under § l.34. (6) For an exposure that is a cleared transaction, the exposure amount determined under § l.35. (7) For an exposure that is an eligible margin loan or repo-style transaction for which the bank calculates the exposure amount as provided in § l.37, the exposure amount determined under § l.37. (8) For an exposure that is a securitization exposure, the exposure amount determined under § l.42. Federal Deposit Insurance Act means the Federal Deposit Insurance Act (12 U.S.C. 1813). Federal Deposit Insurance Corporation Improvement Act means the Federal Deposit Insurance Corporation Improvement Act of 1991 (12 U.S.C. 4401). Financial collateral means collateral: (1) In the form of: (i) Cash on deposit with the [BANK] (including cash held for the [BANK] by a third-party custodian or trustee); (ii) Gold bullion; (iii) Long-term debt securities that are not resecuritization exposures and that are investment grade; (iv) Short-term debt instruments that are not resecuritization exposures and that are investment grade; (v) Equity securities that are publicly traded; (vi) Convertible bonds that are publicly traded; or (vii) Money market fund shares and other mutual fund shares if a price for the shares is publicly quoted daily; and (2) In which the [BANK] has a perfected, first-priority security interest or, outside of the United States, the legal equivalent thereof (with the exception of cash on deposit and notwithstanding the prior security interest of any custodial agent). Financial institution means: (1) A bank holding company; savings and loan holding company; nonbank financial institution supervised by the Board under Title I of the Dodd-Frank Act; depository institution; foreign bank; credit union; industrial loan company, industrial bank, or other similar institution described in section 2 of the Bank Holding Company Act; national association, state member bank, or state non-member bank that is not a depository institution; insurance company; securities holding company as defined in section 618 of the DoddFrank Act; broker or dealer registered with the SEC under section 15 of the Securities Exchange Act; futures commission merchant as defined in section 1a of the Commodity Exchange VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 Act; swap dealer as defined in section 1a of the Commodity Exchange Act; or security-based swap dealer as defined in section 3 of the Securities Exchange Act; (2) Any designated financial market utility, as defined in section 803 of the Dodd-Frank Act; (3) Any entity not domiciled in the United States (or a political subdivision thereof) that is supervised and regulated in a manner similar to entities described in paragraphs (1) or (2) of this definition; or (4) Any other company: (i) Of which the [BANK] owns: (A) An investment in GAAP equity instruments of the company with an adjusted carrying value or exposure amount equal to or greater than $10 million; or (B) More than 10 percent of the company’s issued and outstanding common shares (or similar equity interest), and (ii) Which is predominantly engaged in the following activities: (A) Lending money, securities or other financial instruments, including servicing loans; (B) Insuring, guaranteeing, indemnifying against loss, harm, damage, illness, disability, or death, or issuing annuities; (C) Underwriting, dealing in, making a market in, or investing as principal in securities or other financial instruments; or (D) Asset management activities (not including investment or financial advisory activities). (5) For the purposes of this definition, a company is ‘‘predominantly engaged’’ in an activity or activities if: (i) 85 percent or more of the total consolidated annual gross revenues (as determined in accordance with applicable accounting standards) of the company is either of the two most recent calendar years were derived, directly or indirectly, by the company on a consolidated basis from the activities; or (ii) 85 percent or more of the company’s consolidated total assets (as determined in accordance with applicable accounting standards) as of the end of either of the two most recent calendar years were related to the activities. (6) Any other company that the [AGENCY] may determine is a financial institution based on activities similar in scope, nature, or operation to those of the entities included in paragraphs (1) through (4) of this definition. (7) For purposes of this part, ‘‘financial institution’’ does not include the following entities: (i) GSEs; PO 00000 Frm 00148 Fmt 4701 Sfmt 4700 (ii) Small business investment companies, as defined in section 102 of the Small Business Investment Act of 1958 (15 U.S.C. 662); (iii) Entities designated as Community Development Financial Institutions (CDFIs) under 12 U.S.C. 4701 et seq. and 12 CFR part 1805; (iv) Entities registered with the SEC under the Investment Company Act of 1940 (15 U.S.C. 80a–1) or foreign equivalents thereof; (v) Entities to the extent that the [BANK]’s investment in such entities would qualify as a community development investment under section 24 (Eleventh) of the National Bank Act; and (vi) An employee benefit plan as defined in paragraphs (3) and (32) of section 3 of ERISA, a ‘‘governmental plan’’ (as defined in 29 U.S.C. 1002(32)) that complies with the tax deferral qualification requirements provided in the Internal Revenue Code, or any similar employee benefit plan established under the laws of a foreign jurisdiction. First-lien residential mortgage exposure means a residential mortgage exposure secured by a first lien. Foreign bank means a foreign bank as defined in § 211.2 of the Federal Reserve Board’s Regulation K (12 CFR 211.2) (other than a depository institution). Forward agreement means a legally binding contractual obligation to purchase assets with certain drawdown at a specified future date, not including commitments to make residential mortgage loans or forward foreign exchange contracts. GAAP means generally accepted accounting principles as used in the United States. Gain-on-sale means an increase in the equity capital of a [BANK] (as reported on [Schedule RC of the Call Report or Schedule HC of the FR Y–9C]) resulting from a traditional securitization (other than an increase in equity capital resulting from the [BANK]’s receipt of cash in connection with the securitization or reporting of a mortgage servicing asset on [Schedule RC of the Call Report or Schedule HC of the FRY– 9C]). General obligation means a bond or similar obligation that is backed by the full faith and credit of a public sector entity (PSE). Government-sponsored enterprise (GSE) means an entity established or chartered by the U.S. government to serve public purposes specified by the U.S. Congress but whose debt obligations are not explicitly guaranteed by the full faith and credit of the U.S. government. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations Guarantee means a financial guarantee, letter of credit, insurance, or other similar financial instrument (other than a credit derivative) that allows one party (beneficiary) to transfer the credit risk of one or more specific exposures (reference exposure) to another party (protection provider). High volatility commercial real estate (HVCRE) exposure means a credit facility that, prior to conversion to permanent financing, finances or has financed the acquisition, development, or construction (ADC) of real property, unless the facility finances: (1) One- to four-family residential properties; (2) Real property that: (i) Would qualify as an investment in community development under 12 U.S.C. 338a or 12 U.S.C. 24 (Eleventh), as applicable, or as a ‘‘qualified investment’’ under [12 CFR part 25 (national bank), 12 CFR part 195 (Federal savings association) (OCC); 12 CFR part 228 (Board)], and (ii) Is not an ADC loan to any entity described in [12 CFR part 25.12(g)(3) (national banks) and 12 CFR 195.12(g)(3) (Federal savings associations) (OCC); 12 CFR 208.22(a)(3) or 228.12(g)(3) (Board)], unless it is otherwise described in paragraph (1), (2)(i), (3) or (4) of this definition; (3) The purchase or development of agricultural land, which includes all land known to be used or usable for agricultural purposes (such as crop and livestock production), provided that the valuation of the agricultural land is based on its value for agricultural purposes and the valuation does not take into consideration any potential use of the land for non-agricultural commercial development or residential development; or (4) Commercial real estate projects in which: (i) The loan-to-value ratio is less than or equal to the applicable maximum supervisory loan-to-value ratio in the [AGENCY]’s real estate lending standards at [12 CFR part 34, subpart D (national banks) and 12 CFR part 160, subparts A and B (Federal savings associations) (OCC); 12 CFR part 208, appendix C (Board)]; (ii) The borrower has contributed capital to the project in the form of cash or unencumbered readily marketable assets (or has paid development expenses out-of-pocket) of at least 15 percent of the real estate’s appraised ‘‘as completed’’ value; and (iii) The borrower contributed the amount of capital required by paragraph (4)(ii) of this definition before the [BANK] advances funds under the credit facility, and the capital contributed by VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 the borrower, or internally generated by the project, is contractually required to remain in the project throughout the life of the project. The life of a project concludes only when the credit facility is converted to permanent financing or is sold or paid in full. Permanent financing may be provided by the [BANK] that provided the ADC facility as long as the permanent financing is subject to the [BANK]’s underwriting criteria for long-term mortgage loans. Home country means the country where an entity is incorporated, chartered, or similarly established. Indirect exposure means an exposure that arises from the [BANK]’s investment in an investment fund which holds an investment in the [BANK]’s own capital instrument or an investment in the capital of an unconsolidated financial institution. Insurance company means an insurance company as defined in section 201 of the Dodd-Frank Act (12 U.S.C. 5381). Insurance underwriting company means an insurance company as defined in section 201 of the Dodd-Frank Act (12 U.S.C. 5381) that engages in insurance underwriting activities. Insured depository institution means an insured depository institution as defined in section 3 of the Federal Deposit Insurance Act. Interest rate derivative contract means a single-currency interest rate swap, basis swap, forward rate agreement, purchased interest rate option, whenissued securities, or any other instrument linked to interest rates that gives rise to similar counterparty credit risks. International Lending Supervision Act means the International Lending Supervision Act of 1983 (12 U.S.C. 3907). Investing bank means, with respect to a securitization, a [BANK] that assumes the credit risk of a securitization exposure (other than an originating [BANK] of the securitization). In the typical synthetic securitization, the investing [BANK] sells credit protection on a pool of underlying exposures to the originating [BANK]. Investment fund means a company: (1) Where all or substantially all of the assets of the company are financial assets; and (2) That has no material liabilities. Investment grade means that the entity to which the [BANK] is exposed through a loan or security, or the reference entity with respect to a credit derivative, has adequate capacity to meet financial commitments for the projected life of the asset or exposure. Such an entity or reference entity has PO 00000 Frm 00149 Fmt 4701 Sfmt 4700 62165 adequate capacity to meet financial commitments if the risk of its default is low and the full and timely repayment of principal and interest is expected. Investment in the capital of an unconsolidated financial institution means a net long position calculated in accordance with § l.22(h) in an instrument that is recognized as capital for regulatory purposes by the primary supervisor of an unconsolidated regulated financial institution and is an instrument that is part of the GAAP equity of an unconsolidated unregulated financial institution, including direct, indirect, and synthetic exposures to capital instruments, excluding underwriting positions held by the [BANK] for five or fewer business days. Investment in the [BANK]’s own capital instrument means a net long position calculated in accordance with § l.22(h) in the [BANK]’s own common stock instrument, own additional tier 1 capital instrument or own tier 2 capital instrument, including direct, indirect, or synthetic exposures to such capital instruments. An investment in the [BANK]’s own capital instrument includes any contractual obligation to purchase such capital instrument. Junior-lien residential mortgage exposure means a residential mortgage exposure that is not a first-lien residential mortgage exposure. Main index means the Standard & Poor’s 500 Index, the FTSE All-World Index, and any other index for which the [BANK] can demonstrate to the satisfaction of the [AGENCY] that the equities represented in the index have comparable liquidity, depth of market, and size of bid-ask spreads as equities in the Standard & Poor’s 500 Index and FTSE All-World Index. Market risk [BANK] means a [BANK] that is described in § l.201(b). Money market fund means an investment fund that is subject to 17 CFR 270.2a–7 or any foreign equivalent thereof. Mortgage servicing assets (MSAs) means the contractual rights owned by a [BANK] to service for a fee mortgage loans that are owned by others. Multilateral development bank (MDB) means the International Bank for Reconstruction and Development, the Multilateral Investment Guarantee Agency, the International Finance Corporation, the Inter-American Development Bank, the Asian Development Bank, the African Development Bank, the European Bank for Reconstruction and Development, the European Investment Bank, the European Investment Fund, the Nordic Investment Bank, the Caribbean Development Bank, the Islamic E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62166 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations Development Bank, the Council of Europe Development Bank, and any other multilateral lending institution or regional development bank in which the U.S. government is a shareholder or contributing member or which the [AGENCY] determines poses comparable credit risk. National Bank Act means the National Bank Act (12 U.S.C. 24). Netting set means a group of transactions with a single counterparty that are subject to a qualifying master netting agreement or a qualifying crossproduct master netting agreement. For purposes of calculating risk-based capital requirements using the internal models methodology in subpart E of this part, this term does not cover a transaction: (1) That is not subject to such a master netting agreement; or (2) Where the [BANK] has identified specific wrong-way risk. Non-significant investment in the capital of an unconsolidated financial institution means an investment in the capital of an unconsolidated financial institution where the [BANK] owns 10 percent or less of the issued and outstanding common stock of the unconsolidated financial institution. Nth-to-default credit derivative means a credit derivative that provides credit protection only for the nth-defaulting reference exposure in a group of reference exposures. Operating entity means a company established to conduct business with clients with the intention of earning a profit in its own right. Original maturity with respect to an off-balance sheet commitment means the length of time between the date a commitment is issued and: (1) For a commitment that is not subject to extension or renewal, the stated expiration date of the commitment; or (2) For a commitment that is subject to extension or renewal, the earliest date on which the [BANK] can, at its option, unconditionally cancel the commitment. Originating [BANK], with respect to a securitization, means a [BANK] that: (1) Directly or indirectly originated or securitized the underlying exposures included in the securitization; or (2) Serves as an ABCP program sponsor to the securitization. Over-the-counter (OTC) derivative contract means a derivative contract that is not a cleared transaction. An OTC derivative includes a transaction: (1) Between a [BANK] that is a clearing member and a counterparty where the [BANK] is acting as a financial intermediary and enters into a VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 cleared transaction with a CCP that offsets the transaction with the counterparty; or (2) In which a [BANK] that is a clearing member provides a CCP a guarantee on the performance of the counterparty to the transaction. Performance standby letter of credit (or performance bond) means an irrevocable obligation of a [BANK] to pay a third-party beneficiary when a customer (account party) fails to perform on any contractual nonfinancial or commercial obligation. To the extent permitted by law or regulation, performance standby letters of credit include arrangements backing, among other things, subcontractors’ and suppliers’ performance, labor and materials contracts, and construction bids. Pre-sold construction loan means any one-to-four family residential construction loan to a builder that meets the requirements of section 618(a)(1) or (2) of the Resolution Trust Corporation Refinancing, Restructuring, and Improvement Act of 1991 (12 U.S.C. 1831n note) and the following criteria: (1) The loan is made in accordance with prudent underwriting standards, meaning that the [BANK] has obtained sufficient documentation that the buyer of the home has a legally binding written sales contract and has a firm written commitment for permanent financing of the home upon completion; (2) The purchaser is an individual(s) that intends to occupy the residence and is not a partnership, joint venture, trust, corporation, or any other entity (including an entity acting as a sole proprietorship) that is purchasing one or more of the residences for speculative purposes; (3) The purchaser has entered into a legally binding written sales contract for the residence; (4) The purchaser has not terminated the contract; (5) The purchaser has made a substantial earnest money deposit of no less than 3 percent of the sales price, which is subject to forfeiture if the purchaser terminates the sales contract; provided that, the earnest money deposit shall not be subject to forfeiture by reason of breach or termination of the sales contract on the part of the builder; (6) The earnest money deposit must be held in escrow by the [BANK] or an independent party in a fiduciary capacity, and the escrow agreement must provide that in an event of default arising from the cancellation of the sales contract by the purchaser of the residence, the escrow funds shall be used to defray any cost incurred by the [BANK]; PO 00000 Frm 00150 Fmt 4701 Sfmt 4700 (7) The builder must incur at least the first 10 percent of the direct costs of construction of the residence (that is, actual costs of the land, labor, and material) before any drawdown is made under the loan; (8) The loan may not exceed 80 percent of the sales price of the presold residence; and (9) The loan is not more than 90 days past due, or on nonaccrual. Protection amount (P) means, with respect to an exposure hedged by an eligible guarantee or eligible credit derivative, the effective notional amount of the guarantee or credit derivative, reduced to reflect any currency mismatch, maturity mismatch, or lack of restructuring coverage (as provided in §§ l.36 or l.134, as appropriate). Publicly-traded means traded on: (1) Any exchange registered with the SEC as a national securities exchange under section 6 of the Securities Exchange Act; or (2) Any non-U.S.-based securities exchange that: (i) Is registered with, or approved by, a national securities regulatory authority; and (ii) Provides a liquid, two-way market for the instrument in question. Public sector entity (PSE) means a state, local authority, or other governmental subdivision below the sovereign level. Qualifying central counterparty (QCCP) means a central counterparty that: (1)(i) Is a designated financial market utility (FMU) under Title VIII of the Dodd-Frank Act; (ii) If not located in the United States, is regulated and supervised in a manner equivalent to a designated FMU; or (iii) Meets the following standards: (A) The central counterparty requires all parties to contracts cleared by the counterparty to be fully collateralized on a daily basis; (B) The [BANK] demonstrates to the satisfaction of the [AGENCY] that the central counterparty: (1) Is in sound financial condition; (2) Is subject to supervision by the Board, the CFTC, or the Securities Exchange Commission (SEC), or, if the central counterparty is not located in the United States, is subject to effective oversight by a national supervisory authority in its home country; and (3) Meets or exceeds the riskmanagement standards for central counterparties set forth in regulations established by the Board, the CFTC, or the SEC under Title VII or Title VIII of the Dodd-Frank Act; or if the central counterparty is not located in the United States, meets or exceeds similar E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations risk-management standards established under the law of its home country that are consistent with international standards for central counterparty risk management as established by the relevant standard setting body of the Bank of International Settlements; and (2)(i) Provides the [BANK] with the central counterparty’s hypothetical capital requirement or the information necessary to calculate such hypothetical capital requirement, and other information the [BANK] is required to obtain under §§ l.35(d)(3) and l.133(d)(3); (ii) Makes available to the [AGENCY] and the CCP’s regulator the information described in paragraph (2)(i) of this definition; and (iii) Has not otherwise been determined by the [AGENCY] to not be a QCCP due to its financial condition, risk profile, failure to meet supervisory risk management standards, or other weaknesses or supervisory concerns that are inconsistent with the risk weight assigned to qualifying central counterparties under §§ l.35 and l.133. (3) Exception. A QCCP that fails to meet the requirements of a QCCP in the future may still be treated as a QCCP under the conditions specified in § l.3(f). Qualifying master netting agreement means a written, legally enforceable agreement provided that: (1) The agreement creates a single legal obligation for all individual transactions covered by the agreement upon an event of default, including upon an event of receivership, insolvency, liquidation, or similar proceeding, of the counterparty; (2) The agreement provides the [BANK] the right to accelerate, terminate, and close-out on a net basis all transactions under the agreement and to liquidate or set-off collateral promptly upon an event of default, including upon an event of receivership, insolvency, liquidation, or similar proceeding, of the counterparty, provided that, in any such case, any exercise of rights under the agreement will not be stayed or avoided under applicable law in the relevant jurisdictions, other than in receivership, conservatorship, resolution under the Federal Deposit Insurance Act, Title II of the Dodd-Frank Act, or under any similar insolvency law applicable to GSEs; (3) The agreement does not contain a walkaway clause (that is, a provision that permits a non-defaulting counterparty to make a lower payment than it otherwise would make under the agreement, or no payment at all, to a VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 defaulter or the estate of a defaulter, even if the defaulter or the estate of the defaulter is a net creditor under the agreement); and (4) In order to recognize an agreement as a qualifying master netting agreement for purposes of this subpart, a [BANK] must comply with the requirements of § l.3(d) with respect to that agreement. Regulated financial institution means a financial institution subject to consolidated supervision and regulation comparable to that imposed on the following U.S. financial institutions: Depository institutions, depository institution holding companies, nonbank financial companies supervised by the Board, designated financial market utilities, securities broker-dealers, credit unions, or insurance companies. Repo-style transaction means a repurchase or reverse repurchase transaction, or a securities borrowing or securities lending transaction, including a transaction in which the [BANK] acts as agent for a customer and indemnifies the customer against loss, provided that: (1) The transaction is based solely on liquid and readily marketable securities, cash, or gold; (2) The transaction is marked-to-fair value daily and subject to daily margin maintenance requirements; (3)(i) The transaction is a ‘‘securities contract’’ or ‘‘repurchase agreement’’ under section 555 or 559, respectively, of the Bankruptcy Code (11 U.S.C. 555 or 559), a qualified financial contract under section 11(e)(8) of the Federal Deposit Insurance Act, or a netting contract between or among financial institutions under sections 401–407 of the Federal Deposit Insurance Corporation Improvement Act or the Federal Reserve Board’s Regulation EE (12 CFR part 231); or (ii) If the transaction does not meet the criteria set forth in paragraph (3)(i) of this definition, then either: (A) The transaction is executed under an agreement that provides the [BANK] the right to accelerate, terminate, and close-out the transaction on a net basis and to liquidate or set-off collateral promptly upon an event of default, including upon an event of receivership, insolvency, liquidation, or similar proceeding, of the counterparty, provided that, in any such case, any exercise of rights under the agreement will not be stayed or avoided under applicable law in the relevant jurisdictions, other than in receivership, conservatorship, resolution under the Federal Deposit Insurance Act, Title II of the Dodd-Frank Act, or under any similar insolvency law applicable to GSEs; or (B) The transaction is: PO 00000 Frm 00151 Fmt 4701 Sfmt 4700 62167 (1) Either overnight or unconditionally cancelable at any time by the [BANK]; and (2) Executed under an agreement that provides the [BANK] the right to accelerate, terminate, and close-out the transaction on a net basis and to liquidate or set-off collateral promptly upon an event of counterparty default; and (4) In order to recognize an exposure as a repo-style transaction for purposes of this subpart, a [BANK] must comply with the requirements of § l.3(e) of this part with respect to that exposure. Resecuritization means a securitization which has more than one underlying exposure and in which one or more of the underlying exposures is a securitization exposure. Resecuritization exposure means: (1) An on- or off-balance sheet exposure to a resecuritization; (2) An exposure that directly or indirectly references a resecuritization exposure. (3) An exposure to an asset-backed commercial paper program is not a resecuritization exposure if either: (i) The program-wide credit enhancement does not meet the definition of a resecuritization exposure; or (ii) The entity sponsoring the program fully supports the commercial paper through the provision of liquidity so that the commercial paper holders effectively are exposed to the default risk of the sponsor instead of the underlying exposures. Residential mortgage exposure means an exposure (other than a securitization exposure, equity exposure, statutory multifamily mortgage, or presold construction loan) that is: (1) An exposure that is primarily secured by a first or subsequent lien on one-to-four family residential property; or (2)(i) An exposure with an original and outstanding amount of $1 million or less that is primarily secured by a first or subsequent lien on residential property that is not one-to-four family; and (ii) For purposes of calculating capital requirements under subpart E of this part, is managed as part of a segment of exposures with homogeneous risk characteristics and not on an individualexposure basis. Revenue obligation means a bond or similar obligation that is an obligation of a PSE, but which the PSE is committed to repay with revenues from the specific project financed rather than general tax funds. Savings and loan holding company means a savings and loan holding E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62168 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations company as defined in section 10 of the Home Owners’ Loan Act (12 U.S.C. 1467a). Securities and Exchange Commission (SEC) means the U.S. Securities and Exchange Commission. Securities Exchange Act means the Securities Exchange Act of 1934 (15 U.S.C. 78). Securitization exposure means: (1) An on-balance sheet or off-balance sheet credit exposure (including creditenhancing representations and warranties) that arises from a traditional securitization or synthetic securitization (including a resecuritization), or (2) An exposure that directly or indirectly references a securitization exposure described in paragraph (1) of this definition. Securitization special purpose entity (securitization SPE) means a corporation, trust, or other entity organized for the specific purpose of holding underlying exposures of a securitization, the activities of which are limited to those appropriate to accomplish this purpose, and the structure of which is intended to isolate the underlying exposures held by the entity from the credit risk of the seller of the underlying exposures to the entity. Separate account means a legally segregated pool of assets owned and held by an insurance company and maintained separately from the insurance company’s general account assets for the benefit of an individual contract holder. To be a separate account: (1) The account must be legally recognized as a separate account under applicable law; (2) The assets in the account must be insulated from general liabilities of the insurance company under applicable law in the event of the insurance company’s insolvency; (3) The insurance company must invest the funds within the account as directed by the contract holder in designated investment alternatives or in accordance with specific investment objectives or policies; and (4) All investment gains and losses, net of contract fees and assessments, must be passed through to the contract holder, provided that the contract may specify conditions under which there may be a minimum guarantee but must not include contract terms that limit the maximum investment return available to the policyholder. Servicer cash advance facility means a facility under which the servicer of the underlying exposures of a securitization may advance cash to ensure an uninterrupted flow of payments to VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 investors in the securitization, including advances made to cover foreclosure costs or other expenses to facilitate the timely collection of the underlying exposures. Significant investment in the capital of an unconsolidated financial institution means an investment in the capital of an unconsolidated financial institution where the [BANK] owns more than 10 percent of the issued and outstanding common stock of the unconsolidated financial institution. Small Business Act means the Small Business Act (15 U.S.C. 632). Small Business Investment Act means the Small Business Investment Act of 1958 (15 U.S.C. 682). Sovereign means a central government (including the U.S. government) or an agency, department, ministry, or central bank of a central government. Sovereign default means noncompliance by a sovereign with its external debt service obligations or the inability or unwillingness of a sovereign government to service an existing loan according to its original terms, as evidenced by failure to pay principal and interest timely and fully, arrearages, or restructuring. Sovereign exposure means: (1) A direct exposure to a sovereign; or (2) An exposure directly and unconditionally backed by the full faith and credit of a sovereign. Specific wrong-way risk means wrongway risk that arises when either: (1) The counterparty and issuer of the collateral supporting the transaction; or (2) The counterparty and the reference asset of the transaction, are affiliates or are the same entity. Standardized market risk-weighted assets means the standardized measure for market risk calculated under § l.204 multiplied by 12.5. Standardized total risk-weighted assets means: (1) The sum of: (i) Total risk-weighted assets for general credit risk as calculated under § l.31; (ii) Total risk-weighted assets for cleared transactions and default fund contributions as calculated under § l.35; (iii) Total risk-weighted assets for unsettled transactions as calculated under § l.38; (iv) Total risk-weighted assets for securitization exposures as calculated under § l.42; (v) Total risk-weighted assets for equity exposures as calculated under §§ l.52 and l.53; and (vi) For a market risk [BANK] only, standardized market risk-weighted assets; minus PO 00000 Frm 00152 Fmt 4701 Sfmt 4700 (2) Any amount of the [BANK]’s allowance for loan and lease losses that is not included in tier 2 capital and any amount of allocated transfer risk reserves. Statutory multifamily mortgage means a loan secured by a multifamily residential property that meets the requirements under section 618(b)(1) of the Resolution Trust Corporation Refinancing, Restructuring, and Improvement Act of 1991, and that meets the following criteria: 5 (1) The loan is made in accordance with prudent underwriting standards; (2) The principal amount of the loan at origination does not exceed 80 percent of the value of the property (or 75 percent of the value of the property if the loan is based on an interest rate that changes over the term of the loan) where the value of the property is the lower of the acquisition cost of the property or the appraised (or, if appropriate, evaluated) value of the property; (3) All principal and interest payments on the loan must have been made on a timely basis in accordance with the terms of the loan for at least one year prior to applying a 50 percent risk weight to the loan, or in the case where an existing owner is refinancing a loan on the property, all principal and interest payments on the loan being refinanced must have been made on a timely basis in accordance with the terms of the loan for at least one year prior to applying a 50 percent risk weight to the loan; (4) Amortization of principal and interest on the loan must occur over a period of not more than 30 years and the minimum original maturity for repayment of principal must not be less than 7 years; (5) Annual net operating income (before making any payment on the loan) generated by the property securing the loan during its most recent fiscal year must not be less than 120 percent of the loan’s current annual debt service (or 115 percent of current annual debt service if the loan is based on an interest rate that changes over the term of the loan) or, in the case of a cooperative or other not-for-profit housing project, the property must generate sufficient cash flow to provide comparable protection to the [BANK]; and (6) The loan is not more than 90 days past due, or on nonaccrual. Subsidiary means, with respect to a company, a company controlled by that company. 5 The types of loans that qualify as loans secured by multifamily residential properties are listed in the instructions for preparation of the [REGULATORY REPORT]. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations Synthetic exposure means an exposure whose value is linked to the value of an investment in the [BANK]’s own capital instrument or to the value of an investment in the capital of an unconsolidated financial institution. Synthetic securitization means a transaction in which: (1) All or a portion of the credit risk of one or more underlying exposures is retained or transferred to one or more third parties through the use of one or more credit derivatives or guarantees (other than a guarantee that transfers only the credit risk of an individual retail exposure); (2) The credit risk associated with the underlying exposures has been separated into at least two tranches reflecting different levels of seniority; (3) Performance of the securitization exposures depends upon the performance of the underlying exposures; and (4) All or substantially all of the underlying exposures are financial exposures (such as loans, commitments, credit derivatives, guarantees, receivables, asset-backed securities, mortgage-backed securities, other debt securities, or equity securities). Tier 1 capital means the sum of common equity tier 1 capital and additional tier 1 capital. Tier 1 minority interest means the tier 1 capital of a consolidated subsidiary of a [BANK] that is not owned by the [BANK]. Tier 2 capital is defined in § l.20(d). Total capital means the sum of tier 1 capital and tier 2 capital. Total capital minority interest means the total capital of a consolidated subsidiary of a [BANK] that is not owned by the [BANK]. Total leverage exposure means the sum of the following: (1) The balance sheet carrying value of all of the [BANK]’s on-balance sheet assets, less amounts deducted from tier 1 capital under § l.22(a), (c), and (d); (2) The potential future credit exposure (PFE) amount for each derivative contract to which the [BANK] is a counterparty (or each single-product netting set of such transactions) determined in accordance with § l.34, but without regard to § l.34(b); (3) 10 percent of the notional amount of unconditionally cancellable commitments made by the [BANK]; and (4) The notional amount of all other off-balance sheet exposures of the [BANK] (excluding securities lending, securities borrowing, reverse repurchase transactions, derivatives and unconditionally cancellable commitments). Traditional securitization means a transaction in which: VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (1) All or a portion of the credit risk of one or more underlying exposures is transferred to one or more third parties other than through the use of credit derivatives or guarantees; (2) The credit risk associated with the underlying exposures has been separated into at least two tranches reflecting different levels of seniority; (3) Performance of the securitization exposures depends upon the performance of the underlying exposures; (4) All or substantially all of the underlying exposures are financial exposures (such as loans, commitments, credit derivatives, guarantees, receivables, asset-backed securities, mortgage-backed securities, other debt securities, or equity securities); (5) The underlying exposures are not owned by an operating company; (6) The underlying exposures are not owned by a small business investment company defined in section 302 of the Small Business Investment Act; (7) The underlying exposures are not owned by a firm an investment in which qualifies as a community development investment under section 24(Eleventh) of the National Bank Act; (8) The [AGENCY] may determine that a transaction in which the underlying exposures are owned by an investment firm that exercises substantially unfettered control over the size and composition of its assets, liabilities, and off-balance sheet exposures is not a traditional securitization based on the transaction’s leverage, risk profile, or economic substance; (9) The [AGENCY] may deem a transaction that meets the definition of a traditional securitization, notwithstanding paragraph (5), (6), or (7) of this definition, to be a traditional securitization based on the transaction’s leverage, risk profile, or economic substance; and (10) The transaction is not: (i) An investment fund; (ii) A collective investment fund (as defined in [12 CFR 9.18 (national bank) and 12 CFR 151.40 (Federal saving association) (OCC); 12 CFR 208.34 (Board)]; (iii) An employee benefit plan (as defined in paragraphs (3) and (32) of section 3 of ERISA), a ‘‘governmental plan’’ (as defined in 29 U.S.C. 1002(32)) that complies with the tax deferral qualification requirements provided in the Internal Revenue Code, or any similar employee benefit plan established under the laws of a foreign jurisdiction; (iv) A synthetic exposure to the capital of a financial institution to the PO 00000 Frm 00153 Fmt 4701 Sfmt 4700 62169 extent deducted from capital under § l.22; or (v) Registered with the SEC under the Investment Company Act of 1940 (15 U.S.C. 80a–1) or foreign equivalents thereof. Tranche means all securitization exposures associated with a securitization that have the same seniority level. Two-way market means a market where there are independent bona fide offers to buy and sell so that a price reasonably related to the last sales price or current bona fide competitive bid and offer quotations can be determined within one day and settled at that price within a relatively short time frame conforming to trade custom. Unconditionally cancelable means with respect to a commitment, that a [BANK] may, at any time, with or without cause, refuse to extend credit under the commitment (to the extent permitted under applicable law). Underlying exposures means one or more exposures that have been securitized in a securitization transaction. Unregulated financial institution means, for purposes of § l.131, a financial institution that is not a regulated financial institution, including any financial institution that would meet the definition of ‘‘financial institution’’ under this section but for the ownership interest thresholds set forth in paragraph (4)(i) of that definition. U.S. Government agency means an instrumentality of the U.S. Government whose obligations are fully and explicitly guaranteed as to the timely payment of principal and interest by the full faith and credit of the U.S. Government. Value-at-Risk (VaR) means the estimate of the maximum amount that the value of one or more exposures could decline due to market price or rate movements during a fixed holding period within a stated confidence interval. Wrong-way risk means the risk that arises when an exposure to a particular counterparty is positively correlated with the probability of default of such counterparty itself. § l.3 Operational requirements for counterparty credit risk. For purposes of calculating riskweighted assets under subparts D and E of this part: (a) Cleared transaction. In order to recognize certain exposures as cleared transactions pursuant to paragraphs (1)(ii), (iii) or (iv) of the definition of ‘‘cleared transaction’’ in § l.2, the E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62170 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations exposures must meet the applicable requirements set forth in this paragraph (a). (1) The offsetting transaction must be identified by the CCP as a transaction for the clearing member client. (2) The collateral supporting the transaction must be held in a manner that prevents the [BANK] from facing any loss due to an event of default, including from a liquidation, receivership, insolvency, or similar proceeding of either the clearing member or the clearing member’s other clients. Omnibus accounts established under 17 CFR parts 190 and 300 satisfy the requirements of this paragraph (a). (3) The [BANK] must conduct sufficient legal review to conclude with a well-founded basis (and maintain sufficient written documentation of that legal review) that in the event of a legal challenge (including one resulting from a default or receivership, insolvency, liquidation, or similar proceeding) the relevant court and administrative authorities would find the arrangements of paragraph (a)(2) of this section to be legal, valid, binding and enforceable under the law of the relevant jurisdictions. (4) The offsetting transaction with a clearing member must be transferable under the transaction documents and applicable laws in the relevant jurisdiction(s) to another clearing member should the clearing member default, become insolvent, or enter receivership, insolvency, liquidation, or similar proceedings. (b) Eligible margin loan. In order to recognize an exposure as an eligible margin loan as defined in § l.2, a [BANK] must conduct sufficient legal review to conclude with a well-founded basis (and maintain sufficient written documentation of that legal review) that the agreement underlying the exposure: (1) Meets the requirements of paragraph (1)(iii) of the definition of eligible margin loan in § l.2, and (2) Is legal, valid, binding, and enforceable under applicable law in the relevant jurisdictions. (c) Qualifying cross-product master netting agreement. In order to recognize an agreement as a qualifying crossproduct master netting agreement as defined in § l.101, a [BANK] must obtain a written legal opinion verifying the validity and enforceability of the agreement under applicable law of the relevant jurisdictions if the counterparty fails to perform upon an event of default, including upon receivership, insolvency, liquidation, or similar proceeding. (d) Qualifying master netting agreement. In order to recognize an VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 agreement as a qualifying master netting agreement as defined in § l.2, a [BANK] must: (1) Conduct sufficient legal review to conclude with a well-founded basis (and maintain sufficient written documentation of that legal review) that: (i) The agreement meets the requirements of paragraph (2) of the definition of qualifying master netting agreement in § l.2; and (ii) In the event of a legal challenge (including one resulting from default or from receivership, insolvency, liquidation, or similar proceeding) the relevant court and administrative authorities would find the agreement to be legal, valid, binding, and enforceable under the law of the relevant jurisdictions; and (2) Establish and maintain written procedures to monitor possible changes in relevant law and to ensure that the agreement continues to satisfy the requirements of the definition of qualifying master netting agreement in § l.2. (e) Repo-style transaction. In order to recognize an exposure as a repo-style transaction as defined in § l.2, a [BANK] must conduct sufficient legal review to conclude with a well-founded basis (and maintain sufficient written documentation of that legal review) that the agreement underlying the exposure: (1) Meets the requirements of paragraph (3) of the definition of repostyle transaction in § l.2, and (2) Is legal, valid, binding, and enforceable under applicable law in the relevant jurisdictions. (f) Failure of a QCCP to satisfy the rule’s requirements. If a [BANK] determines that a CCP ceases to be a QCCP due to the failure of the CCP to satisfy one or more of the requirements set forth in paragraphs (2)(i) through (2)(iii) of the definition of a QCCP in § l.2, the [BANK] may continue to treat the CCP as a QCCP for up to three months following the determination. If the CCP fails to remedy the relevant deficiency within three months after the initial determination, or the CCP fails to satisfy the requirements set forth in paragraphs (2)(i) through (2)(iii) of the definition of a QCCP continuously for a three-month period after remedying the relevant deficiency, a [BANK] may not treat the CCP as a QCCP for the purposes of this part until after the [BANK] has determined that the CCP has satisfied the requirements in paragraphs (2)(i) through (2)(iii) of the definition of a QCCP for three continuous months. PO 00000 Frm 00154 Fmt 4701 Sfmt 4700 §§ l.4 through l.9 [Reserved] Subpart B—Capital Ratio Requirements and Buffers § l.10 Minimum capital requirements. (a) Minimum capital requirements. A [BANK] must maintain the following minimum capital ratios: (1) A common equity tier 1 capital ratio of 4.5 percent. (2) A tier 1 capital ratio of 6 percent. (3) A total capital ratio of 8 percent. (4) A leverage ratio of 4 percent. (5) For advanced approaches [BANK]s, a supplementary leverage ratio of 3 percent. (b) Standardized capital ratio calculations. Other than as provided in paragraph (c) of this section: (1) Common equity tier 1 capital ratio. A [BANK]’s common equity tier 1 capital ratio is the ratio of the [BANK]’s common equity tier 1 capital to standardized total risk-weighted assets; (2) Tier 1 capital ratio. A [BANK]’s tier 1 capital ratio is the ratio of the [BANK]’s tier 1 capital to standardized total risk-weighted assets; (3) Total capital ratio. A [BANK]’s total capital ratio is the ratio of the [BANK]’s total capital to standardized total risk-weighted assets; and (4) Leverage ratio. A [BANK]’s leverage ratio is the ratio of the [BANK]’s tier 1 capital to the [BANK]’s average total consolidated assets as reported on the [BANK]’s [REGULATORY REPORT] minus amounts deducted from tier 1 capital under § l.22(a), (c) and (d). (c) Advanced approaches capital ratio calculations. An advanced approaches [BANK] that has completed the parallel run process and received notification from the [AGENCY] pursuant to § l.121(d) must determine its regulatory capital ratios as described in this paragraph (c). (1) Common equity tier 1 capital ratio. The [BANK]’s common equity tier 1 capital ratio is the lower of: (i) The ratio of the [BANK]’s common equity tier 1 capital to standardized total risk-weighted assets; and (ii) The ratio of the [BANK]’s common equity tier 1 capital to advanced approaches total risk-weighted assets. (2) Tier 1 capital ratio. The [BANK]’s tier 1 capital ratio is the lower of: (i) The ratio of the [BANK]’s tier 1 capital to standardized total riskweighted assets; and (ii) The ratio of the [BANK]’s tier 1 capital to advanced approaches total risk-weighted assets. (3) Total capital ratio. The [BANK]’s total capital ratio is the lower of: E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (i) The ratio of the [BANK]’s total capital to standardized total riskweighted assets; and (ii) The ratio of the [BANK]’s advanced-approaches-adjusted total capital to advanced approaches total risk-weighted assets. A [BANK]’s advanced-approaches-adjusted total capital is the [BANK]’s total capital after being adjusted as follows: (A) An advanced approaches [BANK] must deduct from its total capital any allowance for loan and lease losses included in its tier 2 capital in accordance with § l.20(d)(3); and (B) An advanced approaches [BANK] must add to its total capital any eligible credit reserves that exceed the [BANK]’s total expected credit losses to the extent that the excess reserve amount does not exceed 0.6 percent of the [BANK]’s credit risk-weighted assets. (4) Supplementary leverage ratio. An advanced approaches [BANK]’s supplementary leverage ratio is the simple arithmetic mean of the ratio of its tier 1 capital to total leverage exposure calculated as of the last day of each month in the reporting quarter. (d) Capital adequacy. (1) Notwithstanding the minimum requirements in this part, a [BANK] must maintain capital commensurate with the level and nature of all risks to which the [BANK] is exposed. The supervisory evaluation of a [BANK]’s capital adequacy is based on an individual assessment of numerous factors, including those listed at [12 CFR 3.10 (national banks), 12 CFR 167.3(c) (Federal savings associations) and 12 CFR 208.4 (state member banks)]. (2) A [BANK] must have a process for assessing its overall capital adequacy in relation to its risk profile and a comprehensive strategy for maintaining an appropriate level of capital. § l.11 Capital conservation buffer and countercyclical capital buffer amount. (a) Capital conservation buffer. (1) Composition of the capital conservation buffer. The capital conservation buffer is composed solely of common equity tier 1 capital. (2) Definitions. For purposes of this section, the following definitions apply: (i) Eligible retained income. The eligible retained income of a [BANK] is the [BANK]’s net income for the four calendar quarters preceding the current calendar quarter, based on the [BANK]’s quarterly [REGULATORY REPORT]s, net of any distributions and associated tax effects not already reflected in net income. (ii) Maximum payout ratio. The maximum payout ratio is the percentage of eligible retained income that a [BANK] can pay out in the form of distributions and discretionary bonus payments during the current calendar quarter. The maximum payout ratio is based on the [BANK]’s capital conservation buffer, calculated as of the last day of the previous calendar quarter, as set forth in Table 1 to § l.11. (iii) Maximum payout amount. A [BANK]’s maximum payout amount for the current calendar quarter is equal to the [BANK]’s eligible retained income, multiplied by the applicable maximum payout ratio, as set forth in Table 1 to § l.11. (iv) Private sector credit exposure. Private sector credit exposure means an exposure to a company or an individual that is not an exposure to a sovereign, the Bank for International Settlements, the European Central Bank, the European Commission, the International Monetary Fund, a MDB, a PSE, or a GSE. (3) Calculation of capital conservation buffer. (i) A [BANK]’s capital conservation buffer is equal to the lowest of the following ratios, calculated as of the last day of the previous calendar quarter based on the [BANK]’s most recent [REGULATORY REPORT]: (A) The [BANK]’s common equity tier 1 capital ratio minus the [BANK]’s minimum common equity tier 1 capital ratio requirement under § l.10; (B) The [BANK]’s tier 1 capital ratio minus the [BANK]’s minimum tier 1 capital ratio requirement under § l.10; and (C) The [BANK]’s total capital ratio minus the [BANK]’s minimum total 62171 capital ratio requirement under § l.10; or (ii) Notwithstanding paragraphs (a)(3)(i)(A)–(C) of this section, if the [BANK]’s common equity tier 1, tier 1 or total capital ratio is less than or equal to the [BANK]’s minimum common equity tier 1, tier 1 or total capital ratio requirement under § l.10, respectively, the [BANK]’s capital conservation buffer is zero. (4) Limits on distributions and discretionary bonus payments. (i) A [BANK] shall not make distributions or discretionary bonus payments or create an obligation to make such distributions or payments during the current calendar quarter that, in the aggregate, exceed the maximum payout amount. (ii) A [BANK] with a capital conservation buffer that is greater than 2.5 percent plus 100 percent of its applicable countercyclical capital buffer, in accordance with paragraph (b) of this section, is not subject to a maximum payout amount under this section. (iii) Negative eligible retained income. Except as provided in paragraph (a)(4)(iv) of this section, a [BANK] may not make distributions or discretionary bonus payments during the current calendar quarter if the [BANK]’s: (A) Eligible retained income is negative; and (B) Capital conservation buffer was less than 2.5 percent as of the end of the previous calendar quarter. (iv) Prior approval. Notwithstanding the limitations in paragraphs (a)(4)(i) through (iii) of this section, the [AGENCY] may permit a [BANK] to make a distribution or discretionary bonus payment upon a request of the [BANK], if the [AGENCY] determines that the distribution or discretionary bonus payment would not be contrary to the purposes of this section, or to the safety and soundness of the [BANK]. In making such a determination, the [AGENCY] will consider the nature and extent of the request and the particular circumstances giving rise to the request. TABLE 1 TO § l.11—CALCULATION OF MAXIMUM PAYOUT AMOUNT Maximum payout ratio (as a percentage of eligible retained income) wreier-aviles on DSK5TPTVN1PROD with RULES2 Capital conservation buffer Greater than 2.5 percent plus 100 percent of the [BANK]’s applicable countercyclical capital buffer amount ............. Less than amount, amount. Less than amount, amount. or equal to 2.5 percent plus 100 percent of the [BANK]’s applicable countercyclical capital buffer and greater than 1.875 percent plus 75 percent of the [BANK]’s applicable countercyclical capital buffer or equal to 1.875 percent plus 75 percent of the [BANK]’s applicable countercyclical capital buffer and greater than 1.25 percent plus 50 percent of the [BANK]’s applicable countercyclical capital buffer VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00155 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 No payout ratio limitation applies. 60 percent. 40 percent. 62172 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations TABLE 1 TO § l.11—CALCULATION OF MAXIMUM PAYOUT AMOUNT—Continued Maximum payout ratio (as a percentage of eligible retained income) Capital conservation buffer wreier-aviles on DSK5TPTVN1PROD with RULES2 Less than or equal to 1.25 percent plus 50 percent of the [BANK]’s applicable countercyclical capital buffer amount, and greater than 0.625 percent plus 25 percent of the [BANK]’s applicable countercyclical capital buffer amount. Less than or equal to 0.625 percent plus 25 percent of the [BANK]’s applicable countercyclical capital buffer amount. (v) Other limitations on distributions. Additional limitations on distributions may apply to a [BANK] under [12 CFR part 3, subparts H and I; 12 CFR part 5.46, 12 CFR part 5, subpart E; 12 CFR part 6 (OCC); 12 CFR 225.4; 12 CFR 225.8; 12 CFR 263.202 (Board)]. (b) Countercyclical capital buffer amount. (1) General. An advanced approaches [BANK] must calculate a countercyclical capital buffer amount in accordance with the following paragraphs for purposes of determining its maximum payout ratio under Table 1 to § l.11. (i) Extension of capital conservation buffer. The countercyclical capital buffer amount is an extension of the capital conservation buffer as described in paragraph (a) of this section. (ii) Amount. An advanced approaches [BANK] has a countercyclical capital buffer amount determined by calculating the weighted average of the countercyclical capital buffer amounts established for the national jurisdictions where the [BANK]’s private sector credit exposures are located, as specified in paragraphs (b)(2) and (3) of this section. (iii) Weighting. The weight assigned to a jurisdiction’s countercyclical capital buffer amount is calculated by dividing the total risk-weighted assets for the [BANK]’s private sector credit exposures located in the jurisdiction by the total risk-weighted assets for all of the [BANK]’s private sector credit exposures. The methodology a [BANK] uses for determining risk-weighted assets for purposes of this paragraph (b) must be the methodology that determines its risk-based capital ratios under § l.10. Notwithstanding the previous sentence, the risk-weighted asset amount for a private sector credit exposure that is a covered position under subpart F of this part is its specific risk add-on as determined under § l.210 multiplied by 12.5. (iv) Location. (A) Except as provided in paragraphs (b)(1)(iv)(B) and (b)(1)(iv)(C) of this section, the location of a private sector credit exposure is the national jurisdiction where the borrower is located (that is, where it is incorporated, chartered, or similarly VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 established or, if the borrower is an individual, where the borrower resides). (B) If, in accordance with subparts D or E of this part, the [BANK] has assigned to a private sector credit exposure a risk weight associated with a protection provider on a guarantee or credit derivative, the location of the exposure is the national jurisdiction where the protection provider is located. (C) The location of a securitization exposure is the location of the underlying exposures, or, if the underlying exposures are located in more than one national jurisdiction, the national jurisdiction where the underlying exposures with the largest aggregate unpaid principal balance are located. For purposes of this paragraph (b), the location of an underlying exposure shall be the location of the borrower, determined consistent with paragraph (b)(1)(iv)(A) of this section. (2) Countercyclical capital buffer amount for credit exposures in the United States—(i) Initial countercyclical capital buffer amount with respect to credit exposures in the United States. The initial countercyclical capital buffer amount in the United States is zero. (ii) Adjustment of the countercyclical capital buffer amount. The [AGENCY] will adjust the countercyclical capital buffer amount for credit exposures in the United States in accordance with applicable law.6 (iii) Range of countercyclical capital buffer amount. The [AGENCY] will adjust the countercyclical capital buffer amount for credit exposures in the United States between zero percent and 2.5 percent of risk-weighted assets. (iv) Adjustment determination. The [AGENCY] will base its decision to adjust the countercyclical capital buffer amount under this section on a range of macroeconomic, financial, and supervisory information indicating an increase in systemic risk including, but not limited to, the ratio of credit to gross domestic product, a variety of asset prices, other factors indicative of 6 The [AGENCY] expects that any adjustment will be based on a determination made jointly by the Board, OCC, and FDIC. PO 00000 Frm 00156 Fmt 4701 Sfmt 4700 20 percent. 0 percent. relative credit and liquidity expansion or contraction, funding spreads, credit condition surveys, indices based on credit default swap spreads, options implied volatility, and measures of systemic risk. (v) Effective date of adjusted countercyclical capital buffer amount. (A) Increase adjustment. A determination by the [AGENCY] under paragraph (b)(2)(ii) of this section to increase the countercyclical capital buffer amount will be effective 12 months from the date of announcement, unless the [AGENCY] establishes an earlier effective date and includes a statement articulating the reasons for the earlier effective date. (B) Decrease adjustment. A determination by the [AGENCY] to decrease the established countercyclical capital buffer amount under paragraph (b)(2)(ii) of this section will be effective on the day following announcement of the final determination or the earliest date permissible under applicable law or regulation, whichever is later. (vi) Twelve month sunset. The countercyclical capital buffer amount will return to zero percent 12 months after the effective date that the adjusted countercyclical capital buffer amount is announced, unless the [AGENCY] announces a decision to maintain the adjusted countercyclical capital buffer amount or adjust it again before the expiration of the 12-month period. (3) Countercyclical capital buffer amount for foreign jurisdictions. The [AGENCY] will adjust the countercyclical capital buffer amount for private sector credit exposures to reflect decisions made by foreign jurisdictions consistent with due process requirements described in paragraph (b)(2) of this section. §§ l.12 through l.19 [Reserved] Subpart C—Definition of Capital § l.20 Capital components and eligibility criteria for regulatory capital instruments. (a) Regulatory capital components. A [BANK]’s regulatory capital components are: (1) Common equity tier 1 capital; E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (2) Additional tier 1 capital; and (3) Tier 2 capital. (b) Common equity tier 1 capital. Common equity tier 1 capital is the sum of the common equity tier 1 capital elements in this paragraph (b), minus regulatory adjustments and deductions in § l.22. The common equity tier 1 capital elements are: (1) Any common stock instruments (plus any related surplus) issued by the [BANK], net of treasury stock, and any capital instruments issued by mutual banking organizations, that meet all the following criteria: (i) The instrument is paid-in, issued directly by the [BANK], and represents the most subordinated claim in a receivership, insolvency, liquidation, or similar proceeding of the [BANK]; (ii) The holder of the instrument is entitled to a claim on the residual assets of the [BANK] that is proportional with the holder’s share of the [BANK]’s issued capital after all senior claims have been satisfied in a receivership, insolvency, liquidation, or similar proceeding; (iii) The instrument has no maturity date, can only be redeemed via discretionary repurchases with the prior approval of the [AGENCY], and does not contain any term or feature that creates an incentive to redeem; (iv) The [BANK] did not create at issuance of the instrument through any action or communication an expectation that it will buy back, cancel, or redeem the instrument, and the instrument does not include any term or feature that might give rise to such an expectation; (v) Any cash dividend payments on the instrument are paid out of the [BANK]’s net income, retained earnings, or surplus related to common stock, and are not subject to a limit imposed by the contractual terms governing the instrument; (vi) The [BANK] has full discretion at all times to refrain from paying any dividends and making any other distributions on the instrument without triggering an event of default, a requirement to make a payment-in-kind, or an imposition of any other restrictions on the [BANK]; (vii) Dividend payments and any other distributions on the instrument may be paid only after all legal and contractual obligations of the [BANK] have been satisfied, including payments due on more senior claims; (viii) The holders of the instrument bear losses as they occur equally, proportionately, and simultaneously with the holders of all other common stock instruments before any losses are borne by holders of claims on the [BANK] with greater priority in a VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 receivership, insolvency, liquidation, or similar proceeding; (ix) The paid-in amount is classified as equity under GAAP; (x) The [BANK], or an entity that the [BANK] controls, did not purchase or directly or indirectly fund the purchase of the instrument; (xi) The instrument is not secured, not covered by a guarantee of the [BANK] or of an affiliate of the [BANK], and is not subject to any other arrangement that legally or economically enhances the seniority of the instrument; (xii) The instrument has been issued in accordance with applicable laws and regulations; and (xiii) The instrument is reported on the [BANK]’s regulatory financial statements separately from other capital instruments. (2) Retained earnings. (3) Accumulated other comprehensive income (AOCI) as reported under GAAP.7 (4) Any common equity tier 1 minority interest, subject to the limitations in § l.21(c). (5) Notwithstanding the criteria for common stock instruments referenced above, a [BANK]’s common stock issued and held in trust for the benefit of its employees as part of an employee stock ownership plan does not violate any of the criteria in paragraph (b)(1)(iii), paragraph (b)(1)(iv) or paragraph (b)(1)(xi) of this section, provided that any repurchase of the stock is required solely by virtue of ERISA for an instrument of a [BANK] that is not publicly-traded. In addition, an instrument issued by a [BANK] to its employee stock ownership plan does not violate the criterion in paragraph (b)(1)(x) of this section. (c) Additional tier 1 capital. Additional tier 1 capital is the sum of additional tier 1 capital elements and any related surplus, minus the regulatory adjustments and deductions in § l.22. Additional tier 1 capital elements are: (1) Instruments (plus any related surplus) that meet the following criteria: (i) The instrument is issued and paidin; (ii) The instrument is subordinated to depositors, general creditors, and subordinated debt holders of the [BANK] in a receivership, insolvency, liquidation, or similar proceeding; (iii) The instrument is not secured, not covered by a guarantee of the [BANK] or of an affiliate of the [BANK], and not subject to any other arrangement that legally or 7 See § l.22 for specific adjustments related to AOCI. PO 00000 Frm 00157 Fmt 4701 Sfmt 4700 62173 economically enhances the seniority of the instrument; (iv) The instrument has no maturity date and does not contain a dividend step-up or any other term or feature that creates an incentive to redeem; and (v) If callable by its terms, the instrument may be called by the [BANK] only after a minimum of five years following issuance, except that the terms of the instrument may allow it to be called earlier than five years upon the occurrence of a regulatory event that precludes the instrument from being included in additional tier 1 capital, a tax event, or if the issuing entity is required to register as an investment company pursuant to the Investment Company Act of 1940 (15 U.S.C. 80a–1 et seq.). In addition: (A) The [BANK] must receive prior approval from the [AGENCY] to exercise a call option on the instrument. (B) The [BANK] does not create at issuance of the instrument, through any action or communication, an expectation that the call option will be exercised. (C) Prior to exercising the call option, or immediately thereafter, the [BANK] must either: Replace the instrument to be called with an equal amount of instruments that meet the criteria under paragraph (b) of this section or this paragraph (c); 8 or demonstrate to the satisfaction of the [AGENCY] that following redemption, the [BANK] will continue to hold capital commensurate with its risk. (vi) Redemption or repurchase of the instrument requires prior approval from the [AGENCY]. (vii) The [BANK] has full discretion at all times to cancel dividends or other distributions on the instrument without triggering an event of default, a requirement to make a payment-in-kind, or an imposition of other restrictions on the [BANK] except in relation to any distributions to holders of common stock or instruments that are pari passu with the instrument. (viii) Any distributions on the instrument are paid out of the [BANK]’s net income, retained earnings, or surplus related to other additional tier 1 capital instruments. (ix) The instrument does not have a credit-sensitive feature, such as a dividend rate that is reset periodically based in whole or in part on the [BANK]’s credit quality, but may have a dividend rate that is adjusted periodically independent of the [BANK]’s credit quality, in relation to 8 Replacement can be concurrent with redemption of existing additional tier 1 capital instruments. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62174 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations general market interest rates or similar adjustments. (x) The paid-in amount is classified as equity under GAAP. (xi) The [BANK], or an entity that the [BANK] controls, did not purchase or directly or indirectly fund the purchase of the instrument. (xii) The instrument does not have any features that would limit or discourage additional issuance of capital by the [BANK], such as provisions that require the [BANK] to compensate holders of the instrument if a new instrument is issued at a lower price during a specified time frame. (xiii) If the instrument is not issued directly by the [BANK] or by a subsidiary of the [BANK] that is an operating entity, the only asset of the issuing entity is its investment in the capital of the [BANK], and proceeds must be immediately available without limitation to the [BANK] or to the [BANK]’s top-tier holding company in a form which meets or exceeds all of the other criteria for additional tier 1 capital instruments.9 (xiv) For an advanced approaches [BANK], the governing agreement, offering circular, or prospectus of an instrument issued after the date upon which the [BANK] becomes subject to this part as set forth in § l.1(f) must disclose that the holders of the instrument may be fully subordinated to interests held by the U.S. government in the event that the [BANK] enters into a receivership, insolvency, liquidation, or similar proceeding. (2) Tier 1 minority interest, subject to the limitations in § l.21(d), that is not included in the [BANK]’s common equity tier 1 capital. (3) Any and all instruments that qualified as tier 1 capital under the [AGENCY]’s general risk-based capital rules under [12 CFR part 3, appendix A (national banks), 12 CFR 167 (Federal savings associations) (OCC); 12 CFR part 208, appendix A, 12 CFR part 225, appendix A (Board)] as then in effect, that were issued under the Small Business Jobs Act of 2010 10 or prior to October 4, 2010, under the Emergency Economic Stabilization Act of 2008.11 (4) Notwithstanding the criteria for additional tier 1 capital instruments referenced above: (i) An instrument issued by a [BANK] and held in trust for the benefit of its employees as part of an employee stock ownership plan does not violate any of minimis assets related to the operation of the issuing entity can be disregarded for purposes of this criterion. 10 Public Law 111–240; 124 Stat. 2504 (2010). 11 Public Law 110–343, 122 Stat. 3765 (2008). the criteria in paragraph (c)(1)(iii) of this section, provided that any repurchase is required solely by virtue of ERISA for an instrument of a [BANK] that is not publicly-traded. In addition, an instrument issued by a [BANK] to its employee stock ownership plan does not violate the criteria in paragraph (c)(1)(v) or paragraph (c)(1)(xi) of this section; and (ii) An instrument with terms that provide that the instrument may be called earlier than five years upon the occurrence of a rating agency event does not violate the criterion in paragraph (c)(1)(v) of this section provided that the instrument was issued and included in a [BANK]’s tier 1 capital prior to January 1, 2014, and that such instrument satisfies all other criteria under this § l.20(c). (d) Tier 2 Capital. Tier 2 capital is the sum of tier 2 capital elements and any related surplus, minus regulatory adjustments and deductions in § l.22. Tier 2 capital elements are: (1) Instruments (plus related surplus) that meet the following criteria: (i) The instrument is issued and paidin; (ii) The instrument is subordinated to depositors and general creditors of the [BANK]; (iii) The instrument is not secured, not covered by a guarantee of the [BANK] or of an affiliate of the [BANK], and not subject to any other arrangement that legally or economically enhances the seniority of the instrument in relation to more senior claims; (iv) The instrument has a minimum original maturity of at least five years. At the beginning of each of the last five years of the life of the instrument, the amount that is eligible to be included in tier 2 capital is reduced by 20 percent of the original amount of the instrument (net of redemptions) and is excluded from regulatory capital when the remaining maturity is less than one year. In addition, the instrument must not have any terms or features that require, or create significant incentives for, the [BANK] to redeem the instrument prior to maturity; 12 and (v) The instrument, by its terms, may be called by the [BANK] only after a minimum of five years following issuance, except that the terms of the instrument may allow it to be called sooner upon the occurrence of an event that would preclude the instrument from being included in tier 2 capital, a 9 De VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 12 An instrument that by its terms automatically converts into a tier 1 capital instrument prior to five years after issuance complies with the five-year maturity requirement of this criterion. PO 00000 Frm 00158 Fmt 4701 Sfmt 4700 tax event, or if the issuing entity is required to register as an investment company pursuant to the Investment Company Act of 1940 (15 U.S.C. 80a–1 et seq.). In addition: (A) The [BANK] must receive the prior approval of the [AGENCY] to exercise a call option on the instrument. (B) The [BANK] does not create at issuance, through action or communication, an expectation the call option will be exercised. (C) Prior to exercising the call option, or immediately thereafter, the [BANK] must either: Replace any amount called with an equivalent amount of an instrument that meets the criteria for regulatory capital under this section; 13 or demonstrate to the satisfaction of the [AGENCY] that following redemption, the [BANK] would continue to hold an amount of capital that is commensurate with its risk. (vi) The holder of the instrument must have no contractual right to accelerate payment of principal or interest on the instrument, except in the event of a receivership, insolvency, liquidation, or similar proceeding of the [BANK]. (vii) The instrument has no creditsensitive feature, such as a dividend or interest rate that is reset periodically based in whole or in part on the [BANK]’s credit standing, but may have a dividend rate that is adjusted periodically independent of the [BANK]’s credit standing, in relation to general market interest rates or similar adjustments. (viii) The [BANK], or an entity that the [BANK] controls, has not purchased and has not directly or indirectly funded the purchase of the instrument. (ix) If the instrument is not issued directly by the [BANK] or by a subsidiary of the [BANK] that is an operating entity, the only asset of the issuing entity is its investment in the capital of the [BANK], and proceeds must be immediately available without limitation to the [BANK] or the [BANK]’s top-tier holding company in a form that meets or exceeds all the other criteria for tier 2 capital instruments under this section.14 (x) Redemption of the instrument prior to maturity or repurchase requires the prior approval of the [AGENCY]. (xi) For an advanced approaches [BANK], the governing agreement, offering circular, or prospectus of an instrument issued after the date on which the advanced approaches [BANK] 13 A [BANK] may replace tier 2 capital instruments concurrent with the redemption of existing tier 2 capital instruments. 14 A [BANK] may disregard de minimis assets related to the operation of the issuing entity for purposes of this criterion. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations becomes subject to this part under § l.1(f) must disclose that the holders of the instrument may be fully subordinated to interests held by the U.S. government in the event that the [BANK] enters into a receivership, insolvency, liquidation, or similar proceeding. (2) Total capital minority interest, subject to the limitations set forth in § l.21(e), that is not included in the [BANK]’s tier 1 capital. (3) ALLL up to 1.25 percent of the [BANK]’s standardized total riskweighted assets not including any amount of the ALLL (and excluding in the case of a market risk [BANK], its standardized market risk-weighted assets). (4) Any instrument that qualified as tier 2 capital under the [AGENCY]’s general risk-based capital rules under [12 CFR part 3, appendix A, 12 CFR 167 (OCC); 12 CFR part 208, appendix A, 12 CFR part 225, appendix A (Board)] as then in effect, that were issued under the Small Business Jobs Act of 2010,15 or prior to October 4, 2010, under the Emergency Economic Stabilization Act of 2008.16 (5) For a [BANK] that makes an AOCI opt-out election (as defined in paragraph (b)(2) of this section), 45 percent of pretax net unrealized gains on available-for-sale preferred stock classified as an equity security under GAAP and available-for-sale equity exposures. (6) Notwithstanding the criteria for tier 2 capital instruments referenced above, an instrument with terms that provide that the instrument may be called earlier than five years upon the occurrence of a rating agency event does not violate the criterion in paragraph (d)(1)(v) of this section provided that the instrument was issued and included in a [BANK]’s tier 1 or tier 2 capital prior to January 1, 2014, and that such instrument satisfies all other criteria under this paragraph (d). (e) [AGENCY] approval of a capital element. (1) A [BANK] must receive [AGENCY] prior approval to include a capital element (as listed in this section) in its common equity tier 1 capital, additional tier 1 capital, or tier 2 capital unless the element: (i) Was included in a [BANK]’s tier 1 capital or tier 2 capital prior to May 19, 2010 in accordance with the [AGENCY]’s risk-based capital rules that were effective as of that date and the underlying instrument may continue to be included under the criteria set forth in this section; or 15 Public 16 Public Law 111–240; 124 Stat. 2504 (2010). Law 110–343, 122 Stat. 3765 (2008). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (ii) Is equivalent, in terms of capital quality and ability to absorb losses with respect to all material terms, to a regulatory capital element the [AGENCY] determined may be included in regulatory capital pursuant to paragraph (e)(3) of this section. (2) When considering whether a [BANK] may include a regulatory capital element in its common equity tier 1 capital, additional tier 1 capital, or tier 2 capital, the [AGENCY] will consult with the [other Federal banking agencies]. (3) After determining that a regulatory capital element may be included in a [BANK]’s common equity tier 1 capital, additional tier 1 capital, or tier 2 capital, the [AGENCY] will make its decision publicly available, including a brief description of the material terms of the regulatory capital element and the rationale for the determination. § l.21 Minority interest. (a) Applicability. For purposes of § l.20, a [BANK] is subject to the minority interest limitations in this section if: (1) A consolidated subsidiary of the [BANK] has issued regulatory capital that is not owned by the [BANK]; and (2) For each relevant regulatory capital ratio of the consolidated subsidiary, the ratio exceeds the sum of the subsidiary’s minimum regulatory capital requirements plus its capital conservation buffer. (b) Difference in capital adequacy standards at the subsidiary level. For purposes of the minority interest calculations in this section, if the consolidated subsidiary issuing the capital is not subject to capital adequacy standards similar to those of the [BANK], the [BANK] must assume that the capital adequacy standards of the [BANK] apply to the subsidiary. (c) Common equity tier 1 minority interest includable in the common equity tier 1 capital of the [BANK]. For each consolidated subsidiary of a [BANK], the amount of common equity tier 1 minority interest the [BANK] may include in common equity tier 1 capital is equal to: (1) The common equity tier 1 minority interest of the subsidiary; minus (2) The percentage of the subsidiary’s common equity tier 1 capital that is not owned by the [BANK], multiplied by the difference between the common equity tier 1 capital of the subsidiary and the lower of: (i) The amount of common equity tier 1 capital the subsidiary must hold, or would be required to hold pursuant to paragraph (b) of this section, to avoid restrictions on distributions and PO 00000 Frm 00159 Fmt 4701 Sfmt 4700 62175 discretionary bonus payments under § l.11 or equivalent standards established by the subsidiary’s home country supervisor; or (ii)(A) The standardized total riskweighted assets of the [BANK] that relate to the subsidiary multiplied by (B) The common equity tier 1 capital ratio the subsidiary must maintain to avoid restrictions on distributions and discretionary bonus payments under § l.11 or equivalent standards established by the subsidiary’s home country supervisor. (d) Tier 1 minority interest includable in the tier 1 capital of the [BANK]. For each consolidated subsidiary of the [BANK], the amount of tier 1 minority interest the [BANK] may include in tier 1 capital is equal to: (1) The tier 1 minority interest of the subsidiary; minus (2) The percentage of the subsidiary’s tier 1 capital that is not owned by the [BANK] multiplied by the difference between the tier 1 capital of the subsidiary and the lower of: (i) The amount of tier 1 capital the subsidiary must hold, or would be required to hold pursuant to paragraph (b) of this section, to avoid restrictions on distributions and discretionary bonus payments under § l.11 or equivalent standards established by the subsidiary’s home country supervisor, or (ii)(A) The standardized total riskweighted assets of the [BANK] that relate to the subsidiary multiplied by (B) The tier 1 capital ratio the subsidiary must maintain to avoid restrictions on distributions and discretionary bonus payments under § l.11 or equivalent standards established by the subsidiary’s home country supervisor. (e) Total capital minority interest includable in the total capital of the [BANK]. For each consolidated subsidiary of the [BANK], the amount of total capital minority interest the [BANK] may include in total capital is equal to: (1) The total capital minority interest of the subsidiary; minus (2) The percentage of the subsidiary’s total capital that is not owned by the [BANK] multiplied by the difference between the total capital of the subsidiary and the lower of: (i) The amount of total capital the subsidiary must hold, or would be required to hold pursuant to paragraph (b) of this section, to avoid restrictions on distributions and discretionary bonus payments under § l.11 or equivalent standards established by the subsidiary’s home country supervisor, or E:\FR\FM\11OCR2.SGM 11OCR2 62176 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (ii)(A) The standardized total riskweighted assets of the [BANK] that relate to the subsidiary multiplied by (B) The total capital ratio the subsidiary must maintain to avoid restrictions on distributions and discretionary bonus payments under § l.11 or equivalent standards established by the subsidiary’s home country supervisor. wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.22 Regulatory capital adjustments and deductions. (a) Regulatory capital deductions from common equity tier 1 capital. A [BANK] must deduct from the sum of its common equity tier 1 capital elements the items set forth in this paragraph (a): (1) Goodwill, net of associated deferred tax liabilities (DTLs) in accordance with paragraph (e) of this section, including goodwill that is embedded in the valuation of a significant investment in the capital of an unconsolidated financial institution in the form of common stock (and that is reflected in the consolidated financial statements of the [BANK]), in accordance with paragraph (d) of this section; (2) Intangible assets, other than MSAs, net of associated DTLs in accordance with paragraph (e) of this section; (3) Deferred tax assets (DTAs) that arise from net operating loss and tax credit carryforwards net of any related valuation allowances and net of DTLs in accordance with paragraph (e) of this section; (4) Any gain-on-sale in connection with a securitization exposure; (5)(i) Any defined benefit pension fund net asset, net of any associated DTL in accordance with paragraph (e) of this section, held by a depository institution holding company. With the prior approval of the [AGENCY], this deduction is not required for any defined benefit pension fund net asset to the extent the depository institution holding company has unrestricted and unfettered access to the assets in that fund. (ii) For an insured depository institution, no deduction is required. (iii) A [BANK] must risk weight any portion of the defined benefit pension fund asset that is not deducted under paragraphs (a)(5)(i) or (a)(5)(ii) of this section as if the [BANK] directly holds a proportional ownership share of each exposure in the defined benefit pension fund. (6) For an advanced approaches [BANK] that has completed the parallel run process and that has received notification from the [AGENCY] pursuant to § l.121(d), the amount of VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 expected credit loss that exceeds its eligible credit reserves; and (7) With respect to a financial subsidiary, the aggregate amount of the [BANK]’s outstanding equity investment, including retained earnings, in its financial subsidiaries (as defined in [12 CFR 5.39 (OCC); 12 CFR 208.77 (Board))]. A [BANK] must not consolidate the assets and liabilities of a financial subsidiary with those of the parent bank, and no other deduction is required under paragraph (c) of this section for investments in the capital instruments of financial subsidiaries. (b) Regulatory adjustments to common equity tier 1 capital. (1) A [BANK] must adjust the sum of common equity tier 1 capital elements pursuant to the requirements set forth in this paragraph (b). Such adjustments to common equity tier 1 capital must be made net of the associated deferred tax effects. (i) A [BANK] that makes an AOCI optout election (as defined in paragraph (b)(2) of this section), must make the adjustments required under § l.22(b)(2)(i). (ii) A [BANK] that is an advanced approaches [BANK], and a [BANK] that has not made an AOCI opt-out election (as defined in paragraph (b)(2) of this section), must deduct any accumulated net gains and add any accumulated net losses on cash flow hedges included in AOCI that relate to the hedging of items that are not recognized at fair value on the balance sheet. (iii) A [BANK] must deduct any net gain and add any net loss related to changes in the fair value of liabilities that are due to changes in the [BANK]’s own credit risk. An advanced approaches [BANK] also must deduct the credit spread premium over the risk free rate for derivatives that are liabilities. (2) AOCI opt-out election. (i) A [BANK] that is not an advanced approaches [BANK] may make a onetime election to opt out of the requirement to include all components of AOCI (with the exception of accumulated net gains and losses on cash flow hedges related to items that are not fair-valued on the balance sheet) in common equity tier 1 capital (AOCI opt-out election). A [BANK] that makes an AOCI opt-out election in accordance with this paragraph (b)(2) must adjust common equity tier 1 capital as follows: (A) Subtract any net unrealized gains and add any net unrealized losses on available-for-sale securities; (B) Subtract any net unrealized losses on available-for-sale preferred stock classified as an equity security under PO 00000 Frm 00160 Fmt 4701 Sfmt 4700 GAAP and available-for-sale equity exposures; (C) Subtract any accumulated net gains and add any accumulated net losses on cash flow hedges; (D) Subtract any amounts recorded in AOCI attributed to defined benefit postretirement plans resulting from the initial and subsequent application of the relevant GAAP standards that pertain to such plans (excluding, at the [BANK]’s option, the portion relating to pension assets deducted under paragraph (a)(5) of this section); and (E) Subtract any net unrealized gains and add any net unrealized losses on held-to-maturity securities that are included in AOCI. (ii) A [BANK] that is not an advanced approaches [BANK] must make its AOCI opt-out election in its [REGULATORY REPORT] filed for the first regulatory reporting period after the date required for such [BANK] to comply with subpart A of this part as set forth in § l.1(f). (iii) With respect to a [BANK] that is not an advanced approaches [BANK], each of its subsidiary banking organizations that is subject to regulatory capital requirements issued by the Board of Governors of the Federal Reserve, the Federal Deposit Insurance Corporation, or the Office of the Comptroller of the Currency 17 must elect the same option as the [BANK] pursuant to this paragraph (b)(2). (iv) With prior notice to the [AGENCY], a [BANK] resulting from a merger, acquisition, or purchase transaction and that is not an advanced approaches [BANK] may change its AOCI opt-out election in its [REGULATORY REPORT] filed for the first reporting period after the date required for such [BANK] to comply with subpart A of this part as set forth in § l.1(f) if: (A) Other than as set forth in paragraph (b)(2)(iv)(C) of this section, the merger, acquisition, or purchase transaction involved the acquisition or purchase of all or substantially all of either the assets or voting stock of another banking organization that is subject to regulatory capital requirements issued by the Board of Governors of the Federal Reserve, the Federal Deposit Insurance Corporation, or the Office of the Comptroller of the Currency; 18 17 These rules include the regulatory capital requirements set forth at 12 CFR part 3 (OCC); 12 CFR part 225 (Board); 12 CFR part 325, and 12 CFR part 390 (FDIC). 18 These rules include the regulatory capital requirements set forth at 12 CFR part 3 (OCC); 12 CFR part 225 (Board); 12 CFR part 325, and 12 CFR part 390 (FDIC). E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (B) Prior to the merger, acquisition, or purchase transaction, only one of the banking organizations involved in the transaction made an AOCI opt-out election under this section; and (C) A [BANK] may, with the prior approval of the [AGENCY], change its AOCI opt-out election under this paragraph (b) in the case of a merger, acquisition, or purchase transaction that meets the requirements set forth at paragraph (b)(2)(iv)(B) of this section, but does not meet the requirements of paragraph (b)(2)(iv)(A). In making such a determination, the [AGENCY] may consider the terms of the merger, acquisition, or purchase transaction, as well as the extent of any changes to the risk profile, complexity, and scope of operations of the [BANK] resulting from the merger, acquisition, or purchase transaction. (c) Deductions from regulatory capital related to investments in capital instruments 19—(1) Investment in the [BANK]’s own capital instruments. A [BANK] must deduct an investment in the [BANK]’s own capital instruments as follows: (i) A [BANK] must deduct an investment in the [BANK]’s own common stock instruments from its common equity tier 1 capital elements to the extent such instruments are not excluded from regulatory capital under § l.20(b)(1); (ii) A [BANK] must deduct an investment in the [BANK]’s own additional tier 1 capital instruments from its additional tier 1 capital elements; and (iii) A [BANK] must deduct an investment in the [BANK]’s own tier 2 capital instruments from its tier 2 capital elements. (2) Corresponding deduction approach. For purposes of subpart C of this part, the corresponding deduction approach is the methodology used for the deductions from regulatory capital related to reciprocal cross holdings (as described in paragraph (c)(3) of this section), non-significant investments in the capital of unconsolidated financial institutions (as described in paragraph (c)(4) of this section), and non-common stock significant investments in the capital of unconsolidated financial institutions (as described in paragraph (c)(5) of this section). Under the corresponding deduction approach, a [BANK] must make deductions from the component of capital for which the underlying instrument would qualify if 19 The [BANK] must calculate amounts deducted under paragraphs (c) through (f) of this section after it calculates the amount of ALLL includable in tier 2 capital under § l.20(d)(3). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 it were issued by the [BANK] itself, as described in paragraphs (c)(2)(i)–(iii) of this section. If the [BANK] does not have a sufficient amount of a specific component of capital to effect the required deduction, the shortfall must be deducted according to paragraph (f) of this section. (i) If an investment is in the form of an instrument issued by a financial institution that is not a regulated financial institution, the [BANK] must treat the instrument as: (A) A common equity tier 1 capital instrument if it is common stock or represents the most subordinated claim in liquidation of the financial institution; and (B) An additional tier 1 capital instrument if it is subordinated to all creditors of the financial institution and is senior in liquidation only to common shareholders. (ii) If an investment is in the form of an instrument issued by a regulated financial institution and the instrument does not meet the criteria for common equity tier 1, additional tier 1 or tier 2 capital instruments under § l.20, the [BANK] must treat the instrument as: (A) A common equity tier 1 capital instrument if it is common stock included in GAAP equity or represents the most subordinated claim in liquidation of the financial institution; (B) An additional tier 1 capital instrument if it is included in GAAP equity, subordinated to all creditors of the financial institution, and senior in a receivership, insolvency, liquidation, or similar proceeding only to common shareholders; and (C) A tier 2 capital instrument if it is not included in GAAP equity but considered regulatory capital by the primary supervisor of the financial institution. (iii) If an investment is in the form of a non-qualifying capital instrument (as defined in § l.300(c)), the [BANK] must treat the instrument as: (A) An additional tier 1 capital instrument if such instrument was included in the issuer’s tier 1 capital prior to May 19, 2010; or (B) A tier 2 capital instrument if such instrument was included in the issuer’s tier 2 capital (but not includable in tier 1 capital) prior to May 19, 2010. (3) Reciprocal cross holdings in the capital of financial institutions. A [BANK] must deduct investments in the capital of other financial institutions it holds reciprocally, where such reciprocal cross holdings result from a formal or informal arrangement to swap, exchange, or otherwise intend to hold each other’s capital instruments, by PO 00000 Frm 00161 Fmt 4701 Sfmt 4700 62177 applying the corresponding deduction approach. (4) Non-significant investments in the capital of unconsolidated financial institutions. (i) A [BANK] must deduct its non-significant investments in the capital of unconsolidated financial institutions (as defined in § l.2) that, in the aggregate, exceed 10 percent of the sum of the [BANK]’s common equity tier 1 capital elements minus all deductions from and adjustments to common equity tier 1 capital elements required under paragraphs (a) through (c)(3) of this section (the 10 percent threshold for non-significant investments) by applying the corresponding deduction approach.20 The deductions described in this section are net of associated DTLs in accordance with paragraph (e) of this section. In addition, a [BANK] that underwrites a failed underwriting, with the prior written approval of the [AGENCY], for the period of time stipulated by the [AGENCY], is not required to deduct a non-significant investment in the capital of an unconsolidated financial institution pursuant to this paragraph (c) to the extent the investment is related to the failed underwriting.21 (ii) The amount to be deducted under this section from a specific capital component is equal to: (A) The [BANK]’s non-significant investments in the capital of unconsolidated financial institutions exceeding the 10 percent threshold for non-significant investments, multiplied by (B) The ratio of the [BANK]’s nonsignificant investments in the capital of unconsolidated financial institutions in the form of such capital component to the [BANK]’s total non-significant investments in unconsolidated financial institutions. (5) Significant investments in the capital of unconsolidated financial institutions that are not in the form of common stock. A [BANK] must deduct its significant investments in the capital of unconsolidated financial institutions that are not in the form of common stock by applying the corresponding 20 With the prior written approval of the [AGENCY], for the period of time stipulated by the [AGENCY], a [BANK] is not required to deduct a non-significant investment in the capital instrument of an unconsolidated financial institution pursuant to this paragraph if the financial institution is in distress and if such investment is made for the purpose of providing financial support to the financial institution, as determined by the [AGENCY]. 21 Any non-significant investments in the capital of unconsolidated financial institutions that do not exceed the 10 percent threshold for non-significant investments under this section must be assigned the appropriate risk weight under subparts D, E, or F of this part, as applicable. E:\FR\FM\11OCR2.SGM 11OCR2 62178 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 deduction approach.22 The deductions described in this section are net of associated DTLs in accordance with paragraph (e) of this section. In addition, with the prior written approval of the [AGENCY], for the period of time stipulated by the [AGENCY], a [BANK] that underwrites a failed underwriting is not required to deduct a significant investment in the capital of an unconsolidated financial institution pursuant to this paragraph (c) if such investment is related to such failed underwriting. (d) Items subject to the 10 and 15 percent common equity tier 1 capital deduction thresholds. (1) A [BANK] must deduct from common equity tier 1 capital elements the amount of each of the items set forth in this paragraph (d) that, individually, exceeds 10 percent of the sum of the [BANK]’s common equity tier 1 capital elements, less adjustments to and deductions from common equity tier 1 capital required under paragraphs (a) through (c) of this section (the 10 percent common equity tier 1 capital deduction threshold). (i) DTAs arising from temporary differences that the [BANK] could not realize through net operating loss carrybacks, net of any related valuation allowances and net of DTLs, in accordance with paragraph (e) of this section. A [BANK] is not required to deduct from the sum of its common equity tier 1 capital elements DTAs (net of any related valuation allowances and net of DTLs, in accordance with § l.22(e)) arising from timing differences that the [BANK] could realize through net operating loss carrybacks. The [BANK] must risk weight these assets at 100 percent. For a [BANK] that is a member of a consolidated group for tax purposes, the amount of DTAs that could be realized through net operating loss carrybacks may not exceed the amount that the [BANK] could reasonably expect to have refunded by its parent holding company. (ii) MSAs net of associated DTLs, in accordance with paragraph (e) of this section. (iii) Significant investments in the capital of unconsolidated financial institutions in the form of common stock, net of associated DTLs in accordance with paragraph (e) of this 22 With prior written approval of the [AGENCY], for the period of time stipulated by the [AGENCY], a [BANK] is not required to deduct a significant investment in the capital instrument of an unconsolidated financial institution in distress which is not in the form of common stock pursuant to this section if such investment is made for the purpose of providing financial support to the financial institution as determined by the [AGENCY]. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 section.23 Significant investments in the capital of unconsolidated financial institutions in the form of common stock subject to the 10 percent common equity tier 1 capital deduction threshold may be reduced by any goodwill embedded in the valuation of such investments deducted by the [BANK] pursuant to paragraph (a)(1) of this section. In addition, with the prior written approval of the [AGENCY], for the period of time stipulated by the [AGENCY], a [BANK] that underwrites a failed underwriting is not required to deduct a significant investment in the capital of an unconsolidated financial institution in the form of common stock pursuant to this paragraph (d) if such investment is related to such failed underwriting. (2) A [BANK] must deduct from common equity tier 1 capital elements the items listed in paragraph (d)(1) of this section that are not deducted as a result of the application of the 10 percent common equity tier 1 capital deduction threshold, and that, in aggregate, exceed 17.65 percent of the sum of the [BANK]’s common equity tier 1 capital elements, minus adjustments to and deductions from common equity tier 1 capital required under paragraphs (a) through (c) of this section, minus the items listed in paragraph (d)(1) of this section (the 15 percent common equity tier 1 capital deduction threshold). Any goodwill that has been deducted under paragraph (a)(1) of this section can be excluded from the significant investments in the capital of unconsolidated financial institutions in the form of common stock.24 (3) For purposes of calculating the amount of DTAs subject to the 10 and 15 percent common equity tier 1 capital deduction thresholds, a [BANK] may exclude DTAs and DTLs relating to adjustments made to common equity tier 1 capital under paragraph (b) of this section. A [BANK] that elects to exclude DTAs relating to adjustments under paragraph (b) of this section also must exclude DTLs and must do so consistently in all future calculations. A [BANK] may change its exclusion 23 With the prior written approval of the [AGENCY], for the period of time stipulated by the [AGENCY], a [BANK] is not required to deduct a significant investment in the capital instrument of an unconsolidated financial institution in distress in the form of common stock pursuant to this section if such investment is made for the purpose of providing financial support to the financial institution as determined by the [AGENCY]. 24 The amount of the items in paragraph (d) of this section that is not deducted from common equity tier 1 capital pursuant to this section must be included in the risk-weighted assets of the [BANK] and assigned a 250 percent risk weight. PO 00000 Frm 00162 Fmt 4701 Sfmt 4700 preference only after obtaining the prior approval of the [AGENCY]. (e) Netting of DTLs against assets subject to deduction. (1) Except as described in paragraph (e)(3) of this section, netting of DTLs against assets that are subject to deduction under this section is permitted, but not required, if the following conditions are met: (i) The DTL is associated with the asset; and (ii) The DTL would be extinguished if the associated asset becomes impaired or is derecognized under GAAP. (2) A DTL may only be netted against a single asset. (3) For purposes of calculating the amount of DTAs subject to the threshold deduction in paragraph (d) of this section, the amount of DTAs that arise from net operating loss and tax credit carryforwards, net of any related valuation allowances, and of DTAs arising from temporary differences that the [BANK] could not realize through net operating loss carrybacks, net of any related valuation allowances, may be offset by DTLs (that have not been netted against assets subject to deduction pursuant to paragraph (e)(1) of this section) subject to the conditions set forth in this paragraph (e). (i) Only the DTAs and DTLs that relate to taxes levied by the same taxation authority and that are eligible for offsetting by that authority may be offset for purposes of this deduction. (ii) The amount of DTLs that the [BANK] nets against DTAs that arise from net operating loss and tax credit carryforwards, net of any related valuation allowances, and against DTAs arising from temporary differences that the [BANK] could not realize through net operating loss carrybacks, net of any related valuation allowances, must be allocated in proportion to the amount of DTAs that arise from net operating loss and tax credit carryforwards (net of any related valuation allowances, but before any offsetting of DTLs) and of DTAs arising from temporary differences that the [BANK] could not realize through net operating loss carrybacks (net of any related valuation allowances, but before any offsetting of DTLs), respectively. (4) A [BANK] may offset DTLs embedded in the carrying value of a leveraged lease portfolio acquired in a business combination that are not recognized under GAAP against DTAs that are subject to paragraph (d) of this section in accordance with this paragraph (e). (5) A [BANK] must net DTLs against assets subject to deduction under this section in a consistent manner from reporting period to reporting period. A [BANK] may change its preference E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations regarding the manner in which it nets DTLs against specific assets subject to deduction under this section only after obtaining the prior approval of the [AGENCY]. (f) Insufficient amounts of a specific regulatory capital component to effect deductions. Under the corresponding deduction approach, if a [BANK] does not have a sufficient amount of a specific component of capital to effect the required deduction after completing the deductions required under paragraph (d) of this section, the [BANK] must deduct the shortfall from the next higher (that is, more subordinated) component of regulatory capital. (g) Treatment of assets that are deducted. A [BANK] must exclude from standardized total risk-weighted assets and, as applicable, advanced approaches total risk-weighted assets any item deducted from regulatory capital under paragraphs (a), (c), and (d) of this section. (h) Net long position. (1) For purposes of calculating an investment in the [BANK]’s own capital instrument and an investment in the capital of an unconsolidated financial institution under this section, the net long position is the gross long position in the underlying instrument determined in accordance with paragraph (h)(2) of this section, as adjusted to recognize a short position in the same instrument calculated in accordance with paragraph (h)(3) of this section. (2) Gross long position. The gross long position is determined as follows: (i) For an equity exposure that is held directly, the adjusted carrying value as that term is defined in § l.51(b); (ii) For an exposure that is held directly and is not an equity exposure or a securitization exposure, the exposure amount as that term is defined in § l.2; (iii) For an indirect exposure, the [BANK]’s carrying value of the investment in the investment fund, provided that, alternatively: (A) A [BANK] may, with the prior approval of the [AGENCY], use a conservative estimate of the amount of its investment in its own capital instruments or the capital of an unconsolidated financial institution held through a position in an index; or (B) A [BANK] may calculate the gross long position for the [BANK]’s own capital instruments or the capital of an unconsolidated financial institution by multiplying the [BANK]’s carrying value of its investment in the investment fund by either: (1) The highest stated investment limit (in percent) for investments in the VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 [BANK]’s own capital instruments or the capital of unconsolidated financial institutions as stated in the prospectus, partnership agreement, or similar contract defining permissible investments of the investment fund; or (2) The investment fund’s actual holdings of own capital instruments or the capital of unconsolidated financial institutions. (iv) For a synthetic exposure, the amount of the [BANK]’s loss on the exposure if the reference capital instrument were to have a value of zero. (3) Adjustments to reflect a short position. In order to adjust the gross long position to recognize a short position in the same instrument, the following criteria must be met: (i) The maturity of the short position must match the maturity of the long position, or the short position has a residual maturity of at least one year (maturity requirement); or (ii) For a position that is a trading asset or trading liability (whether on- or off-balance sheet) as reported on the [BANK]’s [REGULATORY REPORT], if the [BANK] has a contractual right or obligation to sell the long position at a specific point in time and the counterparty to the contract has an obligation to purchase the long position if the [BANK] exercises its right to sell, this point in time may be treated as the maturity of the long position such that the maturity of the long position and short position are deemed to match for purposes of the maturity requirement, even if the maturity of the short position is less than one year; and (iii) For an investment in the [BANK]’s own capital instrument under paragraph (c)(1) of this section or an investment in a capital of an unconsolidated financial institution under paragraphs (c)(4), (c)(5), and (d)(1)(iii) of this section. (A) A [BANK] may only net a short position against a long position in the [BANK]’s own capital instrument under paragraph (c)(1) of this section if the short position involves no counterparty credit risk. (B) A gross long position in a [BANK]’s own capital instrument or in a capital instrument of an unconsolidated financial institution resulting from a position in an index may be netted against a short position in the same index. Long and short positions in the same index without maturity dates are considered to have matching maturities. (C) A short position in an index that is hedging a long cash or synthetic position in a [BANK]’s own capital instrument or in a capital instrument of an unconsolidated financial institution PO 00000 Frm 00163 Fmt 4701 Sfmt 4700 62179 can be decomposed to provide recognition of the hedge. More specifically, the portion of the index that is composed of the same underlying instrument that is being hedged may be used to offset the long position if both the long position being hedged and the short position in the index are reported as a trading asset or trading liability (whether on- or off-balance sheet) on the [BANK]’s [REGULATORY REPORT], and the hedge is deemed effective by the [BANK]’s internal control processes, which have not been found to be inadequate by the [AGENCY]. §§ l.23 through l.29 [Reserved] Subpart D—Risk-Weighted Assets— Standardized Approach § l.30 Applicability. (a) This subpart sets forth methodologies for determining riskweighted assets for purposes of the generally applicable risk-based capital requirements for all [BANK]s. (b) Notwithstanding paragraph (a) of this section, a market risk [BANK] must exclude from its calculation of riskweighted assets under this subpart the risk-weighted asset amounts of all covered positions, as defined in subpart F of this part (except foreign exchange positions that are not trading positions, OTC derivative positions, cleared transactions, and unsettled transactions). Risk-Weighted Assets For General Credit Risk § l.31 Mechanics for calculating riskweighted assets for general credit risk. (a) General risk-weighting requirements. A [BANK] must apply risk weights to its exposures as follows: (1) A [BANK] must determine the exposure amount of each on-balance sheet exposure, each OTC derivative contract, and each off-balance sheet commitment, trade and transactionrelated contingency, guarantee, repostyle transaction, financial standby letter of credit, forward agreement, or other similar transaction that is not: (i) An unsettled transaction subject to § l.38; (ii) A cleared transaction subject to § l.35; (iii) A default fund contribution subject to § l.35; (iv) A securitization exposure subject to §§ l.41 through l.45; or (v) An equity exposure (other than an equity OTC derivative contract) subject to §§ l.51 through l.53. (2) The [BANK] must multiply each exposure amount by the risk weight appropriate to the exposure based on E:\FR\FM\11OCR2.SGM 11OCR2 62180 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations the exposure type or counterparty, eligible guarantor, or financial collateral to determine the risk-weighted asset amount for each exposure. (b) Total risk-weighted assets for general credit risk equals the sum of the risk-weighted asset amounts calculated under this section. § l.32 General risk weights. (a) Sovereign exposures—(1) Exposures to the U.S. government. (i) Notwithstanding any other requirement in this subpart, a [BANK] must assign a zero percent risk weight to: (A) An exposure to the U.S. government, its central bank, or a U.S. government agency; and (B) The portion of an exposure that is directly and unconditionally guaranteed by the U.S. government, its central bank, or a U.S. government agency. This includes a deposit or other exposure, or the portion of a deposit or other exposure, that is insured or otherwise unconditionally guaranteed by the FDIC or National Credit Union Administration. (ii) A [BANK] must assign a 20 percent risk weight to the portion of an exposure that is conditionally guaranteed by the U.S. government, its central bank, or a U.S. government agency. This includes an exposure, or the portion of an exposure, that is conditionally guaranteed by the FDIC or National Credit Union Administration. (2) Other sovereign exposures. In accordance with Table 1 to § l.32, a [BANK] must assign a risk weight to a sovereign exposure based on the CRC applicable to the sovereign or the sovereign’s OECD membership status if there is no CRC applicable to the sovereign. TABLE 1 TO § l.32—RISK WEIGHTS FOR SOVEREIGN EXPOSURES Risk weight (in percent) wreier-aviles on DSK5TPTVN1PROD with RULES2 CRC: 0–1 .................................... 2 ........................................ 3 ........................................ 4–6 .................................... 7 ........................................ OECD Member with No CRC Non-OECD Member with No CRC .................................. Sovereign Default ................. 0 20 50 100 150 0 100 150 (3) Certain sovereign exposures. Notwithstanding paragraph (a)(2) of this section, a [BANK] may assign to a sovereign exposure a risk weight that is lower than the applicable risk weight in Table 1 to § l.32 if: (i) The exposure is denominated in the sovereign’s currency; VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (ii) The [BANK] has at least an equivalent amount of liabilities in that currency; and (iii) The risk weight is not lower than the risk weight that the home country supervisor allows [BANK]s under its jurisdiction to assign to the same exposures to the sovereign. (4) Exposures to a non-OECD member sovereign with no CRC. Except as provided in paragraphs (a)(3), (a)(5) and (a)(6) of this section, a [BANK] must assign a 100 percent risk weight to an exposure to a sovereign if the sovereign does not have a CRC. (5) Exposures to an OECD member sovereign with no CRC. Except as provided in paragraph (a)(6) of this section, a [BANK] must assign a 0 percent risk weight to an exposure to a sovereign that is a member of the OECD if the sovereign does not have a CRC. (6) Sovereign default. A [BANK] must assign a 150 percent risk weight to a sovereign exposure immediately upon determining that an event of sovereign default has occurred, or if an event of sovereign default has occurred during the previous five years. (b) Certain supranational entities and multilateral development banks (MDBs). A [BANK] must assign a zero percent risk weight to an exposure to the Bank for International Settlements, the European Central Bank, the European Commission, the International Monetary Fund, or an MDB. (c) Exposures to GSEs. (1) A [BANK] must assign a 20 percent risk weight to an exposure to a GSE other than an equity exposure or preferred stock. (2) A [BANK] must assign a 100 percent risk weight to preferred stock issued by a GSE. (d) Exposures to depository institutions, foreign banks, and credit unions—(1) Exposures to U.S. depository institutions and credit unions. A [BANK] must assign a 20 percent risk weight to an exposure to a depository institution or credit union that is organized under the laws of the United States or any state thereof, except as otherwise provided under paragraph (d)(3) of this section. (2) Exposures to foreign banks. (i) Except as otherwise provided under paragraphs (d)(2)(iv) and (d)(3) of this section, a [BANK] must assign a risk weight to an exposure to a foreign bank, in accordance with Table 2 to § l.32, based on the CRC that corresponds to the foreign bank’s home country or the OECD membership status of the foreign bank’s home country if there is no CRC applicable to the foreign bank’s home country. PO 00000 Frm 00164 Fmt 4701 Sfmt 4700 TABLE 2 TO § l.32—RISK WEIGHTS FOR EXPOSURES TO FOREIGN BANKS Risk weight (in percent) CRC: 0–1 .................................... 2 ........................................ 3 ........................................ 4–7 .................................... OECD Member with No CRC Non-OECD Member with No CRC .................................. Sovereign Default ................. 20 50 100 150 20 100 150 (ii) A [BANK] must assign a 20 percent risk weight to an exposure to a foreign bank whose home country is a member of the OECD and does not have a CRC. (iii) A [BANK] must assign a 100 percent risk weight to an exposure to a foreign bank whose home country is not a member of the OECD and does not have a CRC, with the exception of selfliquidating, trade-related contingent items that arise from the movement of goods, and that have a maturity of three months or less, which may be assigned a 20 percent risk weight. (iv) A [BANK] must assign a 150 percent risk weight to an exposure to a foreign bank immediately upon determining that an event of sovereign default has occurred in the bank’s home country, or if an event of sovereign default has occurred in the foreign bank’s home country during the previous five years. (3) A [BANK] must assign a 100 percent risk weight to an exposure to a financial institution if the exposure may be included in that financial institution’s capital unless the exposure is: (i) An equity exposure; (ii) A significant investment in the capital of an unconsolidated financial institution in the form of common stock pursuant to § l.22(d)(iii); (iii) Deducted from regulatory capital under § l.22; or (iv) Subject to a 150 percent risk weight under paragraph (d)(2)(iv) or Table 2 of paragraph (d)(2) of this section. (e) Exposures to public sector entities (PSEs)—(1) Exposures to U.S. PSEs. (i) A [BANK] must assign a 20 percent risk weight to a general obligation exposure to a PSE that is organized under the laws of the United States or any state or political subdivision thereof. (ii) A [BANK] must assign a 50 percent risk weight to a revenue obligation exposure to a PSE that is organized under the laws of the United States or any state or political subdivision thereof. E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (2) Exposures to foreign PSEs. (i) Except as provided in paragraphs (e)(1) and (e)(3) of this section, a [BANK] must assign a risk weight to a general obligation exposure to a PSE, in accordance with Table 3 to § l.32, based on the CRC that corresponds to the PSE’s home country or the OECD membership status of the PSE’s home country if there is no CRC applicable to the PSE’s home country. (ii) Except as provided in paragraphs (e)(1) and (e)(3) of this section, a [BANK] must assign a risk weight to a revenue obligation exposure to a PSE, in accordance with Table 4 to § l.32, based on the CRC that corresponds to the PSE’s home country; or the OECD membership status of the PSE’s home country if there is no CRC applicable to the PSE’s home country. (3) A [BANK] may assign a lower risk weight than would otherwise apply under Tables 3 or 4 to § l.32 to an exposure to a foreign PSE if: (i) The PSE’s home country supervisor allows banks under its jurisdiction to assign a lower risk weight to such exposures; and (ii) The risk weight is not lower than the risk weight that corresponds to the PSE’s home country in accordance with Table 1 to § l.32. TABLE 3 TO § l.32—RISK WEIGHTS FOR NON-U.S. PSE GENERAL OBLIGATIONS Risk weight (in percent) CRC: 0–1 .................................... 2 ........................................ 3 ........................................ 4–7 .................................... OECD Member with No CRC Non-OECD Member with No CRC .................................. Sovereign Default ................. 20 50 100 150 20 100 150 TABLE 4 TO § l.32—RISK WEIGHTS FOR NON-U.S. PSE REVENUE OBLIGATIONS wreier-aviles on DSK5TPTVN1PROD with RULES2 Risk weight (in percent) CRC: 0–1 .................................... 2–3 .................................... 4–7 .................................... OECD Member with No CRC Non-OECD Member with No CRC .................................. Sovereign Default ................. 50 100 150 50 100 150 (4) Exposures to PSEs from an OECD member sovereign with no CRC. (i) A [BANK] must assign a 20 percent risk VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 weight to a general obligation exposure to a PSE whose home country is an OECD member sovereign with no CRC. (ii) A [BANK] must assign a 50 percent risk weight to a revenue obligation exposure to a PSE whose home country is an OECD member sovereign with no CRC. (5) Exposures to PSEs whose home country is not an OECD member sovereign with no CRC. A [BANK] must assign a 100 percent risk weight to an exposure to a PSE whose home country is not a member of the OECD and does not have a CRC. (6) A [BANK] must assign a 150 percent risk weight to a PSE exposure immediately upon determining that an event of sovereign default has occurred in a PSE’s home country or if an event of sovereign default has occurred in the PSE’s home country during the previous five years. (f) Corporate exposures. A [BANK] must assign a 100 percent risk weight to all its corporate exposures. (g) Residential mortgage exposures. (1) A [BANK] must assign a 50 percent risk weight to a first-lien residential mortgage exposure that: (i) Is secured by a property that is either owner-occupied or rented; (ii) Is made in accordance with prudent underwriting standards, including standards relating to the loan amount as a percent of the appraised value of the property; (iii) Is not 90 days or more past due or carried in nonaccrual status; and (iv) Is not restructured or modified. (2) A [BANK] must assign a 100 percent risk weight to a first-lien residential mortgage exposure that does not meet the criteria in paragraph (g)(1) of this section, and to junior-lien residential mortgage exposures. (3) For the purpose of this paragraph (g), if a [BANK] holds the first-lien and junior-lien(s) residential mortgage exposures, and no other party holds an intervening lien, the [BANK] must combine the exposures and treat them as a single first-lien residential mortgage exposure. (4) A loan modified or restructured solely pursuant to the U.S. Treasury’s Home Affordable Mortgage Program is not modified or restructured for purposes of this section. (h) Pre-sold construction loans. A [BANK] must assign a 50 percent risk weight to a pre-sold construction loan unless the purchase contract is cancelled, in which case a [BANK] must assign a 100 percent risk weight. (i) Statutory multifamily mortgages. A [BANK] must assign a 50 percent risk weight to a statutory multifamily mortgage. PO 00000 Frm 00165 Fmt 4701 Sfmt 4700 62181 (j) High-volatility commercial real estate (HVCRE) exposures. A [BANK] must assign a 150 percent risk weight to an HVCRE exposure. (k) Past due exposures. Except for a sovereign exposure or a residential mortgage exposure, a [BANK] must determine a risk weight for an exposure that is 90 days or more past due or on nonaccrual according to the requirements set forth in this paragraph (k). (1) A [BANK] must assign a 150 percent risk weight to the portion of the exposure that is not guaranteed or that is unsecured. (2) A [BANK] may assign a risk weight to the guaranteed portion of a past due exposure based on the risk weight that applies under § l.36 if the guarantee or credit derivative meets the requirements of that section. (3) A [BANK] may assign a risk weight to the collateralized portion of a past due exposure based on the risk weight that applies under § l.37 if the collateral meets the requirements of that section. (l) Other assets. (1) A [BANK] must assign a zero percent risk weight to cash owned and held in all offices of the [BANK] or in transit; to gold bullion held in the [BANK]’s own vaults or held in another depository institution’s vaults on an allocated basis, to the extent the gold bullion assets are offset by gold bullion liabilities; and to exposures that arise from the settlement of cash transactions (such as equities, fixed income, spot foreign exchange and spot commodities) with a central counterparty where there is no assumption of ongoing counterparty credit risk by the central counterparty after settlement of the trade and associated default fund contributions. (2) A [BANK] must assign a 20 percent risk weight to cash items in the process of collection. (3) A [BANK] must assign a 100 percent risk weight to DTAs arising from temporary differences that the [BANK] could realize through net operating loss carrybacks. (4) A [BANK] must assign a 250 percent risk weight to the portion of each of the following items that is not deducted from common equity tier 1 capital pursuant to § l.22(d): (i) MSAs; and (ii) DTAs arising from temporary differences that the [BANK] could not realize through net operating loss carrybacks. (5) A [BANK] must assign a 100 percent risk weight to all assets not specifically assigned a different risk weight under this subpart and that are E:\FR\FM\11OCR2.SGM 11OCR2 62182 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations not deducted from tier 1 or tier 2 capital pursuant to § l.22. (6) Notwithstanding the requirements of this section, a [BANK] may assign an asset that is not included in one of the categories provided in this section to the risk weight category applicable under the capital rules applicable to bank holding companies and savings and loan holding companies at 12 CFR part 217, provided that all of the following conditions apply: (i) The [BANK] is not authorized to hold the asset under applicable law other than debt previously contracted or similar authority; and (ii) The risks associated with the asset are substantially similar to the risks of assets that are otherwise assigned to a risk weight category of less than 100 percent under this subpart. § l.33 Off-balance sheet exposures. wreier-aviles on DSK5TPTVN1PROD with RULES2 (a) General. (1) A [BANK] must calculate the exposure amount of an offbalance sheet exposure using the credit conversion factors (CCFs) in paragraph (b) of this section. (2) Where a [BANK] commits to provide a commitment, the [BANK] may apply the lower of the two applicable CCFs. (3) Where a [BANK] provides a commitment structured as a syndication or participation, the [BANK] is only required to calculate the exposure amount for its pro rata share of the commitment. (4) Where a [BANK] provides a commitment, enters into a repurchase agreement, or provides a creditenhancing representation and warranty, and such commitment, repurchase agreement, or credit-enhancing representation and warranty is not a securitization exposure, the exposure amount shall be no greater than the maximum contractual amount of the commitment, repurchase agreement, or credit-enhancing representation and warranty, as applicable. (b) Credit conversion factors—(1) Zero percent CCF. A [BANK] must apply a zero percent CCF to the unused portion VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 of a commitment that is unconditionally cancelable by the [BANK]. (2) 20 percent CCF. A [BANK] must apply a 20 percent CCF to the amount of: (i) Commitments with an original maturity of one year or less that are not unconditionally cancelable by the [BANK]; and (ii) Self-liquidating, trade-related contingent items that arise from the movement of goods, with an original maturity of one year or less. (3) 50 percent CCF. A [BANK] must apply a 50 percent CCF to the amount of: (i) Commitments with an original maturity of more than one year that are not unconditionally cancelable by the [BANK]; and (ii) Transaction-related contingent items, including performance bonds, bid bonds, warranties, and performance standby letters of credit. (4) 100 percent CCF. A [BANK] must apply a 100 percent CCF to the amount of the following off-balance-sheet items and other similar transactions: (i) Guarantees; (ii) Repurchase agreements (the offbalance sheet component of which equals the sum of the current fair values of all positions the [BANK] has sold subject to repurchase); (iii) Credit-enhancing representations and warranties that are not securitization exposures; (iv) Off-balance sheet securities lending transactions (the off-balance sheet component of which equals the sum of the current fair values of all positions the [BANK] has lent under the transaction); (v) Off-balance sheet securities borrowing transactions (the off-balance sheet component of which equals the sum of the current fair values of all noncash positions the [BANK] has posted as collateral under the transaction); (vi) Financial standby letters of credit; and (vii) Forward agreements. PO 00000 Frm 00166 Fmt 4701 Sfmt 4700 § l.34 OTC derivative contracts. (a) Exposure amount—(1) Single OTC derivative contract. Except as modified by paragraph (b) of this section, the exposure amount for a single OTC derivative contract that is not subject to a qualifying master netting agreement is equal to the sum of the [BANK]’s current credit exposure and potential future credit exposure (PFE) on the OTC derivative contract. (i) Current credit exposure. The current credit exposure for a single OTC derivative contract is the greater of the mark-to-fair value of the OTC derivative contract or zero. (ii) PFE. (A) The PFE for a single OTC derivative contract, including an OTC derivative contract with a negative mark-to-fair value, is calculated by multiplying the notional principal amount of the OTC derivative contract by the appropriate conversion factor in Table 1 to § l.34. (B) For purposes of calculating either the PFE under this paragraph (a) or the gross PFE under paragraph (a)(2) of this section for exchange rate contracts and other similar contracts in which the notional principal amount is equivalent to the cash flows, notional principal amount is the net receipts to each party falling due on each value date in each currency. (C) For an OTC derivative contract that does not fall within one of the specified categories in Table 1 to § l.34, the PFE must be calculated using the appropriate ‘‘other’’ conversion factor. (D) A [BANK] must use an OTC derivative contract’s effective notional principal amount (that is, the apparent or stated notional principal amount multiplied by any multiplier in the OTC derivative contract) rather than the apparent or stated notional principal amount in calculating PFE. (E) The PFE of the protection provider of a credit derivative is capped at the net present value of the amount of unpaid premiums. E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 62183 TABLE 1 TO § l.34—CONVERSION FACTOR MATRIX FOR DERIVATIVE CONTRACTS1 Remaining maturity 2 Interest rate One year or less ...................................... Greater than one year and less than or equal to five years ................................ Greater than five years ............................ Foreign exchange rate and gold Credit (investment grade reference asset) 3 Credit (non-investment-grade reference asset) Equity Precious metals (except gold) Other 0.00 0.01 0.05 0.10 0.06 0.07 0.10 0.005 0.015 0.05 0.075 0.05 0.05 0.10 0.10 0.08 0.10 0.07 0.08 0.12 0.15 1 For a derivative contract with multiple exchanges of principal, the conversion factor is multiplied by the number of remaining payments in the derivative contract. 2 For an OTC derivative contract that is structured such that on specified dates any outstanding exposure is settled and the terms are reset so that the fair value of the contract is zero, the remaining maturity equals the time until the next reset date. For an interest rate derivative contract with a remaining maturity of greater than one year that meets these criteria, the minimum conversion factor is 0.005. 3 A [BANK] must use the column labeled ‘‘Credit (investment-grade reference asset)’’ for a credit derivative whose reference asset is an outstanding unsecured long-term debt security without credit enhancement that is investment grade. A [BANK] must use the column labeled ‘‘Credit (non-investment-grade reference asset)’’ for all other credit derivatives. (2) Multiple OTC derivative contracts subject to a qualifying master netting agreement. Except as modified by paragraph (b) of this section, the exposure amount for multiple OTC derivative contracts subject to a qualifying master netting agreement is equal to the sum of the net current credit exposure and the adjusted sum of the PFE amounts for all OTC derivative contracts subject to the qualifying master netting agreement. (i) Net current credit exposure. The net current credit exposure is the greater of the net sum of all positive and negative mark-to-fair values of the individual OTC derivative contracts subject to the qualifying master netting agreement or zero. (ii) Adjusted sum of the PFE amounts. The adjusted sum of the PFE amounts, Anet, is calculated as Anet = (0.4 × Agross) + (0.6 × NGR × Agross), wreier-aviles on DSK5TPTVN1PROD with RULES2 where: (A) Agross = the gross PFE (that is, the sum of the PFE amounts as determined under paragraph (a)(1)(ii) of this section for each individual derivative contract subject to the qualifying master netting agreement); and (B) Net-to-gross Ratio (NGR) = the ratio of the net current credit exposure to the gross current credit exposure. In calculating the NGR, the gross current credit exposure equals the sum of the positive current credit exposures (as determined under paragraph (a)(1)(i) of this section) of all individual derivative contracts subject to the qualifying master netting agreement. (b) Recognition of credit risk mitigation of collateralized OTC derivative contracts: (1) A [BANK] may recognize the credit risk mitigation benefits of financial collateral that secures an OTC derivative contract or multiple OTC derivative contracts subject to a qualifying master netting agreement (netting set) by using the simple approach in § l.37(b). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (2) As an alternative to the simple approach, a [BANK] may recognize the credit risk mitigation benefits of financial collateral that secures such a contract or netting set if the financial collateral is marked-to-fair value on a daily basis and subject to a daily margin maintenance requirement by applying a risk weight to the exposure as if it were uncollateralized and adjusting the exposure amount calculated under paragraph (a)(1) or (2) of this section using the collateral haircut approach in § l.37(c). The [BANK] must substitute the exposure amount calculated under paragraph (a)(1) or (2) of this section for SE in the equation in § l.37(c)(2). (c) Counterparty credit risk for OTC credit derivatives. (1) Protection purchasers. A [BANK] that purchases an OTC credit derivative that is recognized under § l.36 as a credit risk mitigant for an exposure that is not a covered position under subpart F is not required to compute a separate counterparty credit risk capital requirement under § l.32 provided that the [BANK] does so consistently for all such credit derivatives. The [BANK] must either include all or exclude all such credit derivatives that are subject to a qualifying master netting agreement from any measure used to determine counterparty credit risk exposure to all relevant counterparties for risk-based capital purposes. (2) Protection providers. (i) A [BANK] that is the protection provider under an OTC credit derivative must treat the OTC credit derivative as an exposure to the underlying reference asset. The [BANK] is not required to compute a counterparty credit risk capital requirement for the OTC credit derivative under § l.32, provided that this treatment is applied consistently for all such OTC credit derivatives. The [BANK] must either include all or exclude all such OTC credit derivatives PO 00000 Frm 00167 Fmt 4701 Sfmt 4700 that are subject to a qualifying master netting agreement from any measure used to determine counterparty credit risk exposure. (ii) The provisions of this paragraph (c)(2) apply to all relevant counterparties for risk-based capital purposes unless the [BANK] is treating the OTC credit derivative as a covered position under subpart F, in which case the [BANK] must compute a supplemental counterparty credit risk capital requirement under this section. (d) Counterparty credit risk for OTC equity derivatives. (1) A [BANK] must treat an OTC equity derivative contract as an equity exposure and compute a risk-weighted asset amount for the OTC equity derivative contract under §§ l.51 through l.53 (unless the [BANK] is treating the contract as a covered position under subpart F of this part). (2) In addition, the [BANK] must also calculate a risk-based capital requirement for the counterparty credit risk of an OTC equity derivative contract under this section if the [BANK] is treating the contract as a covered position under subpart F of this part. (3) If the [BANK] risk weights the contract under the Simple Risk-Weight Approach (SRWA) in § l.52, the [BANK] may choose not to hold riskbased capital against the counterparty credit risk of the OTC equity derivative contract, as long as it does so for all such contracts. Where the OTC equity derivative contracts are subject to a qualified master netting agreement, a [BANK] using the SRWA must either include all or exclude all of the contracts from any measure used to determine counterparty credit risk exposure. (e) Clearing member [BANK]’s exposure amount. A clearing member [BANK]’s exposure amount for an OTC E:\FR\FM\11OCR2.SGM 11OCR2 62184 derivative contract or netting set of OTC derivative contracts where the [BANK] is either acting as a financial intermediary and enters into an offsetting transaction with a QCCP or where the [BANK] provides a guarantee to the QCCP on the performance of the client equals the exposure amount calculated according to paragraph (a)(1) or (2) of this section multiplied by the scaling factor 0.71. If the [BANK] determines that a longer period is appropriate, the [BANK] must use a larger scaling factor to adjust for a longer holding period as follows: where H = the holding period greater than five days. Additionally, the [AGENCY] may require the [BANK] to set a longer holding period if the [AGENCY] determines that a longer period is appropriate due to the nature, structure, or characteristics of the transaction or is commensurate with the risks associated with the transaction. wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.35 Cleared transactions. (a) General requirements—(1) Clearing member clients. A [BANK] that is a clearing member client must use the methodologies described in paragraph (b) of this section to calculate riskweighted assets for a cleared transaction. (2) Clearing members. A [BANK] that is a clearing member must use the methodologies described in paragraph (c) of this section to calculate its riskweighted assets for a cleared transaction and paragraph (d) of this section to calculate its risk-weighted assets for its default fund contribution to a CCP. (b) Clearing member client [BANK]s— (1) Risk-weighted assets for cleared transactions. (i) To determine the riskweighted asset amount for a cleared transaction, a [BANK] that is a clearing member client must multiply the trade exposure amount for the cleared transaction, calculated in accordance with paragraph (b)(2) of this section, by the risk weight appropriate for the cleared transaction, determined in accordance with paragraph (b)(3) of this section. (ii) A clearing member client [BANK]’s total risk-weighted assets for cleared transactions is the sum of the risk-weighted asset amounts for all its cleared transactions. (2) Trade exposure amount. (i) For a cleared transaction that is either a derivative contract or a netting set of derivative contracts, the trade exposure amount equals: VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (A) The exposure amount for the derivative contract or netting set of derivative contracts, calculated using the methodology used to calculate exposure amount for OTC derivative contracts under § l.34; plus (B) The fair value of the collateral posted by the clearing member client [BANK] and held by the CCP, clearing member, or custodian in a manner that is not bankruptcy remote. (ii) For a cleared transaction that is a repo-style transaction or netting set of repo-style transactions, the trade exposure amount equals: (A) The exposure amount for the repostyle transaction calculated using the methodologies under § l.37(c); plus (B) The fair value of the collateral posted by the clearing member client [BANK] and held by the CCP, clearing member, or custodian in a manner that is not bankruptcy remote. (3) Cleared transaction risk weights. (i) For a cleared transaction with a QCCP, a clearing member client [BANK] must apply a risk weight of: (A) 2 percent if the collateral posted by the [BANK] to the QCCP or clearing member is subject to an arrangement that prevents any losses to the clearing member client [BANK] due to the joint default or a concurrent insolvency, liquidation, or receivership proceeding of the clearing member and any other clearing member clients of the clearing member; and the clearing member client [BANK] has conducted sufficient legal review to conclude with a well-founded basis (and maintains sufficient written documentation of that legal review) that in the event of a legal challenge (including one resulting from an event of default or from liquidation, insolvency, or receivership proceedings) the relevant court and administrative authorities would find the arrangements to be legal, valid, binding and enforceable under the law of the relevant jurisdictions; or (B) 4 percent if the requirements of §l.35(b)(3)(A) are not met. (ii) For a cleared transaction with a CCP that is not a QCCP, a clearing member client [BANK] must apply the risk weight appropriate for the CCP according to § l.32. (4) Collateral. (i) Notwithstanding any other requirements in this section, collateral posted by a clearing member client [BANK] that is held by a custodian (in its capacity as custodian) in a manner that is bankruptcy remote from the CCP, the custodian, clearing member and other clearing member clients of the clearing member, is not subject to a capital requirement under this section. PO 00000 Frm 00168 Fmt 4701 Sfmt 4700 (ii) A clearing member client [BANK] must calculate a risk-weighted asset amount for any collateral provided to a CCP, clearing member, or custodian in connection with a cleared transaction in accordance with the requirements under § l.32. (c) Clearing member [BANK]s—(1) Risk-weighted assets for cleared transactions. (i) To determine the risk-weighted asset amount for a cleared transaction, a clearing member [BANK] must multiply the trade exposure amount for the cleared transaction, calculated in accordance with paragraph (c)(2) of this section, by the risk weight appropriate for the cleared transaction, determined in accordance with paragraph (c)(3) of this section. (ii) A clearing member [BANK]’s total risk-weighted assets for cleared transactions is the sum of the riskweighted asset amounts for all of its cleared transactions. (2) Trade exposure amount. A clearing member [BANK] must calculate its trade exposure amount for a cleared transaction as follows: (i) For a cleared transaction that is either a derivative contract or a netting set of derivative contracts, the trade exposure amount equals: (A) The exposure amount for the derivative contract, calculated using the methodology to calculate exposure amount for OTC derivative contracts under § l.34; plus (B) The fair value of the collateral posted by the clearing member [BANK] and held by the CCP in a manner that is not bankruptcy remote. (ii) For a cleared transaction that is a repo-style transaction or netting set of repo-style transactions, trade exposure amount equals: (A) The exposure amount for repostyle transactions calculated using methodologies under § l.37(c); plus (B) The fair value of the collateral posted by the clearing member [BANK] and held by the CCP in a manner that is not bankruptcy remote. (3) Cleared transaction risk weight. (i) A clearing member [BANK] must apply a risk weight of 2 percent to the trade exposure amount for a cleared transaction with a QCCP. (ii) For a cleared transaction with a CCP that is not a QCCP, a clearing member [BANK] must apply the risk weight appropriate for the CCP according to § l.32. (4) Collateral. (i) Notwithstanding any other requirement in this section, collateral posted by a clearing member [BANK] that is held by a custodian in a manner that is bankruptcy remote E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.015</GPH> Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 62185 [AGENCY], there is a material change in the financial condition of the CCP. (2) Risk-weighted asset amount for default fund contributions to nonqualifying CCPs. A clearing member [BANK]’s risk-weighted asset amount for default fund contributions to CCPs that are not QCCPs equals the sum of such default fund contributions multiplied by 1,250 percent, or an amount determined by the [AGENCY], based on factors such as size, structure and membership characteristics of the CCP and riskiness of its transactions, in cases where such default fund contributions may be unlimited. (3) Risk-weighted asset amount for default fund contributions to QCCPs. A clearing member [BANK]’s riskweighted asset amount for default fund contributions to QCCPs equals the sum of its capital requirement, KCM for each QCCP, as calculated under the methodology set forth in paragraphs (d)(3)(i) through (iii) of this section (Method 1), multiplied by 1,250 percent or in paragraphs (d)(3)(iv) of this section (Method 2). (i) Method 1. The hypothetical capital requirement of a QCCP (KCCP) equals: Where: (A) EBRMi = the exposure amount for each transaction cleared through the QCCP by clearing member i, calculated in accordance with § l.34 for OTC derivative contracts and § l.37(c)(2) for repo-style transactions, provided that: (1) For purposes of this section, in calculating the exposure amount the [BANK] may replace the formula provided in § l.34(a)(2)(ii) with the following: Anet = (0.15 × Agross) + (0.85 × NGR × Agross); and (2) For option derivative contracts that are cleared transactions, the PFE described in § l.34(a)(1)(ii) must be adjusted by multiplying the notional principal amount of the derivative contract by the appropriate conversion factor in Table 1 to § l.34 and the absolute value of the option’s delta, that is, the ratio of the change in the value of the derivative contract to the corresponding change in the price of the underlying asset. (3) For repo-style transactions, when applying § l.37(c)(2), the [BANK] must use the methodology in § l.37(c)(3); (B) VMi = any collateral posted by clearing member i to the QCCP that it is entitled to receive from the QCCP, but has not yet received, and any collateral that the QCCP has actually received from clearing member i; (C) IMi = the collateral posted as initial margin by clearing member i to the QCCP; (D) DFi = the funded portion of clearing member i’s default fund contribution that will be applied to reduce the QCCP’s loss upon a default by clearing member i; (E) RW = 20 percent, except when the [AGENCY] has determined that a higher risk weight is more appropriate based on the specific characteristics of the QCCP and its clearing members; and (F) Where a QCCP has provided its KCCP, a [BANK] must rely on such disclosed figure instead of calculating KCCP under this paragraph (d), unless the [BANK] determines that a more conservative figure is appropriate based on the nature, structure, or characteristics of the QCCP. Subscripts 1 and 2 denote the clearing members with the two largest ANet values. For purposes of this paragraph (d), for derivatives ANet is defined in § l.34(a)(2)(ii) and for repo-style transactions, ANet means the exposure amount as defined in § l.37(c)(2) using the methodology in § l.37(c)(3); (B) N = the number of clearing members in the QCCP; (C) DFCCP = the QCCP’s own funds and other financial resources that would be used to cover its losses before clearing members’ default fund contributions are used to cover losses; (D) DFCM = funded default fund contributions from all clearing members and any other clearing member VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00169 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.016</GPH> (ii) For a [BANK] that is a clearing member of a QCCP with a default fund supported by funded commitments, KCM equals: ER11OC13.058</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 from the CCP is not subject to a capital requirement under this section. (ii) A clearing member [BANK] must calculate a risk-weighted asset amount for any collateral provided to a CCP, clearing member, or a custodian in connection with a cleared transaction in accordance with requirements under § l.32. (d) Default fund contributions. (1) General requirement. A clearing member [BANK] must determine the risk-weighted asset amount for a default fund contribution to a CCP at least quarterly, or more frequently if, in the opinion of the [BANK] or the 62186 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (E) DF = DFCCP + DFCM (that is, the total funded default fund contribution); Where: (1) DFi = the [BANK]’s unfunded commitment to the default fund; (2) DFCM = the total of all clearing members’ unfunded commitment to the default fund; and (3) K*CM as defined in paragraph (d)(3)(ii) of this section. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 described in paragraph (d)(3)(iii) of this section, KCM equals: (B) For a [BANK] that is a clearing member of a QCCP with a default fund supported by unfunded commitments and is unable to calculate KCM using the methodology PO 00000 Frm 00170 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.017</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 contributed financial resources that are available to absorb mutualized QCCP losses; Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (iv) Method 2. A clearing member [BANK]’s risk-weighted asset amount for its default fund contribution to a QCCP, RWADF, equals: RWADF = Min {12.5 * DF; 0.18 * TE} Where: (A) TE = the [BANK]’s trade exposure amount to the QCCP, calculated according to section 35(c)(2); (B) DF = the funded portion of the [BANK]’s default fund contribution to the QCCP. (4) Total risk-weighted assets for default fund contributions. Total riskweighted assets for default fund contributions is the sum of a clearing member [BANK]’s risk-weighted assets for all of its default fund contributions to all CCPs of which the [BANK] is a clearing member. wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.36 Guarantees and credit derivatives: substitution treatment. (a) Scope—(1) General. A [BANK] may recognize the credit risk mitigation benefits of an eligible guarantee or eligible credit derivative by substituting the risk weight associated with the protection provider for the risk weight assigned to an exposure, as provided under this section. (2) This section applies to exposures for which: (i) Credit risk is fully covered by an eligible guarantee or eligible credit derivative; or (ii) Credit risk is covered on a pro rata basis (that is, on a basis in which the [BANK] and the protection provider share losses proportionately) by an eligible guarantee or eligible credit derivative. (3) Exposures on which there is a tranching of credit risk (reflecting at least two different levels of seniority) generally are securitization exposures subject to §§ l.41 through l.45. (4) If multiple eligible guarantees or eligible credit derivatives cover a single exposure described in this section, a [BANK] may treat the hedged exposure as multiple separate exposures each covered by a single eligible guarantee or eligible credit derivative and may calculate a separate risk-weighted asset amount for each separate exposure as described in paragraph (c) of this section. (5) If a single eligible guarantee or eligible credit derivative covers multiple VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00171 Fmt 4701 Sfmt 4700 unprotected exposure under § l.32, where the applicable risk weight is that of the unprotected portion of the hedged exposure. (iii) The treatment provided in this section is applicable when the credit risk of an exposure is covered on a partial pro rata basis and may be applicable when an adjustment is made to the effective notional amount of the guarantee or credit derivative under paragraphs (d), (e), or (f) of this section. (d) Maturity mismatch adjustment. (1) A [BANK] that recognizes an eligible guarantee or eligible credit derivative in determining the risk-weighted asset amount for a hedged exposure must adjust the effective notional amount of the credit risk mitigant to reflect any maturity mismatch between the hedged exposure and the credit risk mitigant. (2) A maturity mismatch occurs when the residual maturity of a credit risk mitigant is less than that of the hedged exposure(s). (3) The residual maturity of a hedged exposure is the longest possible remaining time before the obligated party of the hedged exposure is scheduled to fulfil its obligation on the hedged exposure. If a credit risk mitigant has embedded options that may reduce its term, the [BANK] (protection purchaser) must use the shortest possible residual maturity for the credit risk mitigant. If a call is at the discretion of the protection provider, the residual maturity of the credit risk mitigant is at the first call date. If the call is at the discretion of the [BANK] (protection purchaser), but the terms of the arrangement at origination of the credit risk mitigant contain a positive incentive for the [BANK] to call the transaction before contractual maturity, the remaining time to the first call date is the residual maturity of the credit risk mitigant. (4) A credit risk mitigant with a maturity mismatch may be recognized only if its original maturity is greater than or equal to one year and its residual maturity is greater than three months. (5) When a maturity mismatch exists, the [BANK] must apply the following adjustment to reduce the effective notional amount of the credit risk mitigant: Pm = E × (t¥0.25)/(T¥0.25), where: (i) Pm = effective notional amount of the credit risk mitigant, adjusted for maturity mismatch; (ii) E = effective notional amount of the credit risk mitigant; (iii) t = the lesser of T or the residual maturity of the credit risk mitigant, expressed in years; and E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.018</GPH> Where: (1) IMi = the [BANK]’s initial margin posted to the QCCP; (2) IMCM = the total of initial margin posted to the QCCP; and (3)K*CM as defined in paragraph (d)(3)(ii) of this section. hedged exposures described in paragraph (a)(2) of this section, a [BANK] must treat each hedged exposure as covered by a separate eligible guarantee or eligible credit derivative and must calculate a separate risk-weighted asset amount for each exposure as described in paragraph (c) of this section. (b) Rules of recognition. (1) A [BANK] may only recognize the credit risk mitigation benefits of eligible guarantees and eligible credit derivatives. (2) A [BANK] may only recognize the credit risk mitigation benefits of an eligible credit derivative to hedge an exposure that is different from the credit derivative’s reference exposure used for determining the derivative’s cash settlement value, deliverable obligation, or occurrence of a credit event if: (i) The reference exposure ranks pari passu with, or is subordinated to, the hedged exposure; and (ii) The reference exposure and the hedged exposure are to the same legal entity, and legally enforceable crossdefault or cross-acceleration clauses are in place to ensure payments under the credit derivative are triggered when the obligated party of the hedged exposure fails to pay under the terms of the hedged exposure. (c) Substitution approach—(1) Full coverage. If an eligible guarantee or eligible credit derivative meets the conditions in paragraphs (a) and (b) of this section and the protection amount (P) of the guarantee or credit derivative is greater than or equal to the exposure amount of the hedged exposure, a [BANK] may recognize the guarantee or credit derivative in determining the risk-weighted asset amount for the hedged exposure by substituting the risk weight applicable to the guarantor or credit derivative protection provider under § l.32 for the risk weight assigned to the exposure. (2) Partial coverage. If an eligible guarantee or eligible credit derivative meets the conditions in §§ l.36(a) and l.37(b) and the protection amount (P) of the guarantee or credit derivative is less than the exposure amount of the hedged exposure, the [BANK] must treat the hedged exposure as two separate exposures (protected and unprotected) in order to recognize the credit risk mitigation benefit of the guarantee or credit derivative. (i) The [BANK] may calculate the riskweighted asset amount for the protected exposure under § l.32, where the applicable risk weight is the risk weight applicable to the guarantor or credit derivative protection provider. (ii) The [BANK] must calculate the risk-weighted asset amount for the 62187 62188 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (iv) T = the lesser of five or the residual maturity of the hedged exposure, expressed in years. (2) Pm = effective notional amount of the credit risk mitigant (adjusted for maturity mismatch, if applicable). (e) Adjustment for credit derivatives without restructuring as a credit event. If a [BANK] recognizes an eligible credit derivative that does not include as a credit event a restructuring of the hedged exposure involving forgiveness or postponement of principal, interest, or fees that results in a credit loss event (that is, a charge-off, specific provision, or other similar debit to the profit and loss account), the [BANK] must apply the following adjustment to reduce the effective notional amount of the credit derivative: Pr = Pm × 0.60, where: (f) Currency mismatch adjustment. (1) If a [BANK] recognizes an eligible guarantee or eligible credit derivative that is denominated in a currency different from that in which the hedged exposure is denominated, the [BANK] must apply the following formula to the effective notional amount of the guarantee or credit derivative: Pc = Pr × (1¥HFX), where: wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.37 Collateralized transactions. (a) General. (1) To recognize the riskmitigating effects of financial collateral, a [BANK] may use: (i) The simple approach in paragraph (b) of this section for any exposure; or (ii) The collateral haircut approach in paragraph (c) of this section for repostyle transactions, eligible margin loans, collateralized derivative contracts, and single-product netting sets of such transactions. (2) A [BANK] may use any approach described in this section that is valid for a particular type of exposure or transaction; however, it must use the same approach for similar exposures or transactions. (b) The simple approach—(1) General requirements. (i) A [BANK] may recognize the credit risk mitigation benefits of financial collateral that secures any exposure. (ii) To qualify for the simple approach, the financial collateral must meet the following requirements: (A) The collateral must be subject to a collateral agreement for at least the life of the exposure; (B) The collateral must be revalued at least every six months; and (C) The collateral (other than gold) and the exposure must be denominated in the same currency. (2) Risk weight substitution. (i) A [BANK] may apply a risk weight to the portion of an exposure that is secured by the fair value of financial collateral VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (i) Pc = effective notional amount of the credit risk mitigant, adjusted for currency mismatch (and maturity mismatch and lack of restructuring event, if applicable); (ii) Pr = effective notional amount of the credit risk mitigant (adjusted for maturity mismatch and lack of restructuring event, if applicable); and (2) A [BANK] must set HFX equal to eight percent unless it qualifies for the use of and uses its own internal estimates of foreign exchange volatility based on a ten-business-day holding period. A [BANK] qualifies for the use of its own internal estimates of foreign exchange volatility if it qualifies for the use of its own-estimates haircuts in § l.37(c)(4). (3) A [BANK] must adjust HFX calculated in paragraph (f)(2) of this section upward if the [BANK] revalues the guarantee or credit derivative less frequently than once every 10 business days using the following square root of time formula: (that meets the requirements of paragraph (b)(1) of this section) based on the risk weight assigned to the collateral under § l.32. For repurchase agreements, reverse repurchase agreements, and securities lending and borrowing transactions, the collateral is the instruments, gold, and cash the [BANK] has borrowed, purchased subject to resale, or taken as collateral from the counterparty under the transaction. Except as provided in paragraph (b)(3) of this section, the risk weight assigned to the collateralized portion of the exposure may not be less than 20 percent. (ii) A [BANK] must apply a risk weight to the unsecured portion of the exposure based on the risk weight applicable to the exposure under this subpart. (3) Exceptions to the 20 percent riskweight floor and other requirements. Notwithstanding paragraph (b)(2)(i) of this section: (i) A [BANK] may assign a zero percent risk weight to an exposure to an OTC derivative contract that is markedto-market on a daily basis and subject to a daily margin maintenance requirement, to the extent the contract is collateralized by cash on deposit. (ii) A [BANK] may assign a 10 percent risk weight to an exposure to an OTC derivative contract that is marked-tomarket daily and subject to a daily margin maintenance requirement, to the extent that the contract is collateralized by an exposure to a sovereign that qualifies for a zero percent risk weight under § l.32. (iii) A [BANK] may assign a zero percent risk weight to the collateralized portion of an exposure where: (A) The financial collateral is cash on deposit; or (B) The financial collateral is an exposure to a sovereign that qualifies for a zero percent risk weight under § l.32, and the [BANK] has discounted the fair value of the collateral by 20 percent. (c) Collateral haircut approach—(1) General. A [BANK] may recognize the credit risk mitigation benefits of financial collateral that secures an eligible margin loan, repo-style transaction, collateralized derivative contract, or single-product netting set of such transactions, and of any collateral that secures a repo-style transaction that is included in the [BANK]’s VaR-based measure under subpart F of this part by using the collateral haircut approach in this section. A [BANK] may use the standard supervisory haircuts in paragraph (c)(3) of this section or, with prior written approval of the [AGENCY], its own estimates of haircuts according to paragraph (c)(4) of this section. (2) Exposure amount equation. A [BANK] must determine the exposure amount for an eligible margin loan, repo-style transaction, collateralized derivative contract, or a single-product netting set of such transactions by setting the exposure amount equal to PO 00000 Frm 00172 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.021</GPH> (1) Pr = effective notional amount of the credit risk mitigant, adjusted for lack of restructuring event (and maturity mismatch, if applicable); and (iii) HFX = haircut appropriate for the currency mismatch between the credit risk mitigant and the hedged exposure. Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations max {0, [(SE ¥ SC) + S(Es × Hs) + S(Efx × Hfx)]}, where: (i)(A) For eligible margin loans and repostyle transactions and netting sets thereof, SE equals the value of the exposure (the sum of the current fair values of all instruments, gold, and cash the [BANK] has lent, sold subject to repurchase, or posted as collateral to the counterparty under the transaction (or netting set)); and (B) For collateralized derivative contracts and netting sets thereof, SE equals the exposure amount of the OTC derivative contract (or netting set) calculated under § l.34 (a)(1) or (2). (ii) SC equals the value of the collateral (the sum of the current fair values of all instruments, gold and cash the [BANK] has borrowed, purchased subject to resale, or taken as collateral from the counterparty under the transaction (or netting set)); (iii) Es equals the absolute value of the net position in a given instrument or in gold (where the net position in the instrument or gold equals the sum of the current fair values of the instrument or gold the [BANK] has lent, sold subject to repurchase, or posted as collateral to the counterparty minus the sum of the current fair values of that same instrument or gold the [BANK] has borrowed, purchased subject to resale, or taken as collateral from the counterparty); (iv) Hs equals the market price volatility haircut appropriate to the instrument or gold referenced in Es; (v) Efx equals the absolute value of the net position of instruments and cash in a currency that is different from the settlement currency (where the net position in a given currency equals the sum of the current fair 62189 values of any instruments or cash in the currency the [BANK] has lent, sold subject to repurchase, or posted as collateral to the counterparty minus the sum of the current fair values of any instruments or cash in the currency the [BANK] has borrowed, purchased subject to resale, or taken as collateral from the counterparty); and (vi) Hfx equals the haircut appropriate to the mismatch between the currency referenced in Efx and the settlement currency. (3) Standard supervisory haircuts. (i) A [BANK] must use the haircuts for market price volatility (Hs) provided in Table 1 to § l.37, as adjusted in certain circumstances in accordance with the requirements of paragraphs (c)(3)(iii) and (iv) of this section. TABLE 1 TO § l.37—STANDARD SUPERVISORY MARKET PRICE VOLATILITY HAIRCUTS 1 Haircut (in percent) assigned based on: Zero Less than or equal to 1 year ....................... Greater than 1 year and less than or equal to 5 years ................................................. Greater than 5 years .................................... 20 or 50 Investment grade securitization exposures (in percent) Non-sovereign issuers risk weight under § l.32 (in percent) Sovereign issuers risk weight under § l.32 (in percent) 2 Residual maturity 100 20 50 100 0.5 1.0 15.0 1.0 2.0 4.0 4.0 2.0 4.0 3.0 6.0 15.0 15.0 4.0 8.0 6.0 12.0 8.0 16.0 12.0 24.0 Main index equities (including convertible bonds) and gold ......................................... 15.0 Other publicly traded equities (including convertible bonds) ......................................... 25.0 Mutual funds .................................................................................................................. Highest haircut applicable to any security in which the fund can invest. Cash collateral held ....................................................................................................... Zero. Other exposure types .................................................................................................... 25.0 1 The market price volatility haircuts in Table 1 to § l.37 are based on a 10 business-day holding period. a foreign PSE that receives a zero percent risk weight. (ii) For currency mismatches, a [BANK] must use a haircut for foreign exchange rate volatility (Hfx) of 8.0 percent, as adjusted in certain circumstances under paragraphs (c)(3)(iii) and (iv) of this section. (iii) For repo-style transactions, a [BANK] may multiply the standard supervisory haircuts provided in paragraphs (c)(3)(i) and (ii) of this section by the square root of 1⁄2 (which equals 0.707107). (iv) If the number of trades in a netting set exceeds 5,000 at any time during a quarter, a [BANK] must adjust the supervisory haircuts provided in paragraphs (c)(3)(i) and (ii) of this section upward on the basis of a holding period of twenty business days for the following quarter except in the calculation of the exposure amount for purposes of § l.35. If a netting set contains one or more trades involving VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 illiquid collateral or an OTC derivative that cannot be easily replaced, a [BANK] must adjust the supervisory haircuts upward on the basis of a holding period of twenty business days. If over the two previous quarters more than two margin disputes on a netting set have occurred that lasted more than the holding period, then the [BANK] must adjust the supervisory haircuts upward for that netting set on the basis of a holding period that is at least two times the minimum holding period for that netting set. A [BANK] must adjust the standard supervisory haircuts upward using the following formula: (A) TM equals a holding period of longer than 10 business days for eligible margin PO 00000 Frm 00173 Fmt 4701 Sfmt 4700 loans and derivative contracts or longer than 5 business days for repo-style transactions; (B) HS equals the standard supervisory haircut; and (C) TS equals 10 business days for eligible margin loans and derivative contracts or 5 business days for repo-style transactions. (v) If the instrument a [BANK] has lent, sold subject to repurchase, or posted as collateral does not meet the definition of financial collateral, the [BANK] must use a 25.0 percent haircut for market price volatility (Hs). (4) Own internal estimates for haircuts. With the prior written approval of the [AGENCY], a [BANK] may calculate haircuts (Hs and Hfx) using its own internal estimates of the volatilities of market prices and foreign exchange rates: (i) To receive [AGENCY] approval to use its own internal estimates, a [BANK] E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.022</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 2 Includes Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations must satisfy the following minimum standards: (A) A [BANK] must use a 99th percentile one-tailed confidence interval. (B) The minimum holding period for a repo-style transaction is five business days and for an eligible margin loan is ten business days except for transactions or netting sets for which paragraph (c)(4)(i)(C) of this section applies. When a [BANK] calculates an own-estimates haircut on a TN-day holding period, which is different from the minimum holding period for the transaction type, the applicable haircut (HM) is calculated using the following square root of time formula: wreier-aviles on DSK5TPTVN1PROD with RULES2 (1) TM equals 5 for repo-style transactions and 10 for eligible margin loans; (2) TN equals the holding period used by the [BANK] to derive HN; and (3) HN equals the haircut based on the holding period TN. (C) If the number of trades in a netting set exceeds 5,000 at any time during a quarter, a [BANK] must calculate the haircut using a minimum holding period of twenty business days for the following quarter except in the calculation of the exposure amount for purposes of § l.35. If a netting set contains one or more trades involving illiquid collateral or an OTC derivative that cannot be easily replaced, a [BANK] must calculate the haircut using a minimum holding period of twenty business days. If over the two previous quarters more than two margin disputes on a netting set have occurred that lasted more than the holding period, then the [BANK] must calculate the haircut for transactions in that netting set on the basis of a holding period that is at least two times the minimum holding period for that netting set. (D) A [BANK] is required to calculate its own internal estimates with inputs calibrated to historical data from a continuous 12-month period that reflects a period of significant financial stress appropriate to the security or category of securities. (E) A [BANK] must have policies and procedures that describe how it determines the period of significant financial stress used to calculate the [BANK]’s own internal estimates for haircuts under this section and must be able to provide empirical support for the period used. The [BANK] must obtain the prior approval of the [AGENCY] for, and notify the [AGENCY] if the [BANK] makes any material changes to, these policies and procedures. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (F) Nothing in this section prevents the [AGENCY] from requiring a [BANK] to use a different period of significant financial stress in the calculation of own internal estimates for haircuts. (G) A [BANK] must update its data sets and calculate haircuts no less frequently than quarterly and must also reassess data sets and haircuts whenever market prices change materially. (ii) With respect to debt securities that are investment grade, a [BANK] may calculate haircuts for categories of securities. For a category of securities, the [BANK] must calculate the haircut on the basis of internal volatility estimates for securities in that category that are representative of the securities in that category that the [BANK] has lent, sold subject to repurchase, posted as collateral, borrowed, purchased subject to resale, or taken as collateral. In determining relevant categories, the [BANK] must at a minimum take into account: (A) The type of issuer of the security; (B) The credit quality of the security; (C) The maturity of the security; and (D) The interest rate sensitivity of the security. (iii) With respect to debt securities that are not investment grade and equity securities, a [BANK] must calculate a separate haircut for each individual security. (iv) Where an exposure or collateral (whether in the form of cash or securities) is denominated in a currency that differs from the settlement currency, the [BANK] must calculate a separate currency mismatch haircut for its net position in each mismatched currency based on estimated volatilities of foreign exchange rates between the mismatched currency and the settlement currency. (v) A [BANK]’s own estimates of market price and foreign exchange rate volatilities may not take into account the correlations among securities and foreign exchange rates on either the exposure or collateral side of a transaction (or netting set) or the correlations among securities and foreign exchange rates between the exposure and collateral sides of the transaction (or netting set). Risk-Weighted Assets for Unsettled Transactions § l.38 Unsettled transactions. (a) Definitions. For purposes of this section: (1) Delivery-versus-payment (DvP) transaction means a securities or commodities transaction in which the buyer is obligated to make payment only if the seller has made delivery of the PO 00000 Frm 00174 Fmt 4701 Sfmt 4700 securities or commodities and the seller is obligated to deliver the securities or commodities only if the buyer has made payment. (2) Payment-versus-payment (PvP) transaction means a foreign exchange transaction in which each counterparty is obligated to make a final transfer of one or more currencies only if the other counterparty has made a final transfer of one or more currencies. (3) A transaction has a normal settlement period if the contractual settlement period for the transaction is equal to or less than the market standard for the instrument underlying the transaction and equal to or less than five business days. (4) Positive current exposure of a [BANK] for a transaction is the difference between the transaction value at the agreed settlement price and the current market price of the transaction, if the difference results in a credit exposure of the [BANK] to the counterparty. (b) Scope. This section applies to all transactions involving securities, foreign exchange instruments, and commodities that have a risk of delayed settlement or delivery. This section does not apply to: (1) Cleared transactions that are marked-to-market daily and subject to daily receipt and payment of variation margin; (2) Repo-style transactions, including unsettled repo-style transactions; (3) One-way cash payments on OTC derivative contracts; or (4) Transactions with a contractual settlement period that is longer than the normal settlement period (which are treated as OTC derivative contracts as provided in § l.34). (c) System-wide failures. In the case of a system-wide failure of a settlement, clearing system or central counterparty, the [AGENCY] may waive risk-based capital requirements for unsettled and failed transactions until the situation is rectified. (d) Delivery-versus-payment (DvP) and payment-versus-payment (PvP) transactions. A [BANK] must hold riskbased capital against any DvP or PvP transaction with a normal settlement period if the [BANK]’s counterparty has not made delivery or payment within five business days after the settlement date. The [BANK] must determine its risk-weighted asset amount for such a transaction by multiplying the positive current exposure of the transaction for the [BANK] by the appropriate risk weight in Table 1 to § l.38. E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.023</GPH> 62190 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 62191 TABLE 1 TO § l.38—RISK WEIGHTS must hold risk-based capital against any the credit quality of the underlying exposures; FOR UNSETTLED DVP AND PVP credit risk it retains in connection with (ii) Require the [BANK] to alter or the securitization. A [BANK] that fails to TRANSACTIONS meet these conditions must hold riskbased capital against the transferred Number of business exposures as if they had not been days after securitized and must deduct from contractual settlement date common equity tier 1 capital any aftertax gain-on-sale resulting from the From 5 to 15 ..................... 100.0 transaction. The conditions are: From 16 to 30 ................... 625.0 (1) The exposures are not reported on From 31 to 45 ................... 937.5 the [BANK]’s consolidated balance sheet 46 or more ........................ 1,250.0 under GAAP; (2) The [BANK] has transferred to one (e) Non-DvP/non-PvP (non-deliveryor more third parties credit risk versus-payment/non-payment-versusassociated with the underlying payment) transactions. (1) A [BANK] exposures; must hold risk-based capital against any (3) Any clean-up calls relating to the non-DvP/non-PvP transaction with a securitization are eligible clean-up calls; normal settlement period if the [BANK] and has delivered cash, securities, (4) The securitization does not: commodities, or currencies to its (i) Include one or more underlying counterparty but has not received its exposures in which the borrower is corresponding deliverables by the end permitted to vary the drawn amount of the same business day. The [BANK] within an agreed limit under a line of must continue to hold risk-based capital credit; and against the transaction until the [BANK] (ii) Contain an early amortization has received its corresponding provision. deliverables. (b) Operational criteria for synthetic (2) From the business day after the securitizations. For synthetic [BANK] has made its delivery until five securitizations, a [BANK] may recognize business days after the counterparty for risk-based capital purposes the use delivery is due, the [BANK] must of a credit risk mitigant to hedge calculate the risk-weighted asset amount underlying exposures only if each for the transaction by treating the condition in this paragraph (b) is current fair value of the deliverables satisfied. A [BANK] that meets these owed to the [BANK] as an exposure to conditions must hold risk-based capital the counterparty and using the against any credit risk of the exposures applicable counterparty risk weight it retains in connection with the under § l.32. synthetic securitization. A [BANK] that (3) If the [BANK] has not received its fails to meet these conditions or chooses deliverables by the fifth business day after counterparty delivery was due, the not to recognize the credit risk mitigant [BANK] must assign a 1,250 percent risk for purposes of this section must instead hold risk-based capital against the weight to the current fair value of the underlying exposures as if they had not deliverables owed to the [BANK]. been synthetically securitized. The (f) Total risk-weighted assets for conditions are: unsettled transactions. Total risk(1) The credit risk mitigant is: weighted assets for unsettled (i) Financial collateral; transactions is the sum of the risk(ii) A guarantee that meets all criteria weighted asset amounts of all DvP, PvP, as set forth in the definition of ‘‘eligible and non-DvP/non-PvP transactions. guarantee’’ in § l.2, except for the §§ l.39 through l.40 [Reserved] criteria in paragraph (3) of that Risk-Weighted Assets for Securitization definition; or (iii) A credit derivative that meets all Exposures criteria as set forth in the definition of § l.41 Operational requirements for ‘‘eligible credit derivative’’ in § l.2, securitization exposures. except for the criteria in paragraph (3) (a) Operational criteria for traditional of the definition of ‘‘eligible guarantee’’ securitizations. A [BANK] that transfers in § l.2. exposures it has originated or purchased (2) The [BANK] transfers credit risk to a securitization SPE or other third associated with the underlying party in connection with a traditional exposures to one or more third parties, securitization may exclude the and the terms and conditions in the exposures from the calculation of its credit risk mitigants employed do not risk-weighted assets only if each include provisions that: condition in this section is satisfied. A (i) Allow for the termination of the [BANK] that meets these conditions credit protection due to deterioration in wreier-aviles on DSK5TPTVN1PROD with RULES2 Risk weight to be applied to positive current exposure (in percent) VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00175 Fmt 4701 Sfmt 4700 replace the underlying exposures to improve the credit quality of the underlying exposures; (iii) Increase the [BANK]’s cost of credit protection in response to deterioration in the credit quality of the underlying exposures; (iv) Increase the yield payable to parties other than the [BANK] in response to a deterioration in the credit quality of the underlying exposures; or (v) Provide for increases in a retained first loss position or credit enhancement provided by the [BANK] after the inception of the securitization; (3) The [BANK] obtains a wellreasoned opinion from legal counsel that confirms the enforceability of the credit risk mitigant in all relevant jurisdictions; and (4) Any clean-up calls relating to the securitization are eligible clean-up calls. (c) Due diligence requirements for securitization exposures. (1) Except for exposures that are deducted from common equity tier 1 capital and exposures subject to § l.42(h), if a [BANK] is unable to demonstrate to the satisfaction of the [AGENCY] a comprehensive understanding of the features of a securitization exposure that would materially affect the performance of the exposure, the [BANK] must assign the securitization exposure a risk weight of 1,250 percent. The [BANK]’s analysis must be commensurate with the complexity of the securitization exposure and the materiality of the exposure in relation to its capital. (2) A [BANK] must demonstrate its comprehensive understanding of a securitization exposure under paragraph (c)(1) of this section, for each securitization exposure by: (i) Conducting an analysis of the risk characteristics of a securitization exposure prior to acquiring the exposure, and documenting such analysis within three business days after acquiring the exposure, considering: (A) Structural features of the securitization that would materially impact the performance of the exposure, for example, the contractual cash flow waterfall, waterfall-related triggers, credit enhancements, liquidity enhancements, fair value triggers, the performance of organizations that service the exposure, and deal-specific definitions of default; (B) Relevant information regarding the performance of the underlying credit exposure(s), for example, the percentage of loans 30, 60, and 90 days past due; default rates; prepayment rates; loans in foreclosure; property types; occupancy; E:\FR\FM\11OCR2.SGM 11OCR2 62192 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations average credit score or other measures of creditworthiness; average LTV ratio; and industry and geographic diversification data on the underlying exposure(s); (C) Relevant market data of the securitization, for example, bid-ask spread, most recent sales price and historic price volatility, trading volume, implied market rating, and size, depth and concentration level of the market for the securitization; and (D) For resecuritization exposures, performance information on the underlying securitization exposures, for example, the issuer name and credit quality, and the characteristics and performance of the exposures underlying the securitization exposures; and (ii) On an on-going basis (no less frequently than quarterly), evaluating, reviewing, and updating as appropriate the analysis required under paragraph (c)(1) of this section for each securitization exposure. wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.42 Risk-weighted assets for securitization exposures. (a) Securitization risk weight approaches. Except as provided elsewhere in this section or in § l.41: (1) A [BANK] must deduct from common equity tier 1 capital any aftertax gain-on-sale resulting from a securitization and apply a 1,250 percent risk weight to the portion of a CEIO that does not constitute after-tax gain-onsale. (2) If a securitization exposure does not require deduction under paragraph (a)(1) of this section, a [BANK] may assign a risk weight to the securitization exposure using the simplified supervisory formula approach (SSFA) in accordance with §§ l.43(a) through l.43(d) and subject to the limitation under paragraph (e) of this section. Alternatively, a [BANK] that is not subject to subpart F of this part may assign a risk weight to the securitization exposure using the gross-up approach in accordance with § l.43(e), provided, however, that such [BANK] must apply either the SSFA or the gross-up approach consistently across all of its securitization exposures, except as provided in paragraphs (a)(1), (a)(3), and (a)(4) of this section. (3) If a securitization exposure does not require deduction under paragraph (a)(1) of this section and the [BANK] cannot, or chooses not to apply the SSFA or the gross-up approach to the exposure, the [BANK] must assign a risk weight to the exposure as described in § l.44. (4) If a securitization exposure is a derivative contract (other than protection provided by a [BANK] in the VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 form of a credit derivative) that has a first priority claim on the cash flows from the underlying exposures (notwithstanding amounts due under interest rate or currency derivative contracts, fees due, or other similar payments), a [BANK] may choose to set the risk-weighted asset amount of the exposure equal to the amount of the exposure as determined in paragraph (c) of this section. (b) Total risk-weighted assets for securitization exposures. A [BANK]’s total risk-weighted assets for securitization exposures equals the sum of the risk-weighted asset amount for securitization exposures that the [BANK] risk weights under §§ l.41(c), l.42(a)(1), and l.43, l.44, or l.45, and paragraphs (e) through (j) of this section, as applicable. (c) Exposure amount of a securitization exposure—(1) On-balance sheet securitization exposures. The exposure amount of an on-balance sheet securitization exposure (excluding an available-for-sale or held-to-maturity security where the [BANK] has made an AOCI opt-out election under § l.22(b)(2), a repo-style transaction, eligible margin loan, OTC derivative contract, or cleared transaction) is equal to the carrying value of the exposure. (2) On-balance sheet securitization exposures held by a [BANK] that has made an AOCI opt-out election. The exposure amount of an on-balance sheet securitization exposure that is an available-for-sale or held-to-maturity security held by a [BANK] that has made an AOCI opt-out election under § l.22(b)(2) is the [BANK]’s carrying value (including net accrued but unpaid interest and fees), less any net unrealized gains on the exposure and plus any net unrealized losses on the exposure. (3) Off-balance sheet securitization exposures. (i) Except as provided in paragraph (j) of this section, the exposure amount of an off-balance sheet securitization exposure that is not a repo-style transaction, eligible margin loan, cleared transaction (other than a credit derivative), or an OTC derivative contract (other than a credit derivative) is the notional amount of the exposure. For an off-balance sheet securitization exposure to an ABCP program, such as an eligible ABCP liquidity facility, the notional amount may be reduced to the maximum potential amount that the [BANK] could be required to fund given the ABCP program’s current underlying assets (calculated without regard to the current credit quality of those assets). (ii) A [BANK] must determine the exposure amount of an eligible ABCP liquidity facility for which the SSFA PO 00000 Frm 00176 Fmt 4701 Sfmt 4700 does not apply by multiplying the notional amount of the exposure by a CCF of 50 percent. (iii) A [BANK] must determine the exposure amount of an eligible ABCP liquidity facility for which the SSFA applies by multiplying the notional amount of the exposure by a CCF of 100 percent. (4) Repo-style transactions, eligible margin loans, and derivative contracts. The exposure amount of a securitization exposure that is a repo-style transaction, eligible margin loan, or derivative contract (other than a credit derivative) is the exposure amount of the transaction as calculated under § l.34 or § l.37, as applicable. (d) Overlapping exposures. If a [BANK] has multiple securitization exposures that provide duplicative coverage to the underlying exposures of a securitization (such as when a [BANK] provides a program-wide credit enhancement and multiple pool-specific liquidity facilities to an ABCP program), the [BANK] is not required to hold duplicative risk-based capital against the overlapping position. Instead, the [BANK] may apply to the overlapping position the applicable risk-based capital treatment that results in the highest risk-based capital requirement. (e) Implicit support. If a [BANK] provides support to a securitization in excess of the [BANK]’s contractual obligation to provide credit support to the securitization (implicit support): (1) The [BANK] must include in riskweighted assets all of the underlying exposures associated with the securitization as if the exposures had not been securitized and must deduct from common equity tier 1 capital any after-tax gain-on-sale resulting from the securitization; and (2) The [BANK] must disclose publicly: (i) That it has provided implicit support to the securitization; and (ii) The risk-based capital impact to the [BANK] of providing such implicit support. (f) Undrawn portion of a servicer cash advance facility. (1) Notwithstanding any other provision of this subpart, a [BANK] that is a servicer under an eligible servicer cash advance facility is not required to hold risk-based capital against potential future cash advance payments that it may be required to provide under the contract governing the facility. (2) For a [BANK] that acts as a servicer, the exposure amount for a servicer cash advance facility that is not an eligible servicer cash advance facility is equal to the amount of all potential future cash advance payments that the E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations [BANK] may be contractually required to provide during the subsequent 12 month period under the contract governing the facility. (g) Interest-only mortgage-backed securities. Regardless of any other provisions in this subpart, the risk weight for a non-credit-enhancing interest-only mortgage-backed security may not be less than 100 percent. (h) Small-business loans and leases on personal property transferred with retained contractual exposure. (1) Regardless of any other provision of this subpart, a [BANK] that has transferred small-business loans and leases on personal property (small-business obligations) with recourse must include in risk-weighted assets only its contractual exposure to the smallbusiness obligations if all the following conditions are met: (i) The transaction must be treated as a sale under GAAP. (ii) The [BANK] establishes and maintains, pursuant to GAAP, a noncapital reserve sufficient to meet the [BANK]’s reasonably estimated liability under the contractual obligation. (iii) The small-business obligations are to businesses that meet the criteria for a small-business concern established by the Small Business Administration under section 3(a) of the Small Business Act (15 U.S.C. 632 et seq.). (iv) The [BANK] is well capitalized, as defined in [12 CFR 6.4 (OCC); 12 CFR 208.43 (Board)]. For purposes of determining whether a [BANK] is well capitalized for purposes of this paragraph (h), the [BANK]’s capital ratios must be calculated without regard to the capital treatment for transfers of small-business obligations under this paragraph (h). (2) The total outstanding amount of contractual exposure retained by a [BANK] on transfers of small-business obligations receiving the capital treatment specified in paragraph (h)(1) of this section cannot exceed 15 percent of the [BANK]’s total capital. (3) If a [BANK] ceases to be well capitalized under [12 CFR 6.4 (OCC); 12 CFR 208.43 (Board)] or exceeds the 15 percent capital limitation provided in paragraph (h)(2) of this section, the capital treatment under paragraph (h)(1) of this section will continue to apply to any transfers of small-business obligations with retained contractual exposure that occurred during the time that the [BANK] was well capitalized and did not exceed the capital limit. (4) The risk-based capital ratios of the [BANK] must be calculated without regard to the capital treatment for transfers of small-business obligations VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 specified in paragraph (h)(1) of this section for purposes of: (i) Determining whether a [BANK] is adequately capitalized, undercapitalized, significantly undercapitalized, or critically undercapitalized under the [AGENCY]’s prompt corrective action regulations; and (ii) Reclassifying a well-capitalized [BANK] to adequately capitalized and requiring an adequately capitalized [BANK] to comply with certain mandatory or discretionary supervisory actions as if the [BANK] were in the next lower prompt-corrective-action category. (i) Nth-to-default credit derivatives— (1) Protection provider. A [BANK] may assign a risk weight using the SSFA in § l.43 to an nth-to-default credit derivative in accordance with this paragraph (i). A [BANK] must determine its exposure in the nth-to-default credit derivative as the largest notional amount of all the underlying exposures. (2) For purposes of determining the risk weight for an nth-to-default credit derivative using the SSFA, the [BANK] must calculate the attachment point and detachment point of its exposure as follows: (i) The attachment point (parameter A) is the ratio of the sum of the notional amounts of all underlying exposures that are subordinated to the [BANK]’s exposure to the total notional amount of all underlying exposures. The ratio is expressed as a decimal value between zero and one. In the case of a first-todefault credit derivative, there are no underlying exposures that are subordinated to the [BANK]’s exposure. In the case of a second-or-subsequent-todefault credit derivative, the smallest (n1) notional amounts of the underlying exposure(s) are subordinated to the [BANK]’s exposure. (ii) The detachment point (parameter D) equals the sum of parameter A plus the ratio of the notional amount of the [BANK]’s exposure in the nth-to-default credit derivative to the total notional amount of all underlying exposures. The ratio is expressed as a decimal value between zero and one. (3) A [BANK] that does not use the SSFA to determine a risk weight for its nth-to-default credit derivative must assign a risk weight of 1,250 percent to the exposure. (4) Protection purchaser—(i) First-todefault credit derivatives. A [BANK] that obtains credit protection on a group of underlying exposures through a firstto-default credit derivative that meets the rules of recognition of § l.36(b) must determine its risk-based capital requirement for the underlying PO 00000 Frm 00177 Fmt 4701 Sfmt 4700 62193 exposures as if the [BANK] synthetically securitized the underlying exposure with the smallest risk-weighted asset amount and had obtained no credit risk mitigant on the other underlying exposures. A [BANK] must calculate a risk-based capital requirement for counterparty credit risk according to § l.34 for a first-to-default credit derivative that does not meet the rules of recognition of § l.36(b). (ii) Second-or-subsequent-to-default credit derivatives. (A) A [BANK] that obtains credit protection on a group of underlying exposures through a nth-todefault credit derivative that meets the rules of recognition of § l.36(b) (other than a first-to-default credit derivative) may recognize the credit risk mitigation benefits of the derivative only if: (1) The [BANK] also has obtained credit protection on the same underlying exposures in the form of first-through-(n-1)-to-default credit derivatives; or (2) If n-1 of the underlying exposures have already defaulted. (B) If a [BANK] satisfies the requirements of paragraph (i)(4)(ii)(A) of this section, the [BANK] must determine its risk-based capital requirement for the underlying exposures as if the [BANK] had only synthetically securitized the underlying exposure with the nth smallest risk-weighted asset amount and had obtained no credit risk mitigant on the other underlying exposures. (C) A [BANK] must calculate a riskbased capital requirement for counterparty credit risk according to § l.34 for a nth-to-default credit derivative that does not meet the rules of recognition of § l.36(b). (j) Guarantees and credit derivatives other than nth-to-default credit derivatives—(1) Protection provider. For a guarantee or credit derivative (other than an nth-to-default credit derivative) provided by a [BANK] that covers the full amount or a pro rata share of a securitization exposure’s principal and interest, the [BANK] must risk weight the guarantee or credit derivative as if it holds the portion of the reference exposure covered by the guarantee or credit derivative. (2) Protection purchaser. (i) A [BANK] that purchases a guarantee or OTC credit derivative (other than an nth-todefault credit derivative) that is recognized under § l.45 as a credit risk mitigant (including via collateral recognized under § l.37) is not required to compute a separate counterparty credit risk capital requirement under § l.31, in accordance with 34(c). (ii) If a [BANK] cannot, or chooses not to, recognize a purchased credit E:\FR\FM\11OCR2.SGM 11OCR2 62194 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations derivative as a credit risk mitigant under § l.45, the [BANK] must determine the exposure amount of the credit derivative under § l.34. (A) If the [BANK] purchases credit protection from a counterparty that is not a securitization SPE, the [BANK] must determine the risk weight for the exposure according to general risk weights under § l.32. (B) If the [BANK] purchases the credit protection from a counterparty that is a securitization SPE, the [BANK] must determine the risk weight for the exposure according to section § l.42, including § l.42(a)(4) for a credit derivative that has a first priority claim on the cash flows from the underlying exposures of the securitization SPE (notwithstanding amounts due under interest rate or currency derivative contracts, fees due, or other similar payments). § l.43 Simplified supervisory formula approach (SSFA) and the gross-up approach. wreier-aviles on DSK5TPTVN1PROD with RULES2 (a) General requirements for the SSFA. To use the SSFA to determine the risk weight for a securitization exposure, a [BANK] must have data that enables it to assign accurately the parameters described in paragraph (b) of this section. Data used to assign the parameters described in paragraph (b) of this section must be the most currently available data; if the contracts governing the underlying exposures of the securitization require payments on a monthly or quarterly basis, the data used to assign the parameters described in paragraph (b) of this section must be no more than 91 calendar days old. A [BANK] that does not have the appropriate data to assign the parameters described in paragraph (b) of this section must assign a risk weight of 1,250 percent to the exposure. (b) SSFA parameters. To calculate the risk weight for a securitization exposure using the SSFA, a [BANK] must have accurate information on the following five inputs to the SSFA calculation: (1) KG is the weighted-average (with unpaid principal used as the weight for each exposure) total capital requirement of the underlying exposures calculated VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 using this subpart. KG is expressed as a decimal value between zero and one (that is, an average risk weight of 100 percent represents a value of KG equal to 0.08). (2) Parameter W is expressed as a decimal value between zero and one. Parameter W is the ratio of the sum of the dollar amounts of any underlying exposures of the securitization that meet any of the criteria as set forth in paragraphs (b)(2)(i) through (vi) of this section to the balance, measured in dollars, of underlying exposures: (i) Ninety days or more past due; (ii) Subject to a bankruptcy or insolvency proceeding; (iii) In the process of foreclosure; (iv) Held as real estate owned; (v) Has contractually deferred payments for 90 days or more, other than principal or interest payments deferred on: (A) Federally-guaranteed student loans, in accordance with the terms of those guarantee programs; or (B) Consumer loans, including nonfederally-guaranteed student loans, provided that such payments are deferred pursuant to provisions included in the contract at the time funds are disbursed that provide for period(s) of deferral that are not initiated based on changes in the creditworthiness of the borrower; or (vi) Is in default. (3) Parameter A is the attachment point for the exposure, which represents the threshold at which credit losses will first be allocated to the exposure. Except as provided in § l.42(i) for nth-todefault credit derivatives, parameter A equals the ratio of the current dollar amount of underlying exposures that are subordinated to the exposure of the [BANK] to the current dollar amount of underlying exposures. Any reserve account funded by the accumulated cash flows from the underlying exposures that is subordinated to the [BANK]’s securitization exposure may be included in the calculation of parameter A to the extent that cash is present in the account. Parameter A is expressed as a decimal value between zero and one. PO 00000 Frm 00178 Fmt 4701 Sfmt 4700 (4) Parameter D is the detachment point for the exposure, which represents the threshold at which credit losses of principal allocated to the exposure would result in a total loss of principal. Except as provided in section 42(i) for nth-to-default credit derivatives, parameter D equals parameter A plus the ratio of the current dollar amount of the securitization exposures that are pari passu with the exposure (that is, have equal seniority with respect to credit risk) to the current dollar amount of the underlying exposures. Parameter D is expressed as a decimal value between zero and one. (5) A supervisory calibration parameter, p, is equal to 0.5 for securitization exposures that are not resecuritization exposures and equal to 1.5 for resecuritization exposures. (c) Mechanics of the SSFA. KG and W are used to calculate KA, the augmented value of KG, which reflects the observed credit quality of the underlying exposures. KA is defined in paragraph (d) of this section. The values of parameters A and D, relative to KA determine the risk weight assigned to a securitization exposure as described in paragraph (d) of this section. The risk weight assigned to a securitization exposure, or portion of a securitization exposure, as appropriate, is the larger of the risk weight determined in accordance with this paragraph (c) or paragraph (d) of this section and a risk weight of 20 percent. (1) When the detachment point, parameter D, for a securitization exposure is less than or equal to KA, the exposure must be assigned a risk weight of 1,250 percent. (2) When the attachment point, parameter A, for a securitization exposure is greater than or equal to KA, the [BANK] must calculate the risk weight in accordance with paragraph (d) of this section. (3) When A is less than KA and D is greater than KA, the risk weight is a weighted-average of 1,250 percent and 1,250 percent times KSSFA calculated in accordance with paragraph (d) of this section. For the purpose of this weighted-average calculation: E:\FR\FM\11OCR2.SGM 11OCR2 (e) Gross-up approach—(1) Applicability. A [BANK] that is not subject to subpart F of this part may apply the gross-up approach set forth in this section instead of the SSFA to determine the risk weight of its securitization exposures, provided that it applies the gross-up approach to all of its securitization exposures, except as otherwise provided for certain securitization exposures in §§ l.44 and l.45. (2) To use the gross-up approach, a [BANK] must calculate the following four inputs: VerDate Mar<15>2010 14:37 Oct 10, 2013 Jkt 232001 (i) Pro rata share, which is the par value of the [BANK]’s securitization exposure as a percent of the par value of the tranche in which the securitization exposure resides; (ii) Enhanced amount, which is the par value of tranches that are more senior to the tranche in which the [BANK]’s securitization resides; (iii) Exposure amount of the [BANK]’s securitization exposure calculated under § l.42(c); and (iv) Risk weight, which is the weighted-average risk weight of underlying exposures of the PO 00000 Frm 00179 Fmt 4701 Sfmt 4700 62195 securitization as calculated under this subpart. (3) Credit equivalent amount. The credit equivalent amount of a securitization exposure under this section equals the sum of: (i) The exposure amount of the [BANK]’s securitization exposure; and (ii) The pro rata share multiplied by the enhanced amount, each calculated in accordance with paragraph (e)(2) of this section. (4) Risk-weighted assets. To calculate risk-weighted assets for a securitization exposure under the gross-up approach, a [BANK] must apply the risk weight E:\FR\FM\11OCR2.SGM 11OCR2 er11oc13.024</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 62196 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations required under paragraph (e)(2) of this section to the credit equivalent amount calculated in paragraph (e)(3) of this section. (f) Limitations. Notwithstanding any other provision of this section, a [BANK] must assign a risk weight of not less than 20 percent to a securitization exposure. § l.44 Securitization exposures to which the SSFA and gross-up approach do not apply. (a) General requirement. A [BANK] must assign a 1,250 percent risk weight to all securitization exposures to which the [BANK] does not apply the SSFA or the gross-up approach under § l.43, except as set forth in this section. (b) Eligible ABCP liquidity facilities. A [BANK] may determine the riskweighted asset amount of an eligible ABCP liquidity facility by multiplying the exposure amount by the highest risk weight applicable to any of the individual underlying exposures covered by the facility. (c) A securitization exposure in a second loss position or better to an ABCP program—(1) Risk weighting. A [BANK] may determine the riskweighted asset amount of a securitization exposure that is in a second loss position or better to an ABCP program that meets the requirements of paragraph (c)(2) of this section by multiplying the exposure amount by the higher of the following risk weights: (i) 100 percent; and (ii) The highest risk weight applicable to any of the individual underlying exposures of the ABCP program. (2) Requirements. (i) The exposure is not an eligible ABCP liquidity facility; (ii) The exposure must be economically in a second loss position or better, and the first loss position must provide significant credit protection to the second loss position; (iii) The exposure qualifies as investment grade; and (iv) The [BANK] holding the exposure must not retain or provide protection to the first loss position. wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.45 Recognition of credit risk mitigants for securitization exposures. (a) General. (1) An originating [BANK] that has obtained a credit risk mitigant to hedge its exposure to a synthetic or traditional securitization that satisfies the operational criteria provided in § l.41 may recognize the credit risk mitigant under §§ l.36 or l.37, but only as provided in this section. (2) An investing [BANK] that has obtained a credit risk mitigant to hedge a securitization exposure may recognize VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 the credit risk mitigant under §§ l.36 orl.37, but only as provided in this section. (b) Mismatches. A [BANK] must make any applicable adjustment to the protection amount of an eligible guarantee or credit derivative as required in § l.36(d), (e), and (f) for any hedged securitization exposure. In the context of a synthetic securitization, when an eligible guarantee or eligible credit derivative covers multiple hedged exposures that have different residual maturities, the [BANK] must use the longest residual maturity of any of the hedged exposures as the residual maturity of all hedged exposures. §§ l.46 through l.50 [Reserved] Risk-Weighted Assets for Equity Exposures § l.51 Introduction and exposure measurement. (a) General. (1) To calculate its riskweighted asset amounts for equity exposures that are not equity exposures to an investment fund, a [BANK] must use the Simple Risk-Weight Approach (SRWA) provided in l.52. A [BANK] must use the look-through approaches provided in § l.53 to calculate its riskweighted asset amounts for equity exposures to investment funds. (2) A [BANK] must treat an investment in a separate account (as defined in § l.2) as if it were an equity exposure to an investment fund as provided in § l.53. (3) Stable value protection. (i) Stable value protection means a contract where the provider of the contract is obligated to pay: (A) The policy owner of a separate account an amount equal to the shortfall between the fair value and cost basis of the separate account when the policy owner of the separate account surrenders the policy; or (B) The beneficiary of the contract an amount equal to the shortfall between the fair value and book value of a specified portfolio of assets. (ii) A [BANK] that purchases stable value protection on its investment in a separate account must treat the portion of the carrying value of its investment in the separate account attributable to the stable value protection as an exposure to the provider of the protection and the remaining portion of the carrying value of its separate account as an equity exposure to an investment fund. (iii) A [BANK] that provides stable value protection must treat the exposure as an equity derivative with an adjusted carrying value determined as the sum of paragraphs (b)(1) and (3) of this section. PO 00000 Frm 00180 Fmt 4701 Sfmt 4700 (b) Adjusted carrying value. For purposes of §§ l.51 through l.53, the adjusted carrying value of an equity exposure is: (1) For the on-balance sheet component of an equity exposure (other than an equity exposure that is classified as available-for-sale where the [BANK] has made an AOCI opt-out election under § l.22(b)(2)), the [BANK]’s carrying value of the exposure; (2) For the on-balance sheet component of an equity exposure that is classified as available-for-sale where the [BANK] has made an AOCI opt-out election under § l.22(b)(2), the [BANK]’s carrying value of the exposure less any net unrealized gains on the exposure that are reflected in such carrying value but excluded from the [BANK]’s regulatory capital components; (3) For the off-balance sheet component of an equity exposure that is not an equity commitment, the effective notional principal amount of the exposure, the size of which is equivalent to a hypothetical on-balance sheet position in the underlying equity instrument that would evidence the same change in fair value (measured in dollars) given a small change in the price of the underlying equity instrument, minus the adjusted carrying value of the on-balance sheet component of the exposure as calculated in paragraph (b)(1) of this section; and (4) For a commitment to acquire an equity exposure (an equity commitment), the effective notional principal amount of the exposure is multiplied by the following conversion factors (CFs): (i) Conditional equity commitments with an original maturity of one year or less receive a CF of 20 percent. (ii) Conditional equity commitments with an original maturity of over one year receive a CF of 50 percent. (iii) Unconditional equity commitments receive a CF of 100 percent. § l.52 Simple risk-weight approach (SRWA). (a) General. Under the SRWA, a [BANK]’s total risk-weighted assets for equity exposures equals the sum of the risk-weighted asset amounts for each of the [BANK]’s individual equity exposures (other than equity exposures to an investment fund) as determined under this section and the risk-weighted asset amounts for each of the [BANK]’s individual equity exposures to an investment fund as determined under § l.53. E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 (b) SRWA computation for individual equity exposures. A [BANK] must determine the risk-weighted asset amount for an individual equity exposure (other than an equity exposure to an investment fund) by multiplying the adjusted carrying value of the equity exposure or the effective portion and ineffective portion of a hedge pair (as defined in paragraph (c) of this section) by the lowest applicable risk weight in this paragraph (b). (1) Zero percent risk weight equity exposures. An equity exposure to a sovereign, the Bank for International Settlements, the European Central Bank, the European Commission, the International Monetary Fund, an MDB, and any other entity whose credit exposures receive a zero percent risk weight under § l.32 may be assigned a zero percent risk weight. (2) 20 percent risk weight equity exposures. An equity exposure to a PSE, Federal Home Loan Bank or the Federal Agricultural Mortgage Corporation (Farmer Mac) must be assigned a 20 percent risk weight. (3) 100 percent risk weight equity exposures. The equity exposures set forth in this paragraph (b)(3) must be assigned a 100 percent risk weight. (i) Community development equity exposures. An equity exposure that qualifies as a community development investment under section 24 (Eleventh) of the National Bank Act, excluding equity exposures to an unconsolidated small business investment company and equity exposures held through a consolidated small business investment company described in section 302 of the Small Business Investment Act. (ii) Effective portion of hedge pairs. The effective portion of a hedge pair. (iii) Non-significant equity exposures. Equity exposures, excluding significant investments in the capital of an unconsolidated financial institution in the form of common stock and exposures to an investment firm that would meet the definition of a traditional securitization were it not for the application of paragraph (8) of that definition in § l.2 and has greater than immaterial leverage, to the extent that the aggregate adjusted carrying value of the exposures does not exceed 10 percent of the [BANK]’s total capital. (A) To compute the aggregate adjusted carrying value of a [BANK]’s equity VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 exposures for purposes of this section, the [BANK] may exclude equity exposures described in paragraphs (b)(1), (b)(2), (b)(3)(i), and (b)(3)(ii) of this section, the equity exposure in a hedge pair with the smaller adjusted carrying value, and a proportion of each equity exposure to an investment fund equal to the proportion of the assets of the investment fund that are not equity exposures or that meet the criterion of paragraph (b)(3)(i) of this section. If a [BANK] does not know the actual holdings of the investment fund, the [BANK] may calculate the proportion of the assets of the fund that are not equity exposures based on the terms of the prospectus, partnership agreement, or similar contract that defines the fund’s permissible investments. If the sum of the investment limits for all exposure classes within the fund exceeds 100 percent, the [BANK] must assume for purposes of this section that the investment fund invests to the maximum extent possible in equity exposures. (B) When determining which of a [BANK]’s equity exposures qualify for a 100 percent risk weight under this paragraph (b), a [BANK] first must include equity exposures to unconsolidated small business investment companies or held through consolidated small business investment companies described in section 302 of the Small Business Investment Act, then must include publicly traded equity exposures (including those held indirectly through investment funds), and then must include non-publicly traded equity exposures (including those held indirectly through investment funds). (4) 250 percent risk weight equity exposures. Significant investments in the capital of unconsolidated financial institutions in the form of common stock that are not deducted from capital pursuant to § l.22(d) are assigned a 250 percent risk weight. (5) 300 percent risk weight equity exposures. A publicly traded equity exposure (other than an equity exposure described in paragraph (b)(7) of this section and including the ineffective portion of a hedge pair) must be assigned a 300 percent risk weight. (6) 400 percent risk weight equity exposures. An equity exposure (other PO 00000 Frm 00181 Fmt 4701 Sfmt 4700 62197 than an equity exposure described in paragraph (b)(7)) of this section that is not publicly traded must be assigned a 400 percent risk weight. (7) 600 percent risk weight equity exposures. An equity exposure to an investment firm must be assigned a 600 percent risk weight, provided that the investment firm: (i) Would meet the definition of a traditional securitization were it not for the application of paragraph (8) of that definition; and (ii) Has greater than immaterial leverage. (c) Hedge transactions—(1) Hedge pair. A hedge pair is two equity exposures that form an effective hedge so long as each equity exposure is publicly traded or has a return that is primarily based on a publicly traded equity exposure. (2) Effective hedge. Two equity exposures form an effective hedge if the exposures either have the same remaining maturity or each has a remaining maturity of at least three months; the hedge relationship is formally documented in a prospective manner (that is, before the [BANK] acquires at least one of the equity exposures); the documentation specifies the measure of effectiveness (E) the [BANK] will use for the hedge relationship throughout the life of the transaction; and the hedge relationship has an E greater than or equal to 0.8. A [BANK] must measure E at least quarterly and must use one of three alternative measures of E as set forth in this paragraph (c). (i) Under the dollar-offset method of measuring effectiveness, the [BANK] must determine the ratio of value change (RVC). The RVC is the ratio of the cumulative sum of the changes in value of one equity exposure to the cumulative sum of the changes in the value of the other equity exposure. If RVC is positive, the hedge is not effective and E equals 0. If RVC is negative and greater than or equal to ¥1 (that is, between zero and ¥1), then E equals the absolute value of RVC. If RVC is negative and less than ¥1, then E equals 2 plus RVC. (ii) Under the variability-reduction method of measuring effectiveness: E:\FR\FM\11OCR2.SGM 11OCR2 62198 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.53 funds. Equity exposures to investment (a) Available approaches. (1) Unless the exposure meets the requirements for a community development equity exposure under § l.52(b)(3)(i), a [BANK] must determine the riskweighted asset amount of an equity exposure to an investment fund under the full look-through approach described in paragraph (b) of this section, the simple modified lookthrough approach described in paragraph (c) of this section, or the alterative modified look-through approach described paragraph (d) of this section, provided, however, that the minimum risk weight that may be assigned to an equity exposure under this section is 20 percent. (2) The risk-weighted asset amount of an equity exposure to an investment fund that meets the requirements for a community development equity exposure in § l.52(b)(3)(i) is its adjusted carrying value. (3) If an equity exposure to an investment fund is part of a hedge pair and the [BANK] does not use the full look-through approach, the [BANK] must use the ineffective portion of the VerDate Mar<15>2010 16:32 Oct 10, 2013 Jkt 232001 hedge pair as determined under § l.52(c) as the adjusted carrying value for the equity exposure to the investment fund. The risk-weighted asset amount of the effective portion of the hedge pair is equal to its adjusted carrying value. (b) Full look-through approach. A [BANK] that is able to calculate a riskweighted asset amount for its proportional ownership share of each exposure held by the investment fund (as calculated under this subpart as if the proportional ownership share of the adjusted carrying value of each exposure were held directly by the [BANK]) may set the risk-weighted asset amount of the [BANK]’s exposure to the fund equal to the product of: (1) The aggregate risk-weighted asset amounts of the exposures held by the fund as if they were held directly by the [BANK]; and (2) The [BANK]’s proportional ownership share of the fund. (c) Simple modified look-through approach. Under the simple modified look-through approach, the riskweighted asset amount for a [BANK]’s equity exposure to an investment fund equals the adjusted carrying value of the equity exposure multiplied by the highest risk weight that applies to any exposure the fund is permitted to hold under the prospectus, partnership agreement, or similar agreement that defines the fund’s permissible investments (excluding derivative contracts that are used for hedging rather than speculative purposes and that do not constitute a material portion of the fund’s exposures). (d) Alternative modified look-through approach. Under the alternative modified look-through approach, a [BANK] may assign the adjusted carrying value of an equity exposure to an investment fund on a pro rata basis to different risk weight categories under this subpart based on the investment limits in the fund’s prospectus, PO 00000 Frm 00182 Fmt 4701 Sfmt 4700 partnership agreement, or similar contract that defines the fund’s permissible investments. The riskweighted asset amount for the [BANK]’s equity exposure to the investment fund equals the sum of each portion of the adjusted carrying value assigned to an exposure type multiplied by the applicable risk weight under this subpart. If the sum of the investment limits for all exposure types within the fund exceeds 100 percent, the [BANK] must assume that the fund invests to the maximum extent permitted under its investment limits in the exposure type with the highest applicable risk weight under this subpart and continues to make investments in order of the exposure type with the next highest applicable risk weight under this subpart until the maximum total investment level is reached. If more than one exposure type applies to an exposure, the [BANK] must use the highest applicable risk weight. A [BANK] may exclude derivative contracts held by the fund that are used for hedging rather than for speculative purposes and do not constitute a material portion of the fund’s exposures. §§ l.54 through l.60 [Reserved] Disclosures § l.61 Purpose and scope. Sections l.61–l.63 of this subpart establish public disclosure requirements related to the capital requirements described in subpart B of this part for a [BANK] with total consolidated assets of $50 billion or more as reported on the [BANK]’s most recent year-end [REGULATORY REPORT] that is not an advanced approaches [BANK] making public disclosures pursuant to § l.172. An advanced approaches [BANK] that has not received approval from the [AGENCY] to exit parallel run pursuant to § l.121(d) is subject to the disclosure requirements described in §§ l.62 and l.63. Such a [BANK] must comply with E:\FR\FM\11OCR2.SGM 11OCR2 er11oc13.027</GPH> (iii) Under the regression method of measuring effectiveness, E equals the coefficient of determination of a regression in which the change in value of one exposure in a hedge pair is the dependent variable and the change in value of the other exposure in a hedge pair is the independent variable. However, if the estimated regression coefficient is positive, then E equals zero. (3) The effective portion of a hedge pair is E multiplied by the greater of the adjusted carrying values of the equity exposures forming a hedge pair. (4) The ineffective portion of a hedge pair is (1–E) multiplied by the greater of the adjusted carrying values of the equity exposures forming a hedge pair. Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations § l.62 unless it is a consolidated subsidiary of a bank holding company, savings and loan holding company, or depository institution that is subject to these disclosure requirements or a subsidiary of a non-U.S. banking organization that is subject to comparable public disclosure requirements in its home jurisdiction. For purposes of this section, total consolidated assets are determined based on the average of the [BANK]’s total consolidated assets in the four most recent quarters as reported on the [REGULATORY REPORT]; or the average of the [BANK]’s total consolidated assets in the most recent consecutive quarters as reported quarterly on the [BANK]’s [REGULATORY REPORT] if the [BANK] has not filed such a report for each of the most recent four quarters. § l.62 Disclosure requirements. (a) A [BANK] described in § l.61 must provide timely public disclosures each calendar quarter of the information in the applicable tables in § l.63. If a significant change occurs, such that the most recent reported amounts are no longer reflective of the [BANK]’s capital adequacy and risk profile, then a brief discussion of this change and its likely impact must be disclosed as soon as practicable thereafter. Qualitative disclosures that typically do not change each quarter (for example, a general summary of the [BANK]’s risk management objectives and policies, reporting system, and definitions) may be disclosed annually after the end of the fourth calendar quarter, provided that any significant changes are disclosed in the interim. The [BANK]’s management may provide all of the disclosures required by §§ l.61 through l.63 in one place on the [BANK]’s public Web site or may provide the disclosures in more than one public financial report or other regulatory reports, provided that the [BANK] publicly provides a summary table specifically indicating the location(s) of all such disclosures. (b) A [BANK] described in § l.61 must have a formal disclosure policy approved by the board of directors that addresses its approach for determining the disclosures it makes. The policy must address the associated internal controls and disclosure controls and procedures. The board of directors and senior management are responsible for establishing and maintaining an effective internal control structure over financial reporting, including the disclosures required by this subpart, and must ensure that appropriate review of the disclosures takes place. One or more senior officers of the [BANK] must attest that the disclosures meet the requirements of this subpart. (c) If a [BANK] described in § l.61 concludes that specific commercial or financial information that it would otherwise be required to disclose under this section would be exempt from disclosure by the [AGENCY] under the Freedom of Information Act (5 U.S.C. 552), then the [BANK] is not required to disclose that specific information pursuant to this section, but must 62199 disclose more general information about the subject matter of the requirement, together with the fact that, and the reason why, the specific items of information have not been disclosed. § l.63 Disclosures by [BANK]s described in § l.61. (a) Except as provided in § l.62, a [BANK] described in § l.61 must make the disclosures described in Tables 1 through 10 of this section. The [BANK] must make these disclosures publicly available for each of the last three years (that is, twelve quarters) or such shorter period beginning on January 1, 2015. (b) A [BANK] must publicly disclose each quarter the following: (1) Common equity tier 1 capital, additional tier 1 capital, tier 2 capital, tier 1 and total capital ratios, including the regulatory capital elements and all the regulatory adjustments and deductions needed to calculate the numerator of such ratios; (2) Total risk-weighted assets, including the different regulatory adjustments and deductions needed to calculate total risk-weighted assets; (3) Regulatory capital ratios during any transition periods, including a description of all the regulatory capital elements and all regulatory adjustments and deductions needed to calculate the numerator and denominator of each capital ratio during any transition period; and (4) A reconciliation of regulatory capital elements as they relate to its balance sheet in any audited consolidated financial statements. TABLE 1 TO § l.63—SCOPE OF APPLICATION Qualitative Disclosures .......................... (a) ................................ (b) ................................ (c) ................................ (d) ................................ wreier-aviles on DSK5TPTVN1PROD with RULES2 (e) ................................ The name of the top corporate entity in the group to which subpart D of this part applies. A brief description of the differences in the basis for consolidating entities 1 for accounting and regulatory purposes, with a description of those entities: (1) That are fully consolidated; (2) That are deconsolidated and deducted from total capital; (3) For which the total capital requirement is deducted; and (4) That are neither consolidated nor deducted (for example, where the investment in the entity is assigned a risk weight in accordance with this subpart). Any restrictions, or other major impediments, on transfer of funds or total capital within the group. The aggregate amount of surplus capital of insurance subsidiaries included in the total capital of the consolidated group. The aggregate amount by which actual total capital is less than the minimum total capital requirement in all subsidiaries, with total capital requirements and the name(s) of the subsidiaries with such deficiencies. 1 Entities include securities, insurance and other financial subsidiaries, commercial subsidiaries (where permitted), and significant minority equity investments in insurance, financial and commercial entities. TABLE 2 TO § l.63—CAPITAL STRUCTURE Qualitative Disclosures .......................... (a) ................................ Quantitative Disclosures ....................... (b) ................................ VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00183 Summary information on the terms and conditions of the main features of all regulatory capital instruments. The amount of common equity tier 1 capital, with separate disclosure of: (1) Common stock and related surplus; Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 62200 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations TABLE 2 TO § l.63—CAPITAL STRUCTURE—Continued (c) ................................ (d) ................................ (2) Retained earnings; (3) Common equity minority interest; (4) AOCI; and (5) Regulatory adjustments and deductions made to common equity tier 1 capital. The amount of tier 1 capital, with separate disclosure of: (1) Additional tier 1 capital elements, including additional tier 1 capital instruments and tier 1 minority interest not included in common equity tier 1 capital; and (2) Regulatory adjustments and deductions made to tier 1 capital. The amount of total capital, with separate disclosure of: (1) Tier 2 capital elements, including tier 2 capital instruments and total capital minority interest not included in tier 1 capital; and (2) Regulatory adjustments and deductions made to total capital. TABLE 3 TO § l.63—CAPITAL ADEQUACY Qualitative disclosures .......................... (a) ................................ Quantitative disclosures ........................ (b) ................................ (c) ................................ (d) ................................ (e) ................................ A summary discussion of the [BANK]’s approach to assessing the adequacy of its capital to support current and future activities. Risk-weighted assets for: (1) Exposures to sovereign entities; (2) Exposures to certain supranational entities and MDBs; (3) Exposures to depository institutions, foreign banks, and credit unions; (4) Exposures to PSEs; (5) Corporate exposures; (6) Residential mortgage exposures; (7) Statutory multifamily mortgages and pre-sold construction loans; (8) HVCRE loans; (9) Past due loans; (10) Other assets; (11) Cleared transactions; (12) Default fund contributions; (13) Unsettled transactions; (14) Securitization exposures; and (15) Equity exposures. Standardized market risk-weighted assets as calculated under subpart F of this part. Common equity tier 1, tier 1 and total risk-based capital ratios: (1) For the top consolidated group; and (2) For each depository institution subsidiary. Total standardized risk-weighted assets. TABLE 4 TO § l.63—CAPITAL CONSERVATION BUFFER Quantitative Disclosures ....................... (a) ................................ (b) ................................ (c) ................................ (c) General qualitative disclosure requirement. For each separate risk area described in Tables 5 through 10, the [BANK] must describe its risk management objectives and policies, At least quarterly, the [BANK] must calculate and publicly disclose the capital conservation buffer as described under § l.11. At least quarterly, the [BANK] must calculate and publicly disclose the eligible retained income of the [BANK], as described under § l.11. At least quarterly, the [BANK] must calculate and publicly disclose any limitations it has on distributions and discretionary bonus payments resulting from the capital conservation buffer framework described under § l.11, including the maximum payout amount for the quarter. including: Strategies and processes; the structure and organization of the relevant risk management function; the scope and nature of risk reporting and/ or measurement systems; policies for hedging and/or mitigating risk and strategies and processes for monitoring the continuing effectiveness of hedges/ mitigants. wreier-aviles on DSK5TPTVN1PROD with RULES2 TABLE 5 TO § l.63 1—CREDIT RISK: GENERAL DISCLOSURES Qualitative Disclosures .......................... VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (a) ................................ PO 00000 Frm 00184 The general qualitative disclosure requirement with respect to credit risk (excluding counterparty credit risk disclosed in accordance with Table 6), including the: (1) Policy for determining past due or delinquency status; (2) Policy for placing loans on nonaccrual; (3) Policy for returning loans to accrual status; (4) Definition of and policy for identifying impaired loans (for financial accounting purposes); Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 62201 TABLE 5 TO § l.63 1—CREDIT RISK: GENERAL DISCLOSURES—Continued Quantitative Disclosures ....................... (b) ................................ (c) ................................ (d) ................................ (e) ................................ (f) ................................. (g) ................................ (h) ................................ (5) Description of the methodology that the [BANK] uses to estimate its allowance for loan and lease losses, including statistical methods used where applicable; (6) Policy for charging-off uncollectible amounts; and (7) Discussion of the [BANK]’s credit risk management policy. Total credit risk exposures and average credit risk exposures, after accounting offsets in accordance with GAAP, without taking into account the effects of credit risk mitigation techniques (for example, collateral and netting not permitted under GAAP), over the period categorized by major types of credit exposure. For example, [BANK]s could use categories similar to that used for financial statement purposes. Such categories might include, for instance (1) Loans, off-balance sheet commitments, and other non-derivative off-balance sheet exposures; (2) Debt securities; and (3) OTC derivatives.2 Geographic distribution of exposures, categorized in significant areas by major types of credit exposure.3 Industry or counterparty type distribution of exposures, categorized by major types of credit exposure. By major industry or counterparty type: (1) Amount of impaired loans for which there was a related allowance under GAAP; (2) Amount of impaired loans for which there was no related allowance under GAAP; (3) Amount of loans past due 90 days and on nonaccrual; (4) Amount of loans past due 90 days and still accruing; 4 (5) The balance in the allowance for loan and lease losses at the end of each period, disaggregated on the basis of the [BANK]’s impairment method. To disaggregate the information required on the basis of impairment methodology, an entity shall separately disclose the amounts based on the requirements in GAAP; and (6) Charge-offs during the period. Amount of impaired loans and, if available, the amount of past due loans categorized by significant geographic areas including, if practical, the amounts of allowances related to each geographical area,5 further categorized as required by GAAP. Reconciliation of changes in ALLL.6 Remaining contractual maturity delineation (for example, one year or less) of the whole portfolio, categorized by credit exposure. 1 Table 5 does not cover equity exposures, which should be reported in Table 9. for example, ASC Topic 815–10 and 210, as they may be amended from time to time. 3 Geographical areas may consist of individual countries, groups of countries, or regions within countries. A [BANK] might choose to define the geographical areas based on the way the [BANK]’s portfolio is geographically managed. The criteria used to allocate the loans to geographical areas must be specified. 4 A [BANK] is encouraged also to provide an analysis of the aging of past-due loans. 5 The portion of the general allowance that is not allocated to a geographical area should be disclosed separately. 6 The reconciliation should include the following: A description of the allowance; the opening balance of the allowance; charge-offs taken against the allowance during the period; amounts provided (or reversed) for estimated probable loan losses during the period; any other adjustments (for example, exchange rate differences, business combinations, acquisitions and disposals of subsidiaries), including transfers between allowances; and the closing balance of the allowance. Charge-offs and recoveries that have been recorded directly to the income statement should be disclosed separately. 2 See, TABLE 6 TO § l.63—GENERAL DISCLOSURE FOR COUNTERPARTY CREDIT RISK-RELATED EXPOSURES wreier-aviles on DSK5TPTVN1PROD with RULES2 Qualitative Disclosures .......................... (a) ................................ Quantitative Disclosures ....................... (b) ................................ VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00185 The general qualitative disclosure requirement with respect to OTC derivatives, eligible margin loans, and repo-style transactions, including a discussion of: (1) The methodology used to assign credit limits for counterparty credit exposures; (2) Policies for securing collateral, valuing and managing collateral, and establishing credit reserves; (3) The primary types of collateral taken; and (4) The impact of the amount of collateral the [BANK] would have to provide given a deterioration in the [BANK]’s own creditworthiness. Gross positive fair value of contracts, collateral held (including type, for example, cash, government securities), and net unsecured credit exposure.1 A [BANK] also must disclose the notional value of credit derivative hedges purchased for counterparty credit risk protection and the distribution of current credit exposure by exposure type.2 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 62202 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations TABLE 6 TO § l.63—GENERAL DISCLOSURE FOR COUNTERPARTY CREDIT RISK-RELATED EXPOSURES—Continued (c) ................................ Notional amount of purchased and sold credit derivatives, segregated between use for the [BANK]’s own credit portfolio and in its intermediation activities, including the distribution of the credit derivative products used, categorized further by protection bought and sold within each product group. 1 Net unsecured credit exposure is the credit exposure after considering both the benefits from legally enforceable netting agreements and collateral arrangements without taking into account haircuts for price volatility, liquidity, etc. 2 This may include interest rate derivative contracts, foreign exchange derivative contracts, equity derivative contracts, credit derivatives, commodity or other derivative contracts, repo-style transactions, and eligible margin loans. TABLE 7 TO § l.63—CREDIT RISK MITIGATION 1 2 Qualitative Disclosures .......................... (a) ................................ Quantitative Disclosures ....................... (b) ................................ (c) ................................ The general qualitative disclosure requirement with respect to credit risk mitigation, including: (1) Policies and processes for collateral valuation and management; (2) A description of the main types of collateral taken by the [BANK]; (3) The main types of guarantors/credit derivative counterparties and their creditworthiness; and (4) Information about (market or credit) risk concentrations with respect to credit risk mitigation. For each separately disclosed credit risk portfolio, the total exposure that is covered by eligible financial collateral, and after the application of haircuts. For each separately disclosed portfolio, the total exposure that is covered by guarantees/credit derivatives and the risk-weighted asset amount associated with that exposure. 1 At a minimum, a [BANK] must provide the disclosures in Table 7 in relation to credit risk mitigation that has been recognized for the purposes of reducing capital requirements under this subpart. Where relevant, [BANK]s are encouraged to give further information about mitigants that have not been recognized for that purpose. 2 Credit derivatives that are treated, for the purposes of this subpart, as synthetic securitization exposures should be excluded from the credit risk mitigation disclosures and included within those relating to securitization (Table 8). TABLE 8 TO § l.63—SECURITIZATION Qualitative Disclosures .......................... (a) ................................ (b) ................................ wreier-aviles on DSK5TPTVN1PROD with RULES2 (c) ................................ VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00186 The general qualitative disclosure requirement with respect to a securitization (including synthetic securitizations), including a discussion of: (1) The [BANK]’s objectives for securitizing assets, including the extent to which these activities transfer credit risk of the underlying exposures away from the [BANK] to other entities and including the type of risks assumed and retained with resecuritization activity; 1 (2) The nature of the risks (e.g. liquidity risk) inherent in the securitized assets; (3) The roles played by the [BANK] in the securitization process 2 and an indication of the extent of the [BANK]’s involvement in each of them; (4) The processes in place to monitor changes in the credit and market risk of securitization exposures including how those processes differ for resecuritization exposures; (5) The [BANK]’s policy for mitigating the credit risk retained through securitization and resecuritization exposures; and (6) The risk-based capital approaches that the [BANK] follows for its securitization exposures including the type of securitization exposure to which each approach applies. A list of: (1) The type of securitization SPEs that the [BANK], as sponsor, uses to securitize third-party exposures. The [BANK] must indicate whether it has exposure to these SPEs, either on- or off-balance sheet; and (2) Affiliated entities: (i) That the [BANK] manages or advises; and (ii) That invest either in the securitization exposures that the [BANK] has securitized or in securitization SPEs that the [BANK] sponsors.3 Summary of the [BANK]’s accounting policies for securitization activities, including: (1) Whether the transactions are treated as sales or financings; (2) Recognition of gain-on-sale; (3) Methods and key assumptions applied in valuing retained or purchased interests; (4) Changes in methods and key assumptions from the previous period for valuing retained interests and impact of the changes; (5) Treatment of synthetic securitizations; (6) How exposures intended to be securitized are valued and whether they are recorded under subpart D of this part; and (7) Policies for recognizing liabilities on the balance sheet for arrangements that could require the [BANK] to provide financial support for securitized assets. Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 62203 TABLE 8 TO § l.63—SECURITIZATION—Continued (d) ................................ Quantitative Disclosures ....................... (e) ................................ (f) ................................. (g) ................................ (h) ................................ (i) ................................. (j) ................................. (k) ................................ An explanation of significant changes to any quantitative information since the last reporting period. The total outstanding exposures securitized by the [BANK] in securitizations that meet the operational criteria provided in § l.41 (categorized into traditional and synthetic securitizations), by exposure type, separately for securitizations of third-party exposures for which the bank acts only as sponsor.4 For exposures securitized by the [BANK] in securitizations that meet the operational criteria in § l.41: (1) Amount of securitized assets that are impaired/past due categorized by exposure type; 5 and (2) Losses recognized by the [BANK] during the current period categorized by exposure type.6 The total amount of outstanding exposures intended to be securitized categorized by exposure type. Aggregate amount of: (1) On-balance sheet securitization exposures retained or purchased categorized by exposure type; and (2) Off-balance sheet securitization exposures categorized by exposure type. (1) Aggregate amount of securitization exposures retained or purchased and the associated capital requirements for these exposures, categorized between securitization and resecuritization exposures, further categorized into a meaningful number of risk weight bands and by risk-based capital approach (e.g., SSFA); and (2) Exposures that have been deducted entirely from tier 1 capital, CEIOs deducted from total capital (as described in § l.42(a)(1), and other exposures deducted from total capital should be disclosed separately by exposure type. Summary of current year’s securitization activity, including the amount of exposures securitized (by exposure type), and recognized gain or loss on sale by exposure type. Aggregate amount of resecuritization exposures retained or purchased categorized according to: (1) Exposures to which credit risk mitigation is applied and those not applied; and (2) Exposures to guarantors categorized according to guarantor creditworthiness categories or guarantor name. 1 The [BANK] should describe the structure of resecuritizations in which it participates; this description should be provided for the main categories of resecuritization products in which the [BANK] is active. 2 For example, these roles may include originator, investor, servicer, provider of credit enhancement, sponsor, liquidity provider, or swap provider. 3 Such affiliated entities may include, for example, money market funds, to be listed individually, and personal and private trusts, to be noted collectively. 4 ‘‘Exposures securitized’’ include underlying exposures originated by the bank, whether generated by them or purchased, and recognized in the balance sheet, from third parties, and third-party exposures included in sponsored transactions. Securitization transactions (including underlying exposures originally on the bank’s balance sheet and underlying exposures acquired by the bank from third-party entities) in which the originating bank does not retain any securitization exposure should be shown separately but need only be reported for the year of inception. Banks are required to disclose exposures regardless of whether there is a capital charge under this part. 5 Include credit-related other than temporary impairment (OTTI). 6 For example, charge-offs/allowances (if the assets remain on the bank’s balance sheet) or credit-related OTTI of interest-only strips and other retained residual interests, as well as recognition of liabilities for probable future financial support required of the bank with respect to securitized assets. TABLE 9 TO § l.63—EQUITIES NOT SUBJECT TO SUBPART F OF THIS PART wreier-aviles on DSK5TPTVN1PROD with RULES2 Qualitative Disclosures .......................... (a) ................................ Quantitative Disclosures ....................... (b) ................................ (c) ................................ (d) ................................ VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00187 The general qualitative disclosure requirement with respect to equity risk for equities not subject to subpart F of this part, including: (1) Differentiation between holdings on which capital gains are expected and those taken under other objectives including for relationship and strategic reasons; and (2) Discussion of important policies covering the valuation of and accounting for equity holdings not subject to subpart F of this part. This includes the accounting techniques and valuation methodologies used, including key assumptions and practices affecting valuation as well as significant changes in these practices. Value disclosed on the balance sheet of investments, as well as the fair value of those investments; for securities that are publicly traded, a comparison to publicly-quoted share values where the share price is materially different from fair value. The types and nature of investments, including the amount that is: (1) Publicly traded; and (2) Non publicly traded. The cumulative realized gains (losses) arising from sales and liquidations in the reporting period. Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 62204 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations TABLE 9 TO § l.63—EQUITIES NOT SUBJECT TO SUBPART F OF THIS PART—Continued (e) ................................ (f) ................................. 1 Unrealized 2 Unrealized (1) Total unrealized gains (losses).1 (2) Total latent revaluation gains (losses).2 (3) Any amounts of the above included in tier 1 or tier 2 capital. Capital requirements categorized by appropriate equity groupings, consistent with the [BANK]’s methodology, as well as the aggregate amounts and the type of equity investments subject to any supervisory transition regarding regulatory capital requirements. gains (losses) recognized on the balance sheet but not through earnings. gains (losses) not recognized either on the balance sheet or through earnings. TABLE 10 TO § l.63—INTEREST RATE RISK FOR NON-TRADING ACTIVITIES Qualitative disclosures .......................... (a) ................................ Quantitative disclosures ........................ (b) ................................ §§ l.64 through l.99 [Reserved] Subpart E—Risk-Weighted Assets— Internal Ratings-Based and Advanced Measurement Approaches wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.100 Purpose, applicability, and principle of conservatism. (a) Purpose. This subpart E establishes: (1) Minimum qualifying criteria for [BANK]s using institution-specific internal risk measurement and management processes for calculating risk-based capital requirements; and (2) Methodologies for such [BANK]s to calculate their total risk-weighted assets. (b) Applicability. (1) This subpart applies to a [BANK] that: (i) Has consolidated total assets, as reported on its most recent year-end [REGULATORY REPORT] equal to $250 billion or more; (ii) Has consolidated total on-balance sheet foreign exposure on its most recent year-end [REGULATORY REPORT] equal to $10 billion or more (where total on-balance sheet foreign exposure equals total cross-border claims less claims with a head office or guarantor located in another country plus redistributed guaranteed amounts to the country of head office or guarantor plus local country claims on local residents plus revaluation gains on foreign exchange and derivative products, calculated in accordance with the Federal Financial Institutions Examination Council (FFIEC) 009 Country Exposure Report); (iii) Is a subsidiary of a depository institution that uses the advanced approaches pursuant to subpart E of 12 CFR part 3 (OCC), 12 CFR part 217 VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 The general qualitative disclosure requirement, including the nature of interest rate risk for non-trading activities and key assumptions, including assumptions regarding loan prepayments and behavior of non-maturity deposits, and frequency of measurement of interest rate risk for non-trading activities. The increase (decline) in earnings or economic value (or relevant measure used by management) for upward and downward rate shocks according to management’s method for measuring interest rate risk for non-trading activities, categorized by currency (as appropriate). (Board), or 12 CFR part 325 (FDIC) to calculate its total risk-weighted assets; (iv) Is a subsidiary of a bank holding company or savings and loan holding company that uses the advanced approaches pursuant to 12 CFR part 217 to calculate its total risk-weighted assets; or (v) Elects to use this subpart to calculate its total risk-weighted assets. (2) A [BANK] that is subject to this subpart shall remain subject to this subpart unless the [AGENCY] determines in writing that application of this subpart is not appropriate in light of the [BANK]’s asset size, level of complexity, risk profile, or scope of operations. In making a determination under this paragraph (b), the [AGENCY] will apply notice and response procedures in the same manner and to the same extent as the notice and response procedures in [12 CFR 3.404 (OCC), 12 CFR 263.202 (Board), and 12 CFR 324.5 (FDIC)]. (3) A market risk [BANK] must exclude from its calculation of riskweighted assets under this subpart the risk-weighted asset amounts of all covered positions, as defined in subpart F of this part (except foreign exchange positions that are not trading positions, over-the-counter derivative positions, cleared transactions, and unsettled transactions). (c) Principle of conservatism. Notwithstanding the requirements of this subpart, a [BANK] may choose not to apply a provision of this subpart to one or more exposures provided that: (1) The [BANK] can demonstrate on an ongoing basis to the satisfaction of the [AGENCY] that not applying the provision would, in all circumstances, unambiguously generate a risk-based PO 00000 Frm 00188 Fmt 4701 Sfmt 4700 capital requirement for each such exposure greater than that which would otherwise be required under this subpart; (2) The [BANK] appropriately manages the risk of each such exposure; (3) The [BANK] notifies the [AGENCY] in writing prior to applying this principle to each such exposure; and (4) The exposures to which the [BANK] applies this principle are not, in the aggregate, material to the [BANK]. § l.101 Definitions. (a) Terms that are set forth in § l.2 and used in this subpart have the definitions assigned thereto in § l.2. (b) For the purposes of this subpart, the following terms are defined as follows: Advanced internal ratings-based (IRB) systems means an advanced approaches [BANK]’s internal risk rating and segmentation system; risk parameter quantification system; data management and maintenance system; and control, oversight, and validation system for credit risk of wholesale and retail exposures. Advanced systems means an advanced approaches [BANK]’s advanced IRB systems, operational risk management processes, operational risk data and assessment systems, operational risk quantification systems, and, to the extent used by the [BANK], the internal models methodology, advanced CVA approach, double default excessive correlation detection process, and internal models approach (IMA) for equity exposures. Backtesting means the comparison of a [BANK]’s internal estimates with actual outcomes during a sample period E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations not used in model development. In this context, backtesting is one form of outof-sample testing. Benchmarking means the comparison of a [BANK]’s internal estimates with relevant internal and external data or with estimates based on other estimation techniques. Bond option contract means a bond option, bond future, or any other instrument linked to a bond that gives rise to similar counterparty credit risk. Business environment and internal control factors means the indicators of a [BANK]’s operational risk profile that reflect a current and forward-looking assessment of the [BANK]’s underlying business risk factors and internal control environment. Credit default swap (CDS) means a financial contract executed under standard industry documentation that allows one party (the protection purchaser) to transfer the credit risk of one or more exposures (reference exposure(s)) to another party (the protection provider) for a certain period of time. Credit valuation adjustment (CVA) means the fair value adjustment to reflect counterparty credit risk in valuation of OTC derivative contracts. Default—For the purposes of calculating capital requirements under this subpart: (1) Retail. (i) A retail exposure of a [BANK] is in default if: (A) The exposure is 180 days past due, in the case of a residential mortgage exposure or revolving exposure; (B) The exposure is 120 days past due, in the case of retail exposures that are not residential mortgage exposures or revolving exposures; or (C) The [BANK] has taken a full or partial charge-off, write-down of principal, or material negative fair value adjustment of principal on the exposure for credit-related reasons. (ii) Notwithstanding paragraph (1)(i) of this definition, for a retail exposure held by a non-U.S. subsidiary of the [BANK] that is subject to an internal ratings-based approach to capital adequacy consistent with the Basel Committee on Banking Supervision’s ‘‘International Convergence of Capital Measurement and Capital Standards: A Revised Framework’’ in a non-U.S. jurisdiction, the [BANK] may elect to use the definition of default that is used in that jurisdiction, provided that the [BANK] has obtained prior approval from the [AGENCY] to use the definition of default in that jurisdiction. (iii) A retail exposure in default remains in default until the [BANK] has reasonable assurance of repayment and VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 performance for all contractual principal and interest payments on the exposure. (2) Wholesale. (i) A [BANK]’s wholesale obligor is in default if: (A) The [BANK] determines that the obligor is unlikely to pay its credit obligations to the [BANK] in full, without recourse by the [BANK] to actions such as realizing collateral (if held); or (B) The obligor is past due more than 90 days on any material credit obligation(s) to the [BANK].25 (ii) An obligor in default remains in default until the [BANK] has reasonable assurance of repayment and performance for all contractual principal and interest payments on all exposures of the [BANK] to the obligor (other than exposures that have been fully written-down or charged-off). Dependence means a measure of the association among operational losses across and within units of measure. Economic downturn conditions means, with respect to an exposure held by the [BANK], those conditions in which the aggregate default rates for that exposure’s wholesale or retail exposure subcategory (or subdivision of such subcategory selected by the [BANK]) in the exposure’s national jurisdiction (or subdivision of such jurisdiction selected by the [BANK]) are significantly higher than average. Effective maturity (M) of a wholesale exposure means: (1) For wholesale exposures other than repo-style transactions, eligible margin loans, and OTC derivative contracts described in paragraph (2) or (3) of this definition: (i) The weighted-average remaining maturity (measured in years, whole or fractional) of the expected contractual cash flows from the exposure, using the undiscounted amounts of the cash flows as weights; or (ii) The nominal remaining maturity (measured in years, whole or fractional) of the exposure. (2) For repo-style transactions, eligible margin loans, and OTC derivative contracts subject to a qualifying master netting agreement for which the [BANK] does not apply the internal models approach in section 132(d), the weighted-average remaining maturity (measured in years, whole or fractional) of the individual transactions subject to the qualifying master netting agreement, with the weight of each individual transaction set equal to the notional amount of the transaction. 25 Overdrafts are past due once the obligor has breached an advised limit or been advised of a limit smaller than the current outstanding balance. PO 00000 Frm 00189 Fmt 4701 Sfmt 4700 62205 (3) For repo-style transactions, eligible margin loans, and OTC derivative contracts for which the [BANK] applies the internal models approach in § l.132(d), the value determined in § l.132(d)(4). Eligible double default guarantor, with respect to a guarantee or credit derivative obtained by a [BANK], means: (1) U.S.-based entities. A depository institution, a bank holding company, a savings and loan holding company, or a securities broker or dealer registered with the SEC under the Securities Exchange Act, if at the time the guarantee is issued or anytime thereafter, has issued and outstanding an unsecured debt security without credit enhancement that is investment grade. (2) Non-U.S.-based entities. A foreign bank, or a non-U.S.-based securities firm if the [BANK] demonstrates that the guarantor is subject to consolidated supervision and regulation comparable to that imposed on U.S. depository institutions, or securities broker-dealers) if at the time the guarantee is issued or anytime thereafter, has issued and outstanding an unsecured debt security without credit enhancement that is investment grade. Eligible operational risk offsets means amounts, not to exceed expected operational loss, that: (1) Are generated by internal business practices to absorb highly predictable and reasonably stable operational losses, including reserves calculated consistent with GAAP; and (2) Are available to cover expected operational losses with a high degree of certainty over a one-year horizon. Eligible purchased wholesale exposure means a purchased wholesale exposure that: (1) The [BANK] or securitization SPE purchased from an unaffiliated seller and did not directly or indirectly originate; (2) Was generated on an arm’s-length basis between the seller and the obligor (intercompany accounts receivable and receivables subject to contra-accounts between firms that buy and sell to each other do not satisfy this criterion); (3) Provides the [BANK] or securitization SPE with a claim on all proceeds from the exposure or a pro rata interest in the proceeds from the exposure; (4) Has an M of less than one year; and (5) When consolidated by obligor, does not represent a concentrated exposure relative to the portfolio of purchased wholesale exposures. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62206 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations Expected exposure (EE) means the expected value of the probability distribution of non-negative credit risk exposures to a counterparty at any specified future date before the maturity date of the longest term transaction in the netting set. Any negative fair values in the probability distribution of fair values to a counterparty at a specified future date are set to zero to convert the probability distribution of fair values to the probability distribution of credit risk exposures. Expected operational loss (EOL) means the expected value of the distribution of potential aggregate operational losses, as generated by the [BANK]’s operational risk quantification system using a one-year horizon. Expected positive exposure (EPE) means the weighted average over time of expected (non-negative) exposures to a counterparty where the weights are the proportion of the time interval that an individual expected exposure represents. When calculating risk-based capital requirements, the average is taken over a one-year horizon. Exposure at default (EAD) means: (1) For the on-balance sheet component of a wholesale exposure or segment of retail exposures (other than an OTC derivative contract, a repo-style transaction or eligible margin loan for which the [BANK] determines EAD under § l.132, a cleared transaction, or default fund contribution), EAD means the [BANK]’s carrying value (including net accrued but unpaid interest and fees) for the exposure or segment less any allocated transfer risk reserve for the exposure or segment. (2) For the off-balance sheet component of a wholesale exposure or segment of retail exposures (other than an OTC derivative contract, a repo-style transaction or eligible margin loan for which the [BANK] determines EAD under § l.132, cleared transaction, or default fund contribution) in the form of a loan commitment, line of credit, traderelated letter of credit, or transactionrelated contingency, EAD means the [BANK]’s best estimate of net additions to the outstanding amount owed the [BANK], including estimated future additional draws of principal and accrued but unpaid interest and fees, that are likely to occur over a one-year horizon assuming the wholesale exposure or the retail exposures in the segment were to go into default. This estimate of net additions must reflect what would be expected during economic downturn conditions. For the purposes of this definition: (i) Trade-related letters of credit are short-term, self-liquidating instruments that are used to finance the movement VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 of goods and are collateralized by the underlying goods. (ii) Transaction-related contingencies relate to a particular transaction and include, among other things, performance bonds and performancebased letters of credit. (3) For the off-balance sheet component of a wholesale exposure or segment of retail exposures (other than an OTC derivative contract, a repo-style transaction, or eligible margin loan for which the [BANK] determines EAD under § l.132, cleared transaction, or default fund contribution) in the form of anything other than a loan commitment, line of credit, trade-related letter of credit, or transaction-related contingency, EAD means the notional amount of the exposure or segment. (4) EAD for OTC derivative contracts is calculated as described in § l.132. A [BANK] also may determine EAD for repo-style transactions and eligible margin loans as described in § l.132. Exposure category means any of the wholesale, retail, securitization, or equity exposure categories. External operational loss event data means, with respect to a [BANK], gross operational loss amounts, dates, recoveries, and relevant causal information for operational loss events occurring at organizations other than the [BANK]. IMM exposure means a repo-style transaction, eligible margin loan, or OTC derivative for which a [BANK] calculates its EAD using the internal models methodology of § l.132(d). Internal operational loss event data means, with respect to a [BANK], gross operational loss amounts, dates, recoveries, and relevant causal information for operational loss events occurring at the [BANK]. Loss given default (LGD) means: (1) For a wholesale exposure, the greatest of: (i) Zero; (ii) The [BANK]’s empirically based best estimate of the long-run defaultweighted average economic loss, per dollar of EAD, the [BANK] would expect to incur if the obligor (or a typical obligor in the loss severity grade assigned by the [BANK] to the exposure) were to default within a one-year horizon over a mix of economic conditions, including economic downturn conditions; or (iii) The [BANK]’s empirically based best estimate of the economic loss, per dollar of EAD, the [BANK] would expect to incur if the obligor (or a typical obligor in the loss severity grade assigned by the [BANK] to the exposure) were to default within a one-year PO 00000 Frm 00190 Fmt 4701 Sfmt 4700 horizon during economic downturn conditions. (2) For a segment of retail exposures, the greatest of: (i) Zero; (ii) The [BANK]’s empirically based best estimate of the long-run defaultweighted average economic loss, per dollar of EAD, the [BANK] would expect to incur if the exposures in the segment were to default within a one-year horizon over a mix of economic conditions, including economic downturn conditions; or (iii) The [BANK]’s empirically based best estimate of the economic loss, per dollar of EAD, the [BANK] would expect to incur if the exposures in the segment were to default within a one-year horizon during economic downturn conditions. (3) The economic loss on an exposure in the event of default is all material credit-related losses on the exposure (including accrued but unpaid interest or fees, losses on the sale of collateral, direct workout costs, and an appropriate allocation of indirect workout costs). Where positive or negative cash flows on a wholesale exposure to a defaulted obligor or a defaulted retail exposure (including proceeds from the sale of collateral, workout costs, additional extensions of credit to facilitate repayment of the exposure, and drawdowns of unused credit lines) occur after the date of default, the economic loss must reflect the net present value of cash flows as of the default date using a discount rate appropriate to the risk of the defaulted exposure. Obligor means the legal entity or natural person contractually obligated on a wholesale exposure, except that a [BANK] may treat the following exposures as having separate obligors: (1) Exposures to the same legal entity or natural person denominated in different currencies; (2)(i) An income-producing real estate exposure for which all or substantially all of the repayment of the exposure is reliant on the cash flows of the real estate serving as collateral for the exposure; the [BANK], in economic substance, does not have recourse to the borrower beyond the real estate collateral; and no cross-default or crossacceleration clauses are in place other than clauses obtained solely out of an abundance of caution; and (ii) Other credit exposures to the same legal entity or natural person; and (3)(i) A wholesale exposure authorized under section 364 of the U.S. Bankruptcy Code (11 U.S.C. 364) to a legal entity or natural person who is a debtor-in-possession for purposes of Chapter 11 of the Bankruptcy Code; and E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (ii) Other credit exposures to the same legal entity or natural person. Operational loss means a loss (excluding insurance or tax effects) resulting from an operational loss event. Operational loss includes all expenses associated with an operational loss event except for opportunity costs, forgone revenue, and costs related to risk management and control enhancements implemented to prevent future operational losses. Operational loss event means an event that results in loss and is associated with any of the following seven operational loss event type categories: (1) Internal fraud, which means the operational loss event type category that comprises operational losses resulting from an act involving at least one internal party of a type intended to defraud, misappropriate property, or circumvent regulations, the law, or company policy excluding diversityand discrimination-type events. (2) External fraud, which means the operational loss event type category that comprises operational losses resulting from an act by a third party of a type intended to defraud, misappropriate property, or circumvent the law. Retail credit card losses arising from noncontractual, third-party-initiated fraud (for example, identity theft) are external fraud operational losses. All other thirdparty-initiated credit losses are to be treated as credit risk losses. (3) Employment practices and workplace safety, which means the operational loss event type category that comprises operational losses resulting from an act inconsistent with employment, health, or safety laws or agreements, payment of personal injury claims, or payment arising from diversity- and discrimination-type events. (4) Clients, products, and business practices, which means the operational loss event type category that comprises operational losses resulting from the nature or design of a product or from an unintentional or negligent failure to meet a professional obligation to specific clients (including fiduciary and suitability requirements). (5) Damage to physical assets, which means the operational loss event type category that comprises operational losses resulting from the loss of or damage to physical assets from natural disaster or other events. (6) Business disruption and system failures, which means the operational loss event type category that comprises operational losses resulting from disruption of business or system failures. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (7) Execution, delivery, and process management, which means the operational loss event type category that comprises operational losses resulting from failed transaction processing or process management or losses arising from relations with trade counterparties and vendors. Operational risk means the risk of loss resulting from inadequate or failed internal processes, people, and systems or from external events (including legal risk but excluding strategic and reputational risk). Operational risk exposure means the 99.9th percentile of the distribution of potential aggregate operational losses, as generated by the [BANK]’s operational risk quantification system over a oneyear horizon (and not incorporating eligible operational risk offsets or qualifying operational risk mitigants). Other retail exposure means an exposure (other than a securitization exposure, an equity exposure, a residential mortgage exposure, a presold construction loan, a qualifying revolving exposure, or the residual value portion of a lease exposure) that is managed as part of a segment of exposures with homogeneous risk characteristics, not on an individualexposure basis, and is either: (1) An exposure to an individual for non-business purposes; or (2) An exposure to an individual or company for business purposes if the [BANK]’s consolidated business credit exposure to the individual or company is $1 million or less. Probability of default (PD) means: (1) For a wholesale exposure to a nondefaulted obligor, the [BANK]’s empirically based best estimate of the long-run average one-year default rate for the rating grade assigned by the [BANK] to the obligor, capturing the average default experience for obligors in the rating grade over a mix of economic conditions (including economic downturn conditions) sufficient to provide a reasonable estimate of the average one-year default rate over the economic cycle for the rating grade. (2) For a segment of non-defaulted retail exposures, the [BANK]’s empirically based best estimate of the long-run average one-year default rate for the exposures in the segment, capturing the average default experience for exposures in the segment over a mix of economic conditions (including economic downturn conditions) sufficient to provide a reasonable estimate of the average one-year default rate over the economic cycle for the segment. PO 00000 Frm 00191 Fmt 4701 Sfmt 4700 62207 (3) For a wholesale exposure to a defaulted obligor or segment of defaulted retail exposures, 100 percent. Qualifying cross-product master netting agreement means a qualifying master netting agreement that provides for termination and close-out netting across multiple types of financial transactions or qualifying master netting agreements in the event of a counterparty’s default, provided that the underlying financial transactions are OTC derivative contracts, eligible margin loans, or repo-style transactions. In order to treat an agreement as a qualifying cross-product master netting agreement for purposes of this subpart, a [BANK] must comply with the requirements of § l.3(c) of this part with respect to that agreement. Qualifying revolving exposure (QRE) means an exposure (other than a securitization exposure or equity exposure) to an individual that is managed as part of a segment of exposures with homogeneous risk characteristics, not on an individualexposure basis, and: (1) Is revolving (that is, the amount outstanding fluctuates, determined largely by a borrower’s decision to borrow and repay up to a preestablished maximum amount, except for an outstanding amount that the borrower is required to pay in full every month); (2) Is unsecured and unconditionally cancelable by the [BANK] to the fullest extent permitted by Federal law; and (3)(i) Has a maximum contractual exposure amount (drawn plus undrawn) of up to $100,000; or (ii) With respect to a product with an outstanding amount that the borrower is required to pay in full every month, the total outstanding amount does not in practice exceed $100,000. (4) A segment of exposures that contains one or more exposures that fails to meet paragraph (3)(ii) of this definition must be treated as a segment of other retail exposures for the 24 month period following the month in which the total outstanding amount of one or more exposures individually exceeds $100,000. Retail exposure means a residential mortgage exposure, a qualifying revolving exposure, or an other retail exposure. Retail exposure subcategory means the residential mortgage exposure, qualifying revolving exposure, or other retail exposure subcategory. Risk parameter means a variable used in determining risk-based capital requirements for wholesale and retail exposures, specifically probability of default (PD), loss given default (LGD), E:\FR\FM\11OCR2.SGM 11OCR2 62208 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations exposure at default (EAD), or effective maturity (M). Scenario analysis means a systematic process of obtaining expert opinions from business managers and risk management experts to derive reasoned assessments of the likelihood and loss impact of plausible high-severity operational losses. Scenario analysis may include the well-reasoned evaluation and use of external operational loss event data, adjusted as appropriate to ensure relevance to a [BANK]’s operational risk profile and control structure. Total wholesale and retail riskweighted assets means the sum of: (1) Risk-weighted assets for wholesale exposures that are not IMM exposures, cleared transactions, or default fund contributions to non-defaulted obligors and segments of non-defaulted retail exposures; (2) Risk-weighted assets for wholesale exposures to defaulted obligors and segments of defaulted retail exposures; (3) Risk-weighted assets for assets not defined by an exposure category; (4) Risk-weighted assets for nonmaterial portfolios of exposures; (5) Risk-weighted assets for IMM exposures (as determined in § l.132(d)); (6) Risk-weighted assets for cleared transactions and risk-weighted assets for default fund contributions (as determined in § l.133); and (7) Risk-weighted assets for unsettled transactions (as determined in § l.136). Unexpected operational loss (UOL) means the difference between the [BANK]’s operational risk exposure and the [BANK]’s expected operational loss. Unit of measure means the level (for example, organizational unit or operational loss event type) at which the [BANK]’s operational risk quantification system generates a separate distribution of potential operational losses. Wholesale exposure means a credit exposure to a company, natural person, sovereign, or governmental entity (other than a securitization exposure, retail exposure, pre-sold construction loan, or equity exposure). Wholesale exposure subcategory means the HVCRE or non-HVCRE wholesale exposure subcategory. wreier-aviles on DSK5TPTVN1PROD with RULES2 Qualification § l.121 Qualification process. (a) Timing. (1) A [BANK] that is described in § l.100(b)(1)(i) through (iv) must adopt a written implementation plan no later than six months after the date the [BANK] meets a criterion in that section. The implementation plan must incorporate VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 an explicit start date no later than 36 months after the date the [BANK] meets at least one criterion under § l.100(b)(1)(i) through (iv). The [AGENCY] may extend the start date. (2) A [BANK] that elects to be subject to this appendix under § l.100(b)(1)(v) must adopt a written implementation plan. (b) Implementation plan. (1) The [BANK]’s implementation plan must address in detail how the [BANK] complies, or plans to comply, with the qualification requirements in § l.122. The [BANK] also must maintain a comprehensive and sound planning and governance process to oversee the implementation efforts described in the plan. At a minimum, the plan must: (i) Comprehensively address the qualification requirements in § l.122 for the [BANK] and each consolidated subsidiary (U.S. and foreign-based) of the [BANK] with respect to all portfolios and exposures of the [BANK] and each of its consolidated subsidiaries; (ii) Justify and support any proposed temporary or permanent exclusion of business lines, portfolios, or exposures from the application of the advanced approaches in this subpart (which business lines, portfolios, and exposures must be, in the aggregate, immaterial to the [BANK]); (iii) Include the [BANK]’s selfassessment of: (A) The [BANK]’s current status in meeting the qualification requirements in § l.122; and (B) The consistency of the [BANK]’s current practices with the [AGENCY]’s supervisory guidance on the qualification requirements; (iv) Based on the [BANK]’s selfassessment, identify and describe the areas in which the [BANK] proposes to undertake additional work to comply with the qualification requirements in § l.122 or to improve the consistency of the [BANK]’s current practices with the [AGENCY]’s supervisory guidance on the qualification requirements (gap analysis); (v) Describe what specific actions the [BANK] will take to address the areas identified in the gap analysis required by paragraph (b)(1)(iv) of this section; (vi) Identify objective, measurable milestones, including delivery dates and a date when the [BANK]’s implementation of the methodologies described in this subpart will be fully operational; (vii) Describe resources that have been budgeted and are available to implement the plan; and (viii) Receive approval of the [BANK]’s board of directors. PO 00000 Frm 00192 Fmt 4701 Sfmt 4700 (2) The [BANK] must submit the implementation plan, together with a copy of the minutes of the board of directors’ approval, to the [AGENCY] at least 60 days before the [BANK] proposes to begin its parallel run, unless the [AGENCY] waives prior notice. (c) Parallel run. Before determining its risk-weighted assets under this subpart and following adoption of the implementation plan, the [BANK] must conduct a satisfactory parallel run. A satisfactory parallel run is a period of no less than four consecutive calendar quarters during which the [BANK] complies with the qualification requirements in § l.122 to the satisfaction of the [AGENCY]. During the parallel run, the [BANK] must report to the [AGENCY] on a calendar quarterly basis its risk-based capital ratios determined in accordance with § l.10(b)(1) through (3) and § l10.(c)(1) through (3). During this period, the [BANK]’s minimum riskbased capital ratios are determined as set forth in subpart D of this part. (d) Approval to calculate risk-based capital requirements under this subpart. The [AGENCY] will notify the [BANK] of the date that the [BANK] must begin to use this subpart for purposes of § l.10 if the [AGENCY] determines that: (1) The [BANK] fully complies with all the qualification requirements in § l.122; (2) The [BANK] has conducted a satisfactory parallel run under paragraph (c) of this section; and (3) The [BANK] has an adequate process to ensure ongoing compliance with the qualification requirements in § l.122. § l.122 Qualification requirements. (a) Process and systems requirements. (1) A [BANK] must have a rigorous process for assessing its overall capital adequacy in relation to its risk profile and a comprehensive strategy for maintaining an appropriate level of capital. (2) The systems and processes used by a [BANK] for risk-based capital purposes under this subpart must be consistent with the [BANK]’s internal risk management processes and management information reporting systems. (3) Each [BANK] must have an appropriate infrastructure with risk measurement and management processes that meet the qualification requirements of this section and are appropriate given the [BANK]’s size and level of complexity. Regardless of whether the systems and models that generate the risk parameters necessary E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations for calculating a [BANK]’s risk-based capital requirements are located at any affiliate of the [BANK], the [BANK] itself must ensure that the risk parameters and reference data used to determine its risk-based capital requirements are representative of its own credit risk and operational risk exposures. (b) Risk rating and segmentation systems for wholesale and retail exposures. (1) A [BANK] must have an internal risk rating and segmentation system that accurately and reliably differentiates among degrees of credit risk for the [BANK]’s wholesale and retail exposures. (2) For wholesale exposures: (i) A [BANK] must have an internal risk rating system that accurately and reliably assigns each obligor to a single rating grade (reflecting the obligor’s likelihood of default). A [BANK] may elect, however, not to assign to a rating grade an obligor to whom the [BANK] extends credit based solely on the financial strength of a guarantor, provided that all of the [BANK]’s exposures to the obligor are fully covered by eligible guarantees, the [BANK] applies the PD substitution approach in § l.134(c)(1) to all exposures to that obligor, and the [BANK] immediately assigns the obligor to a rating grade if a guarantee can no longer be recognized under this part. The [BANK]’s wholesale obligor rating system must have at least seven discrete rating grades for non-defaulted obligors and at least one rating grade for defaulted obligors. (ii) Unless the [BANK] has chosen to directly assign LGD estimates to each wholesale exposure, the [BANK] must have an internal risk rating system that accurately and reliably assigns each wholesale exposure to a loss severity rating grade (reflecting the [BANK]’s estimate of the LGD of the exposure). A [BANK] employing loss severity rating grades must have a sufficiently granular loss severity grading system to avoid grouping together exposures with widely ranging LGDs. (3) For retail exposures, a [BANK] must have an internal system that groups retail exposures into the appropriate retail exposure subcategory, groups the retail exposures in each retail exposure subcategory into separate segments with homogeneous risk characteristics, and assigns accurate and reliable PD and LGD estimates for each segment on a consistent basis. The [BANK]’s system must identify and group in separate segments by subcategories exposures identified in § l.131(c)(2)(ii) and (iii). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (4) The [BANK]’s internal risk rating policy for wholesale exposures must describe the [BANK]’s rating philosophy (that is, must describe how wholesale obligor rating assignments are affected by the [BANK]’s choice of the range of economic, business, and industry conditions that are considered in the obligor rating process). (5) The [BANK]’s internal risk rating system for wholesale exposures must provide for the review and update (as appropriate) of each obligor rating and (if applicable) each loss severity rating whenever the [BANK] receives new material information, but no less frequently than annually. The [BANK]’s retail exposure segmentation system must provide for the review and update (as appropriate) of assignments of retail exposures to segments whenever the [BANK] receives new material information, but generally no less frequently than quarterly. (c) Quantification of risk parameters for wholesale and retail exposures. (1) The [BANK] must have a comprehensive risk parameter quantification process that produces accurate, timely, and reliable estimates of the risk parameters for the [BANK]’s wholesale and retail exposures. (2) Data used to estimate the risk parameters must be relevant to the [BANK]’s actual wholesale and retail exposures, and of sufficient quality to support the determination of risk-based capital requirements for the exposures. (3) The [BANK]’s risk parameter quantification process must produce appropriately conservative risk parameter estimates where the [BANK] has limited relevant data, and any adjustments that are part of the quantification process must not result in a pattern of bias toward lower risk parameter estimates. (4) The [BANK]’s risk parameter estimation process should not rely on the possibility of U.S. government financial assistance, except for the financial assistance that the U.S. government has a legally binding commitment to provide. (5) Where the [BANK]’s quantifications of LGD directly or indirectly incorporate estimates of the effectiveness of its credit risk management practices in reducing its exposure to troubled obligors prior to default, the [BANK] must support such estimates with empirical analysis showing that the estimates are consistent with its historical experience in dealing with such exposures during economic downturn conditions. (6) PD estimates for wholesale obligors and retail segments must be based on at least five years of default PO 00000 Frm 00193 Fmt 4701 Sfmt 4700 62209 data. LGD estimates for wholesale exposures must be based on at least seven years of loss severity data, and LGD estimates for retail segments must be based on at least five years of loss severity data. EAD estimates for wholesale exposures must be based on at least seven years of exposure amount data, and EAD estimates for retail segments must be based on at least five years of exposure amount data. (7) Default, loss severity, and exposure amount data must include periods of economic downturn conditions, or the [BANK] must adjust its estimates of risk parameters to compensate for the lack of data from periods of economic downturn conditions. (8) The [BANK]’s PD, LGD, and EAD estimates must be based on the definition of default in § l.101. (9) The [BANK] must review and update (as appropriate) its risk parameters and its risk parameter quantification process at least annually. (10) The [BANK] must, at least annually, conduct a comprehensive review and analysis of reference data to determine relevance of reference data to the [BANK]’s exposures, quality of reference data to support PD, LGD, and EAD estimates, and consistency of reference data to the definition of default in § l.101. (d) Counterparty credit risk model. A [BANK] must obtain the prior written approval of the [AGENCY] under § l.132 to use the internal models methodology for counterparty credit risk and the advanced CVA approach for the CVA capital requirement. (e) Double default treatment. A [BANK] must obtain the prior written approval of the [AGENCY] under § l.135 to use the double default treatment. (f) Equity exposures model. A [BANK] must obtain the prior written approval of the [AGENCY] under § l.153 to use the internal models approach for equity exposures. (g) Operational risk. (1) Operational risk management processes. A [BANK] must: (i) Have an operational risk management function that: (A) Is independent of business line management; and (B) Is responsible for designing, implementing, and overseeing the [BANK]’s operational risk data and assessment systems, operational risk quantification systems, and related processes; (ii) Have and document a process (which must capture business environment and internal control factors affecting the [BANK]’s operational risk E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62210 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations profile) to identify, measure, monitor, and control operational risk in the [BANK]’s products, activities, processes, and systems; and (iii) Report operational risk exposures, operational loss events, and other relevant operational risk information to business unit management, senior management, and the board of directors (or a designated committee of the board). (2) Operational risk data and assessment systems. A [BANK] must have operational risk data and assessment systems that capture operational risks to which the [BANK] is exposed. The [BANK]’s operational risk data and assessment systems must: (i) Be structured in a manner consistent with the [BANK]’s current business activities, risk profile, technological processes, and risk management processes; and (ii) Include credible, transparent, systematic, and verifiable processes that incorporate the following elements on an ongoing basis: (A) Internal operational loss event data. The [BANK] must have a systematic process for capturing and using internal operational loss event data in its operational risk data and assessment systems. (1) The [BANK]’s operational risk data and assessment systems must include a historical observation period of at least five years for internal operational loss event data (or such shorter period approved by the [AGENCY] to address transitional situations, such as integrating a new business line). (2) The [BANK] must be able to map its internal operational loss event data into the seven operational loss event type categories. (3) The [BANK] may refrain from collecting internal operational loss event data for individual operational losses below established dollar threshold amounts if the [BANK] can demonstrate to the satisfaction of the [AGENCY] that the thresholds are reasonable, do not exclude important internal operational loss event data, and permit the [BANK] to capture substantially all the dollar value of the [BANK]’s operational losses. (B) External operational loss event data. The [BANK] must have a systematic process for determining its methodologies for incorporating external operational loss event data into its operational risk data and assessment systems. (C) Scenario analysis. The [BANK] must have a systematic process for determining its methodologies for incorporating scenario analysis into its VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 operational risk data and assessment systems. (D) Business environment and internal control factors. The [BANK] must incorporate business environment and internal control factors into its operational risk data and assessment systems. The [BANK] must also periodically compare the results of its prior business environment and internal control factor assessments against its actual operational losses incurred in the intervening period. (3) Operational risk quantification systems. (i) The [BANK]’s operational risk quantification systems: (A) Must generate estimates of the [BANK]’s operational risk exposure using its operational risk data and assessment systems; (B) Must employ a unit of measure that is appropriate for the [BANK]’s range of business activities and the variety of operational loss events to which it is exposed, and that does not combine business activities or operational loss events with demonstrably different risk profiles within the same loss distribution; (C) Must include a credible, transparent, systematic, and verifiable approach for weighting each of the four elements, described in paragraph (g)(2)(ii) of this section, that a [BANK] is required to incorporate into its operational risk data and assessment systems; (D) May use internal estimates of dependence among operational losses across and within units of measure if the [BANK] can demonstrate to the satisfaction of the [AGENCY] that its process for estimating dependence is sound, robust to a variety of scenarios, and implemented with integrity, and allows for uncertainty surrounding the estimates. If the [BANK] has not made such a demonstration, it must sum operational risk exposure estimates across units of measure to calculate its total operational risk exposure; and (E) Must be reviewed and updated (as appropriate) whenever the [BANK] becomes aware of information that may have a material effect on the [BANK]’s estimate of operational risk exposure, but the review and update must occur no less frequently than annually. (ii) With the prior written approval of the [AGENCY], a [BANK] may generate an estimate of its operational risk exposure using an alternative approach to that specified in paragraph (g)(3)(i) of this section. A [BANK] proposing to use such an alternative operational risk quantification system must submit a proposal to the [AGENCY]. In determining whether to approve a [BANK]’s proposal to use an alternative PO 00000 Frm 00194 Fmt 4701 Sfmt 4700 operational risk quantification system, the [AGENCY] will consider the following principles: (A) Use of the alternative operational risk quantification system will be allowed only on an exception basis, considering the size, complexity, and risk profile of the [BANK]; (B) The [BANK] must demonstrate that its estimate of its operational risk exposure generated under the alternative operational risk quantification system is appropriate and can be supported empirically; and (C) A [BANK] must not use an allocation of operational risk capital requirements that includes entities other than depository institutions or the benefits of diversification across entities. (h) Data management and maintenance. (1) A [BANK] must have data management and maintenance systems that adequately support all aspects of its advanced systems and the timely and accurate reporting of riskbased capital requirements. (2) A [BANK] must retain data using an electronic format that allows timely retrieval of data for analysis, validation, reporting, and disclosure purposes. (3) A [BANK] must retain sufficient data elements related to key risk drivers to permit adequate monitoring, validation, and refinement of its advanced systems. (i) Control, oversight, and validation mechanisms. (1) The [BANK]’s senior management must ensure that all components of the [BANK]’s advanced systems function effectively and comply with the qualification requirements in this section. (2) The [BANK]’s board of directors (or a designated committee of the board) must at least annually review the effectiveness of, and approve, the [BANK]’s advanced systems. (3) A [BANK] must have an effective system of controls and oversight that: (i) Ensures ongoing compliance with the qualification requirements in this section; (ii) Maintains the integrity, reliability, and accuracy of the [BANK]’s advanced systems; and (iii) Includes adequate governance and project management processes. (4) The [BANK] must validate, on an ongoing basis, its advanced systems. The [BANK]’s validation process must be independent of the advanced systems’ development, implementation, and operation, or the validation process must be subjected to an independent review of its adequacy and effectiveness. Validation must include: (i) An evaluation of the conceptual soundness of (including developmental E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations evidence supporting) the advanced systems; (ii) An ongoing monitoring process that includes verification of processes and benchmarking; and (iii) An outcomes analysis process that includes backtesting. (5) The [BANK] must have an internal audit function independent of businessline management that at least annually assesses the effectiveness of the controls supporting the [BANK]’s advanced systems and reports its findings to the [BANK]’s board of directors (or a committee thereof). (6) The [BANK] must periodically stress test its advanced systems. The stress testing must include a consideration of how economic cycles, especially downturns, affect risk-based capital requirements (including migration across rating grades and segments and the credit risk mitigation benefits of double default treatment). (j) Documentation. The [BANK] must adequately document all material aspects of its advanced systems. wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.123 Ongoing qualification. (a) Changes to advanced systems. A [BANK] must meet all the qualification requirements in § l.122 on an ongoing basis. A [BANK] must notify the [AGENCY] when the [BANK] makes any change to an advanced system that would result in a material change in the [BANK]’s advanced approaches total risk-weighted asset amount for an exposure type or when the [BANK] makes any significant change to its modeling assumptions. (b) Failure to comply with qualification requirements. (1) If the [AGENCY] determines that a [BANK] that uses this subpart and that has conducted a satisfactory parallel run fails to comply with the qualification requirements in § l.122, the [AGENCY] will notify the [BANK] in writing of the [BANK]’s failure to comply. (2) The [BANK] must establish and submit a plan satisfactory to the [AGENCY] to return to compliance with the qualification requirements. (3) In addition, if the [AGENCY] determines that the [BANK]’s advanced approaches total risk-weighted assets are not commensurate with the [BANK]’s credit, market, operational, or other risks, the [AGENCY] may require such a [BANK] to calculate its advanced approaches total risk-weighted assets with any modifications provided by the [AGENCY]. § l.124 Merger and acquisition transitional arrangements. (a) Mergers and acquisitions of companies without advanced systems. If VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 a [BANK] merges with or acquires a company that does not calculate its riskbased capital requirements using advanced systems, the [BANK] may use subpart D of this part to determine the risk-weighted asset amounts for the merged or acquired company’s exposures for up to 24 months after the calendar quarter during which the merger or acquisition consummates. The [AGENCY] may extend this transition period for up to an additional 12 months. Within 90 days of consummating the merger or acquisition, the [BANK] must submit to the [AGENCY] an implementation plan for using its advanced systems for the acquired company. During the period in which subpart D of this part applies to the merged or acquired company, any ALLL, net of allocated transfer risk reserves established pursuant to 12 U.S.C. 3904, associated with the merged or acquired company’s exposures may be included in the acquiring [BANK]’s tier 2 capital up to 1.25 percent of the acquired company’s risk-weighted assets. All general allowances of the merged or acquired company must be excluded from the [BANK]’s eligible credit reserves. In addition, the riskweighted assets of the merged or acquired company are not included in the [BANK]’s credit-risk-weighted assets but are included in total risk-weighted assets. If a [BANK] relies on this paragraph (a), the [BANK] must disclose publicly the amounts of risk-weighted assets and qualifying capital calculated under this subpart for the acquiring [BANK] and under subpart D of this part for the acquired company. (b) Mergers and acquisitions of companies with advanced systems. (1) If a [BANK] merges with or acquires a company that calculates its risk-based capital requirements using advanced systems, the [BANK] may use the acquired company’s advanced systems to determine total risk-weighted assets for the merged or acquired company’s exposures for up to 24 months after the calendar quarter during which the acquisition or merger consummates. The [AGENCY] may extend this transition period for up to an additional 12 months. Within 90 days of consummating the merger or acquisition, the [BANK] must submit to the [AGENCY] an implementation plan for using its advanced systems for the merged or acquired company. (2) If the acquiring [BANK] is not subject to the advanced approaches in this subpart at the time of acquisition or merger, during the period when subpart D of this part applies to the acquiring [BANK], the ALLL associated with the exposures of the merged or acquired PO 00000 Frm 00195 Fmt 4701 Sfmt 4700 62211 company may not be directly included in tier 2 capital. Rather, any excess eligible credit reserves associated with the merged or acquired company’s exposures may be included in the [BANK]’s tier 2 capital up to 0.6 percent of the credit-risk-weighted assets associated with those exposures. §§ l.125 through l.130 [Reserved] Risk-Weighted Assets for General Credit Risk § l.131 Mechanics for calculating total wholesale and retail risk-weighted assets. (a) Overview. A [BANK] must calculate its total wholesale and retail risk-weighted asset amount in four distinct phases: (1) Phase 1—categorization of exposures; (2) Phase 2—assignment of wholesale obligors and exposures to rating grades and segmentation of retail exposures; (3) Phase 3—assignment of risk parameters to wholesale exposures and segments of retail exposures; and (4) Phase 4—calculation of riskweighted asset amounts. (b) Phase 1—Categorization. The [BANK] must determine which of its exposures are wholesale exposures, retail exposures, securitization exposures, or equity exposures. The [BANK] must categorize each retail exposure as a residential mortgage exposure, a QRE, or an other retail exposure. The [BANK] must identify which wholesale exposures are HVCRE exposures, sovereign exposures, OTC derivative contracts, repo-style transactions, eligible margin loans, eligible purchased wholesale exposures, cleared transactions, default fund contributions, unsettled transactions to which § l.136 applies, and eligible guarantees or eligible credit derivatives that are used as credit risk mitigants. The [BANK] must identify any onbalance sheet asset that does not meet the definition of a wholesale, retail, equity, or securitization exposure, as well as any non-material portfolio of exposures described in paragraph (e)(4) of this section. (c) Phase 2—Assignment of wholesale obligors and exposures to rating grades and retail exposures to segments—(1) Assignment of wholesale obligors and exposures to rating grades. (i) The [BANK] must assign each obligor of a wholesale exposure to a single obligor rating grade and must assign each wholesale exposure to which it does not directly assign an LGD estimate to a loss severity rating grade. (ii) The [BANK] must identify which of its wholesale obligors are in default. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62212 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (2) Segmentation of retail exposures. (i) The [BANK] must group the retail exposures in each retail subcategory into segments that have homogeneous risk characteristics. (ii) The [BANK] must identify which of its retail exposures are in default. The [BANK] must segment defaulted retail exposures separately from nondefaulted retail exposures. (iii) If the [BANK] determines the EAD for eligible margin loans using the approach in § l.132(b), the [BANK] must identify which of its retail exposures are eligible margin loans for which the [BANK] uses this EAD approach and must segment such eligible margin loans separately from other retail exposures. (3) Eligible purchased wholesale exposures. A [BANK] may group its eligible purchased wholesale exposures into segments that have homogeneous risk characteristics. A [BANK] must use the wholesale exposure formula in Table 1 of this section to determine the risk-based capital requirement for each segment of eligible purchased wholesale exposures. (d) Phase 3—Assignment of risk parameters to wholesale exposures and segments of retail exposures. (1) Quantification process. Subject to the limitations in this paragraph (d), the [BANK] must: (i) Associate a PD with each wholesale obligor rating grade; (ii) Associate an LGD with each wholesale loss severity rating grade or assign an LGD to each wholesale exposure; (iii) Assign an EAD and M to each wholesale exposure; and (iv) Assign a PD, LGD, and EAD to each segment of retail exposures. (2) Floor on PD assignment. The PD for each wholesale obligor or retail segment may not be less than 0.03 percent, except for exposures to or directly and unconditionally guaranteed by a sovereign entity, the Bank for International Settlements, the International Monetary Fund, the European Commission, the European Central Bank, or a multilateral development bank, to which the [BANK] assigns a rating grade associated with a PD of less than 0.03 percent. (3) Floor on LGD estimation. The LGD for each segment of residential mortgage exposures may not be less than 10 percent, except for segments of residential mortgage exposures for which all or substantially all of the principal of each exposure is either: (i) Directly and unconditionally guaranteed by the full faith and credit of a sovereign entity; or VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (ii) Guaranteed by a contingent obligation of the U.S. government or its agencies, the enforceability of which is dependent upon some affirmative action on the part of the beneficiary of the guarantee or a third party (for example, meeting servicing requirements). (4) Eligible purchased wholesale exposures. A [BANK] must assign a PD, LGD, EAD, and M to each segment of eligible purchased wholesale exposures. If the [BANK] can estimate ECL (but not PD or LGD) for a segment of eligible purchased wholesale exposures, the [BANK] must assume that the LGD of the segment equals 100 percent and that the PD of the segment equals ECL divided by EAD. The estimated ECL must be calculated for the exposures without regard to any assumption of recourse or guarantees from the seller or other parties. (5) Credit risk mitigation: credit derivatives, guarantees, and collateral. (i) A [BANK] may take into account the risk reducing effects of eligible guarantees and eligible credit derivatives in support of a wholesale exposure by applying the PD substitution or LGD adjustment treatment to the exposure as provided in § l.134 or, if applicable, applying double default treatment to the exposure as provided in § l.135. A [BANK] may decide separately for each wholesale exposure that qualifies for the double default treatment under § l.135 whether to apply the double default treatment or to use the PD substitution or LGD adjustment treatment without recognizing double default effects. (ii) A [BANK] may take into account the risk reducing effects of guarantees and credit derivatives in support of retail exposures in a segment when quantifying the PD and LGD of the segment. (iii) Except as provided in paragraph (d)(6) of this section, a [BANK] may take into account the risk reducing effects of collateral in support of a wholesale exposure when quantifying the LGD of the exposure, and may take into account the risk reducing effects of collateral in support of retail exposures when quantifying the PD and LGD of the segment. (6) EAD for OTC derivative contracts, repo-style transactions, and eligible margin loans. A [BANK] must calculate its EAD for an OTC derivative contract as provided in § l.132 (c) and (d). A [BANK] may take into account the riskreducing effects of financial collateral in support of a repo-style transaction or eligible margin loan and of any collateral in support of a repo-style transaction that is included in the [BANK]’s VaR-based measure under PO 00000 Frm 00196 Fmt 4701 Sfmt 4700 subpart F of this part through an adjustment to EAD as provided in § l.132(b) and (d). A [BANK] that takes collateral into account through such an adjustment to EAD under § l.132 may not reflect such collateral in LGD. (7) Effective maturity. An exposure’s M must be no greater than five years and no less than one year, except that an exposure’s M must be no less than one day if the exposure is a trade related letter of credit, or if the exposure has an original maturity of less than one year and is not part of a [BANK]’s ongoing financing of the obligor. An exposure is not part of a [BANK]’s ongoing financing of the obligor if the [BANK]: (i) Has a legal and practical ability not to renew or roll over the exposure in the event of credit deterioration of the obligor; (ii) Makes an independent credit decision at the inception of the exposure and at every renewal or roll over; and (iii) Has no substantial commercial incentive to continue its credit relationship with the obligor in the event of credit deterioration of the obligor. (8) EAD for exposures to certain central counterparties. A [BANK] may attribute an EAD of zero to exposures that arise from the settlement of cash transactions (such as equities, fixed income, spot foreign exchange, and spot commodities) with a central counterparty where there is no assumption of ongoing counterparty credit risk by the central counterparty after settlement of the trade and associated default fund contributions. (e) Phase 4—Calculation of riskweighted assets—(1) Non-defaulted exposures. (i) A [BANK] must calculate the dollar risk-based capital requirement for each of its wholesale exposures to a non-defaulted obligor (except for eligible guarantees and eligible credit derivatives that hedge another wholesale exposure, IMM exposures, cleared transactions, default fund contributions, unsettled transactions, and exposures to which the [BANK] applies the double default treatment in § l.135) and segments of non-defaulted retail exposures by inserting the assigned risk parameters for the wholesale obligor and exposure or retail segment into the appropriate risk-based capital formula specified in Table 1 and multiplying the output of the formula (K) by the EAD of the exposure or segment. Alternatively, a [BANK] may apply a 300 percent risk weight to the EAD of an eligible margin loan if the [BANK] is not able to meet the [AGENCY]’s requirements for estimation of PD and LGD for the margin loan. E:\FR\FM\11OCR2.SGM 11OCR2 VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00197 Fmt 4701 Sfmt 4725 E:\FR\FM\11OCR2.SGM 11OCR2 62213 er11oc13.028</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (ii) The sum of all the dollar riskbased capital requirements for each wholesale exposure to a non-defaulted obligor and segment of non-defaulted retail exposures calculated in paragraph (e)(1)(i) of this section and in § l.135(e) equals the total dollar risk-based capital requirement for those exposures and segments. (iii) The aggregate risk-weighted asset amount for wholesale exposures to nondefaulted obligors and segments of nondefaulted retail exposures equals the total dollar risk-based capital requirement in paragraph (e)(1)(ii) of this section multiplied by 12.5. (2) Wholesale exposures to defaulted obligors and segments of defaulted retail exposures—(i) Not covered by an eligible U.S. government guarantee: The dollar risk-based capital requirement for VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 each wholesale exposure not covered by an eligible guarantee from the U.S. government to a defaulted obligor and each segment of defaulted retail exposures not covered by an eligible guarantee from the U.S. government equals 0.08 multiplied by the EAD of the exposure or segment. (ii) Covered by an eligible U.S. government guarantee: The dollar riskbased capital requirement for each wholesale exposure to a defaulted obligor covered by an eligible guarantee from the U.S. government and each segment of defaulted retail exposures covered by an eligible guarantee from the U.S. government equals the sum of: (A) The sum of the EAD of the portion of each wholesale exposure to a defaulted obligor covered by an eligible guarantee from the U.S. government PO 00000 Frm 00198 Fmt 4701 Sfmt 4700 plus the EAD of the portion of each segment of defaulted retail exposures that is covered by an eligible guarantee from the U.S. government and the resulting sum is multiplied by 0.016, and (B) The sum of the EAD of the portion of each wholesale exposure to a defaulted obligor not covered by an eligible guarantee from the U.S. government plus the EAD of the portion of each segment of defaulted retail exposures that is not covered by an eligible guarantee from the U.S. government and the resulting sum is multiplied by 0.08. (iii) The sum of all the dollar riskbased capital requirements for each wholesale exposure to a defaulted obligor and each segment of defaulted retail exposures calculated in paragraph E:\FR\FM\11OCR2.SGM 11OCR2 er11oc13.029</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 62214 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (e)(2)(i) of this section plus the dollar risk-based capital requirements each wholesale exposure to a defaulted obligor and for each segment of defaulted retail exposures calculated in paragraph (e)(2)(ii) of this section equals the total dollar risk-based capital requirement for those exposures and segments. (iv) The aggregate risk-weighted asset amount for wholesale exposures to defaulted obligors and segments of defaulted retail exposures equals the total dollar risk-based capital requirement calculated in paragraph (e)(2)(iii) of this section multiplied by 12.5. (3) Assets not included in a defined exposure category. (i) A [BANK] may assign a risk-weighted asset amount of zero to cash owned and held in all offices of the [BANK] or in transit and for gold bullion held in the [BANK]’s own vaults, or held in another [BANK]’s vaults on an allocated basis, to the extent the gold bullion assets are offset by gold bullion liabilities. (ii) A [BANK] must assign a riskweighted asset amount equal to 20 percent of the carrying value of cash items in the process of collection. (iii) A [BANK] must assign a riskweighted asset amount equal to 50 percent of the carrying value to a presold construction loan unless the purchase contract is cancelled, in which case a [BANK] must assign a riskweighted asset amount equal to a 100 percent of the carrying value of the presold construction loan. (iv) The risk-weighted asset amount for the residual value of a retail lease exposure equals such residual value. (v) The risk-weighted asset amount for DTAs arising from temporary differences that the [BANK] could realize through net operating loss carrybacks equals the carrying value, netted in accordance with § l.22. (vi) The risk-weighted asset amount for MSAs, DTAs arising from temporary timing differences that the [BANK] could not realize through net operating loss carrybacks, and significant investments in the capital of unconsolidated financial institutions in the form of common stock that are not deducted pursuant to § l.22(a)(7) equals the amount not subject to deduction multiplied by 250 percent. (vii) The risk-weighted asset amount for any other on-balance-sheet asset that does not meet the definition of a wholesale, retail, securitization, IMM, or equity exposure, cleared transaction, or default fund contribution and is not subject to deduction under § l.22(a), (c), or (d) equals the carrying value of the asset. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (4) Non-material portfolios of exposures. The risk-weighted asset amount of a portfolio of exposures for which the [BANK] has demonstrated to the [AGENCY]’s satisfaction that the portfolio (when combined with all other portfolios of exposures that the [BANK] seeks to treat under this paragraph (e)) is not material to the [BANK] is the sum of the carrying values of on-balance sheet exposures plus the notional amounts of off-balance sheet exposures in the portfolio. For purposes of this paragraph (e)(4), the notional amount of an OTC derivative contract that is not a credit derivative is the EAD of the derivative as calculated in § l.132. § l.132 Counterparty credit risk of repostyle transactions, eligible margin loans, and OTC derivative contracts. (a) Methodologies for collateral recognition. (1) Instead of an LGD estimation methodology, a [BANK] may use the following methodologies to recognize the benefits of financial collateral in mitigating the counterparty credit risk of repo-style transactions, eligible margin loans, collateralized OTC derivative contracts and single product netting sets of such transactions, and to recognize the benefits of any collateral in mitigating the counterparty credit risk of repo-style transactions that are included in a [BANK]’s VaR-based measure under subpart F of this part: (i) The collateral haircut approach set forth in paragraph (b)(2) of this section; (ii) The internal models methodology set forth in paragraph (d) of this section; and (iii) For single product netting sets of repo-style transactions and eligible margin loans, the simple VaR methodology set forth in paragraph (b)(3) of this section. (2) A [BANK] may use any combination of the three methodologies for collateral recognition; however, it must use the same methodology for transactions in the same category. (3) A [BANK] must use the methodology in paragraph (c) of this section, or with prior written approval of the [AGENCY], the internal model methodology in paragraph (d) of this section, to calculate EAD for an OTC derivative contract or a set of OTC derivative contracts subject to a qualifying master netting agreement. To estimate EAD for qualifying crossproduct master netting agreements, a [BANK] may only use the internal models methodology in paragraph (d) of this section. (4) A [BANK] must also use the methodology in paragraph (e) of this section to calculate the risk-weighted PO 00000 Frm 00199 Fmt 4701 Sfmt 4700 62215 asset amounts for CVA for OTC derivatives. (b) EAD for eligible margin loans and repo-style transactions—(1) General. A [BANK] may recognize the credit risk mitigation benefits of financial collateral that secures an eligible margin loan, repo-style transaction, or single-product netting set of such transactions by factoring the collateral into its LGD estimates for the exposure. Alternatively, a [BANK] may estimate an unsecured LGD for the exposure, as well as for any repo-style transaction that is included in the [BANK]’s VaRbased measure under subpart F of this part, and determine the EAD of the exposure using: (i) The collateral haircut approach described in paragraph (b)(2) of this section; (ii) For netting sets only, the simple VaR methodology described in paragraph (b)(3) of this section; or (iii) The internal models methodology described in paragraph (d) of this section. (2) Collateral haircut approach—(i) EAD equation. A [BANK] may determine EAD for an eligible margin loan, repo-style transaction, or netting set by setting EAD equal to max {0, [(SE ¥ SC) + S(Es × Hs) + S(Efx × Hfx)]}, where: (A) SE equals the value of the exposure (the sum of the current fair values of all instruments, gold, and cash the [BANK] has lent, sold subject to repurchase, or posted as collateral to the counterparty under the transaction (or netting set)); (B) SC equals the value of the collateral (the sum of the current fair values of all instruments, gold, and cash the [BANK] has borrowed, purchased subject to resale, or taken as collateral from the counterparty under the transaction (or netting set)); (C) Es equals the absolute value of the net position in a given instrument or in gold (where the net position in a given instrument or in gold equals the sum of the current fair values of the instrument or gold the [BANK] has lent, sold subject to repurchase, or posted as collateral to the counterparty minus the sum of the current fair values of that same instrument or gold the [BANK] has borrowed, purchased subject to resale, or taken as collateral from the counterparty); (D) Hs equals the market price volatility haircut appropriate to the instrument or gold referenced in Es; (E) Efx equals the absolute value of the net position of instruments and cash in a currency that is different from the settlement currency (where the net position in a given currency equals the sum of the current fair values of any instruments or cash in the currency the [BANK] has lent, sold subject to E:\FR\FM\11OCR2.SGM 11OCR2 62216 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations repurchase, or posted as collateral to the counterparty minus the sum of the current fair values of any instruments or cash in the currency the [BANK] has borrowed, purchased subject to resale, or taken as collateral from the counterparty); and (F) Hfx equals the haircut appropriate to the mismatch between the currency referenced in Efx and the settlement currency. (ii) Standard supervisory haircuts. (A) Under the standard supervisory haircuts approach: (1) A [BANK] must use the haircuts for market price volatility (Hs) in Table 1 to § l.132, as adjusted in certain circumstances as provided in paragraphs (b)(2)(ii)(A)(3) and (4) of this section; TABLE 1 TO § l.132—STANDARD SUPERVISORY MARKET PRICE VOLATILITY HAIRCUTS 1 Haircut (in percent) assigned based on: Residual maturity Zero Less than or equal to 1 year .................. Greater than 1 year and less than or equal to 5 years .................................. Greater than 5 years ............................... 20 or 50 Investment grade securitization exposures (in percent) Non-sovereign issuers risk weight under this section (in percent) Sovereign issuers risk weight under this section 2 (in percent) 100 20 50 100 0.5 1.0 15.0 1.0 2.0 4.0 4.0 2.0 4.0 3.0 6.0 15.0 15.0 4.0 8.0 6.0 12.0 8.0 16.0 12.0 24.0 Main index equities (including convertible bonds) and gold .......................................... 15.0 Other publicly traded equities (including convertible bonds) ......................................... 25.0 Mutual funds ................................................................................................................... Highest haircut applicable to any security in which the fund can invest. Cash collateral held ........................................................................................................ Zero Other exposure types ..................................................................................................... 25.0 1 The market price volatility haircuts in Table 1 to § l.132 are based on a 10 business-day holding period. a foreign PSE that receives a zero percent risk weight. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 quarters more than two margin disputes on a netting set have occurred that lasted more than the holding period, then the [BANK] must adjust the supervisory haircuts upward for that netting set on the basis of a holding period that is at least two times the minimum holding period for that netting set. A [BANK] must adjust the standard supervisory haircuts upward using the following formula: (i) TM equals a holding period of longer than 10 business days for eligible margin loans and derivative contracts or longer than 5 business days for repo-style transactions; (ii) Hs equals the standard supervisory haircut; and (iii) Ts equals 10 business days for eligible margin loans and derivative contracts or 5 business days for repo-style transactions. may calculate haircuts (Hs and Hfx) using its own internal estimates of the volatilities of market prices and foreign exchange rates. (A) To receive [AGENCY] approval to use its own internal estimates, a [BANK] must satisfy the following minimum quantitative standards: (1) A [BANK] must use a 99th percentile one-tailed confidence interval. (2) The minimum holding period for a repo-style transaction is five business days and for an eligible margin loan is ten business days except for transactions or netting sets for which paragraph (b)(2)(iii)(A)(3) of this section applies. When a [BANK] calculates an own-estimates haircut on a TN-day holding period, which is different from the minimum holding period for the transaction type, the applicable haircut (HM) is calculated using the following square root of time formula: (5) If the instrument a [BANK] has lent, sold subject to repurchase, or posted as collateral does not meet the definition of financial collateral, the [BANK] must use a 25.0 percent haircut for market price volatility (Hs). (iii) Own internal estimates for haircuts. With the prior written approval of the [AGENCY], a [BANK] (i) TM equals 5 for repo-style transactions and 10 for eligible margin loans; (ii) TN equals the holding period used by the [BANK] to derive HN; and (iii) HN equals the haircut based on the holding period TN PO 00000 Frm 00200 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 er11oc13.031</GPH> (2) For currency mismatches, a [BANK] must use a haircut for foreign exchange rate volatility (Hfx) of 8 percent, as adjusted in certain circumstances as provided in paragraphs (b)(2)(ii)(A)(3) and (4) of this section. (3) For repo-style transactions, a [BANK] may multiply the supervisory haircuts provided in paragraphs (b)(2)(ii)(A)(1) and (2) of this section by the square root of 1⁄2 (which equals 0.707107). (4) A [BANK] must adjust the supervisory haircuts upward on the basis of a holding period longer than ten business days (for eligible margin loans) or five business days (for repo-style transactions) where the following conditions apply. If the number of trades in a netting set exceeds 5,000 at any time during a quarter, a [BANK] must adjust the supervisory haircuts upward on the basis of a holding period of twenty business days for the following quarter (except when a [BANK] is calculating EAD for a cleared transaction under § l.133). If a netting set contains one or more trades involving illiquid collateral or an OTC derivative that cannot be easily replaced, a [BANK] must adjust the supervisory haircuts upward on the basis of a holding period of twenty business days. If over the two previous er11oc13.030</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 2 Includes wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (3) If the number of trades in a netting set exceeds 5,000 at any time during a quarter, a [BANK] must calculate the haircut using a minimum holding period of twenty business days for the following quarter (except when a [BANK] is calculating EAD for a cleared transaction under § l.133). If a netting set contains one or more trades involving illiquid collateral or an OTC derivative that cannot be easily replaced, a [BANK] must calculate the haircut using a minimum holding period of twenty business days. If over the two previous quarters more than two margin disputes on a netting set have occurred that lasted more than the holding period, then the [BANK] must calculate the haircut for transactions in that netting set on the basis of a holding period that is at least two times the minimum holding period for that netting set. (4) A [BANK] is required to calculate its own internal estimates with inputs calibrated to historical data from a continuous 12-month period that reflects a period of significant financial stress appropriate to the security or category of securities. (5) A [BANK] must have policies and procedures that describe how it determines the period of significant financial stress used to calculate the [BANK]’s own internal estimates for haircuts under this section and must be able to provide empirical support for the period used. The [BANK] must obtain the prior approval of the [AGENCY] for, and notify the [AGENCY] if the [BANK] makes any material changes to, these policies and procedures. (6) Nothing in this section prevents the [AGENCY] from requiring a [BANK] to use a different period of significant financial stress in the calculation of own internal estimates for haircuts. (7) A [BANK] must update its data sets and calculate haircuts no less frequently than quarterly and must also reassess data sets and haircuts whenever market prices change materially. (B) With respect to debt securities that are investment grade, a [BANK] may calculate haircuts for categories of securities. For a category of securities, the [BANK] must calculate the haircut on the basis of internal volatility estimates for securities in that category that are representative of the securities in that category that the [BANK] has lent, sold subject to repurchase, posted as collateral, borrowed, purchased subject to resale, or taken as collateral. In determining relevant categories, the [BANK] must at a minimum take into account: (1) The type of issuer of the security; (2) The credit quality of the security; VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (3) The maturity of the security; and (4) The interest rate sensitivity of the security. (C) With respect to debt securities that are not investment grade and equity securities, a [BANK] must calculate a separate haircut for each individual security. (D) Where an exposure or collateral (whether in the form of cash or securities) is denominated in a currency that differs from the settlement currency, the [BANK] must calculate a separate currency mismatch haircut for its net position in each mismatched currency based on estimated volatilities of foreign exchange rates between the mismatched currency and the settlement currency. (E) A [BANK]’s own estimates of market price and foreign exchange rate volatilities may not take into account the correlations among securities and foreign exchange rates on either the exposure or collateral side of a transaction (or netting set) or the correlations among securities and foreign exchange rates between the exposure and collateral sides of the transaction (or netting set). (3) Simple VaR methodology. With the prior written approval of the [AGENCY], a [BANK] may estimate EAD for a netting set using a VaR model that meets the requirements in paragraph (b)(3)(iii) of this section. In such event, the [BANK] must set EAD equal to max {0, [(SE ¥ SC) + PFE]}, where: (i) SE equals the value of the exposure (the sum of the current fair values of all instruments, gold, and cash the [BANK] has lent, sold subject to repurchase, or posted as collateral to the counterparty under the netting set); (ii) SC equals the value of the collateral (the sum of the current fair values of all instruments, gold, and cash the [BANK] has borrowed, purchased subject to resale, or taken as collateral from the counterparty under the netting set); and (iii) PFE (potential future exposure) equals the [BANK]’s empirically based best estimate of the 99th percentile, onetailed confidence interval for an increase in the value of (SE ¥ SC) over a five-business-day holding period for repo-style transactions, or over a tenbusiness-day holding period for eligible margin loans except for netting sets for which paragraph (b)(3)(iv) of this section applies using a minimum oneyear historical observation period of price data representing the instruments that the [BANK] has lent, sold subject to repurchase, posted as collateral, borrowed, purchased subject to resale, or taken as collateral. The [BANK] must validate its VaR model by establishing PO 00000 Frm 00201 Fmt 4701 Sfmt 4700 62217 and maintaining a rigorous and regular backtesting regime. (iv) If the number of trades in a netting set exceeds 5,000 at any time during a quarter, a [BANK] must use a twenty-business-day holding period for the following quarter (except when a [BANK] is calculating EAD for a cleared transaction under § l.133). If a netting set contains one or more trades involving illiquid collateral, a [BANK] must use a twenty-business-day holding period. If over the two previous quarters more than two margin disputes on a netting set have occurred that lasted more than the holding period, then the [BANK] must set its PFE for that netting set equal to an estimate over a holding period that is at least two times the minimum holding period for that netting set. (c) EAD for OTC derivative contracts—(1) OTC derivative contracts not subject to a qualifying master netting agreement. A [BANK] must determine the EAD for an OTC derivative contract that is not subject to a qualifying master netting agreement using the current exposure methodology in paragraph (c)(5) of this section or using the internal models methodology described in paragraph (d) of this section. (2) OTC derivative contracts subject to a qualifying master netting agreement. A [BANK] must determine the EAD for multiple OTC derivative contracts that are subject to a qualifying master netting agreement using the current exposure methodology in paragraph (c)(6) of this section or using the internal models methodology described in paragraph (d) of this section. (3) Credit derivatives. Notwithstanding paragraphs (c)(1) and (c)(2) of this section: (i) A [BANK] that purchases a credit derivative that is recognized under § l.134 or § l.135 as a credit risk mitigant for an exposure that is not a covered position under subpart F of this part is not required to calculate a separate counterparty credit risk capital requirement under this section so long as the [BANK] does so consistently for all such credit derivatives and either includes or excludes all such credit derivatives that are subject to a master netting agreement from any measure used to determine counterparty credit risk exposure to all relevant counterparties for risk-based capital purposes. (ii) A [BANK] that is the protection provider in a credit derivative must treat the credit derivative as a wholesale exposure to the reference obligor and is not required to calculate a counterparty credit risk capital requirement for the E:\FR\FM\11OCR2.SGM 11OCR2 62218 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations credit derivative under this section, so long as it does so consistently for all such credit derivatives and either includes all or excludes all such credit derivatives that are subject to a master netting agreement from any measure used to determine counterparty credit risk exposure to all relevant counterparties for risk-based capital purposes (unless the [BANK] is treating the credit derivative as a covered position under subpart F of this part, in which case the [BANK] must calculate a supplemental counterparty credit risk capital requirement under this section). (4) Equity derivatives. A [BANK] must treat an equity derivative contract as an equity exposure and compute a riskweighted asset amount for the equity derivative contract under §§ l.151– l.155 (unless the [BANK] is treating the contract as a covered position under subpart F of this part). In addition, if the [BANK] is treating the contract as a covered position under subpart F of this part, and under certain other circumstances described in § l.155, the [BANK] must also calculate a risk-based capital requirement for the counterparty credit risk of an equity derivative contract under this section. (5) Single OTC derivative contract. Except as modified by paragraph (c)(7) of this section, the EAD for a single OTC derivative contract that is not subject to a qualifying master netting agreement is equal to the sum of the [BANK]’s current credit exposure and potential future credit exposure (PFE) on the derivative contract. (i) Current credit exposure. The current credit exposure for a single OTC derivative contract is the greater of the mark-to-fair value of the derivative contract or zero; and (ii) PFE. The PFE for a single OTC derivative contract, including an OTC derivative contract with a negative mark-to-fair value, is calculated by multiplying the notional principal amount of the derivative contract by the appropriate conversion factor in Table 2 to § l.132. For purposes of calculating either the PFE under paragraph (c)(5) of this section or the gross PFE under paragraph (c)(6) of this section for exchange rate contracts and other similar contracts in which the notional principal amount is equivalent to the cash flows, the notional principal amount is the net receipts to each party falling due on each value date in each currency. For any OTC derivative contract that does not fall within one of the specified categories in Table 2 to § l.132, the PFE must be calculated using the ‘‘other’’ conversion factors. A [BANK] must use an OTC derivative contract’s effective notional principal amount (that is, its apparent or stated notional principal amount multiplied by any multiplier in the OTC derivative contract) rather than its apparent or stated notional principal amount in calculating PFE. PFE of the protection provider of a credit derivative is capped at the net present value of the amount of unpaid premiums. TABLE 2 TO § l.132—CONVERSION FACTOR MATRIX FOR OTC DERIVATIVE CONTRACTS 1 Remaining maturity 2 Interest rate One year or less .......... Over one to five years Over five years ............. Foreign exchange rate and gold Credit (investment-grade reference asset) 3 0.01 0.05 0.075 Credit (noninvestmentgrade reference asset) 0.05 0.05 0.05 0.00 0.005 0.015 Precious metals (except gold) Equity 0.10 0.10 0.10 0.06 0.08 0.10 0.07 0.07 0.08 Other 0.10 0.12 0.15 wreier-aviles on DSK5TPTVN1PROD with RULES2 1 For an OTC derivative contract with multiple exchanges of principal, the conversion factor is multiplied by the number of remaining payments in the derivative contract. 2 For an OTC derivative contract that is structured such that on specified dates any outstanding exposure is settled and the terms are reset so that the fair value of the contract is zero, the remaining maturity equals the time until the next reset date. For an interest rate derivative contract with a remaining maturity of greater than one year that meets these criteria, the minimum conversion factor is 0.005. 3 A [BANK] must use the column labeled ‘‘Credit (investment-grade reference asset)’’ for a credit derivative whose reference asset is an outstanding unsecured long-term debt security without credit enhancement that is investment grade. A [BANK] must use the column labeled ‘‘Credit (non-investment-grade reference asset)’’ for all other credit derivatives. (6) Multiple OTC derivative contracts subject to a qualifying master netting agreement. Except as modified by paragraph (c)(7) of this section, the EAD for multiple OTC derivative contracts subject to a qualifying master netting agreement is equal to the sum of the net current credit exposure and the adjusted sum of the PFE exposure for all OTC derivative contracts subject to the qualifying master netting agreement. (i) Net current credit exposure. The net current credit exposure is the greater of: (A) The net sum of all positive and negative fair values of the individual OTC derivative contracts subject to the qualifying master netting agreement; or (B) Zero; and (ii) Adjusted sum of the PFE. The adjusted sum of the PFE, Anet, is calculated as VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 Anet = (0.4 × Agross) + (0.6 × NGR × Agross), where: (A) Agross = the gross PFE (that is, the sum of the PFE amounts (as determined under paragraph (c)(5)(ii) of this section) for each individual derivative contract subject to the qualifying master netting agreement); and (B) NGR = the net to gross ratio (that is, the ratio of the net current credit exposure to the gross current credit exposure). In calculating the NGR, the gross current credit exposure equals the sum of the positive current credit exposures (as determined under paragraph (c)(6)(i) of this section) of all individual derivative contracts subject to the qualifying master netting agreement. (7) Collateralized OTC derivative contracts. A [BANK] may recognize the credit risk mitigation benefits of financial collateral that secures an OTC derivative contract or single-product PO 00000 Frm 00202 Fmt 4701 Sfmt 4700 netting set of OTC derivatives by factoring the collateral into its LGD estimates for the contract or netting set. Alternatively, a [BANK] may recognize the credit risk mitigation benefits of financial collateral that secures such a contract or netting set that is marked-tomarket on a daily basis and subject to a daily margin maintenance requirement by estimating an unsecured LGD for the contract or netting set and adjusting the EAD calculated under paragraph (c)(5) or (c)(6) of this section using the collateral haircut approach in paragraph (b)(2) of this section. The [BANK] must substitute the EAD calculated under paragraph (c)(5) or (c)(6) of this section for èE in the equation in paragraph (b)(2)(i) of this section and must use a ten-business day minimum holding period (TM = 10) unless a longer holding period is required by paragraph (b)(2)(iii)(A)(3) of this section. E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 62219 (C) a = 1.4 except as provided in paragraph (d)(5) of this section, or when the [AGENCY] has determined that the [BANK] must set a higher based on the [BANK]’s specific characteristics of wreier-aviles on DSK5TPTVN1PROD with RULES2 where H = the holding period greater than five days. Additionally, the [AGENCY] may require the [BANK] to set a longer holding period if the [AGENCY] determines that a longer period is appropriate due to the nature, structure, or characteristics of the transaction or is commensurate with the risks associated with the transaction. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00203 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.033</GPH> calculates EAD based on that EE. A [BANK] must calculate two EEs and two EADs (one stressed and one unstressed) for each netting set as follows: (i) EADunstressed is calculated using an EE estimate based on the most recent data meeting the requirements of paragraph (d)(3)(vii) of this section; (ii) EADstressed is calculated using an EE estimate based on a historical period that includes a period of stress to the credit default spreads of the [BANK]’s counterparties according to paragraph (d)(3)(viii) of this section; (iii) The [BANK] must use its internal model’s probability distribution for changes in the fair value of a netting set that are attributable to changes in market variables to determine EE; and (iv) Under the internal models methodology, EAD = Max (0, a x effective EPE ¥ CVA), or, subject to the prior written approval of [AGENCY] as provided in paragraph (d)(10) of this section, a more conservative measure of EAD. (A) CVA equals the credit valuation adjustment that the [BANK] has recognized in its balance sheet valuation of any OTC derivative contracts in the netting set. For purposes of this paragraph (d), CVA does not include any adjustments to common equity tier 1 capital attributable to changes in the fair value of the [BANK]’s liabilities that are due to changes in its own credit risk since the inception of the transaction with the counterparty. ER11OC13.032</GPH> (d) Internal models methodology. (1)(i) With prior written approval from the [AGENCY], a [BANK] may use the internal models methodology in this paragraph (d) to determine EAD for counterparty credit risk for derivative contracts (collateralized or uncollateralized) and single-product netting sets thereof, for eligible margin loans and single-product netting sets thereof, and for repo-style transactions and single-product netting sets thereof. (ii) A [BANK] that uses the internal models methodology for a particular transaction type (derivative contracts, eligible margin loans, or repo-style transactions) must use the internal models methodology for all transactions of that transaction type. A [BANK] may choose to use the internal models methodology for one or two of these three types of exposures and not the other types. (iii) A [BANK] may also use the internal models methodology for derivative contracts, eligible margin loans, and repo-style transactions subject to a qualifying cross-product netting agreement if: (A) The [BANK] effectively integrates the risk mitigating effects of crossproduct netting into its risk management and other information technology systems; and (B) The [BANK] obtains the prior written approval of the [AGENCY]. (iv) A [BANK] that uses the internal models methodology for a transaction type must receive approval from the [AGENCY] to cease using the methodology for that transaction type or to make a material change to its internal model. (2) Risk-weighted assets using IMM. Under the IMM, a [BANK] uses an internal model to estimate the expected exposure (EE) for a netting set and then (8) Clearing member [BANK]’s EAD. A clearing member [BANK]’s EAD for an OTC derivative contract or netting set of OTC derivative contracts where the [BANK] is either acting as a financial intermediary and enters into an offsetting transaction with a QCCP or where the [BANK] provides a guarantee to the QCCP on the performance of the client equals the exposure amount calculated according to paragraph (c)(5) or (6) of this section multiplied by the scaling factor 0.71. If the [BANK] determines that a longer period is appropriate, it must use a larger scaling factor to adjust for a longer holding period as follows: 62220 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (iii) The model must account for the possible non-normality of the exposure distribution, where appropriate; (iv) The [BANK] must measure, monitor, and control current counterparty exposure and the exposure to the counterparty over the whole life of all contracts in the netting set; (v) The [BANK] must be able to measure and manage current exposures gross and net of collateral held, where appropriate. The [BANK] must estimate expected exposures for OTC derivative contracts both with and without the effect of collateral agreements; (vi) The [BANK] must have procedures to identify, monitor, and control wrong-way risk throughout the life of an exposure. The procedures must include stress testing and scenario analysis; (vii) The model must use current market data to compute current exposures. The [BANK] must estimate model parameters using historical data from the most recent three-year period and update the data quarterly or more frequently if market conditions warrant. The [BANK] should consider using model parameters based on forwardlooking measures, where appropriate; (viii) When estimating model parameters based on a stress period, the [BANK] must use at least three years of historical data that include a period of stress to the credit default spreads of the [BANK]’s counterparties. The [BANK] must review the data set and update the data as necessary, particularly for any material changes in its counterparties. The [BANK] must demonstrate, at least quarterly, and maintain documentation of such demonstration, that the stress period coincides with increased CDS or other credit spreads of the [BANK]’s counterparties. The [BANK] must have procedures to evaluate the effectiveness of its stress calibration that include a process for using benchmark portfolios that are vulnerable to the same risk factors as the [BANK]’s portfolio. The [AGENCY] may require the [BANK] to modify its stress calibration to better reflect actual historic losses of the portfolio; (ix) A [BANK] must subject its internal model to an initial validation and annual model review process. The model review should consider whether the inputs and risk factors, as well as the model outputs, are appropriate. As part of the model review process, the [BANK] must have a backtesting program for its model that includes a process by which unacceptable model performance will be determined and remedied; (x) A [BANK] must have policies for the measurement, management and control of collateral and margin amounts; and (xi) A [BANK] must have a comprehensive stress testing program that captures all credit exposures to counterparties, and incorporates stress testing of principal market risk factors and creditworthiness of counterparties. (4) Calculating the maturity of exposures. (i) If the remaining maturity of the exposure or the longest-dated contract in the netting set is greater than one year, the [BANK] must set M for the exposure or netting set equal to the lower of five years or M(EPE), where: (ii) If the remaining maturity of the exposure or the longest-dated contract in the netting set is one year or less, the [BANK] must set M for the exposure or netting set equal to one year, except as provided in § l.131(d)(7). (iii) Alternatively, a [BANK] that uses an internal model to calculate a onesided credit valuation adjustment may use the effective credit duration estimated by the model as M(EPE) in place of the formula in paragraph (d)(4)(i) of this section. (5) Effects of collateral agreements on EAD. A [BANK] may capture the effect on EAD of a collateral agreement that requires receipt of collateral when exposure to the counterparty increases, but may not capture the effect on EAD of a collateral agreement that requires receipt of collateral when counterparty credit quality deteriorates. Two methods are available to capture the effect of a collateral agreement, as set forth in paragraphs (d)(5)(i) and (ii) of this section: (i) With prior written approval from the [AGENCY], a [BANK] may include the effect of a collateral agreement within its internal model used to VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00204 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.034</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 counterparty credit risk or model performance. (v) A [BANK] may include financial collateral currently posted by the counterparty as collateral (but may not include other forms of collateral) when calculating EE. (vi) If a [BANK] hedges some or all of the counterparty credit risk associated with a netting set using an eligible credit derivative, the [BANK] may take the reduction in exposure to the counterparty into account when estimating EE. If the [BANK] recognizes this reduction in exposure to the counterparty in its estimate of EE, it must also use its internal model to estimate a separate EAD for the [BANK]’s exposure to the protection provider of the credit derivative. (3) Prior approval relating to EAD calculation. To obtain [AGENCY] approval to calculate the distributions of exposures upon which the EAD calculation is based, the [BANK] must demonstrate to the satisfaction of the [AGENCY] that it has been using for at least one year an internal model that broadly meets the following minimum standards, with which the [BANK] must maintain compliance: (i) The model must have the systems capability to estimate the expected exposure to the counterparty on a daily basis (but is not expected to estimate or report expected exposure on a daily basis); (ii) The model must estimate expected exposure at enough future dates to reflect accurately all the future cash flows of contracts in the netting set; wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations calculate EAD. The [BANK] may set EAD equal to the expected exposure at the end of the margin period of risk. The margin period of risk means, with respect to a netting set subject to a collateral agreement, the time period from the most recent exchange of collateral with a counterparty until the next required exchange of collateral, plus the period of time required to sell and realize the proceeds of the least liquid collateral that can be delivered under the terms of the collateral agreement and, where applicable, the period of time required to re-hedge the resulting market risk upon the default of the counterparty. The minimum margin period of risk is set according to paragraph (d)(5)(iii) of this section; or (ii) As an alternative to paragraph (d)(5)(i) of this section, a [BANK] that can model EPE without collateral agreements but cannot achieve the higher level of modeling sophistication to model EPE with collateral agreements can set effective EPE for a collateralized netting set equal to the lesser of: (A) An add-on that reflects the potential increase in exposure of the netting set over the margin period of risk, plus the larger of: (1) The current exposure of the netting set reflecting all collateral held or posted by the [BANK] excluding any collateral called or in dispute; or (2) The largest net exposure including all collateral held or posted under the margin agreement that would not trigger a collateral call. For purposes of this section, the add-on is computed as the expected increase in the netting set’s exposure over the margin period of risk (set in accordance with paragraph (d)(5)(iii) of this section); or (B) Effective EPE without a collateral agreement plus any collateral the [BANK] posts to the counterparty that exceeds the required margin amount. (iii) For purposes of this part, including paragraphs (d)(5)(i) and (ii) of this section, the margin period of risk for a netting set subject to a collateral agreement is: (A) Five business days for repo-style transactions subject to daily remargining and daily marking-to-market, and ten business days for other transactions when liquid financial collateral is posted under a daily margin maintenance requirement, or (B) Twenty business days if the number of trades in a netting set exceeds 5,000 at any time during the previous quarter or contains one or more trades involving illiquid collateral or any derivative contract that cannot be easily replaced (except if the [BANK] is calculating EAD for a cleared transaction under § l.133). If over the VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 two previous quarters more than two margin disputes on a netting set have occurred that lasted more than the margin period of risk, then the [BANK] must use a margin period of risk for that netting set that is at least two times the minimum margin period of risk for that netting set. If the periodicity of the receipt of collateral is N-days, the minimum margin period of risk is the minimum margin period of risk under this paragraph (d) plus N minus 1. This period should be extended to cover any impediments to prompt re-hedging of any market risk. (C) Five business days for an OTC derivative contract or netting set of OTC derivative contracts where the [BANK] is either acting as a financial intermediary and enters into an offsetting transaction with a CCP or where the [BANK] provides a guarantee to the CCP on the performance of the client. A [BANK] must use a longer holding period if the [BANK] determines that a longer period is appropriate. Additionally, the [AGENCY] may require the [BANK] to set a longer holding period if the [AGENCY] determines that a longer period is appropriate due to the nature, structure, or characteristics of the transaction or is commensurate with the risks associated with the transaction. (6) Own estimate of alpha. With prior written approval of the [AGENCY], a [BANK] may calculate alpha as the ratio of economic capital from a full simulation of counterparty exposure across counterparties that incorporates a joint simulation of market and credit risk factors (numerator) and economic capital based on EPE (denominator), subject to a floor of 1.2. For purposes of this calculation, economic capital is the unexpected losses for all counterparty credit risks measured at a 99.9 percent confidence level over a one-year horizon. To receive approval, the [BANK] must meet the following minimum standards to the satisfaction of the [AGENCY]: (i) The [BANK]’s own estimate of alpha must capture in the numerator the effects of: (A) The material sources of stochastic dependency of distributions of fair values of transactions or portfolios of transactions across counterparties; (B) Volatilities and correlations of market risk factors used in the joint simulation, which must be related to the credit risk factor used in the simulation to reflect potential increases in volatility or correlation in an economic downturn, where appropriate; and (C) The granularity of exposures (that is, the effect of a concentration in the proportion of each counterparty’s PO 00000 Frm 00205 Fmt 4701 Sfmt 4700 62221 exposure that is driven by a particular risk factor). (ii) The [BANK] must assess the potential model uncertainty in its estimates of alpha. (iii) The [BANK] must calculate the numerator and denominator of alpha in a consistent fashion with respect to modeling methodology, parameter specifications, and portfolio composition. (iv) The [BANK] must review and adjust as appropriate its estimates of the numerator and denominator of alpha on at least a quarterly basis and more frequently when the composition of the portfolio varies over time. (7) Risk-based capital requirements for transactions with specific wrong-way risk. A [BANK] must determine if a repo-style transaction, eligible margin loan, bond option, or equity derivative contract or purchased credit derivative to which the [BANK] applies the internal models methodology under this paragraph (d) has specific wrong-way risk. If a transaction has specific wrongway risk, the [BANK] must treat the transaction as its own netting set and exclude it from the model described in § l.132(d)(2) and instead calculate the risk-based capital requirement for the transaction as follows: (i) For an equity derivative contract, by multiplying: (A) K, calculated using the appropriate risk-based capital formula specified in Table 1 of § l.131 using the PD of the counterparty and LGD equal to 100 percent, by (B) The maximum amount the [BANK] could lose on the equity derivative. (ii) For a purchased credit derivative by multiplying: (A) K, calculated using the appropriate risk-based capital formula specified in Table 1 of § l.131 using the PD of the counterparty and LGD equal to 100 percent, by (B) The fair value of the reference asset of the credit derivative. (iii) For a bond option, by multiplying: (A) K, calculated using the appropriate risk-based capital formula specified in Table 1 of § l.131 using the PD of the counterparty and LGD equal to 100 percent, by (B) The smaller of the notional amount of the underlying reference asset and the maximum potential loss under the bond option contract. (iv) For a repo-style transaction or eligible margin loan by multiplying: (A) K, calculated using the appropriate risk-based capital formula specified in Table 1 of § l.131 using the E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62222 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations PD of the counterparty and LGD equal to 100 percent, by (B) The EAD of the transaction determined according to the EAD equation in § l.131(b)(2), substituting the estimated value of the collateral assuming a default of the counterparty for the value of the collateral in Sc of the equation. (8) Risk-weighted asset amount for IMM exposures with specific wrong-way risk. The aggregate risk-weighted asset amount for IMM exposures with specific wrong-way risk is the sum of a [BANK]’s risk-based capital requirement for purchased credit derivatives that are not bond options with specific wrong-way risk as calculated under paragraph (d)(7)(ii) of this section, a [BANK]’s riskbased capital requirement for equity derivatives with specific wrong-way risk as calculated under paragraph (d)(7)(i) of this section, a [BANK]’s risk-based capital requirement for bond options with specific wrong-way risk as calculated under paragraph (d)(7)(iii) of this section, and a [BANK]’s risk-based capital requirement for repo-style transactions and eligible margin loans with specific wrong-way risk as calculated under paragraph (d)(7)(iv) of this section, multiplied by 12.5. (9) Risk-weighted assets for IMM exposures. (i) The [BANK] must insert the assigned risk parameters for each counterparty and netting set into the appropriate formula specified in Table 1 of § l.131 and multiply the output of the formula by the EADunstressed of the netting set to obtain the unstressed capital requirement for each netting set. A [BANK] that uses an advanced CVA approach that captures migrations in credit spreads under paragraph (e)(3) of this section must set the maturity adjustment (b) in the formula equal to zero. The sum of the unstressed capital requirement calculated for each netting set equals Kunstressed. (ii) The [BANK] must insert the assigned risk parameters for each wholesale obligor and netting set into the appropriate formula specified in Table 1 of § l.131 and multiply the output of the formula by the EADstressed of the netting set to obtain the stressed capital requirement for each netting set. A [BANK] that uses an advanced CVA approach that captures migrations in credit spreads under paragraph (e)(3) of this section must set the maturity adjustment (b) in the formula equal to zero. The sum of the stressed capital VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 requirement calculated for each netting set equals Kstressed. (iii) The [BANK]’s dollar risk-based capital requirement under the internal models methodology equals the larger of Kunstressed and Kstressed. A [BANK]’s riskweighted assets amount for IMM exposures is equal to the capital requirement multiplied by 12.5, plus risk-weighted assets for IMM exposures with specific wrong-way risk in paragraph (d)(8) of this section and those in paragraph (d)(10) of this section. (10) Other measures of counterparty exposure. (i) With prior written approval of the [AGENCY], a [BANK] may set EAD equal to a measure of counterparty credit risk exposure, such as peak EAD, that is more conservative than an alpha of 1.4 (or higher under the terms of paragraph (d)(7)(iv)(C) of this section) times the larger of EPEunstressed and EPEstressed for every counterparty whose EAD will be measured under the alternative measure of counterparty exposure. The [BANK] must demonstrate the conservatism of the measure of counterparty credit risk exposure used for EAD. With respect to paragraph (d)(10)(i) of this section: (A) For material portfolios of new OTC derivative products, the [BANK] may assume that the current exposure methodology in paragraphs (c)(5) and (c)(6) of this section meets the conservatism requirement of this section for a period not to exceed 180 days. (B) For immaterial portfolios of OTC derivative contracts, the [BANK] generally may assume that the current exposure methodology in paragraphs (c)(5) and (c)(6) of this section meets the conservatism requirement of this section. (ii) To calculate risk-weighted assets for purposes of the approach in paragraph (d)(10)(i) of this section, the [BANK] must insert the assigned risk parameters for each counterparty and netting set into the appropriate formula specified in Table 1 of § l.131, multiply the output of the formula by the EAD for the exposure as specified above, and multiply by 12.5. (e) Credit valuation adjustment (CVA) risk-weighted assets—(1) In general. With respect to its OTC derivative contracts, a [BANK] must calculate a CVA risk-weighted asset amount for its portfolio of OTC derivative transactions that are subject to the CVA capital requirement using the simple CVA approach described in paragraph (e)(5) PO 00000 Frm 00206 Fmt 4701 Sfmt 4700 of this section or, with prior written approval of the [AGENCY], the advanced CVA approach described in paragraph (e)(6) of this section. A [BANK] that receives prior [AGENCY] approval to calculate its CVA riskweighted asset amounts for a class of counterparties using the advanced CVA approach must continue to use that approach for that class of counterparties until it notifies the [AGENCY] in writing that the [BANK] expects to begin calculating its CVA risk-weighted asset amount using the simple CVA approach. Such notice must include an explanation of the [BANK]’s rationale and the date upon which the [BANK] will begin to calculate its CVA riskweighted asset amount using the simple CVA approach. (2) Market risk [BANK]s. Notwithstanding the prior approval requirement in paragraph (e)(1) of this section, a market risk [BANK] may calculate its CVA risk-weighted asset amount using the advanced CVA approach if the [BANK] has [AGENCY] approval to: (i) Determine EAD for OTC derivative contracts using the internal models methodology described in paragraph (d) of this section; and (ii) Determine its specific risk add-on for debt positions issued by the counterparty using a specific risk model described in § l.207(b). (3) Recognition of hedges. (i) A [BANK] may recognize a single name CDS, single name contingent CDS, any other equivalent hedging instrument that references the counterparty directly, and index credit default swaps (CDSind) as a CVA hedge under paragraph (e)(5)(ii) of this section or paragraph (e)(6) of this section, provided that the position is managed as a CVA hedge in accordance with the [BANK]’s hedging policies. (ii) A [BANK] shall not recognize as a CVA hedge any tranched or nth-todefault credit derivative. (4) Total CVA risk-weighted assets. Total CVA risk-weighted assets is the CVA capital requirement, KCVA, calculated for a [BANK]’s entire portfolio of OTC derivative counterparties that are subject to the CVA capital requirement, multiplied by 12.5. (5) Simple CVA approach. (i) Under the simple CVA approach, the CVA capital requirement, KCVA, is calculated according to the following formula: E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (H) wind = the weight applicable to the CDSind based on the average weight of the underlying reference names that comprise the index under Table 3 to § l.132. impact of changes in the counterparties’ credit spreads, together with any recognized CVA hedges, on the CVA for the counterparties, subject to the following requirements: (ii) The [BANK] may treat the notional (A) The VaR model must incorporate amount of the index attributable to a only changes in the counterparties’ counterparty as a single name hedge of credit spreads, not changes in other risk counterparty i (Bi,) when calculating factors. The VaR model does not need KCVA, and subtract the notional amount to capture jump-to-default risk; of Bi from the notional amount of the CDSind. A [BANK] must treat the CDSind (B) A [BANK] that qualifies to use the hedge with the notional amount advanced CVA approach must include reduced by Bi as a CVA hedge. in that approach any immaterial OTC derivative portfolios for which it uses TABLE 3 TO § l.132—ASSIGNMENT the current exposure methodology in OF COUNTERPARTY WEIGHT paragraph (c) of this section according to paragraph (e)(6)(viii) of this section; Internal PD Weight wi and (in percent) (in percent) (C) A [BANK] must have the systems 0.00–0.07 .............................. 0.70 capability to calculate the CVA capital >0.070–0.15 .......................... 0.80 requirement for a counterparty on a >0.15–0.40 ............................ 1.00 >0.40–2.00 ............................ 2.00 daily basis (but is not required to >2.00–6.00 ............................ 3.00 calculate the CVA capital requirement >6.00 ..................................... 10.00 on a daily basis). (ii) Under the advanced CVA (6) Advanced CVA approach. (i) A approach, the CVA capital requirement, [BANK] may use the VaR model that it KCVA, is calculated according to the uses to determine specific risk under following formulas: § l.207(b) or another VaR model that meets the quantitative requirements of § l.205(b) and § l.207(b)(1) to calculate its CVA capital requirement for a counterparty by modeling the PO 00000 Frm 00207 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.035</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 (A) wi = the weight applicable to counterparty i under Table 3 to § l.132; (B) Mi = the EAD-weighted average of the effective maturity of each netting set with counterparty i (where each netting set’s effective maturity can be no less than one year.) (C) EADitotal = the sum of the EAD for all netting sets of OTC derivative contracts with counterparty i calculated using the current exposure methodology described in paragraph (c) of this section or the internal models methodology described in paragraph (d) of this section. When the [BANK] calculates EAD under paragraph (c) of this section, such EAD may be adjusted for purposes of calculating EADitotal by multiplying EAD by (1-exp(¥0.05 × Mi))/(0.05 × Mi), where ‘‘exp’’ is the exponential function. When the [BANK] calculates EAD under paragraph (d) of this section, EADitotal equals EADunstressed. (D) Mihedge = the notional weighted average maturity of the hedge instrument. (E) Bi = the sum of the notional amounts of any purchased single name CDS referencing counterparty i that is used to hedge CVA risk to counterparty i multiplied by (1-exp(¥0.05 × Mihedge))/ (0.05 × Mihedge). (F) Mind = the maturity of the CDSind or the notional weighted average maturity of any CDSind purchased to hedge CVA risk of counterparty i. (G) Bind = the notional amount of one or more CDSind purchased to hedge CVA risk for counterparty i multiplied by (1exp(¥0.05 × Mind))/(0.05 × Mind) 62223 62224 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (H) The subscript j refers either to a stressed or an unstressed calibration as described in paragraphs (e)(6)(iv) and (v) of this section. (iii) Notwithstanding paragraphs (e)(6)(i) and (e)(6)(ii) of this section, a [BANK] must use the formulas in paragraphs (e)(6)(iii)(A) or (e)(6)(iii)(B) of this section to calculate credit spread sensitivities if its VaR model is not based on full repricing. (A) If the VaR model is based on credit spread sensitivities for specific tenors, the [BANK] must calculate each credit spread sensitivity according to the following formula: ER11OC13.039</GPH> quality, industry, and region of the counterparty. Where no market information and no reliable proxy based on the credit quality, industry, and region of the counterparty are available to determine LGDMKT, a [BANK] may use a conservative estimate when determining LGDMKT, subject to approval by the [AGENCY]. (E) EEi = the sum of the expected exposures for all netting sets with the counterparty at revaluation time ti, calculated according to paragraphs (e)(6)(iv)(A) and (e)(6)(v)(A) of this section. (F) Di = the risk-free discount factor at time ti, where D0 = 1. (G) Exp is the exponential function. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00208 Fmt 4701 Sfmt 4725 E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.037</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 Where (A) ti = the time of the i-th revaluation time bucket starting from t0 = 0. (B) tT = the longest contractual maturity across the OTC derivative contracts with the counterparty. (C) si = the CDS spread for the counterparty at tenor ti used to calculate the CVA for the counterparty. If a CDS spread is not available, the [BANK] must use a proxy spread based on the credit quality, industry and region of the counterparty. (D) LGDMKT = the loss given default of the counterparty based on the spread of a publicly traded debt instrument of the counterparty, or, where a publicly traded debt instrument spread is not available, a proxy spread based on the credit wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (iv) To calculate the CVAUnstressed measure for purposes of paragraph (e)(6)(ii) of this section, the [BANK] must: (A) Use the EEi calculated using the calibration of paragraph (d)(3)(vii) of this section, except as provided in § l.132(e)(6)(vi), and (B) Use the historical observation period required under § l.205(b)(2). (v) To calculate the CVAStressed measure for purposes of paragraph (e)(6)(ii) of this section, the [BANK] must: (A) Use the EEi calculated using the stress calibration in paragraph (d)(3)(viii) of this section except as provided in paragraph (e)(6)(vi) of this section. (B) Calibrate VaR model inputs to historical data from the most severe twelve-month stress period contained within the three-year stress period used to calculate EEi. The [AGENCY] may require a [BANK] to use a different period of significant financial stress in the calculation of the CVAStressed measure. (vi) If a [BANK] captures the effect of a collateral agreement on EAD using the method described in paragraph (d)(5)(ii) of this section, for purposes of paragraph (e)(6)(ii) of this section, the [BANK] must calculate EEi using the method in paragraph (d)(5)(ii) of this section and keep that EE constant with the maturity equal to the maximum of: (A) Half of the longest maturity of a transaction in the netting set, and (B) The notional weighted average maturity of all transactions in the netting set. (vii) For purposes of paragraph (e)(6) of this section, the [BANK]’s VaR model must capture the basis between the spreads of any CDSind that is used as the hedging instrument and the hedged counterparty exposure over various time periods, including benign and stressed environments. If the VaR model does not capture that basis, the [BANK] must reflect only 50 percent of the notional amount of the CDSind hedge in the VaR model. (viii) If a [BANK] uses the current exposure methodology described in paragraphs (c)(5) and (c)(6) of this section to calculate the EAD for any immaterial portfolios of OTC derivative contracts, the [BANK] must use that EAD as a constant EE in the formula for the calculation of CVA with the maturity equal to the maximum of: (A) Half of the longest maturity of a transaction in the netting set, and (B) The notional weighted average maturity of all transactions in the netting set. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 § l.133 Cleared transactions. (a) General requirements. (1) A [BANK] that is a clearing member client must use the methodologies described in paragraph (b) of this section to calculate risk-weighted assets for a cleared transaction. (2) A [BANK] that is a clearing member must use the methodologies described in paragraph (c) of this section to calculate its risk-weighted assets for cleared transactions and paragraph (d) of this section to calculate its risk-weighted assets for its default fund contribution to a CCP. (b) Clearing member client [BANK]s— (1) Risk-weighted assets for cleared transactions. (i) To determine the riskweighted asset amount for a cleared transaction, a [BANK] that is a clearing member client must multiply the trade exposure amount for the cleared transaction, calculated in accordance with paragraph (b)(2) of this section, by the risk weight appropriate for the cleared transaction, determined in accordance with paragraph (b)(3) of this section. (ii) A clearing member client [BANK]’s total risk-weighted assets for cleared transactions is the sum of the risk-weighted asset amounts for all of its cleared transactions. (2) Trade exposure amount. (i) For a cleared transaction that is a derivative contract or a netting set of derivative contracts, trade exposure amount equals the EAD for the derivative contract or netting set of derivative contracts calculated using the methodology used to calculate EAD for OTC derivative contracts set forth in § l.132(c) or (d), plus the fair value of the collateral posted by the clearing member client [BANK] and held by the CCP or a clearing member in a manner that is not bankruptcy remote. When the [BANK] calculates EAD for the cleared transaction using the methodology in § l.132(d), EAD equals EADunstressed. (ii) For a cleared transaction that is a repo-style transaction or netting set of repo-style transactions, trade exposure amount equals the EAD for the repostyle transaction calculated using the methodology set forth in § l.132(b)(2), (b)(3), or (d), plus the fair value of the collateral posted by the clearing member client [BANK] and held by the CCP or a clearing member in a manner that is not bankruptcy remote. When the [BANK] calculates EAD for the cleared transaction under § l.132(d), EAD equals EADunstressed. (3) Cleared transaction risk weights. (i) For a cleared transaction with a QCCP, a clearing member client [BANK] must apply a risk weight of: PO 00000 Frm 00209 Fmt 4701 Sfmt 4700 62225 (A) 2 percent if the collateral posted by the [BANK] to the QCCP or clearing member is subject to an arrangement that prevents any loss to the clearing member client [BANK] due to the joint default or a concurrent insolvency, liquidation, or receivership proceeding of the clearing member and any other clearing member clients of the clearing member; and the clearing member client [BANK] has conducted sufficient legal review to conclude with a well-founded basis (and maintains sufficient written documentation of that legal review) that in the event of a legal challenge (including one resulting from an event of default or from liquidation, insolvency or receivership proceedings) the relevant court and administrative authorities would find the arrangements to be legal, valid, binding and enforceable under the law of the relevant jurisdictions. (B) 4 percent, if the requirements of § l.132(b)(3)(i)(A) are not met. (ii) For a cleared transaction with a CCP that is not a QCCP, a clearing member client [BANK] must apply the risk weight applicable to the CCP under § l.32. (4) Collateral. (i) Notwithstanding any other requirement of this section, collateral posted by a clearing member client [BANK] that is held by a custodian (in its capacity as custodian) in a manner that is bankruptcy remote from the CCP, the custodian, clearing member, and other clearing member clients of the clearing member, is not subject to a capital requirement under this section. (ii) A clearing member client [BANK] must calculate a risk-weighted asset amount for any collateral provided to a CCP, clearing member or a custodian in connection with a cleared transaction in accordance with requirements under § l.131. (c) Clearing member [BANK]—(1) Risk-weighted assets for cleared transactions. (i) To determine the riskweighted asset amount for a cleared transaction, a clearing member [BANK] must multiply the trade exposure amount for the cleared transaction, calculated in accordance with paragraph (c)(2) of this section by the risk weight appropriate for the cleared transaction, determined in accordance with paragraph (c)(3) of this section. (ii) A clearing member [BANK]’s total risk-weighted assets for cleared transactions is the sum of the riskweighted asset amounts for all of its cleared transactions. (2) Trade exposure amount. A clearing member [BANK] must calculate its trade exposure amount for a cleared transaction as follows: E:\FR\FM\11OCR2.SGM 11OCR2 62226 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (2) Risk-weighted asset amount for default fund contributions to nonqualifying CCPs. A clearing member [BANK]’s risk-weighted asset amount for default fund contributions to CCPs that are not QCCPs equals the sum of such default fund contributions multiplied by 1,250 percent or an amount determined by the [AGENCY], based on factors such as size, structure and membership characteristics of the CCP and riskiness of its transactions, in cases where such default fund contributions may be unlimited. (3) Risk-weighted asset amount for default fund contributions to QCCPs. A clearing member [BANK]’s riskweighted asset amount for default fund contributions to QCCPs equals the sum of its capital requirement, KCM for each QCCP, as calculated under the methodology set forth in paragraph (d)(3)(i) of this section (Method 1), multiplied by 1,250 percent or paragraph (d)(3)(iv) of this section (Method 2). (i) Method 1. The hypothetical capital requirement of a QCCP (KCCP) equals: principal amount of the derivative contract by the appropriate conversion factor in Table 2 to § l.132 and the absolute value of the option’s delta, that is, the ratio of the change in the value of the derivative contract to the corresponding change in the price of the underlying asset. (3) For repo-style transactions, when applying § l.132(b)(2), the [BANK] must use the methodology in § l.132(b)(2)(ii). (B) VMi = any collateral posted by clearing member i to the QCCP that it is entitled to receive from the QCCP but has not yet received, and any collateral that the QCCP has actually received from clearing member i; (C) IMi = the collateral posted as initial margin by clearing member i to the QCCP; (D) DFi = the funded portion of clearing member i’s default fund contribution that will be applied to reduce the QCCP’s loss upon a default by clearing member i; and (E) RW = 20 percent, except when the [AGENCY] has determined that a higher risk weight is more appropriate based on the specific characteristics of the QCCP and its clearing members; and (F) Where a QCCP has provided its KCCP, a [BANK] must rely on such disclosed figure instead of calculating KCCP under this paragraph (d), unless the [BANK] determines that a more conservative figure is appropriate based on the nature, structure, or characteristics of the QCCP. (ii) For a [BANK] that is a clearing member of a QCCP with a default fund supported by funded commitments, KCM equals: VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00210 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.042</GPH> trade exposure amount for a cleared transaction with a QCCP. (ii) For a cleared transaction with a CCP that is not a QCCP, a clearing member [BANK] must apply the risk weight applicable to the CCP according to § l.32. (4) Collateral. (i) Notwithstanding any other requirement of this section, collateral posted by a clearing member [BANK] that is held by a custodian in a manner that is bankruptcy remote from the CCP is not subject to a capital requirement under this section. (ii) A clearing member [BANK] must calculate a risk-weighted asset amount for any collateral provided to a CCP, clearing member or a custodian in connection with a cleared transaction in accordance with requirements under § l.131 (d) Default fund contributions—(1) General requirement. A clearing member [BANK] must determine the risk-weighted asset amount for a default fund contribution to a CCP at least quarterly, or more frequently if, in the opinion of the [BANK] or the [AGENCY], there is a material change in the financial condition of the CCP. Where (A) EBRMi = the EAD for each transaction cleared through the QCCP by clearing member i, calculated using the methodology used to calculate EAD for OTC derivative contracts set forth in § l.132(c)(5) and § l.132.(c)(6) or the methodology used to calculate EAD for repo-style transactions set forth in § l.132(b)(2) for repo-style transactions, provided that: (1) For purposes of this section, when calculating the EAD, the [BANK] may replace the formula provided in § l.132(c)(6)(ii) with the following formula: Anet = (0.15 × Agross) + (0.85 × NGR × Agross); and (2) For option derivative contracts that are cleared transactions, the PFE described in § l.132(c)(5) must be adjusted by multiplying the notional wreier-aviles on DSK5TPTVN1PROD with RULES2 (i) For a cleared transaction that is a derivative contract or a netting set of derivative contracts, trade exposure amount equals the EAD calculated using the methodology used to calculate EAD for OTC derivative contracts set forth in § l.132(c) or § l.132(d), plus the fair value of the collateral posted by the clearing member [BANK] and held by the CCP in a manner that is not bankruptcy remote. When the clearing member [BANK] calculates EAD for the cleared transaction using the methodology in § l.132(d), EAD equals EADunstressed. (ii) For a cleared transaction that is a repo-style transaction or netting set of repo-style transactions, trade exposure amount equals the EAD calculated under §§ l.132(b)(2), (b)(3), or (d), plus the fair value of the collateral posted by the clearing member [BANK] and held by the CCP in a manner that is not bankruptcy remote. When the clearing member [BANK] calculates EAD for the cleared transaction under § l.132(d), EAD equals EADunstressed. (3) Cleared transaction risk weights. (i) A clearing member [BANK] must apply a risk weight of 2 percent to the VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00211 Fmt 4701 Sfmt 4725 E:\FR\FM\11OCR2.SGM 11OCR2 62227 ER11OC13.043</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (A) DFi = the [BANK]’s unfunded commitment to the default fund; (B) DFCM = the total of all clearing members’ unfunded commitments to the default fund; and (C) K*CM as defined in paragraph (d)(3)(ii) of this section. (D) For a [BANK] that is a clearing member of a QCCP with a default fund supported by unfunded commitments and that is unable to calculate KCM using the methodology described above in this paragraph (d)(3)(iii), KCM equals: Where: (1) IMi = the [BANK]’s initial margin posted to the QCCP; (2) IMCM = the total of initial margin posted to the QCCP; and (3) K*CM as defined above in this paragraph (d)(3)(iii). (iv) Method 2. A clearing member [BANK]’s risk-weighted asset amount for its default fund contribution to a QCCP, RWADF, equals: RWADF = Min {12.5 * DF; 0.18 * TE} (A) TE = the [BANK]’s trade exposure amount to the QCCP calculated according to section 133(c)(2); (B) DF = the funded portion of the [BANK]’s default fund contribution to the QCCP. (v) Total risk-weighted assets for default fund contributions. Total riskweighted assets for default fund contributions is the sum of a clearing member [BANK]’s risk-weighted assets for all of its default fund contributions to all CCPs of which the [BANK] is a clearing member. Where: VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00212 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.046</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 Where: ER11OC13.044</GPH> 62228 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.134 Guarantees and credit derivatives: PD substitution and LGD adjustment approaches. (a) Scope. (1) This section applies to wholesale exposures for which: (i) Credit risk is fully covered by an eligible guarantee or eligible credit derivative; or (ii) Credit risk is covered on a pro rata basis (that is, on a basis in which the [BANK] and the protection provider share losses proportionately) by an eligible guarantee or eligible credit derivative. (2) Wholesale exposures on which there is a tranching of credit risk (reflecting at least two different levels of seniority) are securitization exposures subject to § l.141 through § l.145. (3) A [BANK] may elect to recognize the credit risk mitigation benefits of an eligible guarantee or eligible credit derivative covering an exposure described in paragraph (a)(1) of this section by using the PD substitution approach or the LGD adjustment approach in paragraph (c) of this section or, if the transaction qualifies, using the double default treatment in § l.135. A [BANK]’s PD and LGD for the hedged exposure may not be lower than the PD and LGD floors described in § l.131(d)(2) and (d)(3). (4) If multiple eligible guarantees or eligible credit derivatives cover a single exposure described in paragraph (a)(1) of this section, a [BANK] may treat the hedged exposure as multiple separate exposures each covered by a single eligible guarantee or eligible credit derivative and may calculate a separate risk-based capital requirement for each separate exposure as described in paragraph (a)(3) of this section. (5) If a single eligible guarantee or eligible credit derivative covers multiple hedged wholesale exposures described in paragraph (a)(1) of this section, a [BANK] must treat each hedged exposure as covered by a separate eligible guarantee or eligible credit derivative and must calculate a separate risk-based capital requirement for each exposure as described in paragraph (a)(3) of this section. (6) A [BANK] must use the same risk parameters for calculating ECL as it uses for calculating the risk-based capital requirement for the exposure. (b) Rules of recognition. (1) A [BANK] may only recognize the credit risk mitigation benefits of eligible guarantees and eligible credit derivatives. (2) A [BANK] may only recognize the credit risk mitigation benefits of an eligible credit derivative to hedge an exposure that is different from the credit derivative’s reference exposure used for determining the derivative’s cash VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 settlement value, deliverable obligation, or occurrence of a credit event if: (i) The reference exposure ranks pari passu (that is, equally) with or is junior to the hedged exposure; and (ii) The reference exposure and the hedged exposure are exposures to the same legal entity, and legally enforceable cross-default or crossacceleration clauses are in place to assure payments under the credit derivative are triggered when the obligor fails to pay under the terms of the hedged exposure. (c) Risk parameters for hedged exposures—(1) PD substitution approach—(i) Full coverage. If an eligible guarantee or eligible credit derivative meets the conditions in paragraphs (a) and (b) of this section and the protection amount (P) of the guarantee or credit derivative is greater than or equal to the EAD of the hedged exposure, a [BANK] may recognize the guarantee or credit derivative in determining the [BANK]’s risk-based capital requirement for the hedged exposure by substituting the PD associated with the rating grade of the protection provider for the PD associated with the rating grade of the obligor in the risk-based capital formula applicable to the guarantee or credit derivative in Table 1 of § l.131 and using the appropriate LGD as described in paragraph (c)(1)(iii) of this section. If the [BANK] determines that full substitution of the protection provider’s PD leads to an inappropriate degree of risk mitigation, the [BANK] may substitute a higher PD than that of the protection provider. (ii) Partial coverage. If an eligible guarantee or eligible credit derivative meets the conditions in paragraphs (a) and (b) of this section and P of the guarantee or credit derivative is less than the EAD of the hedged exposure, the [BANK] must treat the hedged exposure as two separate exposures (protected and unprotected) in order to recognize the credit risk mitigation benefit of the guarantee or credit derivative. (A) The [BANK] must calculate its risk-based capital requirement for the protected exposure under § l.131, where PD is the protection provider’s PD, LGD is determined under paragraph (c)(1)(iii) of this section, and EAD is P. If the [BANK] determines that full substitution leads to an inappropriate degree of risk mitigation, the [BANK] may use a higher PD than that of the protection provider. (B) The [BANK] must calculate its risk-based capital requirement for the unprotected exposure under § l.131, where PD is the obligor’s PD, LGD is the PO 00000 Frm 00213 Fmt 4701 Sfmt 4700 62229 hedged exposure’s LGD (not adjusted to reflect the guarantee or credit derivative), and EAD is the EAD of the original hedged exposure minus P. (C) The treatment in paragraph (c)(1)(ii) of this section is applicable when the credit risk of a wholesale exposure is covered on a partial pro rata basis or when an adjustment is made to the effective notional amount of the guarantee or credit derivative under paragraphs (d), (e), or (f) of this section. (iii) LGD of hedged exposures. The LGD of a hedged exposure under the PD substitution approach is equal to: (A) The lower of the LGD of the hedged exposure (not adjusted to reflect the guarantee or credit derivative) and the LGD of the guarantee or credit derivative, if the guarantee or credit derivative provides the [BANK] with the option to receive immediate payout upon triggering the protection; or (B) The LGD of the guarantee or credit derivative, if the guarantee or credit derivative does not provide the [BANK] with the option to receive immediate payout upon triggering the protection. (2) LGD adjustment approach. (i) Full coverage. If an eligible guarantee or eligible credit derivative meets the conditions in paragraphs (a) and (b) of this section and the protection amount (P) of the guarantee or credit derivative is greater than or equal to the EAD of the hedged exposure, the [BANK]’s riskbased capital requirement for the hedged exposure is the greater of: (A) The risk-based capital requirement for the exposure as calculated under § l.131, with the LGD of the exposure adjusted to reflect the guarantee or credit derivative; or (B) The risk-based capital requirement for a direct exposure to the protection provider as calculated under § l.131, using the PD for the protection provider, the LGD for the guarantee or credit derivative, and an EAD equal to the EAD of the hedged exposure. (ii) Partial coverage. If an eligible guarantee or eligible credit derivative meets the conditions in paragraphs (a) and (b) of this section and the protection amount (P) of the guarantee or credit derivative is less than the EAD of the hedged exposure, the [BANK] must treat the hedged exposure as two separate exposures (protected and unprotected) in order to recognize the credit risk mitigation benefit of the guarantee or credit derivative. (A) The [BANK]’s risk-based capital requirement for the protected exposure would be the greater of: (1) The risk-based capital requirement for the protected exposure as calculated under § l.131, with the LGD of the exposure adjusted to reflect the E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62230 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations guarantee or credit derivative and EAD set equal to P; or (2) The risk-based capital requirement for a direct exposure to the guarantor as calculated under § l.131, using the PD for the protection provider, the LGD for the guarantee or credit derivative, and an EAD set equal to P. (B) The [BANK] must calculate its risk-based capital requirement for the unprotected exposure under § l.131, where PD is the obligor’s PD, LGD is the hedged exposure’s LGD (not adjusted to reflect the guarantee or credit derivative), and EAD is the EAD of the original hedged exposure minus P. (3) M of hedged exposures. For purposes of this paragraph (c), the M of the hedged exposure is the same as the M of the exposure if it were unhedged. (d) Maturity mismatch. (1) A [BANK] that recognizes an eligible guarantee or eligible credit derivative in determining its risk-based capital requirement for a hedged exposure must adjust the effective notional amount of the credit risk mitigant to reflect any maturity mismatch between the hedged exposure and the credit risk mitigant. (2) A maturity mismatch occurs when the residual maturity of a credit risk mitigant is less than that of the hedged exposure(s). (3) The residual maturity of a hedged exposure is the longest possible remaining time before the obligor is scheduled to fulfil its obligation on the exposure. If a credit risk mitigant has embedded options that may reduce its term, the [BANK] (protection purchaser) must use the shortest possible residual maturity for the credit risk mitigant. If a call is at the discretion of the protection provider, the residual maturity of the credit risk mitigant is at the first call date. If the call is at the discretion of the [BANK] (protection purchaser), but the terms of the arrangement at origination of the credit risk mitigant contain a positive incentive for the [BANK] to call the transaction before contractual maturity, the remaining time to the first call date is the residual maturity of the credit risk mitigant.26 (4) A credit risk mitigant with a maturity mismatch may be recognized only if its original maturity is greater than or equal to one year and its residual maturity is greater than three months. (5) When a maturity mismatch exists, the [BANK] must apply the following 26 For example, where there is a step-up in cost in conjunction with a call feature or where the effective cost of protection increases over time even if credit quality remains the same or improves, the residual maturity of the credit risk mitigant will be the remaining time to the first call. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 adjustment to the effective notional amount of the credit risk mitigant: Pm = E × (t ¥ 0.25)/(T ¥ 0.25), where: (i) Pm = effective notional amount of the credit risk mitigant, adjusted for maturity mismatch; (ii) E = effective notional amount of the credit risk mitigant; (iii) t = the lesser of T or the residual maturity of the credit risk mitigant, expressed in years; and (iv) T = the lesser of five or the residual maturity of the hedged exposure, expressed in years. (e) Credit derivatives without restructuring as a credit event. If a [BANK] recognizes an eligible credit derivative that does not include as a credit event a restructuring of the hedged exposure involving forgiveness or postponement of principal, interest, or fees that results in a credit loss event (that is, a charge-off, specific provision, or other similar debit to the profit and loss account), the [BANK] must apply the following adjustment to the effective notional amount of the credit derivative: Pr = Pm × 0.60, where: (1) Pr = effective notional amount of the credit risk mitigant, adjusted for lack of restructuring event (and maturity mismatch, if applicable); and (2) Pm = effective notional amount of the credit risk mitigant adjusted for maturity mismatch (if applicable). (f) Currency mismatch. (1) If a [BANK] recognizes an eligible guarantee or eligible credit derivative that is denominated in a currency different from that in which the hedged exposure is denominated, the [BANK] must apply the following formula to the effective notional amount of the guarantee or credit derivative: Pc = Pr x (1 ¥ HFX), where: (i) Pc = effective notional amount of the credit risk mitigant, adjusted for currency mismatch (and maturity mismatch and lack of restructuring event, if applicable); (ii) Pr = effective notional amount of the credit risk mitigant (adjusted for maturity mismatch and lack of restructuring event, if applicable); and (iii) HFX = haircut appropriate for the currency mismatch between the credit risk mitigant and the hedged exposure. (2) A [BANK] must set HFX equal to 8 percent unless it qualifies for the use of and uses its own internal estimates of foreign exchange volatility based on a ten-business-day holding period and daily marking-to-market and remargining. A [BANK] qualifies for the use of its own internal estimates of foreign exchange volatility if it qualifies for: PO 00000 Frm 00214 Fmt 4701 Sfmt 4700 (i) The own-estimates haircuts in § l.132(b)(2)(iii); (ii) The simple VaR methodology in § l.132(b)(3); or (iii) The internal models methodology in § l.132(d). (3) A [BANK] must adjust HFX calculated in paragraph (f)(2) of this section upward if the [BANK] revalues the guarantee or credit derivative less frequently than once every ten business days using the square root of time formula provided in § l.132(b)(2)(iii)(A)(2). § l.135 Guarantees and credit derivatives: double default treatment. (a) Eligibility and operational criteria for double default treatment. A [BANK] may recognize the credit risk mitigation benefits of a guarantee or credit derivative covering an exposure described in § l.134(a)(1) by applying the double default treatment in this section if all the following criteria are satisfied: (1) The hedged exposure is fully covered or covered on a pro rata basis by: (i) An eligible guarantee issued by an eligible double default guarantor; or (ii) An eligible credit derivative that meets the requirements of § l.134(b)(2) and that is issued by an eligible double default guarantor. (2) The guarantee or credit derivative is: (i) An uncollateralized guarantee or uncollateralized credit derivative (for example, a credit default swap) that provides protection with respect to a single reference obligor; or (ii) An nth-to-default credit derivative (subject to the requirements of § l.142(m). (3) The hedged exposure is a wholesale exposure (other than a sovereign exposure). (4) The obligor of the hedged exposure is not: (i) An eligible double default guarantor or an affiliate of an eligible double default guarantor; or (ii) An affiliate of the guarantor. (5) The [BANK] does not recognize any credit risk mitigation benefits of the guarantee or credit derivative for the hedged exposure other than through application of the double default treatment as provided in this section. (6) The [BANK] has implemented a process (which has received the prior, written approval of the [AGENCY]) to detect excessive correlation between the creditworthiness of the obligor of the hedged exposure and the protection provider. If excessive correlation is present, the [BANK] may not use the double default treatment for the hedged exposure. E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 62231 (b) Full coverage. If a transaction meets the criteria in paragraph (a) of this section and the protection amount (P) of the guarantee or credit derivative is at least equal to the EAD of the hedged exposure, the [BANK] may determine its risk-weighted asset amount for the hedged exposure under paragraph (e) of this section. (c) Partial coverage. If a transaction meets the criteria in paragraph (a) of this section and the protection amount (P) of the guarantee or credit derivative is less than the EAD of the hedged exposure, the [BANK] must treat the hedged exposure as two separate exposures (protected and unprotected) in order to recognize double default treatment on the protected portion of the exposure: (1) For the protected exposure, the [BANK] must set EAD equal to P and calculate its risk-weighted asset amount as provided in paragraph (e) of this section; and (2) For the unprotected exposure, the [BANK] must set EAD equal to the EAD of the original exposure minus P and then calculate its risk-weighted asset amount as provided in § l.131. (d) Mismatches. For any hedged exposure to which a [BANK] applies double default treatment under this part, the [BANK] must make applicable adjustments to the protection amount as required in § l.134(d), (e), and (f). (e) The double default dollar riskbased capital requirement. The dollar risk-based capital requirement for a hedged exposure to which a [BANK] has applied double default treatment is KDD multiplied by the EAD of the exposure. KDD is calculated according to the following formula: KDD = Ko × (0.15 + 160 × PDg), Where: (2) PDg = PD of the protection provider. (3) PDo = PD of the obligor of the hedged exposure. (4) LGDg = (i) The lower of the LGD of the hedged exposure (not adjusted to reflect the guarantee or credit derivative) and the LGD of the guarantee or credit derivative, if the guarantee or credit derivative provides the [BANK] with the option to receive immediate payout on triggering the protection; or (ii) The LGD of the guarantee or credit derivative, if the guarantee or credit derivative does not provide the [BANK] with the option to receive immediate payout on triggering the protection; and (5) ros (asset value correlation of the obligor) is calculated according to the appropriate formula for (R) provided in Table 1 in § l.131, with PD equal to PDo. (6) b (maturity adjustment coefficient) is calculated according to the formula for b provided in Table 1 in § l.131, with PD equal to the lesser of PDo and PDg; and (7) M (maturity) is the effective maturity of the guarantee or credit derivative, which may not be less than one year or greater than five years. counterparty has made a final transfer of one or more currencies. (3) A transaction has a normal settlement period if the contractual settlement period for the transaction is equal to or less than the market standard for the instrument underlying the transaction and equal to or less than five business days. (4) The positive current exposure of a [BANK] for a transaction is the difference between the transaction value at the agreed settlement price and the current market price of the transaction, if the difference results in a credit exposure of the [BANK] to the counterparty. (b) Scope. This section applies to all transactions involving securities, foreign exchange instruments, and commodities that have a risk of delayed settlement or delivery. This section does not apply to: (1) Cleared transactions that are subject to daily marking-to-market and daily receipt and payment of variation margin; (2) Repo-style transactions, including unsettled repo-style transactions (which are addressed in §§ l.131 and 132); (3) One-way cash payments on OTC derivative contracts (which are addressed in §§ l. 131 and 132); or (4) Transactions with a contractual settlement period that is longer than the normal settlement period (which are treated as OTC derivative contracts and addressed in §§ l.131 and 132). (c) System-wide failures. In the case of a system-wide failure of a settlement or clearing system, or a central counterparty, the [AGENCY] may waive risk-based capital requirements for unsettled and failed transactions until the situation is rectified. (d) Delivery-versus-payment (DvP) and payment-versus-payment (PvP) transactions. A [BANK] must hold riskbased capital against any DvP or PvP transaction with a normal settlement period if the [BANK]’s counterparty has not made delivery or payment within five business days after the settlement date. The [BANK] must determine its risk-weighted asset amount for such a transaction by multiplying the positive current exposure of the transaction for the [BANK] by the appropriate risk weight in Table 1 to § l.136. Unsettled transactions. (a) Definitions. For purposes of this section: (1) Delivery-versus-payment (DvP) transaction means a securities or commodities transaction in which the buyer is obligated to make payment only if the seller has made delivery of the securities or commodities and the seller is obligated to deliver the securities or commodities only if the buyer has made payment. (2) Payment-versus-payment (PvP) transaction means a foreign exchange transaction in which each counterparty is obligated to make a final transfer of one or more currencies only if the other VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00215 Fmt 4701 Sfmt 4700 TABLE 1 TO § l.136—RISK WEIGHTS FOR UNSETTLED DVP AND PVP TRANSACTIONS Number of business days after contractual settlement date From From From 46 or 5 to 15 ......................... 16 to 30 ....................... 31 to 45 ....................... more ............................ Risk weight to be applied to positive current exposure (in percent) 100 625 937.5 1,250 (e) Non-DvP/non-PvP (non-deliveryversus-payment/non-payment-versuspayment) transactions. (1) A [BANK] must hold risk-based capital against any non-DvP/non-PvP transaction with a normal settlement period if the [BANK] has delivered cash, securities, commodities, or currencies to its counterparty but has not received its corresponding deliverables by the end of the same business day. The [BANK] must continue to hold risk-based capital against the transaction until the [BANK] has received its corresponding deliverables. E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.048</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.136 (1) 62232 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (2) From the business day after the [BANK] has made its delivery until five business days after the counterparty delivery is due, the [BANK] must calculate its risk-based capital requirement for the transaction by treating the current fair value of the deliverables owed to the [BANK] as a wholesale exposure. (i) A [BANK] may use a 45 percent LGD for the transaction rather than estimating LGD for the transaction provided the [BANK] uses the 45 percent LGD for all transactions described in § l.135(e)(1) and (e)(2). (ii) A [BANK] may use a 100 percent risk weight for the transaction provided the [BANK] uses this risk weight for all transactions described in §§ l.135(e)(1) and (e)(2). (3) If the [BANK] has not received its deliverables by the fifth business day after the counterparty delivery was due, the [BANK] must apply a 1,250 percent risk weight to the current fair value of the deliverables owed to the [BANK]. (f) Total risk-weighted assets for unsettled transactions. Total riskweighted assets for unsettled transactions is the sum of the riskweighted asset amounts of all DvP, PvP, and non-DvP/non-PvP transactions. §§ l.137 through l.140 [Reserved] Risk-Weighted Assets for Securitization Exposures wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.141 Operational criteria for recognizing the transfer of risk. (a) Operational criteria for traditional securitizations. A [BANK] that transfers exposures it has originated or purchased to a securitization SPE or other third party in connection with a traditional securitization may exclude the exposures from the calculation of its risk-weighted assets only if each of the conditions in this paragraph (a) is satisfied. A [BANK] that meets these conditions must hold risk-based capital against any securitization exposures it retains in connection with the securitization. A [BANK] that fails to meet these conditions must hold riskbased capital against the transferred exposures as if they had not been securitized and must deduct from common equity tier 1 capital any aftertax gain-on-sale resulting from the transaction. The conditions are: (1) The exposures are not reported on the [BANK]’s consolidated balance sheet under GAAP; (2) The [BANK] has transferred to one or more third parties credit risk associated with the underlying exposures; VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (3) Any clean-up calls relating to the securitization are eligible clean-up calls; and (4) The securitization does not: (i) Include one or more underlying exposures in which the borrower is permitted to vary the drawn amount within an agreed limit under a line of credit; and (ii) Contain an early amortization provision. (b) Operational criteria for synthetic securitizations. For synthetic securitizations, a [BANK] may recognize for risk-based capital purposes under this subpart the use of a credit risk mitigant to hedge underlying exposures only if each of the conditions in this paragraph (b) is satisfied. A [BANK] that meets these conditions must hold riskbased capital against any credit risk of the exposures it retains in connection with the synthetic securitization. A [BANK] that fails to meet these conditions or chooses not to recognize the credit risk mitigant for purposes of this section must hold risk-based capital under this subpart against the underlying exposures as if they had not been synthetically securitized. The conditions are: (1) The credit risk mitigant is: (i) Financial collateral; or (ii) A guarantee that meets all of the requirements of an eligible guarantee in § l.2 except for paragraph (3) of the definition; or (iii) A credit derivative that meets all of the requirements of an eligible credit derivative except for paragraph (3) of the definition of eligible guarantee in § l.2. (2) The [BANK] transfers credit risk associated with the underlying exposures to third parties, and the terms and conditions in the credit risk mitigants employed do not include provisions that: (i) Allow for the termination of the credit protection due to deterioration in the credit quality of the underlying exposures; (ii) Require the [BANK] to alter or replace the underlying exposures to improve the credit quality of the underlying exposures; (iii) Increase the [BANK]’s cost of credit protection in response to deterioration in the credit quality of the underlying exposures; (iv) Increase the yield payable to parties other than the [BANK] in response to a deterioration in the credit quality of the underlying exposures; or (v) Provide for increases in a retained first loss position or credit enhancement provided by the [BANK] after the inception of the securitization; PO 00000 Frm 00216 Fmt 4701 Sfmt 4700 (3) The [BANK] obtains a wellreasoned opinion from legal counsel that confirms the enforceability of the credit risk mitigant in all relevant jurisdictions; and (4) Any clean-up calls relating to the securitization are eligible clean-up calls. (c) Due diligence requirements for securitization exposures. (1) Except for exposures that are deducted from common equity tier 1 capital and exposures subject to § l.142(k), if a [BANK] is unable to demonstrate to the satisfaction of the [AGENCY] a comprehensive understanding of the features of a securitization exposure that would materially affect the performance of the exposure, the [BANK] must assign a 1,250 percent risk weight to the securitization exposure. The [BANK]’s analysis must be commensurate with the complexity of the securitization exposure and the materiality of the position in relation to regulatory capital according to this part. (2) A [BANK] must demonstrate its comprehensive understanding of a securitization exposure under paragraph (c)(1) of this section, for each securitization exposure by: (i) Conducting an analysis of the risk characteristics of a securitization exposure prior to acquiring the exposure and document such analysis within three business days after acquiring the exposure, considering: (A) Structural features of the securitization that would materially impact the performance of the exposure, for example, the contractual cash flow waterfall, waterfall-related triggers, credit enhancements, liquidity enhancements, fair value triggers, the performance of organizations that service the position, and deal-specific definitions of default; (B) Relevant information regarding the performance of the underlying credit exposure(s), for example, the percentage of loans 30, 60, and 90 days past due; default rates; prepayment rates; loans in foreclosure; property types; occupancy; average credit score or other measures of creditworthiness; average loan-to-value ratio; and industry and geographic diversification data on the underlying exposure(s); (C) Relevant market data of the securitization, for example, bid-ask spreads, most recent sales price and historical price volatility, trading volume, implied market rating, and size, depth and concentration level of the market for the securitization; and (D) For resecuritization exposures, performance information on the underlying securitization exposures, for example, the issuer name and credit quality, and the characteristics and E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations performance of the exposures underlying the securitization exposures; and (ii) On an on-going basis (no less frequently than quarterly), evaluating, reviewing, and updating as appropriate the analysis required under this section for each securitization exposure. wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.142 Risk-weighted assets for securitization exposures. (a) Hierarchy of approaches. Except as provided elsewhere in this section and in § l.141: (1) A [BANK] must deduct from common equity tier 1 capital any aftertax gain-on-sale resulting from a securitization and must apply a 1,250 percent risk weight to the portion of any CEIO that does not constitute after tax gain-on-sale; (2) If a securitization exposure does not require deduction or a 1,250 percent risk weight under paragraph (a)(1) of this section, the [BANK] must apply the supervisory formula approach in § l.143 to the exposure if the [BANK] and the exposure qualify for the supervisory formula approach according to § l.143(a); (3) If a securitization exposure does not require deduction or a 1,250 percent risk weight under paragraph (a)(1) of this section and does not qualify for the supervisory formula approach, the [BANK] may apply the simplified supervisory formula approach under § l.144; (4) If a securitization exposure does not require deduction or a 1,250 percent risk weight under paragraph (a)(1) of this section, does not qualify for the supervisory formula approach in § l.143, and the [BANK] does not apply the simplified supervisory formula approach in § l.144, the [BANK] must apply a 1,250 percent risk weight to the exposure; and (5) If a securitization exposure is a derivative contract (other than protection provided by a [BANK] in the form of a credit derivative) that has a first priority claim on the cash flows from the underlying exposures (notwithstanding amounts due under interest rate or currency derivative contracts, fees due, or other similar payments), a [BANK] may choose to set the risk-weighted asset amount of the exposure equal to the amount of the exposure as determined in paragraph (e) of this section rather than apply the hierarchy of approaches described in paragraphs (a)(1) through (4) of this section. (b) Total risk-weighted assets for securitization exposures. A [BANK]’s total risk-weighted assets for securitization exposures is equal to the VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 sum of its risk-weighted assets calculated using §§ l.141 through 146. (c) Deductions. A [BANK] may calculate any deduction from common equity tier 1 capital for a securitization exposure net of any DTLs associated with the securitization exposure. (d) Maximum risk-based capital requirement. Except as provided in § l.141(c), unless one or more underlying exposures does not meet the definition of a wholesale, retail, securitization, or equity exposure, the total risk-based capital requirement for all securitization exposures held by a single [BANK] associated with a single securitization (excluding any risk-based capital requirements that relate to the [BANK]’s gain-on-sale or CEIOs associated with the securitization) may not exceed the sum of: (1) The [BANK]’s total risk-based capital requirement for the underlying exposures calculated under this subpart as if the [BANK] directly held the underlying exposures; and (2) The total ECL of the underlying exposures calculated under this subpart. (e) Exposure amount of a securitization exposure. (1) The exposure amount of an on-balance sheet securitization exposure that is not a repo-style transaction, eligible margin loan, OTC derivative contract, or cleared transaction is the [BANK]’s carrying value. (2) Except as provided in paragraph (m) of this section, the exposure amount of an off-balance sheet securitization exposure that is not an OTC derivative contract (other than a credit derivative), repo-style transaction, eligible margin loan, or cleared transaction (other than a credit derivative) is the notional amount of the exposure. For an offbalance-sheet securitization exposure to an ABCP program, such as an eligible ABCP liquidity facility, the notional amount may be reduced to the maximum potential amount that the [BANK] could be required to fund given the ABCP program’s current underlying assets (calculated without regard to the current credit quality of those assets). (3) The exposure amount of a securitization exposure that is a repostyle transaction, eligible margin loan, or OTC derivative contract (other than a credit derivative) or cleared transaction (other than a credit derivative) is the EAD of the exposure as calculated in § l.132 or § l.133. (f) Overlapping exposures. If a [BANK] has multiple securitization exposures that provide duplicative coverage of the underlying exposures of a securitization (such as when a [BANK] provides a program-wide credit enhancement and multiple pool-specific PO 00000 Frm 00217 Fmt 4701 Sfmt 4700 62233 liquidity facilities to an ABCP program), the [BANK] is not required to hold duplicative risk-based capital against the overlapping position. Instead, the [BANK] may assign to the overlapping securitization exposure the applicable risk-based capital treatment under this subpart that results in the highest riskbased capital requirement. (g) Securitizations of non-IRB exposures. Except as provided in § l.141(c), if a [BANK] has a securitization exposure where any underlying exposure is not a wholesale exposure, retail exposure, securitization exposure, or equity exposure, the [BANK]: (1) Must deduct from common equity tier 1 capital any after-tax gain-on-sale resulting from the securitization and apply a 1,250 percent risk weight to the portion of any CEIO that does not constitute gain-on-sale, if the [BANK] is an originating [BANK]; (2) May apply the simplified supervisory formula approach in § l.144 to the exposure, if the securitization exposure does not require deduction or a 1,250 percent risk weight under paragraph (g)(1) of this section; (3) Must assign a 1,250 percent risk weight to the exposure if the securitization exposure does not require deduction or a 1,250 percent risk weight under paragraph (g)(1) of this section, does not qualify for the supervisory formula approach in § l.143, and the [BANK] does not apply the simplified supervisory formula approach in § l.144 to the exposure. (h) Implicit support. If a [BANK] provides support to a securitization in excess of the [BANK]’s contractual obligation to provide credit support to the securitization (implicit support): (1) The [BANK] must calculate a riskweighted asset amount for underlying exposures associated with the securitization as if the exposures had not been securitized and must deduct from common equity tier 1 capital any after-tax gain-on-sale resulting from the securitization; and (2) The [BANK] must disclose publicly: (i) That it has provided implicit support to the securitization; and (ii) The regulatory capital impact to the [BANK] of providing such implicit support. (i) Undrawn portion of a servicer cash advance facility. (1) Notwithstanding any other provision of this subpart, a [BANK] that is a servicer under an eligible servicer cash advance facility is not required to hold risk-based capital against potential future cash advance payments that it may be required to E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62234 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations provide under the contract governing the facility. (2) For a [BANK] that acts as a servicer, the exposure amount for a servicer cash advance facility that is not an eligible servicer cash advance facility is equal to the amount of all potential future cash advance payments that the [BANK] may be contractually required to provide during the subsequent 12 month period under the contract governing the facility. (j) Interest-only mortgage-backed securities. Regardless of any other provisions in this part, the risk weight for a non-credit-enhancing interest-only mortgage-backed security may not be less than 100 percent. (k) Small-business loans and leases on personal property transferred with recourse. (1) Notwithstanding any other provisions of this subpart E, a [BANK] that has transferred small-business loans and leases on personal property (smallbusiness obligations) with recourse must include in risk-weighted assets only the contractual amount of retained recourse if all the following conditions are met: (i) The transaction is a sale under GAAP. (ii) The [BANK] establishes and maintains, pursuant to GAAP, a noncapital reserve sufficient to meet the [BANK]’s reasonably estimated liability under the recourse arrangement. (iii) The loans and leases are to businesses that meet the criteria for a small-business concern established by the Small Business Administration under section 3(a) of the Small Business Act (15 U.S.C. 632 et seq.); and (iv) The [BANK] is well-capitalized, as defined in [12 CFR 6.4 (OCC); 12 CFR 208.43 (Board)]. For purposes of determining whether a [BANK] is well capitalized for purposes of this paragraph (k), the [BANK]’s capital ratios must be calculated without regard to the capital treatment for transfers of small-business obligations with recourse specified in paragraph (k)(1) of this section. (2) The total outstanding amount of recourse retained by a [BANK] on transfers of small-business obligations subject to paragraph (k)(1) of this section cannot exceed 15 percent of the [BANK]’s total capital. (3) If a [BANK] ceases to be well capitalized or exceeds the 15 percent capital limitation in paragraph (k)(2) of this section, the preferential capital treatment specified in paragraph (k)(1) of this section will continue to apply to any transfers of small-business obligations with recourse that occurred during the time that the [BANK] was VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 well capitalized and did not exceed the capital limit. (4) The risk-based capital ratios of a [BANK] must be calculated without regard to the capital treatment for transfers of small-business obligations with recourse specified in paragraph (k)(1) of this section. (l) Nth-to-default credit derivatives— (1) Protection provider. A [BANK] must determine a risk weight using the supervisory formula approach (SFA) pursuant to § l.143 or the simplified supervisory formula approach (SSFA) pursuant to § l.144 for an nth-to-default credit derivative in accordance with this paragraph (l). In the case of credit protection sold, a [BANK] must determine its exposure in the nth-todefault credit derivative as the largest notional amount of all the underlying exposures. (2) For purposes of determining the risk weight for an nth-to-default credit derivative using the SFA or the SSFA, the [BANK] must calculate the attachment point and detachment point of its exposure as follows: (i) The attachment point (parameter A) is the ratio of the sum of the notional amounts of all underlying exposures that are subordinated to the [BANK]’s exposure to the total notional amount of all underlying exposures. For purposes of the SSFA, parameter A is expressed as a decimal value between zero and one. For purposes of using the SFA to calculate the risk weight for its exposure in an nth-to-default credit derivative, parameter A must be set equal to the credit enhancement level (L) input to the SFA formula. In the case of a firstto-default credit derivative, there are no underlying exposures that are subordinated to the [BANK]’s exposure. In the case of a second-or-subsequent-todefault credit derivative, the smallest (n1) risk-weighted asset amounts of the underlying exposure(s) are subordinated to the [BANK]’s exposure. (ii) The detachment point (parameter D) equals the sum of parameter A plus the ratio of the notional amount of the [BANK]’s exposure in the nth-to-default credit derivative to the total notional amount of all underlying exposures. For purposes of the SSFA, parameter W is expressed as a decimal value between zero and one. For purposes of the SFA, parameter D must be set to equal L plus the thickness of tranche T input to the SFA formula. (3) A [BANK] that does not use the SFA or the SSFA to determine a risk weight for its exposure in an nth-todefault credit derivative must assign a risk weight of 1,250 percent to the exposure. PO 00000 Frm 00218 Fmt 4701 Sfmt 4700 (4) Protection purchaser—(i) First-todefault credit derivatives. A [BANK] that obtains credit protection on a group of underlying exposures through a firstto-default credit derivative that meets the rules of recognition of § l.134(b) must determine its risk-based capital requirement under this subpart for the underlying exposures as if the [BANK] synthetically securitized the underlying exposure with the lowest risk-based capital requirement and had obtained no credit risk mitigant on the other underlying exposures. A [BANK] must calculate a risk-based capital requirement for counterparty credit risk according to § l.132 for a first-todefault credit derivative that does not meet the rules of recognition of § l.134(b). (ii) Second-or-subsequent-to-default credit derivatives. (A) A [BANK] that obtains credit protection on a group of underlying exposures through a nth-todefault credit derivative that meets the rules of recognition of § l.134(b) (other than a first-to-default credit derivative) may recognize the credit risk mitigation benefits of the derivative only if: (1) The [BANK] also has obtained credit protection on the same underlying exposures in the form of first-through-(n-1)-to-default credit derivatives; or (2) If n-1 of the underlying exposures have already defaulted. (B) If a [BANK] satisfies the requirements of paragraph (l)(3)(ii)(A) of this section, the [BANK] must determine its risk-based capital requirement for the underlying exposures as if the bank had only synthetically securitized the underlying exposure with the nth smallest risk-based capital requirement and had obtained no credit risk mitigant on the other underlying exposures. (C) A [BANK] must calculate a riskbased capital requirement for counterparty credit risk according to § l.132 for a nth-to-default credit derivative that does not meet the rules of recognition of § l.134(b). (m) Guarantees and credit derivatives other than nth-to-default credit derivatives—(1) Protection provider. For a guarantee or credit derivative (other than an nth-to-default credit derivative) provided by a [BANK] that covers the full amount or a pro rata share of a securitization exposure’s principal and interest, the [BANK] must risk weight the guarantee or credit derivative as if it holds the portion of the reference exposure covered by the guarantee or credit derivative. (2) Protection purchaser. (i) A [BANK] that purchases an OTC credit derivative (other than an nth-to-default credit derivative) that is recognized under E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.145 as a credit risk mitigant (including via recognized collateral) is not required to compute a separate counterparty credit risk capital requirement under § l.131 in accordance with § l.132(c)(3). (ii) If a [BANK] cannot, or chooses not to, recognize a purchased credit derivative as a credit risk mitigant under § l.145, the [BANK] must determine the exposure amount of the credit derivative under § l.132(c). (A) If the [BANK] purchases credit protection from a counterparty that is not a securitization SPE, the [BANK] must determine the risk weight for the exposure according § l.131. (B) If the [BANK] purchases the credit protection from a counterparty that is a securitization SPE, the [BANK] must determine the risk weight for the exposure according to this section, including paragraph (a)(5) of this VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 section for a credit derivative that has a first priority claim on the cash flows from the underlying exposures of the securitization SPE (notwithstanding amounts due under interest rate or currency derivative contracts, fees due, or other similar payments. § l.143 (SFA). Supervisory formula approach (a) Eligibility requirements. A [BANK] must use the SFA to determine its riskweighted asset amount for a securitization exposure if the [BANK] can calculate on an ongoing basis each of the SFA parameters in paragraph (e) of this section. (b) Mechanics. The risk-weighted asset amount for a securitization exposure equals its SFA risk-based capital requirement as calculated under paragraph (c) and (d) of this section, multiplied by 12.5. PO 00000 Frm 00219 Fmt 4701 Sfmt 4700 62235 (c) The SFA risk-based capital requirement. (1) If KIRB is greater than or equal to L + T, an exposure’s SFA risk-based capital requirement equals the exposure amount. (2) If KIRB is less than or equal to L, an exposure’s SFA risk-based capital requirement is UE multiplied by TP multiplied by the greater of: (i) F · T (where F is 0.016 for all securitization exposures); or (ii) S[L + T]¥S[L]. (3) If KIRB is greater than L and less than L + T, the [BANK] must apply a 1,250 percent risk weight to an amount equal to UE · TP (KIRB¥L), and the exposure’s SFA risk-based capital requirement is UE multiplied by TP multiplied by the greater of: (i) F · (T¥(KIRB¥L)) (where F is 0.016 for all other securitization exposures); or (ii) S[L + T]¥S[KIRB]. (d) The supervisory formula: E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (e) SFA parameters. For purposes of the calculations in paragraphs (c) and (d) of this section: (1) Amount of the underlying exposures (UE). UE is the EAD of any underlying exposures that are wholesale and retail exposures (including the amount of any funded spread accounts, cash collateral accounts, and other similar funded credit enhancements) plus the amount of any underlying exposures that are securitization exposures (as defined in § l.142(e)) plus the adjusted carrying value of any underlying exposures that are equity exposures (as defined in § l.151(b)). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (2) Tranche percentage (TP). TP is the ratio of the amount of the [BANK]’s securitization exposure to the amount of the tranche that contains the securitization exposure. (3) Capital requirement on underlying exposures (KIRB). (i) KIRB is the ratio of: (A) The sum of the risk-based capital requirements for the underlying exposures plus the expected credit losses of the underlying exposures (as determined under this subpart E as if the underlying exposures were directly held by the [BANK]); to (B) UE. PO 00000 Frm 00220 Fmt 4701 Sfmt 4700 (ii) The calculation of KIRB must reflect the effects of any credit risk mitigant applied to the underlying exposures (either to an individual underlying exposure, to a group of underlying exposures, or to all of the underlying exposures). (iii) All assets related to the securitization are treated as underlying exposures, including assets in a reserve account (such as a cash collateral account). (4) Credit enhancement level (L). (i) L is the ratio of: (A) The amount of all securitization exposures subordinated to the tranche E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.049</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 62236 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (4) Alternatively, if only C1 is available and C1 is no more than 0.03, the [BANK] may set EWALGD = 0.50 if none of the underlying exposures is a securitization exposure, or may set EWALGD = 1 if one or more of the underlying exposures is a securitization exposure and may set N = 1/C1. wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.144 Simplified supervisory formula approach (SSFA). (a) General requirements for the SSFA. To use the SSFA to determine the risk weight for a securitization exposure, a [BANK] must have data that enables it to assign accurately the parameters described in paragraph (b) of this section. Data used to assign the parameters described in paragraph (b) of this section must be the most currently available data; if the contracts governing the underlying exposures of the securitization require payments on a VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 where LGDi represents the average LGD associated with all exposures to the ith obligor. In the case of a resecuritization, an LGD of 100 percent must be assumed for the underlying exposures that are themselves securitization exposures. (ii) Multiple exposures to one obligor must be treated as a single underlying exposure. (iii) In the case of a resecuritization, the [BANK] must treat each underlying exposure as a single underlying exposure and must not look through to the originally securitized underlying exposures. (7) Exposure-weighted average loss given default (EWALGD). EWALGD is calculated as: (f) Simplified method for computing N and EWALGD. (1) If all underlying exposures of a securitization are retail exposures, a [BANK] may apply the SFA using the following simplifications: (i) h = 0; and (ii) v = 0. (2) Under the conditions in §§ .l143(f)(3) and (f)(4), a [BANK] may employ a simplified method for calculating N and EWALGD. (3) If C1 is no more than 0.03, a [BANK] may set EWALGD = 0.50 if none of the underlying exposures is a securitization exposure, or may set EWALGD = 1 if one or more of the underlying exposures is a securitization exposure, and may set N equal to the following amount: monthly or quarterly basis, the data used to assign the parameters described in paragraph (b) of this section must be no more than 91 calendar days old. A [BANK] that does not have the appropriate data to assign the parameters described in paragraph (b) of this section must assign a risk weight of 1,250 percent to the exposure. (b) SSFA parameters. To calculate the risk weight for a securitization exposure using the SSFA, a [BANK] must have accurate information on the following five inputs to the SSFA calculation: (1) KG is the weighted-average (with unpaid principal used as the weight for each exposure) total capital requirement of the underlying exposures calculated using subpart D of this part. KG is expressed as a decimal value between zero and one (that is, an average risk weight of 100 percent represents a value of KG equal to 0.08). (2) Parameter W is expressed as a decimal value between zero and one. Parameter W is the ratio of the sum of the dollar amounts of any underlying exposures of the securitization that meet any of the criteria as set forth in paragraphs (b)(2)(i) through (vi) of this section to the balance, measured in dollars, of underlying exposures: (i) Ninety days or more past due; (ii) Subject to a bankruptcy or insolvency proceeding; (iii) In the process of foreclosure; (iv) Held as real estate owned; (v) Has contractually deferred payments for 90 days or more, other than principal or interest payments deferred on: (A) Federally-guaranteed student loans, in accordance with the terms of those guarantee programs; or (B) Consumer loans, including nonfederally-guaranteed student loans, provided that such payments are deferred pursuant to provisions included in the contract at the time funds are disbursed that provide for period(s) of deferral that are not initiated based on changes in the creditworthiness of the borrower; or (vi) Is in default. (3) Parameter A is the attachment point for the exposure, which represents the threshold at which credit losses will first be allocated to the exposure. Except where EADi represents the EAD associated with the ith instrument in the underlying exposures. PO 00000 Frm 00221 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.051</GPH> ER11OC13.052</GPH> where: (i) Cm is the ratio of the sum of the amounts of the ‘m’ largest underlying exposures to UE; and (ii) The level of m is to be selected by the [BANK]. (5) Thickness of tranche (T). T is the ratio of: (i) The amount of the tranche that contains the [BANK]’s securitization exposure; to (ii) UE. (6) Effective number of exposures (N). (i) Unless the [BANK] elects to use the formula provided in paragraph (f) of this section, ER11OC13.050</GPH> that contains the [BANK]’s securitization exposure; to (B) UE. (ii) A [BANK] must determine L before considering the effects of any tranche-specific credit enhancements. (iii) Any gain-on-sale or CEIO associated with the securitization may not be included in L. (iv) Any reserve account funded by accumulated cash flows from the underlying exposures that is subordinated to the tranche that contains the [BANK]’s securitization exposure may be included in the numerator and denominator of L to the extent cash has accumulated in the account. Unfunded reserve accounts (that is, reserve accounts that are to be funded from future cash flows from the underlying exposures) may not be included in the calculation of L. (v) In some cases, the purchase price of receivables will reflect a discount that provides credit enhancement (for example, first loss protection) for all or certain tranches of the securitization. When this arises, L should be calculated inclusive of this discount if the discount provides credit enhancement for the securitization exposure. 62237 62238 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 as provided in section 142(l) for nth-todefault credit derivatives, parameter A equals the ratio of the current dollar amount of underlying exposures that are subordinated to the exposure of the [BANK] to the current dollar amount of underlying exposures. Any reserve account funded by the accumulated cash flows from the underlying exposures that is subordinated to the [BANK]’s securitization exposure may be included in the calculation of parameter A to the extent that cash is present in the account. Parameter A is expressed as a decimal value between zero and one. (4) Parameter D is the detachment point for the exposure, which represents the threshold at which credit losses of principal allocated to the exposure would result in a total loss of principal. Except as provided in section 142(l) for nth-to-default credit derivatives, parameter D equals parameter A plus VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 the ratio of the current dollar amount of the securitization exposures that are pari passu with the exposure (that is, have equal seniority with respect to credit risk) to the current dollar amount of the underlying exposures. Parameter D is expressed as a decimal value between zero and one. (5) A supervisory calibration parameter, p, is equal to 0.5 for securitization exposures that are not resecuritization exposures and equal to 1.5 for resecuritization exposures. (c) Mechanics of the SSFA. KG and W are used to calculate KA, the augmented value of KG, which reflects the observed credit quality of the underlying exposures. KA is defined in paragraph (d) of this section. The values of parameters A and D, relative to KA determine the risk weight assigned to a securitization exposure as described in paragraph (d) of this section. The risk weight assigned to a securitization PO 00000 Frm 00222 Fmt 4701 Sfmt 4700 exposure, or portion of a securitization exposure, as appropriate, is the larger of the risk weight determined in accordance with this paragraph (c), paragraph (d) of this section, and a risk weight of 20 percent. (1) When the detachment point, parameter D, for a securitization exposure is less than or equal to KA, the exposure must be assigned a risk weight of 1,250 percent; (2) When the attachment point, parameter A, for a securitization exposure is greater than or equal to KA, the [BANK] must calculate the risk weight in accordance with paragraph (d) of this section; (3) When A is less than KA and D is greater than KA, the risk weight is a weighted-average of 1,250 percent and 1,250 percent times KSSFA calculated in accordance with paragraph (d) of this section. For the purpose of this weighted-average calculation: E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (a) General. An originating [BANK] that has obtained a credit risk mitigant to hedge its securitization exposure to a synthetic or traditional securitization that satisfies the operational criteria in § l.141 may recognize the credit risk mitigant, but only as provided in this section. An investing [BANK] that has obtained a credit risk mitigant to hedge a securitization exposure may recognize the credit risk mitigant, but only as provided in this section. VerDate Mar<15>2010 14:37 Oct 10, 2013 Jkt 232001 (b) Collateral. (1) Rules of recognition. A [BANK] may recognize financial collateral in determining the [BANK]’s risk-weighted asset amount for a securitization exposure (other than a repo-style transaction, an eligible margin loan, or an OTC derivative contract for which the [BANK] has reflected collateral in its determination of exposure amount under § l.132) as follows. The [BANK]’s risk-weighted asset amount for the collateralized securitization exposure is equal to the risk-weighted asset amount for the securitization exposure as calculated PO 00000 Frm 00223 Fmt 4701 Sfmt 4700 under the SSFA in § l.144 or under the SFA in § l.143 multiplied by the ratio of adjusted exposure amount (SE*) to original exposure amount (SE), Where: (i) SE* = max {0, [SE¥C × (1¥Hs¥Hfx)]}; (ii) SE = the amount of the securitization exposure calculated under § l.142(e); (iii) C = the current fair value of the collateral; (iv) Hs = the haircut appropriate to the collateral type; and (v) Hfx = the haircut appropriate for any currency mismatch between the collateral and the exposure. E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.053</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.145 Recognition of credit risk mitigants for securitization exposures. 62239 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (3) Standard supervisory haircuts. Unless a [BANK] qualifies for use of and uses own-estimates haircuts in paragraph (b)(4) of this section: (i) A [BANK] must use the collateral type haircuts (Hs) in Table 1 to § l.132 of this subpart; (ii) A [BANK] must use a currency mismatch haircut (Hfx) of 8 percent if the exposure and the collateral are denominated in different currencies; (iii) A [BANK] must multiply the supervisory haircuts obtained in paragraphs (b)(3)(i) and (ii) of this section by the square root of 6.5 (which equals 2.549510); and (iv) A [BANK] must adjust the supervisory haircuts upward on the basis of a holding period longer than 65 business days where and as appropriate to take into account the illiquidity of the collateral. (4) Own estimates for haircuts. With the prior written approval of the [AGENCY], a [BANK] may calculate haircuts using its own internal estimates of market price volatility and foreign exchange volatility, subject to § l.132(b)(2)(iii). The minimum holding period (TM) for securitization exposures is 65 business days. (c) Guarantees and credit derivatives—(1) Limitations on recognition. A [BANK] may only recognize an eligible guarantee or eligible credit derivative provided by an eligible guarantor in determining the [BANK]’s risk-weighted asset amount for a securitization exposure. (2) ECL for securitization exposures. When a [BANK] recognizes an eligible guarantee or eligible credit derivative provided by an eligible guarantor in determining the [BANK]’s risk-weighted asset amount for a securitization exposure, the [BANK] must also: (i) Calculate ECL for the protected portion of the exposure using the same risk parameters that it uses for calculating the risk-weighted asset amount of the exposure as described in paragraph (c)(3) of this section; and (ii) Add the exposure’s ECL to the [BANK]’s total ECL. (3) Rules of recognition. A [BANK] may recognize an eligible guarantee or VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 eligible credit derivative provided by an eligible guarantor in determining the [BANK]’s risk-weighted asset amount for the securitization exposure as follows: (i) Full coverage. If the protection amount of the eligible guarantee or eligible credit derivative equals or exceeds the amount of the securitization exposure, the [BANK] may set the riskweighted asset amount for the securitization exposure equal to the risk-weighted asset amount for a direct exposure to the eligible guarantor (as determined in the wholesale risk weight function described in § l.131), using the [BANK]’s PD for the guarantor, the [BANK]’s LGD for the guarantee or credit derivative, and an EAD equal to the amount of the securitization exposure (as determined in § l.142(e)). (ii) Partial coverage. If the protection amount of the eligible guarantee or eligible credit derivative is less than the amount of the securitization exposure, the [BANK] may set the risk-weighted asset amount for the securitization exposure equal to the sum of: (A) Covered portion. The riskweighted asset amount for a direct exposure to the eligible guarantor (as determined in the wholesale risk weight function described in § l.131), using the [BANK]’s PD for the guarantor, the [BANK]’s LGD for the guarantee or credit derivative, and an EAD equal to the protection amount of the credit risk mitigant; and (B) Uncovered portion. (1) 1.0 minus the ratio of the protection amount of the eligible guarantee or eligible credit derivative to the amount of the securitization exposure); multiplied by (2) The risk-weighted asset amount for the securitization exposure without the credit risk mitigant (as determined in §§ l.142 through 146). (4) Mismatches. The [BANK] must make applicable adjustments to the protection amount as required in § l.134(d), (e), and (f) for any hedged securitization exposure and any more senior securitization exposure that benefits from the hedge. In the context of a synthetic securitization, when an eligible guarantee or eligible credit PO 00000 Frm 00224 Fmt 4701 Sfmt 4700 derivative covers multiple hedged exposures that have different residual maturities, the [BANK] must use the longest residual maturity of any of the hedged exposures as the residual maturity of all the hedged exposures. §§ l.146 through l.150 [Reserved] Risk-Weighted Assets for Equity Exposures § l.151 Introduction and exposure measurement. (a) General. (1) To calculate its riskweighted asset amounts for equity exposures that are not equity exposures to investment funds, a [BANK] may apply either the Simple Risk Weight Approach (SRWA) in § l.152 or, if it qualifies to do so, the Internal Models Approach (IMA) in § l.153. A [BANK] must use the look-through approaches provided in § l.154 to calculate its riskweighted asset amounts for equity exposures to investment funds. (2) A [BANK] must treat an investment in a separate account (as defined in § l.2), as if it were an equity exposure to an investment fund as provided in § l.154. (3) Stable value protection. (i) Stable value protection means a contract where the provider of the contract is obligated to pay: (A) The policy owner of a separate account an amount equal to the shortfall between the fair value and cost basis of the separate account when the policy owner of the separate account surrenders the policy, or (B) The beneficiary of the contract an amount equal to the shortfall between the fair value and book value of a specified portfolio of assets. (ii) A [BANK] that purchases stable value protection on its investment in a separate account must treat the portion of the carrying value of its investment in the separate account attributable to the stable value protection as an exposure to the provider of the protection and the remaining portion of the carrying value of its separate account as an equity exposure to an investment fund. E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.054</GPH> wreier-aviles on DSK5TPTVN1PROD with RULES2 62240 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (iii) A [BANK] that provides stable value protection must treat the exposure as an equity derivative with an adjusted carrying value determined as the sum of § l.151(b)(1) and (2). (b) Adjusted carrying value. For purposes of this subpart, the adjusted carrying value of an equity exposure is: (1) For the on-balance sheet component of an equity exposure, the [BANK]’s carrying value of the exposure; (2) For the off-balance sheet component of an equity exposure, the effective notional principal amount of the exposure, the size of which is equivalent to a hypothetical on-balance sheet position in the underlying equity instrument that would evidence the same change in fair value (measured in dollars) for a given small change in the price of the underlying equity instrument, minus the adjusted carrying value of the on-balance sheet component of the exposure as calculated in paragraph (b)(1) of this section. (3) For unfunded equity commitments that are unconditional, the effective notional principal amount is the notional amount of the commitment. For unfunded equity commitments that are conditional, the effective notional principal amount is the [BANK]’s best estimate of the amount that would be funded under economic downturn conditions. wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.152 Simple risk weight approach (SRWA). (a) General. Under the SRWA, a [BANK]’s aggregate risk-weighted asset amount for its equity exposures is equal to the sum of the risk-weighted asset amounts for each of the [BANK]’s individual equity exposures (other than equity exposures to an investment fund) as determined in this section and the risk-weighted asset amounts for each of the [BANK]’s individual equity exposures to an investment fund as determined in § l.154. (b) SRWA computation for individual equity exposures. A [BANK] must determine the risk-weighted asset amount for an individual equity exposure (other than an equity exposure to an investment fund) by multiplying the adjusted carrying value of the equity exposure or the effective portion and ineffective portion of a hedge pair (as defined in paragraph (c) of this section) by the lowest applicable risk weight in this section. (1) Zero percent risk weight equity exposures. An equity exposure to an entity whose credit exposures are exempt from the 0.03 percent PD floor VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 in § l.131(d)(2) is assigned a zero percent risk weight. (2) 20 percent risk weight equity exposures. An equity exposure to a Federal Home Loan Bank or the Federal Agricultural Mortgage Corporation (Farmer Mac) is assigned a 20 percent risk weight. (3) 100 percent risk weight equity exposures. The following equity exposures are assigned a 100 percent risk weight: (i) Community development equity exposures. An equity exposure that qualifies as a community development investment under section 24 (Eleventh) of the National Bank Act, excluding equity exposures to an unconsolidated small business investment company and equity exposures held through a consolidated small business investment company described in section 302 of the Small Business Investment Act. (ii) Effective portion of hedge pairs. The effective portion of a hedge pair. (iii) Non-significant equity exposures. Equity exposures, excluding significant investments in the capital of an unconsolidated institution in the form of common stock and exposures to an investment firm that would meet the definition of a traditional securitization were it not for the [AGENCY]’s application of paragraph (8) of that definition in § l.2 and has greater than immaterial leverage, to the extent that the aggregate adjusted carrying value of the exposures does not exceed 10 percent of the [BANK]’s total capital. (A) To compute the aggregate adjusted carrying value of a [BANK]’s equity exposures for purposes of this section, the [BANK] may exclude equity exposures described in paragraphs (b)(1), (b)(2), (b)(3)(i), and (b)(3)(ii) of this section, the equity exposure in a hedge pair with the smaller adjusted carrying value, and a proportion of each equity exposure to an investment fund equal to the proportion of the assets of the investment fund that are not equity exposures or that meet the criterion of paragraph (b)(3)(i) of this section. If a [BANK] does not know the actual holdings of the investment fund, the [BANK] may calculate the proportion of the assets of the fund that are not equity exposures based on the terms of the prospectus, partnership agreement, or similar contract that defines the fund’s permissible investments. If the sum of the investment limits for all exposure classes within the fund exceeds 100 percent, the [BANK] must assume for purposes of this section that the investment fund invests to the maximum extent possible in equity exposures. PO 00000 Frm 00225 Fmt 4701 Sfmt 4700 62241 (B) When determining which of a [BANK]’s equity exposures qualifies for a 100 percent risk weight under this section, a [BANK] first must include equity exposures to unconsolidated small business investment companies or held through consolidated small business investment companies described in section 302 of the Small Business Investment Act, then must include publicly traded equity exposures (including those held indirectly through investment funds), and then must include non-publicly traded equity exposures (including those held indirectly through investment funds). (4) 250 percent risk weight equity exposures. Significant investments in the capital of unconsolidated financial institutions in the form of common stock that are not deducted from capital pursuant to § l.22(b)(4) are assigned a 250 percent risk weight. (5) 300 percent risk weight equity exposures. A publicly traded equity exposure (other than an equity exposure described in paragraph (b)(6) of this section and including the ineffective portion of a hedge pair) is assigned a 300 percent risk weight. (6) 400 percent risk weight equity exposures. An equity exposure (other than an equity exposure described in paragraph (b)(6) of this section) that is not publicly traded is assigned a 400 percent risk weight. (7) 600 percent risk weight equity exposures. An equity exposure to an investment firm that: (i) Would meet the definition of a traditional securitization were it not for the [AGENCY]’s application of paragraph (8) of that definition in § l.2; and (ii) Has greater than immaterial leverage is assigned a 600 percent risk weight. (c) Hedge transactions—(1) Hedge pair. A hedge pair is two equity exposures that form an effective hedge so long as each equity exposure is publicly traded or has a return that is primarily based on a publicly traded equity exposure. (2) Effective hedge. Two equity exposures form an effective hedge if the exposures either have the same remaining maturity or each has a remaining maturity of at least three months; the hedge relationship is formally documented in a prospective manner (that is, before the [BANK] acquires at least one of the equity exposures); the documentation specifies the measure of effectiveness (E) the [BANK] will use for the hedge relationship throughout the life of the transaction; and the hedge relationship E:\FR\FM\11OCR2.SGM 11OCR2 62242 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations change (RVC). The RVC is the ratio of the cumulative sum of the periodic changes in value of one equity exposure to the cumulative sum of the periodic changes in the value of the other equity exposure. If RVC is positive, the hedge is not effective and E equals zero. If RVC is negative and greater than or equal to –1 (that is, between zero and –1), then E equals the absolute value of RVC. If RVC is negative and less than –1, then E equals 2 plus RVC. (ii) Under the variability-reduction method of measuring effectiveness: (iii) Under the regression method of measuring effectiveness, E equals the coefficient of determination of a regression in which the change in value of one exposure in a hedge pair is the dependent variable and the change in value of the other exposure in a hedge pair is the independent variable. However, if the estimated regression coefficient is positive, then the value of E is zero. (3) The effective portion of a hedge pair is E multiplied by the greater of the adjusted carrying values of the equity exposures forming a hedge pair. (4) The ineffective portion of a hedge pair is (1–E) multiplied by the greater of the adjusted carrying values of the equity exposures forming a hedge pair. (ii) Are commensurate with the size, complexity, and composition of the [BANK]’s modeled equity exposures; and (iii) Adequately capture both general market risk and idiosyncratic risk. (2) The [BANK]’s model must produce an estimate of potential losses for its modeled equity exposures that is no less than the estimate of potential losses produced by a VaR methodology employing a 99th percentile one-tailed confidence interval of the distribution of quarterly returns for a benchmark portfolio of equity exposures comparable to the [BANK]’s modeled equity exposures using a long-term sample period. (3) The number of risk factors and exposures in the sample and the data period used for quantification in the [BANK]’s model and benchmarking exercise must be sufficient to provide confidence in the accuracy and robustness of the [BANK]’s estimates. (4) The [BANK]’s model and benchmarking process must incorporate data that are relevant in representing the risk profile of the [BANK]’s modeled equity exposures, and must include data from at least one equity market cycle containing adverse market movements relevant to the risk profile of the [BANK]’s modeled equity exposures. In addition, the [BANK]’s benchmarking exercise must be based on daily market prices for the benchmark portfolio. If the [BANK]’s model uses a scenario methodology, the [BANK] must demonstrate that the model produces a conservative estimate of potential losses on the [BANK]’s modeled equity exposures over a relevant long-term market cycle. If the [BANK] employs risk factor models, the [BANK] must demonstrate through empirical analysis the appropriateness of the risk factors used. (5) The [BANK] must be able to demonstrate, using theoretical arguments and empirical evidence, that any proxies used in the modeling process are comparable to the [BANK]’s modeled equity exposures and that the [BANK] has made appropriate adjustments for differences. The [BANK] must derive any proxies for its modeled equity exposures and benchmark portfolio using historical market data that are relevant to the [BANK]’s modeled equity exposures and benchmark portfolio (or, where not, must use appropriately adjusted data), and such proxies must be robust estimates of the risk of the [BANK]’s modeled equity exposures. (c) Risk-weighted assets calculation for a [BANK] using the IMA for publicly traded and non-publicly traded equity exposures. If a [BANK] models publicly traded and non-publicly traded equity exposures, the [BANK]’s aggregate riskweighted asset amount for its equity exposures is equal to the sum of: (1) The risk-weighted asset amount of each equity exposure that qualifies for a 0 percent, 20 percent, or 100 percent risk weight under § l.152(b)(1) through (b)(3)(i) (as determined under § l.152) and each equity exposure to an investment fund (as determined under § l.154); and (2) The greater of: wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.153 Internal models approach (IMA). (a) General. A [BANK] may calculate its risk-weighted asset amount for equity exposures using the IMA by modeling publicly traded and non-publicly traded equity exposures (in accordance with paragraph (c) of this section) or by modeling only publicly traded equity exposures (in accordance with paragraphs (c) and (d) of this section). (b) Qualifying criteria. To qualify to use the IMA to calculate risk-weighted assets for equity exposures, a [BANK] must receive prior written approval from the [AGENCY]. To receive such approval, the [BANK] must demonstrate to the [AGENCY]’s satisfaction that the [BANK] meets the following criteria: (1) The [BANK] must have one or more models that: (i) Assess the potential decline in value of its modeled equity exposures; VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00226 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.055</GPH> has an E greater than or equal to 0.8. A [BANK] must measure E at least quarterly and must use one of three alternative measures of E: (i) Under the dollar-offset method of measuring effectiveness, the [BANK] must determine the ratio of value wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (i) The estimate of potential losses on the [BANK]’s equity exposures (other than equity exposures referenced in paragraph (c)(1) of this section) generated by the [BANK]’s internal equity exposure model multiplied by 12.5; or (ii) The sum of: (A) 200 percent multiplied by the aggregate adjusted carrying value of the [BANK]’s publicly traded equity exposures that do not belong to a hedge pair, do not qualify for a 0 percent, 20 percent, or 100 percent risk weight under § l.152(b)(1) through (b)(3)(i), and are not equity exposures to an investment fund; (B) 200 percent multiplied by the aggregate ineffective portion of all hedge pairs; and (C) 300 percent multiplied by the aggregate adjusted carrying value of the [BANK]’s equity exposures that are not publicly traded, do not qualify for a 0 percent, 20 percent, or 100 percent risk weight under § l.152(b)(1) through (b)(3)(i), and are not equity exposures to an investment fund. (d) Risk-weighted assets calculation for a [BANK] using the IMA only for publicly traded equity exposures. If a [BANK] models only publicly traded equity exposures, the [BANK]’s aggregate risk-weighted asset amount for its equity exposures is equal to the sum of: (1) The risk-weighted asset amount of each equity exposure that qualifies for a 0 percent, 20 percent, or 100 percent risk weight under §§ l.152(b)(1) through (b)(3)(i) (as determined under § l.152), each equity exposure that qualifies for a 400 percent risk weight under § l.152(b)(5) or a 600 percent risk weight under § l.152(b)(6) (as determined under § l.152), and each equity exposure to an investment fund (as determined under § l.154); and (2) The greater of: (i) The estimate of potential losses on the [BANK]’s equity exposures (other than equity exposures referenced in paragraph (d)(1) of this section) generated by the [BANK]’s internal equity exposure model multiplied by 12.5; or (ii) The sum of: (A) 200 percent multiplied by the aggregate adjusted carrying value of the [BANK]’s publicly traded equity exposures that do not belong to a hedge pair, do not qualify for a 0 percent, 20 percent, or 100 percent risk weight under § l.152(b)(1) through (b)(3)(i), and are not equity exposures to an investment fund; and (B) 200 percent multiplied by the aggregate ineffective portion of all hedge pairs. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 § l.154 funds. Equity exposures to investment (a) Available approaches. (1) Unless the exposure meets the requirements for a community development equity exposure in § l.152(b)(3)(i), a [BANK] must determine the risk-weighted asset amount of an equity exposure to an investment fund under the full lookthrough approach in paragraph (b) of this section, the simple modified lookthrough approach in paragraph (c) of this section, or the alternative modified look-through approach in paragraph (d) of this section. (2) The risk-weighted asset amount of an equity exposure to an investment fund that meets the requirements for a community development equity exposure in § l.152(b)(3)(i) is its adjusted carrying value. (3) If an equity exposure to an investment fund is part of a hedge pair and the [BANK] does not use the full look-through approach, the [BANK] may use the ineffective portion of the hedge pair as determined under § l.152(c) as the adjusted carrying value for the equity exposure to the investment fund. The risk-weighted asset amount of the effective portion of the hedge pair is equal to its adjusted carrying value. (b) Full look-through approach. A [BANK] that is able to calculate a riskweighted asset amount for its proportional ownership share of each exposure held by the investment fund (as calculated under this subpart E of this part as if the proportional ownership share of each exposure were held directly by the [BANK]) may either: (1) Set the risk-weighted asset amount of the [BANK]’s exposure to the fund equal to the product of: (i) The aggregate risk-weighted asset amounts of the exposures held by the fund as if they were held directly by the [BANK]; and (ii) The [BANK]’s proportional ownership share of the fund; or (2) Include the [BANK]’s proportional ownership share of each exposure held by the fund in the [BANK]’s IMA. (c) Simple modified look-through approach. Under this approach, the risk-weighted asset amount for a [BANK]’s equity exposure to an investment fund equals the adjusted carrying value of the equity exposure multiplied by the highest risk weight assigned according to subpart D of this part that applies to any exposure the fund is permitted to hold under its prospectus, partnership agreement, or similar contract that defines the fund’s permissible investments (excluding derivative contracts that are used for hedging rather than speculative purposes and that do not constitute a PO 00000 Frm 00227 Fmt 4701 Sfmt 4700 62243 material portion of the fund’s exposures). (d) Alternative modified look-through approach. Under this approach, a [BANK] may assign the adjusted carrying value of an equity exposure to an investment fund on a pro rata basis to different risk weight categories assigned according to subpart D of this part based on the investment limits in the fund’s prospectus, partnership agreement, or similar contract that defines the fund’s permissible investments. The risk-weighted asset amount for the [BANK]’s equity exposure to the investment fund equals the sum of each portion of the adjusted carrying value assigned to an exposure class multiplied by the applicable risk weight. If the sum of the investment limits for all exposure types within the fund exceeds 100 percent, the [BANK] must assume that the fund invests to the maximum extent permitted under its investment limits in the exposure type with the highest risk weight under subpart D of this part, and continues to make investments in order of the exposure type with the next highest risk weight under subpart D of this part until the maximum total investment level is reached. If more than one exposure type applies to an exposure, the [BANK] must use the highest applicable risk weight. A [BANK] may exclude derivative contracts held by the fund that are used for hedging rather than for speculative purposes and do not constitute a material portion of the fund’s exposures. § l.155 Equity derivative contracts. (a) Under the IMA, in addition to holding risk-based capital against an equity derivative contract under this part, a [BANK] must hold risk-based capital against the counterparty credit risk in the equity derivative contract by also treating the equity derivative contract as a wholesale exposure and computing a supplemental riskweighted asset amount for the contract under § l.132. (b) Under the SRWA, a [BANK] may choose not to hold risk-based capital against the counterparty credit risk of equity derivative contracts, as long as it does so for all such contracts. Where the equity derivative contracts are subject to a qualified master netting agreement, a [BANK] using the SRWA must either include all or exclude all of the contracts from any measure used to determine counterparty credit risk exposure. E:\FR\FM\11OCR2.SGM 11OCR2 62244 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations §§ l.166 through l.160 [Reserved] Risk-Weighted Assets for Operational Risk wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.161 Qualification requirements for incorporation of operational risk mitigants. (a) Qualification to use operational risk mitigants. A [BANK] may adjust its estimate of operational risk exposure to reflect qualifying operational risk mitigants if: (1) The [BANK]’s operational risk quantification system is able to generate an estimate of the [BANK]’s operational risk exposure (which does not incorporate qualifying operational risk mitigants) and an estimate of the [BANK]’s operational risk exposure adjusted to incorporate qualifying operational risk mitigants; and (2) The [BANK]’s methodology for incorporating the effects of insurance, if the [BANK] uses insurance as an operational risk mitigant, captures through appropriate discounts to the amount of risk mitigation: (i) The residual term of the policy, where less than one year; (ii) The cancellation terms of the policy, where less than one year; (iii) The policy’s timeliness of payment; (iv) The uncertainty of payment by the provider of the policy; and (v) Mismatches in coverage between the policy and the hedged operational loss event. (b) Qualifying operational risk mitigants. Qualifying operational risk mitigants are: (1) Insurance that: (i) Is provided by an unaffiliated company that the [BANK] deems to have strong capacity to meet its claims payment obligations and the obligor rating category to which the [BANK] assigns the company is assigned a PD equal to or less than 10 basis points; (ii) Has an initial term of at least one year and a residual term of more than 90 days; (iii) Has a minimum notice period for cancellation by the provider of 90 days; (iv) Has no exclusions or limitations based upon regulatory action or for the receiver or liquidator of a failed depository institution; and (v) Is explicitly mapped to a potential operational loss event; (2) Operational risk mitigants other than insurance for which the [AGENCY] has given prior written approval. In evaluating an operational risk mitigant other than insurance, the [AGENCY] will consider whether the operational risk mitigant covers potential operational losses in a manner equivalent to holding total capital. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 § l.162 Mechanics of risk-weighted asset calculation. (a) If a [BANK] does not qualify to use or does not have qualifying operational risk mitigants, the [BANK]’s dollar riskbased capital requirement for operational risk is its operational risk exposure minus eligible operational risk offsets (if any). (b) If a [BANK] qualifies to use operational risk mitigants and has qualifying operational risk mitigants, the [BANK]’s dollar risk-based capital requirement for operational risk is the greater of: (1) The [BANK]’s operational risk exposure adjusted for qualifying operational risk mitigants minus eligible operational risk offsets (if any); or (2) 0.8 multiplied by the difference between: (i) The [BANK]’s operational risk exposure; and (ii) Eligible operational risk offsets (if any). (c) The [BANK]’s risk-weighted asset amount for operational risk equals the [BANK]’s dollar risk-based capital requirement for operational risk determined under sections 162(a) or (b) multiplied by 12.5. §§ l.163 through l.170 [Reserved] Disclosures § l.171 Purpose and scope. §§ l.171 through l.173 establish public disclosure requirements related to the capital requirements of a [BANK] that is an advanced approaches [BANK]. § l.172 Disclosure requirements. (a) A [BANK] that is an advanced approaches [BANK] that has completed the parallel run process and that has received notification from the [AGENCY] pursuant to section 121(d) of subpart E of this part must publicly disclose each quarter its total and tier 1 risk-based capital ratios and their components as calculated under this subpart (that is, common equity tier 1 capital, additional tier 1 capital, tier 2 capital, total qualifying capital, and total risk-weighted assets). (b) A [BANK] that is an advanced approaches [BANK] that has completed the parallel run process and that has received notification from the [AGENCY] pursuant to section 121(d) of subpart E of this part must comply with paragraph (c) of this section unless it is a consolidated subsidiary of a bank holding company, savings and loan holding company, or depository institution that is subject to these disclosure requirements or a subsidiary of a non-U.S. banking organization that is subject to comparable public PO 00000 Frm 00228 Fmt 4701 Sfmt 4700 disclosure requirements in its home jurisdiction. (c)(1) A [BANK] described in paragraph (b) of this section must provide timely public disclosures each calendar quarter of the information in the applicable tables in § l.173. If a significant change occurs, such that the most recent reported amounts are no longer reflective of the [BANK]’s capital adequacy and risk profile, then a brief discussion of this change and its likely impact must be disclosed as soon as practicable thereafter. Qualitative disclosures that typically do not change each quarter (for example, a general summary of the [BANK]’s risk management objectives and policies, reporting system, and definitions) may be disclosed annually after the end of the fourth calendar quarter, provided that any significant changes to these are disclosed in the interim. Management may provide all of the disclosures required by this subpart in one place on the [BANK]’s public Web site or may provide the disclosures in more than one public financial report or other regulatory reports, provided that the [BANK] publicly provides a summary table specifically indicating the location(s) of all such disclosures. (2) A [BANK] described in paragraph (b) of this section must have a formal disclosure policy approved by the board of directors that addresses its approach for determining the disclosures it makes. The policy must address the associated internal controls and disclosure controls and procedures. The board of directors and senior management are responsible for establishing and maintaining an effective internal control structure over financial reporting, including the disclosures required by this subpart, and must ensure that appropriate review of the disclosures takes place. One or more senior officers of the [BANK] must attest that the disclosures meet the requirements of this subpart. (3) If a [BANK] described in paragraph (b) of this section believes that disclosure of specific commercial or financial information would prejudice seriously its position by making public information that is either proprietary or confidential in nature, the [BANK] is not required to disclose those specific items, but must disclose more general information about the subject matter of the requirement, together with the fact that, and the reason why, the specific items of information have not been disclosed. E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations § l.173 Disclosures by certain advanced approaches [BANK]s. (a) Except as provided in § l.172(b), a [BANK] described in § l.172(b) must make the disclosures described in Tables 1 through 12 to § l.173. The [BANK] must make these disclosures publicly available for each of the last 62245 three years (that is, twelve quarters) or such shorter period beginning on January 1, 2014. TABLE 1 TO § l.173—SCOPE OF APPLICATION Qualitative disclosures .......................... (a) ................................ (b) ................................ (c) ................................ Quantitative disclosures ........................ (d) ................................ (e) ................................ The name of the top corporate entity in the group to which subpart E of this part applies. A brief description of the differences in the basis for consolidating entities1 for accounting and regulatory purposes, with a description of those entities: (1) That are fully consolidated; (2) That are deconsolidated and deducted from total capital; (3) For which the total capital requirement is deducted; and (4) That are neither consolidated nor deducted (for example, where the investment in the entity is assigned a risk weight in accordance with this subpart). Any restrictions, or other major impediments, on transfer of funds or total capital within the group. The aggregate amount of surplus capital of insurance subsidiaries included in the total capital of the consolidated group. The aggregate amount by which actual total capital is less than the minimum total capital requirement in all subsidiaries, with total capital requirements and the name(s) of the subsidiaries with such deficiencies. 1 Such entities include securities, insurance and other financial subsidiaries, commercial subsidiaries (where permitted), and significant minority equity investments in insurance, financial and commercial entities. TABLE 2 TO § l.173—CAPITAL STRUCTURE Qualitative disclosures .......................... (a) ................................ Quantitative disclosures ........................ (b) ................................ (c) ................................ (d) ................................ Summary information on the terms and conditions of the main features of all regulatory capital instruments. The amount of common equity tier 1 capital, with separate disclosure of: (1) Common stock and related surplus; (2) Retained earnings; (3) Common equity minority interest; (4) AOCI (net of tax) and other reserves; and (5) Regulatory adjustments and deductions made to common equity tier 1 capital. The amount of tier 1 capital, with separate disclosure of: (1) Additional tier 1 capital elements, including additional tier 1 capital instruments and tier 1 minority interest not included in common equity tier 1 capital; and (2) Regulatory adjustments and deductions made to tier 1 capital. The amount of total capital, with separate disclosure of: (1) Tier 2 capital elements, including tier 2 capital instruments and total capital minority interest not included in tier 1 capital; and (2) Regulatory adjustments and deductions made to total capital. TABLE 3 TO § l.173—CAPITAL ADEQUACY Qualitative disclosures .......................... (a) ................................ Quantitative disclosures ........................ (b) ................................ wreier-aviles on DSK5TPTVN1PROD with RULES2 (c) ................................ (d) ................................ (e) ................................ (f) ................................. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00229 A summary discussion of the [BANK]’s approach to assessing the adequacy of its capital to support current and future activities. Risk-weighted assets for credit risk from: (1) Wholesale exposures; (2) Residential mortgage exposures; (3) Qualifying revolving exposures; (4) Other retail exposures; (5) Securitization exposures; (6) Equity exposures: (7) Equity exposures subject to the simple risk weight approach; and (8) Equity exposures subject to the internal models approach. Standardized market risk-weighted assets and advanced market risk-weighted assets as calculated under subpart F of this part: (1) Standardized approach for specific risk; and (2) Internal models approach for specific risk. Risk-weighted assets for operational risk. Common equity tier 1, tier 1 and total risk-based capital ratios: (1) For the top consolidated group; and (2) For each depository institution subsidiary. Total risk-weighted assets. Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 62246 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations TABLE 4 TO § l.173—CAPITAL CONSERVATION AND COUNTERCYCLICAL CAPITAL BUFFERS Qualitative disclosures .......................... (a) ................................ Quantitative disclosures ........................ (b) ................................ (c) ................................ (d) ................................ (b) General qualitative disclosure requirement. For each separate risk area described in Tables 5 through 12 to § l.173, the [BANK] must describe its risk management objectives and policies, including: The [BANK] must publicly disclose the geographic breakdown of its private sector credit exposures used in the calculation of the countercyclical capital buffer. At least quarterly, the [BANK] must calculate and publicly disclose the capital conservation buffer and the countercyclical capital buffer as described under § l.11 of subpart B. At least quarterly, the [BANK] must calculate and publicly disclose the buffer retained income of the [BANK], as described under § l.11 of subpart B. At least quarterly, the [BANK] must calculate and publicly disclose any limitations it has on distributions and discretionary bonus payments resulting from the capital conservation buffer and the countercyclical capital buffer framework described under § l.11 of subpart B, including the maximum payout amount for the quarter. (1) Strategies and processes; (2) The structure and organization of the relevant risk management function; (3) The scope and nature of risk reporting and/or measurement systems; and (4) Policies for hedging and/or mitigating risk and strategies and processes for monitoring the continuing effectiveness of hedges/mitigants. TABLE 5 1 TO § l.173—CREDIT RISK: GENERAL DISCLOSURES Qualitative disclosures .......................... (a) ................................ Quantitative disclosures ........................ (b) ................................ (c) ................................ (d) ................................ wreier-aviles on DSK5TPTVN1PROD with RULES2 (e) ................................ (f) ................................. (g) ................................ VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00230 The general qualitative disclosure requirement with respect to credit risk (excluding counterparty credit risk disclosed in accordance with Table 7 to § l.173), including: (1) Policy for determining past due or delinquency status; (2) Policy for placing loans on nonaccrual; (3) Policy for returning loans to accrual status; (4) Definition of and policy for identifying impaired loans (for financial accounting purposes). (5) Description of the methodology that the entity uses to estimate its allowance for loan and lease losses, including statistical methods used where applicable; (6) Policy for charging-off uncollectible amounts; and (7) Discussion of the [BANK]’s credit risk management policy Total credit risk exposures and average credit risk exposures, after accounting offsets in accordance with GAAP,2 without taking into account the effects of credit risk mitigation techniques (for example, collateral and netting not permitted under GAAP), over the period categorized by major types of credit exposure. For example, [BANK]s could use categories similar to that used for financial statement purposes. Such categories might include, for instance: (1) Loans, off-balance sheet commitments, and other non-derivative off-balance sheet exposures; (2) Debt securities; and (3) OTC derivatives. Geographic 3 distribution of exposures, categorized in significant areas by major types of credit exposure. Industry or counterparty type distribution of exposures, categorized by major types of credit exposure. By major industry or counterparty type: (1) Amount of impaired loans for which there was a related allowance under GAAP; (2) Amount of impaired loans for which there was no related allowance under GAAP; (3) Amount of loans past due 90 days and on nonaccrual; (4) Amount of loans past due 90 days and still accruing; 4 (5) The balance in the allowance for loan and lease losses at the end of each period, disaggregated on the basis of the entity’s impairment method. To disaggregate the information required on the basis of impairment methodology, an entity shall separately disclose the amounts based on the requirements in GAAP; and (6) Charge-offs during the period. Amount of impaired loans and, if available, the amount of past due loans categorized by significant geographic areas including, if practical, the amounts of allowances related to each geographical area,5 further categorized as required by GAAP. Reconciliation of changes in ALLL.6 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 62247 TABLE 5 1 TO § l.173—CREDIT RISK: GENERAL DISCLOSURES—Continued (h) ................................ Remaining contractual maturity breakdown (for example, one year or less) of the whole portfolio, categorized by credit exposure. 5 to § l.173 does not cover equity exposures, which should be reported in Table 9. for example, ASC Topic 815–10 and 210–20 as they may be amended from time to time. areas may comprise individual countries, groups of countries, or regions within countries. A [BANK] might choose to define the geographical areas based on the way the company’s portfolio is geographically managed. The criteria used to allocate the loans to geographical areas must be specified. 4 A [BANK] is encouraged also to provide an analysis of the aging of past-due loans. 5 The portion of the general allowance that is not allocated to a geographical area should be disclosed separately. 6 The reconciliation should include the following: A description of the allowance; the opening balance of the allowance; charge-offs taken against the allowance during the period; amounts provided (or reversed) for estimated probable loan losses during the period; any other adjustments (for example, exchange rate differences, business combinations, acquisitions and disposals of subsidiaries), including transfers between allowances; and the closing balance of the allowance. Charge-offs and recoveries that have been recorded directly to the income statement should be disclosed separately. 1 Table 2 See, 3 Geographical TABLE 6 TO § l.173—CREDIT RISK: DISCLOSURES FOR PORTFOLIOS SUBJECT TO IRB RISK-BASED CAPITAL FORMULAS Qualitative disclosures .......................... (a) ................................ (b) ................................ Quantitative disclosures: risk assessment. (c) ................................ Quantitative disclosures: historical results. (d) ................................ wreier-aviles on DSK5TPTVN1PROD with RULES2 (e) ................................ Explanation and review of the: (1) Structure of internal rating systems and relation between internal and external ratings; (2) Use of risk parameter estimates other than for regulatory capital purposes; (3) Process for managing and recognizing credit risk mitigation (see Table 8 to § l.173); and (4) Control mechanisms for the rating system, including discussion of independence, accountability, and rating systems review. Description of the internal ratings process, provided separately for the following: (1) Wholesale category; (2) Retail subcategories; (i) Residential mortgage exposures; (ii) Qualifying revolving exposures; and (iii) Other retail exposures. For each category and subcategory above the description should include: (A) The types of exposure included in the category/subcategories; and (B) The definitions, methods and data for estimation and validation of PD, LGD, and EAD, including assumptions employed in the derivation of these variables.1 (1) For wholesale exposures, present the following information across a sufficient number of PD grades (including default) to allow for a meaningful differentiation of credit risk: 2 (i) Total EAD; 3 (ii) Exposure-weighted average LGD (percentage); (iii) Exposure-weighted average risk weight; and (iv) Amount of undrawn commitments and exposure-weighted average EAD including average drawdowns prior to default for wholesale exposures. (2) For each retail subcategory, present the disclosures outlined above across a sufficient number of segments to allow for a meaningful differentiation of credit risk. Actual losses in the preceding period for each category and subcategory and how this differs from past experience. A discussion of the factors that impacted the loss experience in the preceding period—for example, has the [BANK] experienced higher than average default rates, loss rates or EADs. The [BANK]’s estimates compared against actual outcomes over a longer period.4 At a minimum, this should include information on estimates of losses against actual losses in the wholesale category and each retail subcategory over a period sufficient to allow for a meaningful assessment of the performance of the internal rating processes for each category/subcategory.5 Where appropriate, the [BANK] should further decompose this to provide analysis of PD, LGD, and EAD outcomes against estimates provided in the quantitative risk assessment disclosures above.6 1 This disclosure item does not require a detailed description of the model in full—it should provide the reader with a broad overview of the model approach, describing definitions of the variables and methods for estimating and validating those variables set out in the quantitative risk disclosures below. This should be done for each of the four category/subcategories. The [BANK] must disclose any significant differences in approach to estimating these variables within each category/subcategories. 2 The PD, LGD and EAD disclosures in Table 6 (c) to § l.173 should reflect the effects of collateral, qualifying master netting agreements, eligible guarantees and eligible credit derivatives as defined under this part. Disclosure of each PD grade should include the exposure-weighted average PD for each grade. Where a [BANK] aggregates PD grades for the purposes of disclosure, this should be a representative breakdown of the distribution of PD grades used for regulatory capital purposes. 3 Outstanding loans and EAD on undrawn commitments can be presented on a combined basis for these disclosures. 4 These disclosures are a way of further informing the reader about the reliability of the information provided in the ‘‘quantitative disclosures: Risk assessment’’ over the long run. The disclosures are requirements from year-end 2010; in the meantime, early adoption is encouraged. The phased implementation is to allow a [BANK] sufficient time to build up a longer run of data that will make these disclosures meaningful. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00231 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 62248 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 5 This disclosure item is not intended to be prescriptive about the period used for this assessment. Upon implementation, it is expected that a [BANK] would provide these disclosures for as long a set of data as possible—for example, if a [BANK] has 10 years of data, it might choose to disclose the average default rates for each PD grade over that 10-year period. Annual amounts need not be disclosed. 6 A [BANK] must provide this further decomposition where it will allow users greater insight into the reliability of the estimates provided in the ‘‘quantitative disclosures: Risk assessment.’’ In particular, it must provide this information where there are material differences between its estimates of PD, LGD or EAD compared to actual outcomes over the long run. The [BANK] must also provide explanations for such differences. TABLE 7 TO § l.173—GENERAL DISCLOSURE FOR COUNTERPARTY CREDIT RISK OF OTC DERIVATIVE CONTRACTS, REPO-STYLE TRANSACTIONS, AND ELIGIBLE MARGIN LOANS Qualitative Disclosures .......................... (a) ................................ Quantitative Disclosures ....................... (b) ................................ (c) ................................ (d) ................................ The general qualitative disclosure requirement with respect to OTC derivatives, eligible margin loans, and repo-style transactions, including: (1) Discussion of methodology used to assign economic capital and credit limits for counterparty credit exposures; (2) Discussion of policies for securing collateral, valuing and managing collateral, and establishing credit reserves; (3) Discussion of the primary types of collateral taken; (4) Discussion of policies with respect to wrong-way risk exposures; and (5) Discussion of the impact of the amount of collateral the [BANK] would have to provide if the [BANK] were to receive a credit rating downgrade. Gross positive fair value of contracts, netting benefits, netted current credit exposure, collateral held (including type, for example, cash, government securities), and net unsecured credit exposure.1 Also report measures for EAD used for regulatory capital for these transactions, the notional value of credit derivative hedges purchased for counterparty credit risk protection, and, for [BANK]s not using the internal models methodology in § l.132(d) , the distribution of current credit exposure by types of credit exposure.2 Notional amount of purchased and sold credit derivatives, segregated between use for the [BANK]’s own credit portfolio and for its intermediation activities, including the distribution of the credit derivative products used, categorized further by protection bought and sold within each product group. The estimate of alpha if the [BANK] has received supervisory approval to estimate alpha. 1 Net unsecured credit exposure is the credit exposure after considering the benefits from legally enforceable netting agreements and collateral arrangements, without taking into account haircuts for price volatility, liquidity, etc. 2 This may include interest rate derivative contracts, foreign exchange derivative contracts, equity derivative contracts, credit derivatives, commodity or other derivative contracts, repo-style transactions, and eligible margin loans. TABLE 8 TO § l.173—CREDIT RISK MITIGATION 1 2 Qualitative disclosures .......................... (a) ................................ Quantitative disclosures ........................ (b) ................................ The general qualitative disclosure requirement with respect to credit risk mitigation, including: (1) Policies and processes for, and an indication of the extent to which the [BANK] uses, on- or off-balance sheet netting; (2) Policies and processes for collateral valuation and management; (3) A description of the main types of collateral taken by the [BANK]; (4) The main types of guarantors/credit derivative counterparties and their creditworthiness; and (5) Information about (market or credit) risk concentrations within the mitigation taken. For each separately disclosed portfolio, the total exposure (after, where applicable, on- or off-balance sheet netting) that is covered by guarantees/credit derivatives. 1 At a minimum, a [BANK] must provide the disclosures in Table 8 in relation to credit risk mitigation that has been recognized for the purposes of reducing capital requirements under this subpart. Where relevant, [BANK]s are encouraged to give further information about mitigants that have not been recognized for that purpose. 2 Credit derivatives and other credit mitigation that are treated for the purposes of this subpart as synthetic securitization exposures should be excluded from the credit risk mitigation disclosures (in Table 8 to § l.173) and included within those relating to securitization (in Table 9 to § l.173). TABLE 9 TO § l.173—SECURITIZATION wreier-aviles on DSK5TPTVN1PROD with RULES2 Qualitative disclosures .......................... VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (a) ................................ PO 00000 Frm 00232 The general qualitative disclosure requirement with respect to securitization (including synthetic securitizations), including a discussion of: (1) The [BANK]’s objectives for securitizing assets, including the extent to which these activities transfer credit risk of the underlying exposures away from the [BANK] to other entities and including the type of risks assumed and retained with resecuritization activity; 1 (2) The nature of the risks (e.g. liquidity risk) inherent in the securitized assets; (3) The roles played by the [BANK] in the securitization process 2 and an indication of the extent of the [BANK]’s involvement in each of them; Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 62249 TABLE 9 TO § l.173—SECURITIZATION—Continued (b) ................................ (c) ................................ (d) ................................ Quantitative disclosures ........................ (e) ................................ (f) ................................. (g) ................................ (h) ................................ (i) ................................. (j) ................................. wreier-aviles on DSK5TPTVN1PROD with RULES2 (k) ................................ (4) The processes in place to monitor changes in the credit and market risk of securitization exposures including how those processes differ for resecuritization exposures; (5) The [BANK]’s policy for mitigating the credit risk retained through securitization and resecuritization exposures; and (6) The risk-based capital approaches that the [BANK] follows for its securitization exposures including the type of securitization exposure to which each approach applies. A list of: (1) The type of securitization SPEs that the [BANK], as sponsor, uses to securitize third-party exposures. The [BANK] must indicate whether it has exposure to these SPEs, either on- or off- balance sheet; and (2) Affiliated entities: (i) That the [BANK] manages or advises; and (ii) That invest either in the securitization exposures that the [BANK] has securitized or in securitization SPEs that the [BANK] sponsors.3 Summary of the [BANK]’s accounting policies for securitization activities, including: (1) Whether the transactions are treated as sales or financings; (2) Recognition of gain-on-sale; (3) Methods and key assumptions and inputs applied in valuing retained or purchased interests; (4) Changes in methods and key assumptions and inputs from the previous period for valuing retained interests and impact of the changes; (5) Treatment of synthetic securitizations; (6) How exposures intended to be securitized are valued and whether they are recorded under subpart E of this part; and (7) Policies for recognizing liabilities on the balance sheet for arrangements that could require the [BANK] to provide financial support for securitized assets. An explanation of significant changes to any of the quantitative information set forth below since the last reporting period. The total outstanding exposures securitized 4 by the [BANK] in securitizations that meet the operational criteria in § l.141 (categorized into traditional/ synthetic), by underlying exposure type 5 separately for securitizations of third-party exposures for which the bank acts only as sponsor. For exposures securitized by the [BANK] in securitizations that meet the operational criteria in § l.141: (1) Amount of securitized assets that are impaired 6/past due categorized by exposure type; and (2) Losses recognized by the [BANK] during the current period categorized by exposure type.7 The total amount of outstanding exposures intended to be securitized categorized by exposure type. Aggregate amount of: (1) On-balance sheet securitization exposures retained or purchased categorized by exposure type; and (2) Off-balance sheet securitization exposures categorized by exposure type. (1) Aggregate amount of securitization exposures retained or purchased and the associated capital requirements for these exposures, categorized between securitization and resecuritization exposures, further categorized into a meaningful number of risk weight bands and by risk-based capital approach (e.g. SA, SFA, or SSFA). (2) Exposures that have been deducted entirely from tier 1 capital, CEIOs deducted from total capital (as described in § l.42(a)(1), and other exposures deducted from total capital should be disclosed separately by exposure type. Summary of current year’s securitization activity, including the amount of exposures securitized (by exposure type), and recognized gain or loss on sale by asset type. Aggregate amount of resecuritization exposures retained or purchased categorized according to: (1) Exposures to which credit risk mitigation is applied and those not applied; and (2) Exposures to guarantors categorized according to guarantor creditworthiness categories or guarantor name. 1 The [BANK] must describe the structure of resecuritizations in which it participates; this description must be provided for the main categories of resecuritization products in which the [BANK] is active. 2 For example, these roles would include originator, investor, servicer, provider of credit enhancement, sponsor, liquidity provider, or swap provider. 3 For example, money market mutual funds should be listed individually, and personal and private trusts, should be noted collectively. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00233 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 62250 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 4 ‘‘Exposures securitized’’ include underlying exposures originated by the bank, whether generated by them or purchased, and recognized in the balance sheet, from third parties, and third-party exposures included in sponsored transactions. Securitization transactions (including underlying exposures originally on the bank’s balance sheet and underlying exposures acquired by the bank from third-party entities) in which the originating bank does not retain any securitization exposure should be shown separately but need only be reported for the year of inception. 5 A [BANK] is required to disclose exposures regardless of whether there is a capital charge under this part. 6 A [BANK] must include credit-related other than temporary impairment (OTTI). 7 For example, charge-offs/allowances (if the assets remain on the bank’s balance sheet) or credit-related OTTI of I/O strips and other retained residual interests, as well as recognition of liabilities for probable future financial support required of the bank with respect to securitized assets. TABLE 10 TO § l.173—OPERATIONAL RISK Qualitative disclosures .......................... (a) ................................ (b) ................................ (c) ................................ The general qualitative disclosure requirement for operational risk. Description of the AMA, including a discussion of relevant internal and external factors considered in the [BANK]’s measurement approach. A description of the use of insurance for the purpose of mitigating operational risk. TABLE 11 TO § l.173—EQUITIES NOT SUBJECT TO SUBPART F OF THIS PART Qualitative disclosures .......................... (a) ................................ Quantitative disclosures ........................ (b) ................................ (c) ................................ (d) ................................ (e) ................................ (f) ................................. The general qualitative disclosure requirement with respect to the equity risk of equity holdings not subject to subpart F of this part, including: (1) Differentiation between holdings on which capital gains are expected and those held for other objectives, including for relationship and strategic reasons; and (2) Discussion of important policies covering the valuation of and accounting for equity holdings not subject to subpart F of this part. This includes the accounting methodology and valuation methodologies used, including key assumptions and practices affecting valuation as well as significant changes in these practices. Carrying value on the balance sheet of equity investments, as well as the fair value of those investments. The types and nature of investments, including the amount that is: (1) Publicly traded; and (2) Non-publicly traded. The cumulative realized gains (losses) arising from sales and liquidations in the reporting period. (1) Total unrealized gains (losses) 1 (2) Total latent revaluation gains (losses) 2 (3) Any amounts of the above included in tier 1 and/or tier 2 capital. Capital requirements categorized by appropriate equity groupings, consistent with the [BANK]’s methodology, as well as the aggregate amounts and the type of equity investments subject to any supervisory transition regarding total capital requirements.3 1 Unrealized gains (losses) recognized in the balance sheet but not through earnings. gains (losses) not recognized either in the balance sheet or through earnings. disclosure must include a breakdown of equities that are subject to the 0 percent, 20 percent, 100 percent, 300 percent, 400 percent, and 600 percent risk weights, as applicable. 2 Unrealized 3 This TABLE 12 TO § l.173—INTEREST RATE RISK FOR NON-TRADING ACTIVITIES Qualitative disclosures .......................... (a) ................................ Quantitative disclosures ........................ (b) ................................ wreier-aviles on DSK5TPTVN1PROD with RULES2 §§l.174 through l.200 [Reserved] Subpart F—Risk-Weighted Assets— Market Risk § l.201 Purpose, applicability, and reservation of authority. (a) Purpose. This subpart F establishes risk-based capital requirements for [BANK]s with significant exposure to market risk, provides methods for these [BANK]s to calculate their standardized VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 The general qualitative disclosure requirement, including the nature of interest rate risk for non-trading activities and key assumptions, including assumptions regarding loan prepayments and behavior of non-maturity deposits, and frequency of measurement of interest rate risk for non-trading activities. The increase (decline) in earnings or economic value (or relevant measure used by management) for upward and downward rate shocks according to management’s method for measuring interest rate risk for non-trading activities, categorized by currency (as appropriate). measure for market risk and, if applicable, advanced measure for market risk, and establishes public disclosure requirements. (b) Applicability. (1) This subpart F applies to any [BANK] with aggregate trading assets and trading liabilities (as reported in the [BANK]’s most recent quarterly [regulatory report]), equal to: (i) 10 percent or more of quarter-end total assets as reported on the most PO 00000 Frm 00234 Fmt 4701 Sfmt 4700 recent quarterly [Call Report or FR Y– 9C]; or (ii) $1 billion or more. (2) The [AGENCY] may apply this subpart to any [BANK] if the [AGENCY] deems it necessary or appropriate because of the level of market risk of the [BANK] or to ensure safe and sound banking practices. (3) The [AGENCY] may exclude a [BANK] that meets the criteria of E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations paragraph (b)(1) of this section from application of this subpart if the [AGENCY] determines that the exclusion is appropriate based on the level of market risk of the [BANK] and is consistent with safe and sound banking practices. (c) Reservation of authority (1) The [AGENCY] may require a [BANK] to hold an amount of capital greater than otherwise required under this subpart if the [AGENCY] determines that the [BANK]’s capital requirement for market risk as calculated under this subpart is not commensurate with the market risk of the [BANK]’s covered positions. In making determinations under paragraphs (c)(1) through (c)(3) of this section, the [AGENCY] will apply notice and response procedures generally in the same manner as the notice and response procedures set forth in [12 CFR 3.404, 12 CFR 263.202, 12 CFR 324.5(c)]. (2) If the [AGENCY] determines that the risk-based capital requirement calculated under this subpart by the [BANK] for one or more covered positions or portfolios of covered positions is not commensurate with the risks associated with those positions or portfolios, the [AGENCY] may require the [BANK] to assign a different riskbased capital requirement to the positions or portfolios that more accurately reflects the risk of the positions or portfolios. (3) The [AGENCY] may also require a [BANK] to calculate risk-based capital requirements for specific positions or portfolios under this subpart, or under subpart D or subpart E of this part, as appropriate, to more accurately reflect the risks of the positions. (4) Nothing in this subpart limits the authority of the [AGENCY] under any other provision of law or regulation to take supervisory or enforcement action, including action to address unsafe or unsound practices or conditions, deficient capital levels, or violations of law. wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.202 Definitions. (a) Terms set forth in § l.2 and used in this subpart have the definitions assigned thereto in § l.2. (b) For the purposes of this subpart, the following terms are defined as follows: Backtesting means the comparison of a [BANK]’s internal estimates with actual outcomes during a sample period not used in model development. For purposes of this subpart, backtesting is one form of out-of-sample testing. Commodity position means a position for which price risk arises from changes in the price of a commodity. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 Corporate debt position means a debt position that is an exposure to a company that is not a sovereign entity, the Bank for International Settlements, the European Central Bank, the European Commission, the International Monetary Fund, a multilateral development bank, a depository institution, a foreign bank, a credit union, a public sector entity, a GSE, or a securitization. Correlation trading position means: (1) A securitization position for which all or substantially all of the value of the underlying exposures is based on the credit quality of a single company for which a two-way market exists, or on commonly traded indices based on such exposures for which a two-way market exists on the indices; or (2) A position that is not a securitization position and that hedges a position described in paragraph (1) of this definition; and (3) A correlation trading position does not include: (i) A resecuritization position; (ii) A derivative of a securitization position that does not provide a pro rata share in the proceeds of a securitization tranche; or (iii) A securitization position for which the underlying assets or reference exposures are retail exposures, residential mortgage exposures, or commercial mortgage exposures. Covered position means the following positions: (1) A trading asset or trading liability (whether on- or off-balance sheet),27 as reported on [REGULATORY REPORT], that meets the following conditions: (i) The position is a trading position or hedges another covered position; 28 and (ii) The position is free of any restrictive covenants on its tradability or the [BANK] is able to hedge the material risk elements of the position in a twoway market; (2) A foreign exchange or commodity position, regardless of whether the position is a trading asset or trading liability (excluding any structural foreign currency positions that the [BANK] chooses to exclude with prior supervisory approval); and (3) Notwithstanding paragraphs (1) and (2) of this definition, a covered position does not include: (i) An intangible asset, including any servicing asset; 27 Securities subject to repurchase and lending agreements are included as if they are still owned by the lender. 28 A position that hedges a trading position must be within the scope of the bank’s hedging strategy as described in paragraph (a)(2) of section 203 of this subpart. PO 00000 Frm 00235 Fmt 4701 Sfmt 4700 62251 (ii) Any hedge of a trading position that the [AGENCY] determines to be outside the scope of the [BANK]’s hedging strategy required in paragraph (a)(2) of § l.203; (iii) Any position that, in form or substance, acts as a liquidity facility that provides support to asset-backed commercial paper; (iv) A credit derivative the [BANK] recognizes as a guarantee for riskweighted asset amount calculation purposes under subpart D or subpart E of this part; (v) Any position that is recognized as a credit valuation adjustment hedge under § l.132(e)(5) or § l.132(e)(6), except as provided in § l.132(e)(6)(vii); (vi) Any equity position that is not publicly traded, other than a derivative that references a publicly traded equity and other than a position in an investment company as defined in and registered with the SEC under the Investment Company Act of 1940 (15 U.S.C. 80a–1 et seq.), provided that all the underlying equities held by the investment company are publicly traded; (vii) Any equity position that is not publicly traded, other than a derivative that references a publicly traded equity and other than a position in an entity not domiciled in the United States (or a political subdivision thereof) that is supervised and regulated in a manner similar to entities described in paragraph (3)(vi) of this definition; (viii) Any position a [BANK] holds with the intent to securitize; or (ix) Any direct real estate holding. Debt position means a covered position that is not a securitization position or a correlation trading position and that has a value that reacts primarily to changes in interest rates or credit spreads. Default by a sovereign entity has the same meaning as the term sovereign default under § l.2. Equity position means a covered position that is not a securitization position or a correlation trading position and that has a value that reacts primarily to changes in equity prices. Event risk means the risk of loss on equity or hybrid equity positions as a result of a financial event, such as the announcement or occurrence of a company merger, acquisition, spin-off, or dissolution. Foreign exchange position means a position for which price risk arises from changes in foreign exchange rates. General market risk means the risk of loss that could result from broad market movements, such as changes in the general level of interest rates, credit E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62252 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations spreads, equity prices, foreign exchange rates, or commodity prices. Hedge means a position or positions that offset all, or substantially all, of one or more material risk factors of another position. Idiosyncratic risk means the risk of loss in the value of a position that arises from changes in risk factors unique to that position. Incremental risk means the default risk and credit migration risk of a position. Default risk means the risk of loss on a position that could result from the failure of an obligor to make timely payments of principal or interest on its debt obligation, and the risk of loss that could result from bankruptcy, insolvency, or similar proceeding. Credit migration risk means the price risk that arises from significant changes in the underlying credit quality of the position. Market risk means the risk of loss on a position that could result from movements in market prices. Resecuritization position means a covered position that is: (1) An on- or off-balance sheet exposure to a resecuritization; or (2) An exposure that directly or indirectly references a resecuritization exposure in paragraph (1) of this definition. Securitization means a transaction in which: (1) All or a portion of the credit risk of one or more underlying exposures is transferred to one or more third parties; (2) The credit risk associated with the underlying exposures has been separated into at least two tranches that reflect different levels of seniority; (3) Performance of the securitization exposures depends upon the performance of the underlying exposures; (4) All or substantially all of the underlying exposures are financial exposures (such as loans, commitments, credit derivatives, guarantees, receivables, asset-backed securities, mortgage-backed securities, other debt securities, or equity securities); (5) For non-synthetic securitizations, the underlying exposures are not owned by an operating company; (6) The underlying exposures are not owned by a small business investment company described in section 302 of the Small Business Investment Act; (7) The underlying exposures are not owned by a firm an investment in which qualifies as a community development investment under section 24(Eleventh) of the National Bank Act; (8) The [AGENCY] may determine that a transaction in which the underlying exposures are owned by an VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 investment firm that exercises substantially unfettered control over the size and composition of its assets, liabilities, and off-balance sheet exposures is not a securitization based on the transaction’s leverage, risk profile, or economic substance; (9) The [AGENCY] may deem an exposure to a transaction that meets the definition of a securitization, notwithstanding paragraph (5), (6), or (7) of this definition, to be a securitization based on the transaction’s leverage, risk profile, or economic substance; and (10) The transaction is not: (i) An investment fund; (ii) A collective investment fund (as defined in [12 CFR 208.34 (Board), 12 CFR 9.18 (OCC)]); (iii) An employee benefit plan as defined in paragraphs (3) and (32) of section 3 of ERISA, a ‘‘governmental plan’’ (as defined in 29 U.S.C. 1002(32)) that complies with the tax deferral qualification requirements provided in the Internal Revenue Code, or any similar employee benefit plan established under the laws of a foreign jurisdiction; or (iv) Registered with the SEC under the Investment Company Act of 1940 (15 U.S.C. 80a–1 et seq.) or foreign equivalents thereof. Securitization position means a covered position that is: (1) An on-balance sheet or off-balance sheet credit exposure (including creditenhancing representations and warranties) that arises from a securitization (including a resecuritization); or (2) An exposure that directly or indirectly references a securitization exposure described in paragraph (1) of this definition. Sovereign debt position means a direct exposure to a sovereign entity. Specific risk means the risk of loss on a position that could result from factors other than broad market movements and includes event risk, default risk, and idiosyncratic risk. Structural position in a foreign currency means a position that is not a trading position and that is: (1) Subordinated debt, equity, or minority interest in a consolidated subsidiary that is denominated in a foreign currency; (2) Capital assigned to foreign branches that is denominated in a foreign currency; (3) A position related to an unconsolidated subsidiary or another item that is denominated in a foreign currency and that is deducted from the [BANK]’s tier 1 or tier 2 capital; or (4) A position designed to hedge a [BANK]’s capital ratios or earnings PO 00000 Frm 00236 Fmt 4701 Sfmt 4700 against the effect on paragraphs (1), (2), or (3) of this definition of adverse exchange rate movements. Term repo-style transaction means a repo-style transaction that has an original maturity in excess of one business day. Trading position means a position that is held by the [BANK] for the purpose of short-term resale or with the intent of benefiting from actual or expected short-term price movements, or to lock in arbitrage profits. Two-way market means a market where there are independent bona fide offers to buy and sell so that a price reasonably related to the last sales price or current bona fide competitive bid and offer quotations can be determined within one day and settled at that price within a relatively short time frame conforming to trade custom. Value-at-Risk (VaR) means the estimate of the maximum amount that the value of one or more positions could decline due to market price or rate movements during a fixed holding period within a stated confidence interval. § l.203 Requirements for application of this subpart F. (a) Trading positions—(1) Identification of trading positions. A [BANK] must have clearly defined policies and procedures for determining which of its trading assets and trading liabilities are trading positions and which of its trading positions are correlation trading positions. These policies and procedures must take into account: (i) The extent to which a position, or a hedge of its material risks, can be marked-to-market daily by reference to a two-way market; and (ii) Possible impairments to the liquidity of a position or its hedge. (2) Trading and hedging strategies. A [BANK] must have clearly defined trading and hedging strategies for its trading positions that are approved by senior management of the [BANK]. (i) The trading strategy must articulate the expected holding period of, and the market risk associated with, each portfolio of trading positions. (ii) The hedging strategy must articulate for each portfolio of trading positions the level of market risk the [BANK] is willing to accept and must detail the instruments, techniques, and strategies the [BANK] will use to hedge the risk of the portfolio. (b) Management of covered positions—(1) Active management. A [BANK] must have clearly defined policies and procedures for actively managing all covered positions. At a E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations minimum, these policies and procedures must require: (i) Marking positions to market or to model on a daily basis; (ii) Daily assessment of the [BANK]’s ability to hedge position and portfolio risks, and of the extent of market liquidity; (iii) Establishment and daily monitoring of limits on positions by a risk control unit independent of the trading business unit; (iv) Daily monitoring by senior management of information described in paragraphs (b)(1)(i) through (b)(1)(iii) of this section; (v) At least annual reassessment of established limits on positions by senior management; and (vi) At least annual assessments by qualified personnel of the quality of market inputs to the valuation process, the soundness of key assumptions, the reliability of parameter estimation in pricing models, and the stability and accuracy of model calibration under alternative market scenarios. (2) Valuation of covered positions. The [BANK] must have a process for prudent valuation of its covered positions that includes policies and procedures on the valuation of positions, marking positions to market or to model, independent price verification, and valuation adjustments or reserves. The valuation process must consider, as appropriate, unearned credit spreads, close-out costs, early termination costs, investing and funding costs, liquidity, and model risk. (c) Requirements for internal models. (1) A [BANK] must obtain the prior written approval of the [AGENCY] before using any internal model to calculate its risk-based capital requirement under this subpart. (2) A [BANK] must meet all of the requirements of this section on an ongoing basis. The [BANK] must promptly notify the [AGENCY] when: (i) The [BANK] plans to extend the use of a model that the [AGENCY] has approved under this subpart to an additional business line or product type; (ii) The [BANK] makes any change to an internal model approved by the [AGENCY] under this subpart that would result in a material change in the [BANK]’s risk-weighted asset amount for a portfolio of covered positions; or (iii) The [BANK] makes any material change to its modeling assumptions. (3) The [AGENCY] may rescind its approval of the use of any internal model (in whole or in part) or of the determination of the approach under § l.209(a)(2)(ii) for a [BANK]’s modeled correlation trading positions and determine an appropriate capital VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 requirement for the covered positions to which the model would apply, if the [AGENCY] determines that the model no longer complies with this subpart or fails to reflect accurately the risks of the [BANK]’s covered positions. (4) The [BANK] must periodically, but no less frequently than annually, review its internal models in light of developments in financial markets and modeling technologies, and enhance those models as appropriate to ensure that they continue to meet the [AGENCY]’s standards for model approval and employ risk measurement methodologies that are most appropriate for the [BANK]’s covered positions. (5) The [BANK] must incorporate its internal models into its risk management process and integrate the internal models used for calculating its VaR-based measure into its daily risk management process. (6) The level of sophistication of a [BANK]’s internal models must be commensurate with the complexity and amount of its covered positions. A [BANK]’s internal models may use any of the generally accepted approaches, including but not limited to variancecovariance models, historical simulations, or Monte Carlo simulations, to measure market risk. (7) The [BANK]’s internal models must properly measure all the material risks in the covered positions to which they are applied. (8) The [BANK]’s internal models must conservatively assess the risks arising from less liquid positions and positions with limited price transparency under realistic market scenarios. (9) The [BANK] must have a rigorous and well-defined process for reestimating, re-evaluating, and updating its internal models to ensure continued applicability and relevance. (10) If a [BANK] uses internal models to measure specific risk, the internal models must also satisfy the requirements in paragraph (b)(1) of § l.207. (d) Control, oversight, and validation mechanisms. (1) The [BANK] must have a risk control unit that reports directly to senior management and is independent from the business trading units. (2) The [BANK] must validate its internal models initially and on an ongoing basis. The [BANK]’s validation process must be independent of the internal models’ development, implementation, and operation, or the validation process must be subjected to an independent review of its adequacy and effectiveness. Validation must include: PO 00000 Frm 00237 Fmt 4701 Sfmt 4700 62253 (i) An evaluation of the conceptual soundness of (including developmental evidence supporting) the internal models; (ii) An ongoing monitoring process that includes verification of processes and the comparison of the [BANK]’s model outputs with relevant internal and external data sources or estimation techniques; and (iii) An outcomes analysis process that includes backtesting. For internal models used to calculate the VaR-based measure, this process must include a comparison of the changes in the [BANK]’s portfolio value that would have occurred were end-of-day positions to remain unchanged (therefore, excluding fees, commissions, reserves, net interest income, and intraday trading) with VaR-based measures during a sample period not used in model development. (3) The [BANK] must stress test the market risk of its covered positions at a frequency appropriate to each portfolio, and in no case less frequently than quarterly. The stress tests must take into account concentration risk (including but not limited to concentrations in single issuers, industries, sectors, or markets), illiquidity under stressed market conditions, and risks arising from the [BANK]’s trading activities that may not be adequately captured in its internal models. (4) The [BANK] must have an internal audit function independent of businessline management that at least annually assesses the effectiveness of the controls supporting the [BANK]’s market risk measurement systems, including the activities of the business trading units and independent risk control unit, compliance with policies and procedures, and calculation of the [BANK]’s measures for market risk under this subpart. At least annually, the internal audit function must report its findings to the [BANK]’s board of directors (or a committee thereof). (e) Internal assessment of capital adequacy. The [BANK] must have a rigorous process for assessing its overall capital adequacy in relation to its market risk. The assessment must take into account risks that may not be captured fully in the VaR-based measure, including concentration and liquidity risk under stressed market conditions. (f) Documentation. The [BANK] must adequately document all material aspects of its internal models, management and valuation of covered positions, control, oversight, validation and review processes and results, and internal assessment of capital adequacy. E:\FR\FM\11OCR2.SGM 11OCR2 62254 wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.204 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations Measure for market risk. (a) General requirement. (1) A [BANK] must calculate its standardized measure for market risk by following the steps described in paragraph (a)(2) of this section. An advanced approaches [BANK] also must calculate an advanced measure for market risk by following the steps in paragraph (a)(2) of this section. (2) Measure for market risk. A [BANK] must calculate the standardized measure for market risk, which equals the sum of the VaR-based capital requirement, stressed VaR-based capital requirement, specific risk add-ons, incremental risk capital requirement, comprehensive risk capital requirement, and capital requirement for de minimis exposures all as defined under this paragraph (a)(2), (except, that the [BANK] may not use the SFA in section 210(b)(2)(vii)(B) of this subpart for purposes of this calculation)[, plus any additional capital requirement established by the [AGENCY]]. An advanced approaches [BANK] that has completed the parallel run process and that has received notifications from the [AGENCY] pursuant to § l.121(d) also must calculate the advanced measure for market risk, which equals the sum of the VaR-based capital requirement, stressed VaR-based capital requirement, specific risk add-ons, incremental risk capital requirement, comprehensive risk capital requirement, and capital requirement for de minimis exposures as defined under this paragraph (a)(2) [, plus any additional capital requirement established by the [AGENCY]]. (i) VaR-based capital requirement. A [BANK]’s VaR-based capital requirement equals the greater of: (A) The previous day’s VaR-based measure as calculated under § l.205; or (B) The average of the daily VaRbased measures as calculated under § l.205 for each of the preceding 60 business days multiplied by three, except as provided in paragraph (b) of this section. (ii) Stressed VaR-based capital requirement. A [BANK]’s stressed VaRbased capital requirement equals the greater of: (A) The most recent stressed VaRbased measure as calculated under § l.206; or (B) The average of the stressed VaRbased measures as calculated under § l.206 for each of the preceding 12 weeks multiplied by three, except as provided in paragraph (b) of this section. (iii) Specific risk add-ons. A [BANK]’s specific risk add-ons equal any specific risk add-ons that are required under VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 § l.207 and are calculated in accordance with § l.210. (iv) Incremental risk capital requirement. A [BANK]’s incremental risk capital requirement equals any incremental risk capital requirement as calculated under section 208 of this subpart. (v) Comprehensive risk capital requirement. A [BANK]’s comprehensive risk capital requirement equals any comprehensive risk capital requirement as calculated under section 209 of this subpart. (vi) Capital requirement for de minimis exposures. A [BANK]’s capital requirement for de minimis exposures equals: (A) The absolute value of the fair value of those de minimis exposures that are not captured in the [BANK]’s VaR-based measure or under paragraph (a)(2)(vi)(B) of this section; and (B) With the prior written approval of the [AGENCY], the capital requirement for any de minimis exposures using alternative techniques that appropriately measure the market risk associated with those exposures. (b) Backtesting. A [BANK] must compare each of its most recent 250 business days’ trading losses (excluding fees, commissions, reserves, net interest income, and intraday trading) with the corresponding daily VaR-based measures calibrated to a one-day holding period and at a one-tail, 99.0 percent confidence level. A [BANK] must begin backtesting as required by this paragraph (b) no later than one year after the later of January 1, 2014 and the date on which the [BANK] becomes subject to this subpart. In the interim, consistent with safety and soundness principles, a [BANK] subject to this subpart as of January 1, 2014 should continue to follow backtesting procedures in accordance with the [AGENCY]’s supervisory expectations. (1) Once each quarter, the [BANK] must identify the number of exceptions (that is, the number of business days for which the actual daily net trading loss, if any, exceeds the corresponding daily VaR-based measure) that have occurred over the preceding 250 business days. (2) A [BANK] must use the multiplication factor in Table 1 to § l.204 that corresponds to the number of exceptions identified in paragraph (b)(1) of this section to determine its VaR-based capital requirement for market risk under paragraph (a)(2)(i) of this section and to determine its stressed VaR-based capital requirement for market risk under paragraph (a)(2)(ii) of this section until it obtains the next quarter’s backtesting results, unless the [AGENCY] notifies the [BANK] in PO 00000 Frm 00238 Fmt 4701 Sfmt 4700 writing that a different adjustment or other action is appropriate. TABLE 1 TO § l.204—MULTIPLICATION FACTORS BASED ON RESULTS OF BACKTESTING Number of exceptions 4 or fewer ............................. 5 ............................................ 6 ............................................ 7 ............................................ 8 ............................................ 9 ............................................ 10 or more ............................ § l.205 Multiplication factor 3.00 3.40 3.50 3.65 3.75 3.85 4.00 VaR-based measure. (a) General requirement. A [BANK] must use one or more internal models to calculate daily a VaR-based measure of the general market risk of all covered positions. The daily VaR-based measure also may reflect the [BANK]’s specific risk for one or more portfolios of debt and equity positions, if the internal models meet the requirements of paragraph (b)(1) of § l.207. The daily VaR-based measure must also reflect the [BANK]’s specific risk for any portfolio of correlation trading positions that is modeled under § l.209. A [BANK] may elect to include term repo-style transactions in its VaR-based measure, provided that the [BANK] includes all such term repo-style transactions consistently over time. (1) The [BANK]’s internal models for calculating its VaR-based measure must use risk factors sufficient to measure the market risk inherent in all covered positions. The market risk categories must include, as appropriate, interest rate risk, credit spread risk, equity price risk, foreign exchange risk, and commodity price risk. For material positions in the major currencies and markets, modeling techniques must incorporate enough segments of the yield curve—in no case less than six— to capture differences in volatility and less than perfect correlation of rates along the yield curve. (2) The VaR-based measure may incorporate empirical correlations within and across risk categories, provided the [BANK] validates and demonstrates the reasonableness of its process for measuring correlations. If the VaR-based measure does not incorporate empirical correlations across risk categories, the [BANK] must add the separate measures from its internal models used to calculate the VaR-based measure for the appropriate market risk categories (interest rate risk, credit spread risk, equity price risk, foreign exchange rate risk, and/or E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations commodity price risk) to determine its aggregate VaR-based measure. (3) The VaR-based measure must include the risks arising from the nonlinear price characteristics of options positions or positions with embedded optionality and the sensitivity of the fair value of the positions to changes in the volatility of the underlying rates, prices, or other material risk factors. A [BANK] with a large or complex options portfolio must measure the volatility of options positions or positions with embedded optionality by different maturities and/ or strike prices, where material. (4) The [BANK] must be able to justify to the satisfaction of the [AGENCY] the omission of any risk factors from the calculation of its VaR-based measure that the [BANK] uses in its pricing models. (5) The [BANK] must demonstrate to the satisfaction of the [AGENCY] the appropriateness of any proxies used to capture the risks of the [BANK]’s actual positions for which such proxies are used. (b) Quantitative requirements for VaRbased measure. (1) The VaR-based measure must be calculated on a daily basis using a one-tail, 99.0 percent confidence level, and a holding period equivalent to a 10-business-day movement in underlying risk factors, such as rates, spreads, and prices. To calculate VaR-based measures using a 10-business-day holding period, the [BANK] may calculate 10-business-day measures directly or may convert VaRbased measures using holding periods other than 10 business days to the equivalent of a 10-business-day holding period. A [BANK] that converts its VaRbased measure in such a manner must be able to justify the reasonableness of its approach to the satisfaction of the [AGENCY]. (2) The VaR-based measure must be based on a historical observation period of at least one year. Data used to determine the VaR-based measure must be relevant to the [BANK]’s actual exposures and of sufficient quality to support the calculation of risk-based capital requirements. The [BANK] must update data sets at least monthly or more frequently as changes in market conditions or portfolio composition warrant. For a [BANK] that uses a weighting scheme or other method for the historical observation period, the [BANK] must either: (i) Use an effective observation period of at least one year in which the average time lag of the observations is at least six months; or (ii) Demonstrate to the [AGENCY] that its weighting scheme is more effective VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 than a weighting scheme with an average time lag of at least six months representing the volatility of the [BANK]’s trading portfolio over a full business cycle. A [BANK] using this option must update its data more frequently than monthly and in a manner appropriate for the type of weighting scheme. (c) A [BANK] must divide its portfolio into a number of significant subportfolios approved by the [AGENCY] for subportfolio backtesting purposes. These subportfolios must be sufficient to allow the [BANK] and the [AGENCY] to assess the adequacy of the VaR model at the risk factor level; the [AGENCY] will evaluate the appropriateness of these subportfolios relative to the value and composition of the [BANK]’s covered positions. The [BANK] must retain and make available to the [AGENCY] the following information for each subportfolio for each business day over the previous two years (500 business days), with no more than a 60-day lag: (1) A daily VaR-based measure for the subportfolio calibrated to a one-tail, 99.0 percent confidence level; (2) The daily profit or loss for the subportfolio (that is, the net change in price of the positions held in the portfolio at the end of the previous business day); and (3) The p-value of the profit or loss on each day (that is, the probability of observing a profit that is less than, or a loss that is greater than, the amount reported for purposes of paragraph (c)(2) of this section based on the model used to calculate the VaR-based measure described in paragraph (c)(1) of this section). § l.206 Stressed VaR-based measure. (a) General requirement. At least weekly, a [BANK] must use the same internal model(s) used to calculate its VaR-based measure to calculate a stressed VaR-based measure. (b) Quantitative requirements for stressed VaR-based measure. (1) A [BANK] must calculate a stressed VaRbased measure for its covered positions using the same model(s) used to calculate the VaR-based measure, subject to the same confidence level and holding period applicable to the VaRbased measure under § l.205, but with model inputs calibrated to historical data from a continuous 12-month period that reflects a period of significant financial stress appropriate to the [BANK]’s current portfolio. (2) The stressed VaR-based measure must be calculated at least weekly and be no less than the [BANK]’s VaR-based measure. PO 00000 Frm 00239 Fmt 4701 Sfmt 4700 62255 (3) A [BANK] must have policies and procedures that describe how it determines the period of significant financial stress used to calculate the [BANK]’s stressed VaR-based measure under this section and must be able to provide empirical support for the period used. The [BANK] must obtain the prior approval of the [AGENCY] for, and notify the [AGENCY] if the [BANK] makes any material changes to, these policies and procedures. The policies and procedures must address: (i) How the [BANK] links the period of significant financial stress used to calculate the stressed VaR-based measure to the composition and directional bias of its current portfolio; and (ii) The [BANK]’s process for selecting, reviewing, and updating the period of significant financial stress used to calculate the stressed VaR-based measure and for monitoring the appropriateness of the period to the [BANK]’s current portfolio. (4) Nothing in this section prevents the [AGENCY] from requiring a [BANK] to use a different period of significant financial stress in the calculation of the stressed VaR-based measure. § l.207 Specific risk. (a) General requirement. A [BANK] must use one of the methods in this section to measure the specific risk for each of its debt, equity, and securitization positions with specific risk. (b) Modeled specific risk. A [BANK] may use models to measure the specific risk of covered positions as provided in paragraph (a) of section 205 of this subpart (therefore, excluding securitization positions that are not modeled under section 209 of this subpart). A [BANK] must use models to measure the specific risk of correlation trading positions that are modeled under § l.209. (1) Requirements for specific risk modeling. (i) If a [BANK] uses internal models to measure the specific risk of a portfolio, the internal models must: (A) Explain the historical price variation in the portfolio; (B) Be responsive to changes in market conditions; (C) Be robust to an adverse environment, including signaling rising risk in an adverse environment; and (D) Capture all material components of specific risk for the debt and equity positions in the portfolio. Specifically, the internal models must: (1) Capture event risk and idiosyncratic risk; and (2) Capture and demonstrate sensitivity to material differences E:\FR\FM\11OCR2.SGM 11OCR2 62256 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations between positions that are similar but not identical and to changes in portfolio composition and concentrations. (ii) If a [BANK] calculates an incremental risk measure for a portfolio of debt or equity positions under section 208 of this subpart, the [BANK] is not required to capture default and credit migration risks in its internal models used to measure the specific risk of those portfolios. (2) Specific risk fully modeled for one or more portfolios. If the [BANK]’s VaRbased measure captures all material aspects of specific risk for one or more of its portfolios of debt, equity, or correlation trading positions, the [BANK] has no specific risk add-on for those portfolios for purposes of paragraph (a)(2)(iii) of § l.204. (c) Specific risk not modeled. (1) If the [BANK]’s VaR-based measure does not capture all material aspects of specific risk for a portfolio of debt, equity, or correlation trading positions, the [BANK] must calculate a specific-risk add-on for the portfolio under the standardized measurement method as described in § l.210. (2) A [BANK] must calculate a specific risk add-on under the standardized measurement method as described in § l.210 for all of its securitization positions that are not modeled under § l.209. wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.208 Incremental risk. (a) General requirement. A [BANK] that measures the specific risk of a portfolio of debt positions under § l.207(b) using internal models must calculate at least weekly an incremental risk measure for that portfolio according to the requirements in this section. The incremental risk measure is the [BANK]’s measure of potential losses due to incremental risk over a one-year time horizon at a one-tail, 99.9 percent confidence level, either under the assumption of a constant level of risk, or under the assumption of constant positions. With the prior approval of the [AGENCY], a [BANK] may choose to include portfolios of equity positions in its incremental risk model, provided that it consistently includes such equity positions in a manner that is consistent with how the [BANK] internally measures and manages the incremental risk of such positions at the portfolio level. If equity positions are included in the model, for modeling purposes default is considered to have occurred upon the default of any debt of the issuer of the equity position. A [BANK] may not include correlation trading positions or securitization positions in its incremental risk measure. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (b) Requirements for incremental risk modeling. For purposes of calculating the incremental risk measure, the incremental risk model must: (1) Measure incremental risk over a one-year time horizon and at a one-tail, 99.9 percent confidence level, either under the assumption of a constant level of risk, or under the assumption of constant positions. (i) A constant level of risk assumption means that the [BANK] rebalances, or rolls over, its trading positions at the beginning of each liquidity horizon over the one-year horizon in a manner that maintains the [BANK]’s initial risk level. The [BANK] must determine the frequency of rebalancing in a manner consistent with the liquidity horizons of the positions in the portfolio. The liquidity horizon of a position or set of positions is the time required for a [BANK] to reduce its exposure to, or hedge all of its material risks of, the position(s) in a stressed market. The liquidity horizon for a position or set of positions may not be less than the shorter of three months or the contractual maturity of the position. (ii) A constant position assumption means that the [BANK] maintains the same set of positions throughout the one-year horizon. If a [BANK] uses this assumption, it must do so consistently across all portfolios. (iii) A [BANK]’s selection of a constant position or a constant risk assumption must be consistent between the [BANK]’s incremental risk model and its comprehensive risk model described in section 209 of this subpart, if applicable. (iv) A [BANK]’s treatment of liquidity horizons must be consistent between the [BANK]’s incremental risk model and its comprehensive risk model described in section 209, if applicable. (2) Recognize the impact of correlations between default and migration events among obligors. (3) Reflect the effect of issuer and market concentrations, as well as concentrations that can arise within and across product classes during stressed conditions. (4) Reflect netting only of long and short positions that reference the same financial instrument. (5) Reflect any material mismatch between a position and its hedge. (6) Recognize the effect that liquidity horizons have on dynamic hedging strategies. In such cases, a [BANK] must: (i) Choose to model the rebalancing of the hedge consistently over the relevant set of trading positions; (ii) Demonstrate that the inclusion of rebalancing results in a more appropriate risk measurement; PO 00000 Frm 00240 Fmt 4701 Sfmt 4700 (iii) Demonstrate that the market for the hedge is sufficiently liquid to permit rebalancing during periods of stress; and (iv) Capture in the incremental risk model any residual risks arising from such hedging strategies. (7) Reflect the nonlinear impact of options and other positions with material nonlinear behavior with respect to default and migration changes. (8) Maintain consistency with the [BANK]’s internal risk management methodologies for identifying, measuring, and managing risk. (c) Calculation of incremental risk capital requirement. The incremental risk capital requirement is the greater of: (1) The average of the incremental risk measures over the previous 12 weeks; or (2) The most recent incremental risk measure. § l.209 Comprehensive risk. (a) General requirement. (1) Subject to the prior approval of the [AGENCY], a [BANK] may use the method in this section to measure comprehensive risk, that is, all price risk, for one or more portfolios of correlation trading positions. (2) A [BANK] that measures the price risk of a portfolio of correlation trading positions using internal models must calculate at least weekly a comprehensive risk measure that captures all price risk according to the requirements of this section. The comprehensive risk measure is either: (i) The sum of: (A) The [BANK]’s modeled measure of all price risk determined according to the requirements in paragraph (b) of this section; and (B) A surcharge for the [BANK]’s modeled correlation trading positions equal to the total specific risk add-on for such positions as calculated under section 210 of this subpart multiplied by 8.0 percent; or (ii) With approval of the [AGENCY] and provided the [BANK] has met the requirements of this section for a period of at least one year and can demonstrate the effectiveness of the model through the results of ongoing model validation efforts including robust benchmarking, the greater of: (A) The [BANK]’s modeled measure of all price risk determined according to the requirements in paragraph (b) of this section; or (B) The total specific risk add-on that would apply to the bank’s modeled correlation trading positions as calculated under section 210 of this subpart multiplied by 8.0 percent. (b) Requirements for modeling all price risk. If a [BANK] uses an internal E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations model to measure the price risk of a portfolio of correlation trading positions: (1) The internal model must measure comprehensive risk over a one-year time horizon at a one-tail, 99.9 percent confidence level, either under the assumption of a constant level of risk, or under the assumption of constant positions. (2) The model must capture all material price risk, including but not limited to the following: (i) The risks associated with the contractual structure of cash flows of the position, its issuer, and its underlying exposures; (ii) Credit spread risk, including nonlinear price risks; (iii) The volatility of implied correlations, including nonlinear price risks such as the cross-effect between spreads and correlations; (iv) Basis risk; (v) Recovery rate volatility as it relates to the propensity for recovery rates to affect tranche prices; and (vi) To the extent the comprehensive risk measure incorporates the benefits of dynamic hedging, the static nature of the hedge over the liquidity horizon must be recognized. In such cases, a [BANK] must: (A) Choose to model the rebalancing of the hedge consistently over the relevant set of trading positions; (B) Demonstrate that the inclusion of rebalancing results in a more appropriate risk measurement; (C) Demonstrate that the market for the hedge is sufficiently liquid to permit rebalancing during periods of stress; and (D) Capture in the comprehensive risk model any residual risks arising from such hedging strategies; (3) The [BANK] must use market data that are relevant in representing the risk profile of the [BANK]’s correlation trading positions in order to ensure that the [BANK] fully captures the material risks of the correlation trading positions in its comprehensive risk measure in accordance with this section; and (4) The [BANK] must be able to demonstrate that its model is an appropriate representation of comprehensive risk in light of the historical price variation of its correlation trading positions. (c) Requirements for stress testing. (1) A [BANK] must at least weekly apply specific, supervisory stress scenarios to its portfolio of correlation trading positions that capture changes in: (i) Default rates; (ii) Recovery rates; (iii) Credit spreads; (iv) Correlations of underlying exposures; and VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (v) Correlations of a correlation trading position and its hedge. (2) Other requirements. (i) A [BANK] must retain and make available to the [AGENCY] the results of the supervisory stress testing, including comparisons with the capital requirements generated by the [BANK]’s comprehensive risk model. (ii) A [BANK] must report to the [AGENCY] promptly any instances where the stress tests indicate any material deficiencies in the comprehensive risk model. (d) Calculation of comprehensive risk capital requirement. The comprehensive risk capital requirement is the greater of: (1) The average of the comprehensive risk measures over the previous 12 weeks; or (2) The most recent comprehensive risk measure. § l.210 Standardized measurement method for specific risk (a) General requirement. A [BANK] must calculate a total specific risk addon for each portfolio of debt and equity positions for which the [BANK]’s VaRbased measure does not capture all material aspects of specific risk and for all securitization positions that are not modeled under § l.209. A [BANK] must calculate each specific risk add-on in accordance with the requirements of this section. Notwithstanding any other definition or requirement in this subpart, a position that would have qualified as a debt position or an equity position but for the fact that it qualifies as a correlation trading position under paragraph (2) of the definition of correlation trading position in § l.2, shall be considered a debt position or an equity position, respectively, for purposes of this section 210 of this subpart. (1) The specific risk add-on for an individual debt or securitization position that represents sold credit protection is capped at the notional amount of the credit derivative contract. The specific risk add-on for an individual debt or securitization position that represents purchased credit protection is capped at the current fair value of the transaction plus the absolute value of the present value of all remaining payments to the protection seller under the transaction. This sum is equal to the value of the protection leg of the transaction. (2) For debt, equity, or securitization positions that are derivatives with linear payoffs, a [BANK] must assign a specific risk-weighting factor to the fair value of the effective notional amount of the underlying instrument or index portfolio, except for a securitization PO 00000 Frm 00241 Fmt 4701 Sfmt 4700 62257 position for which the [BANK] directly calculates a specific risk add-on using the SFA in paragraph (b)(2)(vii)(B) of this section. A swap must be included as an effective notional position in the underlying instrument or portfolio, with the receiving side treated as a long position and the paying side treated as a short position. For debt, equity, or securitization positions that are derivatives with nonlinear payoffs, a [BANK] must risk weight the fair value of the effective notional amount of the underlying instrument or portfolio multiplied by the derivative’s delta. (3) For debt, equity, or securitization positions, a [BANK] may net long and short positions (including derivatives) in identical issues or identical indices. A [BANK] may also net positions in depositary receipts against an opposite position in an identical equity in different markets, provided that the [BANK] includes the costs of conversion. (4) A set of transactions consisting of either a debt position and its credit derivative hedge or a securitization position and its credit derivative hedge has a specific risk add-on of zero if: (i) The debt or securitization position is fully hedged by a total return swap (or similar instrument where there is a matching of swap payments and changes in fair value of the debt or securitization position); (ii) There is an exact match between the reference obligation of the swap and the debt or securitization position; (iii) There is an exact match between the currency of the swap and the debt or securitization position; and (iv) There is either an exact match between the maturity date of the swap and the maturity date of the debt or securitization position; or, in cases where a total return swap references a portfolio of positions with different maturity dates, the total return swap maturity date must match the maturity date of the underlying asset in that portfolio that has the latest maturity date. (5) The specific risk add-on for a set of transactions consisting of either a debt position and its credit derivative hedge or a securitization position and its credit derivative hedge that does not meet the criteria of paragraph (a)(4) of this section is equal to 20.0 percent of the capital requirement for the side of the transaction with the higher specific risk add-on when: (i) The credit risk of the position is fully hedged by a credit default swap or similar instrument; (ii) There is an exact match between the reference obligation of the credit E:\FR\FM\11OCR2.SGM 11OCR2 62258 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations derivative hedge and the debt or securitization position; (iii) There is an exact match between the currency of the credit derivative hedge and the debt or securitization position; and (iv) There is either an exact match between the maturity date of the credit derivative hedge and the maturity date of the debt or securitization position; or, in the case where the credit derivative hedge has a standard maturity date: (A) The maturity date of the credit derivative hedge is within 30 business days of the maturity date of the debt or securitization position; or (B) For purchased credit protection, the maturity date of the credit derivative hedge is later than the maturity date of the debt or securitization position, but is no later than the standard maturity date for that instrument that immediately follows the maturity date of the debt or securitization position. The maturity date of the credit derivative hedge may not exceed the maturity date of the debt or securitization position by more than 90 calendar days. (6) The specific risk add-on for a set of transactions consisting of either a debt position and its credit derivative hedge or a securitization position and its credit derivative hedge that does not meet the criteria of either paragraph (a)(4) or (a)(5) of this section, but in which all or substantially all of the price risk has been hedged, is equal to the specific risk add-on for the side of the transaction with the higher specific risk add-on. (b) Debt and securitization positions. (1) The total specific risk add-on for a portfolio of debt or securitization positions is the sum of the specific risk add-ons for individual debt or securitization positions, as computed under this section. To determine the specific risk add-on for individual debt or securitization positions, a [BANK] must multiply the absolute value of the current fair value of each net long or net short debt or securitization position in the portfolio by the appropriate specific risk-weighting factor as set forth in paragraphs (b)(2)(i) through (b)(2)(vii) of this section. (2) For the purpose of this section, the appropriate specific risk-weighting factors include: (i) Sovereign debt positions. (A) In accordance with Table 1 to § l.210, a [BANK] must assign a specific riskweighting factor to a sovereign debt position based on the CRC applicable to the sovereign, and, as applicable, the remaining contractual maturity of the position, or if there is no CRC applicable to the sovereign, based on whether the sovereign entity is a member of the OECD. Notwithstanding any other provision in this subpart, sovereign debt positions that are backed by the full faith and credit of the United States are treated as having a CRC of 0. TABLE 1 TO § l.210—SPECIFIC RISK-WEIGHTING FACTORS FOR SOVEREIGN DEBT POSITIONS Specific risk-weighting factor (in percent) CRC: 0–1 ..................................................................................... 2–3 ..................................................................................... 0.0 Remaining contractual maturity of 6 months or less ............... Remaining contractual maturity of greater than 6 and up to and including 24 months. Remaining contractual maturity exceeds 24 months ............... 12.0 OECD Member with No CRC ................................................... 0.0 Non-OECD Member with No CRC ........................................... 8.0 Sovereign Default ..................................................................... 1.6 8.0 7 ......................................................................................... wreier-aviles on DSK5TPTVN1PROD with RULES2 4–6 ..................................................................................... 0.25 1.0 12.0 (B) Notwithstanding paragraph (b)(2)(i)(A) of this section, a [BANK] may assign to a sovereign debt position a specific risk-weighting factor that is lower than the applicable specific riskweighting factor in Table 1 to § l.210 if: (1) The position is denominated in the sovereign entity’s currency; (2) The [BANK] has at least an equivalent amount of liabilities in that currency; and (3) The sovereign entity allows banks under its jurisdiction to assign the lower specific risk-weighting factor to the same exposures to the sovereign entity. (C) A [BANK] must assign a 12.0 percent specific risk-weighting factor to a sovereign debt position immediately upon determination a default has VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 occurred; or if a default has occurred within the previous five years. (D) A [BANK] must assign a 0.0 percent specific risk-weighting factor to a sovereign debt position if the sovereign entity is a member of the OECD and does not have a CRC assigned to it, except as provided in paragraph (b)(2)(i)(C) of this section. (E) A [BANK] must assign an 8.0 percent specific risk-weighting factor to a sovereign debt position if the sovereign is not a member of the OECD and does not have a CRC assigned to it, except as provided in paragraph (b)(2)(i)(C) of this section. (ii) Certain supranational entity and multilateral development bank debt positions. A [BANK] may assign a 0.0 percent specific risk-weighting factor to PO 00000 Frm 00242 Fmt 4701 Sfmt 4700 a debt position that is an exposure to the Bank for International Settlements, the European Central Bank, the European Commission, the International Monetary Fund, or an MDB. (iii) GSE debt positions. A [BANK] must assign a 1.6 percent specific riskweighting factor to a debt position that is an exposure to a GSE. Notwithstanding the foregoing, a [BANK] must assign an 8.0 percent specific risk-weighting factor to preferred stock issued by a GSE. (iv) Depository institution, foreign bank, and credit union debt positions. (A) Except as provided in paragraph (b)(2)(iv)(B) of this section, a [BANK] must assign a specific risk-weighting factor to a debt position that is an exposure to a depository institution, a E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations foreign bank, or a credit union, in accordance with Table 2 to § l.210, based on the CRC that corresponds to that entity’s home country or the OECD membership status of that entity’s home country if there is no CRC applicable to 62259 the entity’s home country, and, as applicable, the remaining contractual maturity of the position. TABLE 2 TO § l.210—SPECIFIC RISK-WEIGHTING FACTORS FOR DEPOSITORY INSTITUTION, FOREIGN BANK, AND CREDIT UNION DEBT POSITIONS Specific risk-weighting factor (in percent) CRC 0–2 or OECD Member with No CRC .............................. Remaining contractual maturity of 6 months or less ............... Remaining contractual maturity of greater than 6 and up to and including 24 months. Remaining contractual maturity exceeds 24 months ............... CRC 3 ....................................................................................... 12.0 Non-OECD Member with No CRC ........................................... 8.0 Sovereign Default ..................................................................... 1.6 8.0 CRC 4–7 ................................................................................... 0.25 1.0 12.0 (B) A [BANK] must assign a specific risk-weighting factor of 8.0 percent to a debt position that is an exposure to a depository institution or a foreign bank that is includable in the depository institution’s or foreign bank’s regulatory capital and that is not subject to deduction as a reciprocal holding under § l.22. (C) A [BANK] must assign a 12.0 percent specific risk-weighting factor to a debt position that is an exposure to a foreign bank immediately upon determination that a default by the foreign bank’s home country has occurred or if a default by the foreign bank’s home country has occurred within the previous five years. (v) PSE debt positions. (A) Except as provided in paragraph (b)(2)(v)(B) of this section, a [BANK] must assign a specific risk-weighting factor to a debt position that is an exposure to a PSE in accordance with Tables 3 and 4 to § l.210 depending on the position’s categorization as a general obligation or revenue obligation based on the CRC that corresponds to the PSE’s home country or the OECD membership status of the PSE’s home country if there is no CRC applicable to the PSE’s home country, and, as applicable, the remaining contractual maturity of the position, as set forth in Tables 3 and 4 of this section. (B) A [BANK] may assign a lower specific risk-weighting factor than would otherwise apply under Tables 3 and 4 of this section to a debt position that is an exposure to a foreign PSE if: (1) The PSE’s home country allows banks under its jurisdiction to assign a lower specific risk-weighting factor to such position; and (2) The specific risk-weighting factor is not lower than the risk weight that corresponds to the PSE’s home country in accordance with Tables 3 and 4 of this section. (C) A [BANK] must assign a 12.0 percent specific risk-weighting factor to a PSE debt position immediately upon determination that a default by the PSE’s home country has occurred or if a default by the PSE’s home country has occurred within the previous five years. TABLE 3 TO § l.210—SPECIFIC RISK-WEIGHTING FACTORS FOR PSE GENERAL OBLIGATION DEBT POSITIONS General obligation specific risk-weighting factor (in percent) CRC 0–2 or OECD Member with No CRC .............................. Remaining contractual maturity of 6 months or less ............... Remaining contractual maturity of greater than 6 and up to and including 24 months. Remaining contractual maturity exceeds 24 months ............... 8.0 CRC 4–7 ................................................................................... 12.0 Non-OECD Member with No CRC ........................................... 8.0 Sovereign Default ..................................................................... wreier-aviles on DSK5TPTVN1PROD with RULES2 CRC 3 ....................................................................................... 12.0 VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00243 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 0.25 1.0 1.6 62260 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations TABLE 4 TO § l.210—SPECIFIC RISK-WEIGHTING FACTORS FOR PSE REVENUE OBLIGATION DEBT POSITIONS Revenue obligation specific risk-weighting factor (in percent) CRC 0–1 or OECD Member with No CRC .............................. Remaining contractual maturity of 6 months or less ............... Remaining contractual maturity of greater than 6 and up to and including 24 months. Remaining contractual maturity exceeds 24 months ............... CRC 2–3 ................................................................................... 12.0 Non-OECD Member with No CRC ........................................... 8.0 Sovereign Default ..................................................................... 1.6 8.0 CRC 4–7 ................................................................................... 0.25 1.0 12.0 (vi) Corporate debt positions. Except as otherwise provided in paragraph (b)(2)(vi)(B) of this section, a [BANK] must assign a specific risk-weighting factor to a corporate debt position in accordance with the investment grade methodology in paragraph (b)(2)(vi)(A) of this section. (A) Investment grade methodology. (1) For corporate debt positions that are exposures to entities that have issued and outstanding publicly traded instruments, a [BANK] must assign a specific risk-weighting factor based on the category and remaining contractual maturity of the position, in accordance with Table 5 to § l.210. For purposes of this paragraph (b)(2)(vi)(A)(1), the [BANK] must determine whether the position is in the investment grade or not investment grade category. TABLE 5 TO § l.210—SPECIFIC RISK-WEIGHTING FACTORS FOR CORPORATE DEBT POSITIONS UNDER THE INVESTMENT GRADE METHODOLOGY Specific riskweighting factor (in percent) Remaining contractual maturity Investment Grade ..................................................................... 6 months or less ...................................................................... Greater than 6 and up to and including 24 months ................ Greater than 24 months ........................................................... 0.50 2.00 4.00 Non-investment Grade ..................................................................................................................................................................... wreier-aviles on DSK5TPTVN1PROD with RULES2 Category 12.00 (2) A [BANK] must assign an 8.0 percent specific risk-weighting factor for corporate debt positions that are exposures to entities that do not have publicly traded instruments outstanding. (B) Limitations. (1) A [BANK] must assign a specific risk-weighting factor of at least 8.0 percent to an interest-only mortgage-backed security that is not a securitization position. (2) A [BANK] shall not assign a corporate debt position a specific riskweighting factor that is lower than the specific risk-weighting factor that corresponds to the CRC of the issuer’s home country, if applicable, in table 1 of this section. (vii) Securitization positions. (A) General requirements. (1) A [BANK] that is not an advanced approaches [BANK] must assign a specific risk-weighting factor to a securitization position using either the simplified supervisory formula approach (SSFA) in paragraph (b)(2)(vii)(C) of this section (and § l.211) or assign a specific riskweighting factor of 100 percent to the position. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (2) A [BANK] that is an advanced approaches [BANK] must calculate a specific risk add-on for a securitization position in accordance with paragraph (b)(2)(vii)(B) of this section if the [BANK] and the securitization position each qualifies to use the SFA in § l.143. A [BANK] that is an advanced approaches [BANK] with a securitization position that does not qualify for the SFA under paragraph (b)(2)(vii)(B) of this section may assign a specific risk-weighting factor to the securitization position using the SSFA in accordance with paragraph (b)(2)(vii)(C) of this section or assign a specific risk-weighting factor of 100 percent to the position. (3) A [BANK] must treat a short securitization position as if it is a long securitization position solely for calculation purposes when using the SFA in paragraph (b)(2)(vii)(B) of this section or the SSFA in paragraph (b)(2)(vii)(C) of this section. (B) SFA. To calculate the specific risk add-on for a securitization position using the SFA, a [BANK] that is an advanced approaches [BANK] must set PO 00000 Frm 00244 Fmt 4701 Sfmt 4700 the specific risk add-on for the position equal to the risk-based capital requirement as calculated under § l .143. (C) SSFA. To use the SSFA to determine the specific risk-weighting factor for a securitization position, a [BANK] must calculate the specific riskweighting factor in accordance with § l .211. (D) Nth-to-default credit derivatives. A [BANK] must determine a specific risk add-on using the SFA in paragraph (b)(2)(vii)(B) of this section, or assign a specific risk-weighting factor using the SSFA in paragraph (b)(2)(vii)(C) of this section to an nth-to-default credit derivative in accordance with this paragraph (b)(2)(vii)(D), regardless of whether the [BANK] is a net protection buyer or net protection seller. A [BANK] must determine its position in the nthto-default credit derivative as the largest notional amount of all the underlying exposures. (1) For purposes of determining the specific risk add-on using the SFA in paragraph (b)(2)(vii)(B) of this section or the specific risk-weighting factor for an E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations nth-to-default credit derivative using the SSFA in paragraph (b)(2)(vii)(C) of this section the [BANK] must calculate the attachment point and detachment point of its position as follows: (i) The attachment point (parameter A) is the ratio of the sum of the notional amounts of all underlying exposures that are subordinated to the [BANK]’s position to the total notional amount of all underlying exposures. For purposes of the SSFA, parameter A is expressed as a decimal value between zero and one. For purposes of using the SFA in paragraph (b)(2)(vii)(B) of this section to calculate the specific add-on for its position in an nth-to-default credit derivative, parameter A must be set equal to the credit enhancement level (L) input to the SFA formula in section 143 of this subpart. In the case of a firstto-default credit derivative, there are no underlying exposures that are subordinated to the [BANK]’s position. In the case of a second-or-subsequent-todefault credit derivative, the smallest (n1) notional amounts of the underlying exposure(s) are subordinated to the [BANK]’s position. (ii) The detachment point (parameter D) equals the sum of parameter A plus the ratio of the notional amount of the [BANK]’s position in the nth-to-default credit derivative to the total notional amount of all underlying exposures. For purposes of the SSFA, parameter A is expressed as a decimal value between zero and one. For purposes of using the SFA in paragraph (b)(2)(vii)(B) of this section to calculate the specific risk add-on for its position in an nth-todefault credit derivative, parameter D must be set to equal the L input plus the thickness of tranche T input to the SFA formula in § l.143 of this subpart. (2) A [BANK] that does not use the SFA in paragraph (b)(2)(vii)(B) of this section to determine a specific risk-add on, or the SSFA in paragraph (b)(2)(vii)(C) of this section to determine a specific risk-weighting factor for its position in an nth-to-default credit derivative must assign a specific riskweighting factor of 100 percent to the position. (c) Modeled correlation trading positions. For purposes of calculating the comprehensive risk measure for modeled correlation trading positions under either paragraph (a)(2)(i) or (a)(2)(ii) of § l.209, the total specific risk add-on is the greater of: (1) The sum of the [BANK]’s specific risk add-ons for each net long correlation trading position calculated under this section; or (2) The sum of the [BANK]’s specific risk add-ons for each net short VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 correlation trading position calculated under this section. (d) Non-modeled securitization positions. For securitization positions that are not correlation trading positions and for securitizations that are correlation trading positions not modeled under § l.209, the total specific risk add-on is the greater of: (1) The sum of the [BANK]’s specific risk add-ons for each net long securitization position calculated under this section; or (2) The sum of the [BANK]’s specific risk add-ons for each net short securitization position calculated under this section. (e) Equity positions. The total specific risk add-on for a portfolio of equity positions is the sum of the specific risk add-ons of the individual equity positions, as computed under this section. To determine the specific risk add-on of individual equity positions, a [BANK] must multiply the absolute value of the current fair value of each net long or net short equity position by the appropriate specific risk-weighting factor as determined under this paragraph (e): (1) The [BANK] must multiply the absolute value of the current fair value of each net long or net short equity position by a specific risk-weighting factor of 8.0 percent. For equity positions that are index contracts comprising a well-diversified portfolio of equity instruments, the absolute value of the current fair value of each net long or net short position is multiplied by a specific risk-weighting factor of 2.0 percent.29 (2) For equity positions arising from the following futures-related arbitrage strategies, a [BANK] may apply a 2.0 percent specific risk-weighting factor to one side (long or short) of each position with the opposite side exempt from an additional capital requirement: (i) Long and short positions in exactly the same index at different dates or in different market centers; or (ii) Long and short positions in index contracts at the same date in different, but similar indices. (3) For futures contracts on main indices that are matched by offsetting positions in a basket of stocks comprising the index, a [BANK] may apply a 2.0 percent specific riskweighting factor to the futures and stock basket positions (long and short), provided that such trades are deliberately entered into and separately 29 A portfolio is well-diversified if it contains a large number of individual equity positions, with no single position representing a substantial portion of the portfolio’s total fair value. PO 00000 Frm 00245 Fmt 4701 Sfmt 4700 62261 controlled, and that the basket of stocks is comprised of stocks representing at least 90.0 percent of the capitalization of the index. A main index refers to the Standard & Poor’s 500 Index, the FTSE All-World Index, and any other index for which the [BANK] can demonstrate to the satisfaction of the [AGENCY] that the equities represented in the index have liquidity, depth of market, and size of bid-ask spreads comparable to equities in the Standard & Poor’s 500 Index and FTSE All-World Index. (f) Due diligence requirements for securitization positions. (1) A [BANK] must demonstrate to the satisfaction of the [AGENCY] a comprehensive understanding of the features of a securitization position that would materially affect the performance of the position by conducting and documenting the analysis set forth in paragraph (f)(2) of this section. The [BANK]’s analysis must be commensurate with the complexity of the securitization position and the materiality of the position in relation to capital. (2) A [BANK] must demonstrate its comprehensive understanding for each securitization position by: (i) Conducting an analysis of the risk characteristics of a securitization position prior to acquiring the position and document such analysis within three business days after acquiring position, considering: (A) Structural features of the securitization that would materially impact the performance of the position, for example, the contractual cash flow waterfall, waterfall-related triggers, credit enhancements, liquidity enhancements, fair value triggers, the performance of organizations that service the position, and deal-specific definitions of default; (B) Relevant information regarding the performance of the underlying credit exposure(s), for example, the percentage of loans 30, 60, and 90 days past due; default rates; prepayment rates; loans in foreclosure; property types; occupancy; average credit score or other measures of creditworthiness; average loan-to-value ratio; and industry and geographic diversification data on the underlying exposure(s); (C) Relevant market data of the securitization, for example, bid-ask spreads, most recent sales price and historical price volatility, trading volume, implied market rating, and size, depth and concentration level of the market for the securitization; and (D) For resecuritization positions, performance information on the underlying securitization exposures, for example, the issuer name and credit E:\FR\FM\11OCR2.SGM 11OCR2 62262 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations quality, and the characteristics and performance of the exposures underlying the securitization exposures. (ii) On an on-going basis (no less frequently than quarterly), evaluating, reviewing, and updating as appropriate the analysis required under paragraph (f)(1) of this section for each securitization position. § l.211 Simplified supervisory formula approach (SSFA). wreier-aviles on DSK5TPTVN1PROD with RULES2 (a) General requirements. To use the SSFA to determine the specific riskweighting factor for a securitization position, a [BANK] must have data that enables it to assign accurately the parameters described in paragraph (b) of this section. Data used to assign the parameters described in paragraph (b) of this section must be the most currently available data; if the contracts governing the underlying exposures of the securitization require payments on a monthly or quarterly basis, the data used to assign the parameters described in paragraph (b) of this section must be no more than 91 calendar days old. A [BANK] that does not have the appropriate data to assign the parameters described in paragraph (b) of this section must assign a specific riskweighting factor of 100 percent to the position. (b) SSFA parameters. To calculate the specific risk-weighting factor for a securitization position using the SSFA, a [BANK] must have accurate information on the five inputs to the SSFA calculation described in paragraphs (b)(1) through (b)(5) of this section. (1) KG is the weighted-average (with unpaid principal used as the weight for each exposure) total capital requirement of the underlying exposures calculated using subpart D. KG is expressed as a decimal value between zero and one (that is, an average risk weight of 100 percent represents a value of KG equal to 0.08). (2) Parameter W is expressed as a decimal value between zero and one. Parameter W is the ratio of the sum of the dollar amounts of any underlying VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 exposures of the securitization that meet any of the criteria as set forth in paragraphs (b)(2)(i) through (vi) of this section to the balance, measured in dollars, of underlying exposures: (i) Ninety days or more past due; (ii) Subject to a bankruptcy or insolvency proceeding; (iii) In the process of foreclosure; (iv) Held as real estate owned; (v) Has contractually deferred payments for 90 days or more, other than principal or interest payments deferred on: (A) Federally-guaranteed student loans, in accordance with the terms of those guarantee programs; or (B) Consumer loans, including nonfederally-guaranteed student loans, provided that such payments are deferred pursuant to provisions included in the contract at the time funds are disbursed that provide for period(s) of deferral that are not initiated based on changes in the creditworthiness of the borrower; or (vi) Is in default. (3) Parameter A is the attachment point for the position, which represents the threshold at which credit losses will first be allocated to the position. Except as provided in § l.210(b)(2)(vii)(D) for nth-to-default credit derivatives, parameter A equals the ratio of the current dollar amount of underlying exposures that are subordinated to the position of the [BANK] to the current dollar amount of underlying exposures. Any reserve account funded by the accumulated cash flows from the underlying exposures that is subordinated to the position that contains the [BANK]’s securitization exposure may be included in the calculation of parameter A to the extent that cash is present in the account. Parameter A is expressed as a decimal value between zero and one. (4) Parameter D is the detachment point for the position, which represents the threshold at which credit losses of principal allocated to the position would result in a total loss of principal. Except as provided in PO 00000 Frm 00246 Fmt 4701 Sfmt 4700 § l.210(b)(2)(vii)(D) for nth-to-default credit derivatives, parameter D equals parameter A plus the ratio of the current dollar amount of the securitization positions that are pari passu with the position (that is, have equal seniority with respect to credit risk) to the current dollar amount of the underlying exposures. Parameter D is expressed as a decimal value between zero and one. (5) A supervisory calibration parameter, p, is equal to 0.5 for securitization positions that are not resecuritization positions and equal to 1.5 for resecuritization positions. (c) Mechanics of the SSFA. KG and W are used to calculate KA, the augmented value of KG, which reflects the observed credit quality of the underlying exposures. KA is defined in paragraph (d) of this section. The values of parameters A and D, relative to KA determine the specific risk-weighting factor assigned to a position as described in this paragraph (c) and paragraph (d) of this section. The specific risk-weighting factor assigned to a securitization position, or portion of a position, as appropriate, is the larger of the specific risk-weighting factor determined in accordance with this paragraph (c), paragraph (d) of this section, and a specific risk-weighting factor of 1.6 percent. (1) When the detachment point, parameter D, for a securitization position is less than or equal to KA, the position must be assigned a specific risk-weighting factor of 100 percent. (2) When the attachment point, parameter A, for a securitization position is greater than or equal to KA, the [BANK] must calculate the specific risk-weighting factor in accordance with paragraph (d) of this section. (3) When A is less than KA and D is greater than KA, the specific riskweighting factor is a weighted-average of 1.00 and KSSFA calculated under paragraphs (c)(3)(i) and (c)(3)(ii) of this section. For the purpose of this calculation: (i) The weight assigned to 1.00 equals E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 § l.212 Market risk disclosures. (a) Scope. A [BANK] must comply with this section unless it is a consolidated subsidiary of a bank holding company or a depository institution that is subject to these requirements or of a non-U.S. banking organization that is subject to comparable public disclosure requirements in its home jurisdiction. A [BANK] must make timely public disclosures each calendar quarter. If a significant change occurs, such that the most recent reporting amounts are no longer reflective of the [BANK]’s capital adequacy and risk profile, then a brief discussion of this change and its likely impact must be provided as soon as practicable thereafter. Qualitative disclosures that typically do not change each quarter may be disclosed annually, provided any significant changes are disclosed in the interim. If a [BANK] VerDate Mar<15>2010 14:37 Oct 10, 2013 Jkt 232001 believes that disclosure of specific commercial or financial information would prejudice seriously its position by making public certain information that is either proprietary or confidential in nature, the [BANK] is not required to disclose these specific items, but must disclose more general information about the subject matter of the requirement, together with the fact that, and the reason why, the specific items of information have not been disclosed. The [BANK]’s management may provide all of the disclosures required by this section in one place on the [BANK]’s public Web site or may provide the disclosures in more than one public financial report or other regulatory reports, provided that the [BANK] publicly provides a summary table specifically indicating the location(s) of all such disclosures. PO 00000 Frm 00247 Fmt 4701 Sfmt 4700 62263 (b) Disclosure policy. The [BANK] must have a formal disclosure policy approved by the board of directors that addresses the [BANK]’s approach for determining its market risk disclosures. The policy must address the associated internal controls and disclosure controls and procedures. The board of directors and senior management must ensure that appropriate verification of the disclosures takes place and that effective internal controls and disclosure controls and procedures are maintained. One or more senior officers of the [BANK] must attest that the disclosures meet the requirements of this subpart, and the board of directors and senior management are responsible for establishing and maintaining an effective internal control structure over financial reporting, including the disclosures required by this section. E:\FR\FM\11OCR2.SGM 11OCR2 ER11OC13.057</GPH> Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations 62264 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (c) Quantitative disclosures. (1) For each material portfolio of covered positions, the [BANK] must provide timely public disclosures of the following information at least quarterly: (i) The high, low, and mean VaRbased measures over the reporting period and the VaR-based measure at period-end; (ii) The high, low, and mean stressed VaR-based measures over the reporting period and the stressed VaR-based measure at period-end; (iii) The high, low, and mean incremental risk capital requirements over the reporting period and the incremental risk capital requirement at period-end; (iv) The high, low, and mean comprehensive risk capital requirements over the reporting period and the comprehensive risk capital requirement at period-end, with the period-end requirement broken down into appropriate risk classifications (for example, default risk, migration risk, correlation risk); (v) Separate measures for interest rate risk, credit spread risk, equity price risk, foreign exchange risk, and commodity price risk used to calculate the VaRbased measure; and (vi) A comparison of VaR-based estimates with actual gains or losses experienced by the [BANK], with an analysis of important outliers. (2) In addition, the [BANK] must disclose publicly the following information at least quarterly: (i) The aggregate amount of onbalance sheet and off-balance sheet securitization positions by exposure type; and (ii) The aggregate amount of correlation trading positions. (d) Qualitative disclosures. For each material portfolio of covered positions, the [BANK] must provide timely public disclosures of the following information at least annually after the end of the fourth calendar quarter, or more frequently in the event of material changes for each portfolio: (1) The composition of material portfolios of covered positions; (2) The [BANK]’s valuation policies, procedures, and methodologies for covered positions including, for securitization positions, the methods and key assumptions used for valuing such positions, any significant changes since the last reporting period, and the impact of such change; (3) The characteristics of the internal models used for purposes of this subpart. For the incremental risk capital requirement and the comprehensive risk capital requirement, this must include: (i) The approach used by the [BANK] to determine liquidity horizons; (ii) The methodologies used to achieve a capital assessment that is consistent with the required soundness standard; and (iii) The specific approaches used in the validation of these models; (4) A description of the approaches used for validating and evaluating the accuracy of internal models and modeling processes for purposes of this subpart; (5) For each market risk category (that is, interest rate risk, credit spread risk, equity price risk, foreign exchange risk, and commodity price risk), a description of the stress tests applied to the positions subject to the factor; (6) The results of the comparison of the [BANK]’s internal estimates for purposes of this subpart with actual outcomes during a sample period not used in model development; (7) The soundness standard on which the [BANK]’s internal capital adequacy assessment under this subpart is based, including a description of the methodologies used to achieve a capital adequacy assessment that is consistent with the soundness standard; (8) A description of the [BANK]’s processes for monitoring changes in the credit and market risk of securitization positions, including how those processes differ for resecuritization positions; and (9) A description of the [BANK]’s policy governing the use of credit risk mitigation to mitigate the risks of securitization and resecuritization positions. §§ l.213 through l.299 [Reserved] Subpart G—Transition Provisions § l.300 Transitions. (a) Capital conservation and countercyclical capital buffer. (1) From January 1, 2014 through December 31, 2015, a [BANK] is not subject to limits on distributions and discretionary bonus payments under § l.11 of subpart B of this part notwithstanding the amount of its capital conservation buffer or any applicable countercyclical capital buffer amount. (2) Beginning January 1, 2016 through December 31, 2018 a [BANK]’s maximum payout ratio shall be determined as set forth in Table 1 to § l.300. TABLE 1 TO § l.300 Transition period wreier-aviles on DSK5TPTVN1PROD with RULES2 Calendar year 2016. Calendar year 2017. VerDate Mar<15>2010 Maximum payout ratio (as a percentage of eligible retained income) Capital conservation buffer Greater than 0.625 percent (plus 25 percent of any applicable countercyclical capital buffer amount). Less than or equal to 0.625 percent (plus 25 percent of any applicable countercyclical capital buffer amount), and greater than 0.469 percent (plus 17.25 percent of any applicable countercyclical capital buffer amount). Less than or equal to 0.469 percent (plus 17.25 percent of any applicable countercyclical capital buffer amount), and greater than 0.313 percent (plus 12.5 percent of any applicable countercyclical capital buffer amount). Less than or equal to 0.313 percent (plus 12.5 percent of any applicable countercyclical capital buffer amount), and greater than 0.156 percent (plus 6.25 percent of any applicable countercyclical capital buffer amount). Less than or equal to 0.156 percent (plus 6.25 percent of any applicable countercyclical capital buffer amount). Greater than 1.25 percent (plus 50 percent of any applicable countercyclical capital buffer amount). Less than or equal to 1.25 percent (plus 50 percent of any applicable countercyclical capital buffer amount), and greater than 0.938 percent (plus 37.5 percent of any applicable countercyclical capital buffer amount). 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00248 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 11OCR2 No payout ratio limitation applies under this section. 60 percent. 40 percent. 20 percent. 0 percent. No payout ratio limitation applies under this section. 60 percent. 62265 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations TABLE 1 TO § l.300—Continued Transition period Calendar year 2018. Maximum payout ratio (as a percentage of eligible retained income) Capital conservation buffer Less than or equal to 0.938 percent (plus 37.5 percent of any applicable countercyclical capital buffer amount), and greater than 0.625 percent (plus 25 percent of any applicable countercyclical capital buffer amount). Less than or equal to 0.625 percent (plus 25 percent of any applicable countercyclical capital buffer amount), and greater than 0.313 percent (plus 12.5 percent of any applicable countercyclical capital buffer amount). Less than or equal to 0.313 percent (plus 12.5 percent of any applicable countercyclical capital buffer amount). Greater than 1.875 percent (plus 75 percent of any applicable countercyclical capital buffer amount). Less than or equal to 1.875 percent (plus 75 percent of any applicable countercyclical capital buffer amount), and greater than 1.406 percent (plus 56.25 percent of any applicable countercyclical capital buffer amount). Less than or equal to 1.406 percent (plus 56.25 percent of any applicable countercyclical capital buffer amount), and greater than 0.938 percent (plus 37.5 percent of any applicable countercyclical capital buffer amount). Less than or equal to 0.938 percent (plus 37.5 percent of any applicable countercyclical capital buffer amount), and greater than 0.469 percent (plus 18.75 percent of any applicable countercyclical capital buffer amount). Less than or equal to 0.469 percent (plus 18.75 percent of any applicable countercyclical capital buffer amount). (b) Regulatory capital adjustments and deductions. Beginning January 1, 2014 for an advanced approaches [BANK], and beginning January 1, 2015 for a [BANK] that is not an advanced approaches [BANK], and in each case through December 31, 2017, a [BANK] must make the capital adjustments and deductions in § l.22 in accordance with the transition requirements in this paragraph (b). Beginning January 1, 2018, a [BANK] must make all regulatory capital adjustments and deductions in accordance with § l.22. (1) Transition deductions from common equity tier 1 capital. Beginning January 1, 2014 for an advanced approaches [BANK], and beginning January 1, 2015 for a [BANK] that is not an advanced approaches [BANK], and in each case through December 31, 2017, a [BANK], must make the deductions required under § l.22(a)(1)–(7) from common equity tier 1 or tier 1 capital elements in accordance with the percentages set forth in Table 2 and Table 3 to § l.300. (i) A [BANK] must deduct the following items from common equity tier 1 and additional tier 1 capital in accordance with the percentages set forth in Table 2 to § l.300: goodwill 40 percent. 20 percent. 0 percent. No payout ratio limitation applies under this section. 60 percent. 40 percent. 20 percent. 0 percent. (§ l.22(a)(1)), DTAs that arise from net operating loss and tax credit carryforwards (§ l.22(a)(3)), a gain-onsale in connection with a securitization exposure (§ l.22(a)(4)), defined benefit pension fund assets (§ l.22(a)(5)), expected credit loss that exceeds eligible credit reserves (for advanced approaches [BANK]s that have completed the parallel run process and that have received notifications from the [AGENCY] pursuant to § l.121(d) of subpart E) (§ l.22(a)(6)), and financial subsidiaries (§ l.22(a)(7)). TABLE 2 TO § l.300 Transition deductions under § l.22(a)(1) and (7) Transition period wreier-aviles on DSK5TPTVN1PROD with RULES2 year year year year year 2014 ..................................................................... 2015 ..................................................................... 2016 ..................................................................... 2017 ..................................................................... 2018, and thereafter ............................................ (ii) A [BANK] must deduct from common equity tier 1 capital any intangible assets other than goodwill and MSAs in accordance with the VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 100 100 100 100 100 percentages set forth in Table 3 to § l.300. (iii) A [BANK] must apply a 100 percent risk-weight to the aggregate PO 00000 Frm 00249 Fmt 4701 Sfmt 4700 Percentage of the deductions from common equity tier 1 capital Percentage of the deductions from tier 1 capital 20 40 60 80 100 Percentage of the deductions from common equity tier 1 capital Calendar Calendar Calendar Calendar Calendar Transition deductions under § l.22(a)(3)–(6) 80 60 40 20 0 amount of intangible assets other than goodwill and MSAs that are not required to be deducted from common equity tier 1 capital under this section. E:\FR\FM\11OCR2.SGM 11OCR2 62266 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations TABLE 3 TO § l.300 Transition deductions under § l.22(a)(2)— percentage of the deductions from common equity tier 1 capital Transition period Calendar Calendar Calendar Calendar Calendar year year year year year 2014 ............................................................................................................................. 2015 ............................................................................................................................. 2016 ............................................................................................................................. 2017 ............................................................................................................................. 2018, and thereafter .................................................................................................... (2) Transition adjustments to common equity tier 1 capital. Beginning January 1, 2014 for an advanced approaches [BANK], and beginning January 1, 2015 for a [BANK] that is not an advanced approaches [BANK], and in each case through December 31, 2017, a [BANK], must allocate the regulatory adjustments related to changes in the fair value of liabilities due to changes in the [BANK]’s own credit risk (§ l.22(b)(1)(iii)) between common equity tier 1 capital and tier 1 capital in accordance with the percentages set forth in Table 4 to § l.300. (i) If the aggregate amount of the adjustment is positive, the [BANK] must allocate the deduction between common 20 40 60 80 100 equity tier 1 and tier 1 capital in accordance with Table 4 to § l.300. (ii) If the aggregate amount of the adjustment is negative, the [BANK] must add back the adjustment to common equity tier 1 capital or to tier 1 capital, in accordance with Table 4 to § l.300. TABLE 4 TO § l.300 Transition adjustments under § l.22(b)(2) Transition period Calendar Calendar Calendar Calendar Calendar year year year year year Percentage of the adjustment applied to common equity tier 1 capital Percentage of the adjustment applied to tier 1 capital 20 40 60 80 100 80 60 40 20 0 2014 ......................................................................... 2015 ......................................................................... 2016 ......................................................................... 2017 ......................................................................... 2018, and thereafter ................................................ (3) Transition adjustments to AOCI for an advanced approaches [BANK] and a [BANK] that has not made an AOCI opt-out election under § l.22(b)(2). Beginning January 1, 2014 for an advanced approaches [BANK], and beginning January 1, 2015 for a [BANK] that is not an advanced approaches [BANK] that has not made an AOCI opt-out election under § l.22(b)(2), and in each case through December 31, 2017, a [BANK] must adjust common equity tier 1 capital with respect to the transition AOCI adjustment amount (transition AOCI adjustment amount): (i) The transition AOCI adjustment amount is the aggregate amount of a [BANK]’s: (A) Unrealized gains on available-forsale securities that are preferred stock classified as an equity security under GAAP or available-for-sale equity exposures, plus (B) Net unrealized gains or losses on available-for-sale securities that are not preferred stock classified as an equity security under GAAP or available-forsale equity exposures, plus (C) Any amounts recorded in AOCI attributed to defined benefit postretirement plans resulting from the initial and subsequent application of the relevant GAAP standards that pertain to such plans (excluding, at the [BANK]’s option, the portion relating to pension assets deducted under section 22(a)(5)), plus (D) Accumulated net gains or losses on cash flow hedges related to items that are reported on the balance sheet at fair value included in AOCI, plus (E) Net unrealized gains or losses on held-to-maturity securities that are included in AOCI. (ii) A [BANK] must make the following adjustment to its common equity tier 1 capital: (A) If the transition AOCI adjustment amount is positive, the appropriate amount must be deducted from common equity tier 1 capital in accordance with Table 5 to § l.300. (B) If the transition AOCI adjustment amount is negative, the appropriate amount must be added back to common equity tier 1 capital in accordance with Table 5 to § l.300. TABLE 5 TO § l.300 Percentage of the transition AOCI adjustment amount to be applied to common equity tier 1 capital wreier-aviles on DSK5TPTVN1PROD with RULES2 Transition period Calendar Calendar Calendar Calendar Calendar year year year year year VerDate Mar<15>2010 2014 2015 2016 2017 2018 ............................................................................................................................. ............................................................................................................................. ............................................................................................................................. ............................................................................................................................. and thereafter ..................................................................................................... 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00250 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 80 60 40 20 0 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (iii) A [BANK] may include in tier 2 capital the percentage of unrealized gains on available-for-sale preferred stock classified as an equity security under GAAP and available-for-sale 62267 equity exposures as set forth in Table 6 to § l.300. TABLE 6 TO § l.300 Percentage of unrealized gains on availablefor-sale preferred stock classified as an equity security under GAAP and availablefor-sale equity exposures that may be included in tier 2 capital Transition period Calendar Calendar Calendar Calendar Calendar year year year year year 2014 2015 2016 2017 2018 ............................................................................................................................. ............................................................................................................................. ............................................................................................................................. ............................................................................................................................. and thereafter ..................................................................................................... (4) Additional transition deductions from regulatory capital. (i) Beginning January 1, 2014 for an advanced approaches [BANK], and beginning January 1, 2015 for a [BANK] that is not an advanced approaches [BANK], and in each case through December 31, 2017, a [BANK], must use Table 7 to § l.300 to determine the amount of investments in capital instruments and the items subject to the 10 and 15 percent common equity tier 1 capital deduction thresholds (§ l.22(d)) (that is, MSAs, DTAs arising from temporary differences that the [BANK] could not realize through net operating loss carrybacks, and significant investments in the capital of unconsolidated financial institutions in the form of common stock) that must be deducted from common equity tier 1 capital. (ii) Beginning January 1, 2014 for an advanced approaches [BANK], and beginning January 1, 2015 for a [BANK] that is not an advanced approaches [BANK], and in each case through December 31, 2017, a [BANK] must 36 27 18 9 0 apply a 100 percent risk-weight to the aggregate amount of the items subject to the 10 and 15 percent common equity tier 1 capital deduction thresholds that are not deducted under this section. As set forth in § l.22(d)(2), beginning January 1, 2018, a [BANK] must apply a 250 percent risk-weight to the aggregate amount of the items subject to the 10 and 15 percent common equity tier 1 capital deduction thresholds that are not deducted from common equity tier 1 capital. TABLE 7 TO § l.300 Transitions for deductions under § l.22(c) and (d)—Percentage of additional deductions from regulatory capital Transition period wreier-aviles on DSK5TPTVN1PROD with RULES2 Calendar Calendar Calendar Calendar Calendar year year year year year 2014 2015 2016 2017 2018 ............................................................................................................................. ............................................................................................................................. ............................................................................................................................. ............................................................................................................................. and thereafter ..................................................................................................... (iii) For purposes of calculating the transition deductions in this paragraph (b)(4) beginning January 1, 2014 for an advanced approaches [BANK], and beginning January 1, 2015 for a [BANK] that is not an advanced approaches [BANK], and in each case through December 31, 2017, a [BANK]’s 15 percent common equity tier 1 capital deduction threshold for MSAs, DTAs arising from temporary differences that the [BANK] could not realize through net operating loss carrybacks, and significant investments in the capital of unconsolidated financial institutions in the form of common stock is equal to 15 percent of the sum of the [BANK]’s common equity tier 1 elements, after regulatory adjustments and deductions required under § l.22(a) through (c) (transition 15 percent common equity tier 1 capital deduction threshold). (iv) Beginning January 1, 2018, a [BANK] must calculate the 15 percent VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 common equity tier 1 capital deduction threshold in accordance with § l.22(d). (c) Non-qualifying capital instruments—(1) Depository institution holding companies with total consolidated assets of more than $15 billion as of December 31, 2009 that were not mutual holding companies prior to May 19, 2010. The transition provisions in this paragraph (c)(1) apply to debt or equity instruments that do not meet the criteria for additional tier 1 or tier 2 capital instruments in § l.20, but that were issued and included in tier 1 or tier 2 capital, respectively prior to May 19, 2010 (non-qualifying capital instruments), and that were issued by a depository institution holding company with total consolidated assets greater than or equal to $15 billion as of December 31, 2009 that was not a mutual holding company prior to May 19, 2010 (2010 MHC) (depository PO 00000 Frm 00251 Fmt 4701 Sfmt 4700 20 40 60 80 100 institution holding company of $15 billion or more). (i) A depository institution holding company of $15 billion or more may include in tier 1 and tier 2 capital nonqualifying capital instruments up to the applicable percentage set forth in Table 8 to § l.300 of the aggregate outstanding principal amounts of nonqualifying tier 1 and tier 2 capital instruments, respectively, that are outstanding as of January 1, 2014, beginning January 1, 2014, for a depository institution holding company of $15 billion or more that is an advanced approaches [BANK] that is not a savings and loan holding company, and beginning January 1, 2015, for all other depository institution holding companies of $15 billion or more. (ii) A depository institution holding company of $15 billion or more must apply the applicable percentages set forth in Table 8 to § l.300 separately to E:\FR\FM\11OCR2.SGM 11OCR2 62268 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations the aggregate amounts of its tier 1 and tier 2 non-qualifying capital instruments. (iii) The amount of non-qualifying capital instruments that must be excluded from additional tier 1 capital in accordance with this section may be included in tier 2 capital without limitation, provided the instruments meet the criteria for tier 2 capital set forth in § l.20(d). (iv) Non-qualifying capital instruments that do not meet the criteria for tier 2 capital set forth in § l.20(d) may be included in tier 2 capital as follows: (A) A depository institution holding company of $15 billion or more that is not an advanced approaches [BANK] may include non-qualifying capital instruments that have been phased-out of tier 1 capital in tier 2 capital, and (B) During calendar years 2014 and 2015, a depository institution holding company of $15 billion or more that is an advanced approaches [BANK] may include non-qualifying capital instruments in tier 2 capital that have been phased out of tier 1 capital in accordance with Table 8 to § l.300. Beginning January 1, 2016, a depository institution holding company of $15 billion or more that is an advanced approaches [BANK] may include nonqualifying capital instruments in tier 2 capital that have been phased out of tier 1 capital in accordance with Table 8, up to the applicable percentages set forth in Table 9 to § l.300. (2) Mergers and acquisitions. (i) A depository institution holding company of $15 billion or more that acquires either a depository institution holding company with total consolidated assets of less than $15 billion as of December 31, 2009 (depository institution holding company under $15 billion) or a depository institution holding company that is a 2010 MHC, may include in regulatory capital the non-qualifying capital instruments issued by the acquired organization up to the applicable percentages set forth in Table 8 to § l.300. (ii) If a depository institution holding company under $15 billion acquires a depository institution holding company under $15 billion or a 2010 MHC, and the resulting organization has total consolidated assets of $15 billion or more as reported on the resulting organization’s FR Y–9C for the period in which the transaction occurred, the resulting organization may include in regulatory capital non-qualifying instruments of the resulting organization up to the applicable percentages set forth in Table 8 to § l.300. TABLE 8 TO § l.300 Transition period (calendar year) Percentage of non-qualifying capital instruments includable in additional tier 1 or tier 2 capital for a depository institution holding company of $15 billion or more Calendar year 2014 ............................................................................................................................. Calendar year 2015 ............................................................................................................................. Calendar year 2016 and thereafter ..................................................................................................... 50 25 0 (3) Depository institution holding companies under $15 billion and 2010 MHCs. (i) Non-qualifying capital instruments issued by depository institution holding companies under $15 billion and 2010 MHCs prior to May 19, 2010 may be included in additional tier 1 or tier 2 capital if the instrument was included in tier 1 or tier 2 capital, respectively, as of January 1, 2014. (ii) Non-qualifying capital instruments includable in tier 1 capital are subject to a limit of 25 percent of tier 1 capital elements, excluding any nonqualifying capital instruments and after applying all regulatory capital deductions and adjustments to tier 1 capital. (iii) Non-qualifying capital instruments that are not included in tier 1 as a result of the limitation in paragraph (c)(3)(ii) of this section are includable in tier 2 capital. (4) Depository institutions. (i) Beginning on January 1, 2014, a depository institution that is an advanced approaches [BANK], and beginning on January 1, 2015, all other depository institutions, may include in regulatory capital debt or equity instruments issued prior to September 12, 2010 that do not meet the criteria for additional tier 1 or tier 2 capital instruments in § l.20 but that were included in tier 1 or tier 2 capital respectively as of September 12, 2010 (non-qualifying capital instruments issued prior to September 12, 2010) up to the percentage of the outstanding principal amount of such non-qualifying capital instruments as of January 1, 2014 in accordance with Table 9 to § l.300. (ii) Table 9 to § l.300 applies separately to tier 1 and tier 2 nonqualifying capital instruments. (iii) The amount of non-qualifying capital instruments that cannot be included in additional tier 1 capital under this section may be included in tier 2 capital without limitation, provided that the instruments meet the criteria for tier 2 capital instruments under § l.20(d). TABLE 9 TO § l.300 Percentage of non-qualifying capital instruments includable in additional tier 1 or tier 2 capital wreier-aviles on DSK5TPTVN1PROD with RULES2 Transition period (calendar year) Calendar Calendar Calendar Calendar Calendar Calendar Calendar Calendar Calendar year year year year year year year year year VerDate Mar<15>2010 2014 2015 2016 2017 2018 2019 2020 2021 2022 ......................................................................................................................... ......................................................................................................................... ......................................................................................................................... ......................................................................................................................... ......................................................................................................................... ......................................................................................................................... ......................................................................................................................... ......................................................................................................................... and thereafter ................................................................................................. 13:14 Oct 10, 2013 Jkt 232001 PO 00000 Frm 00252 Fmt 4701 Sfmt 4700 E:\FR\FM\11OCR2.SGM 80 70 60 50 40 30 20 10 0 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (d) Minority interest—(1) Surplus minority interest. Beginning January 1, 2014 for an advanced approaches [BANK], and beginning January 1, 2015 for a [BANK] that is not an advanced approaches [BANK], and in each case through December 31, 2017, a [BANK] may include in common equity tier 1 capital, tier 1 capital, or total capital the percentage of the common equity tier 1 minority interest, tier 1 minority interest and total capital minority interest outstanding as of January 1, 2014 that exceeds any common equity tier 1 minority interest, tier 1 minority interest or total capital minority interest includable under § l.21 (surplus minority interest), respectively, as set forth in Table 10 to § l.300. (2) Non-qualifying minority interest. Beginning January 1, 2014 for an advanced approaches [BANK], and beginning January 1, 2015 for a [BANK] that is not an advanced approaches 62269 [BANK], and in each case through December 31, 2017, a [BANK] may include in tier 1 capital or total capital the percentage of the tier 1 minority interest and total capital minority interest outstanding as of January 1, 2014 that does not meet the criteria for additional tier 1 or tier 2 capital instruments in § l.20 (non-qualifying minority interest), as set forth in Table 10 to § l.300. TABLE 10 TO § l.300 Percentage of the amount of surplus or nonqualifying minority interest that can be included in regulatory capital during the transition period Transition period Calendar Calendar Calendar Calendar Calendar year year year year year 2014 2015 2016 2017 2018 ............................................................................................................................. ............................................................................................................................. ............................................................................................................................. ............................................................................................................................. and thereafter ..................................................................................................... (e) Prompt corrective action. For purposes of [12 CFR Part 6 (OCC); 12 CFR 208, subpart D (Board)], a [BANK] must calculate its capital measures and tangible equity ratio in accordance with the transition provisions in this section. End of Common Rule. List of Subjects 12 CFR Part 3 DEPARTMENT OF THE TREASURY Administrative practice and procedure, National banks, Reporting and recordkeeping requirements, Securities. Office of the Comptroller of the Currency 12 CFR Chapter I 12 CFR Part 6 Authority and Issuance National banks. 12 CFR Part 165 Administrative practice and procedure, Savings associations. 12 CFR Part 167 Capital, Reporting and recordkeeping requirements, Risk, Savings associations. 12 CFR Part 208 wreier-aviles on DSK5TPTVN1PROD with RULES2 Administrative practice and procedure, Banks, banking, Federal Reserve System, Holding companies, Reporting and recordkeeping requirements, Securities. The adoption of the final common rules by the agencies, as modified by the agency-specific text, is set forth below: 12 CFR Part 5 Confidential business information, Crime, Currency, Federal Reserve System, Mortgages, reporting and recordkeeping requirements, Securities. 12 CFR Part 217 Administrative practice and procedure, Banks, Banking, Capital, Federal Reserve System, Holding 13:14 Oct 10, 2013 12 CFR Part 225 Adoption of Common Rule Administrative practice and procedure, Capital, National banks, Reporting and recordkeeping requirements, Risk. VerDate Mar<15>2010 companies, Reporting and recordkeeping requirements, Risk. Jkt 232001 For the reasons set forth in the common preamble and under the authority of 12 U.S.C. 93a and 5412(b)(2)(B), the Office of the Comptroller of the Currency amends part 3 of chapter I of title 12, Code of Federal Regulations as follows: PART 3—CAPITAL ADEQUACY STANDARDS 1. The authority citation for part 3 is revised to read as follows: ■ Authority: 12 U.S.C. 93a, 161, 1462, 1462a, 1463, 1464, 1818, 1828(n), 1828 note, 1831n note, 1835, 3907, 3909, and 5412(b)(2)(B). 2. Revise the heading of part 3 to read as set forth above. ■ PO 00000 Frm 00253 Fmt 4701 Sfmt 4700 80 60 40 20 0 Subpart A [Removed] 3. Remove subpart A, consisting of §§ 3.1 through 3.4. ■ Subpart B [Removed] 4. Remove subpart B, consisting of §§ 3.5 through 3.8. ■ Subparts C through E [Redesignated as Subparts H through J] 5a. Redesignate subparts C through E as subparts H through J. ■ 5b. Revise newly redesignated subparts H through J to read as follows: ■ Subpart H—Establishment of Minimum Capital Ratios for an Individual Bank or Individual Federal Savings Association Sec. 3.401 Purpose and scope. 3.402 Applicability. 3.403 Standards for determination of appropriate individual minimum capital ratios. 3.404 Procedures. 3.405 Relation to other actions. Subpart H—Establishment of Minimum Capital Ratios for an Individual Bank or Individual Federal Savings Association § 3.401 Purpose and scope. The rules and procedures specified in this subpart are applicable to a proceeding to establish required minimum capital ratios that would otherwise be applicable to a national bank or Federal savings association under subpart B of this part. The OCC is authorized under 12 U.S.C. 1464(s)(2) and 3907(a)(2) to establish such minimum capital requirements for a national bank or Federal savings E:\FR\FM\11OCR2.SGM 11OCR2 62270 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations association as the OCC, in its discretion, deems appropriate in light of the particular circumstances at that national bank or Federal savings association. Proceedings under this subpart also may be initiated to require a national bank or Federal savings association having capital ratios above those set forth in subpart B of this part, or other legal authority to continue to maintain those higher ratios. wreier-aviles on DSK5TPTVN1PROD with RULES2 § 3.402 Applicability. The OCC may require higher minimum capital ratios for an individual national bank or Federal savings association in view of its circumstances. For example, higher capital ratios may be appropriate for: (a) A newly chartered national bank or Federal savings association; (b) A national bank or Federal savings association receiving special supervisory attention; (c) A national bank or Federal savings association that has, or is expected to have, losses resulting in capital inadequacy; (d) A national bank or Federal savings association with significant exposure due to the risks from concentrations of credit, certain risks arising from nontraditional activities, or management’s overall inability to monitor and control financial and operating risks presented by concentrations of credit and nontraditional activities; (e) A national bank or Federal savings association with significant exposure to declines in the economic value of its capital due to changes in interest rates; (f) A national bank or Federal savings association with significant exposure due to fiduciary or operational risk; (g) A national bank or Federal savings association exposed to a high degree of asset depreciation, or a low level of liquid assets in relation to short term liabilities; (h) A national bank or Federal savings association exposed to a high volume of, or particularly severe, problem loans; (i) A national bank or Federal savings association that is growing rapidly, either internally or through acquisitions; or (j) A national bank or Federal savings association that may be adversely affected by the activities or condition of its holding company, affiliate(s), or other persons or institutions, including chain banking organizations, with which it has significant business relationships. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 § 3.403 Standards for determination of appropriate individual minimum capital ratios. The appropriate minimum capital ratios for an individual national bank or Federal savings association cannot be determined solely through the application of a rigid mathematical formula or wholly objective criteria. The decision is necessarily based in part on subjective judgment grounded in agency expertise. The factors to be considered in the determination will vary in each case and may include, for example: (a) The conditions or circumstances leading to the OCC’s determination that higher minimum capital ratios are appropriate or necessary for the national bank or Federal savings association; (b) The exigency of those circumstances or potential problems; (c) The overall condition, management strength, and future prospects of the national bank or Federal savings association and, if applicable, its holding company and/or affiliate(s); (d) The national bank’s or Federal savings association’s liquidity, capital, risk asset and other ratios compared to the ratios of its peer group; and (e) The views of the national bank’s or Federal savings association’s directors and senior management. § 3.404 Procedures. (a) Notice. When the OCC determines that minimum capital ratios above those set forth in subpart B of this part or other legal authority are necessary or appropriate for a particular national bank or Federal savings association, the OCC will notify the national bank or Federal savings association in writing of the proposed minimum capital ratios and the date by which they should be reached (if applicable) and will provide an explanation of why the ratios proposed are considered necessary or appropriate for the national bank or Federal savings association. (b) Response. (1) The national bank or Federal savings association may respond to any or all of the items in the notice. The response should include any matters which the national bank or Federal savings association would have the OCC consider in deciding whether individual minimum capital ratios should be established for the national bank or Federal savings association, what those capital ratios should be, and, if applicable, when they should be achieved. The response must be in writing and delivered to the designated OCC official within 30 days after the date on which the national bank or Federal savings association received the notice. The OCC may shorten the time PO 00000 Frm 00254 Fmt 4701 Sfmt 4700 period when, in the opinion of the OCC, the condition of the national bank or Federal savings association so requires, provided that the national bank or Federal savings association is informed promptly of the new time period, or with the consent of the national bank or Federal savings association. In its discretion, the OCC may extend the time period for good cause. (2) Failure to respond within 30 days or such other time period as may be specified by the OCC shall constitute a waiver of any objections to the proposed minimum capital ratios or the deadline for their achievement. (c) Decision. After the close of the national bank’s or Federal savings association’s response period, the OCC will decide, based on a review of the national bank’s or Federal savings association’s response and other information concerning the national bank or Federal savings association, whether individual minimum capital ratios should be established for the national bank or Federal savings association and, if so, the ratios and the date the requirements will become effective. The national bank or Federal savings association will be notified of the decision in writing. The notice will include an explanation of the decision, except for a decision not to establish individual minimum capital requirements for the national bank or Federal savings association. (d) Submission of plan. The decision may require the national bank or Federal savings association to develop and submit to the OCC, within a time period specified, an acceptable plan to reach the minimum capital ratios established for the national bank or Federal savings association by the date required. (e) Change in circumstances. If, after the OCC’s decision in paragraph (c) of this section, there is a change in the circumstances affecting the national bank’s or Federal savings association’s capital adequacy or its ability to reach the required minimum capital ratios by the specified date, the national bank or Federal savings association may propose to the OCC, or the OCC may propose to the national bank or Federal savings association, a change in the minimum capital ratios for the national bank or Federal savings association, the date when the minimums must be achieved, or the national bank’s or Federal savings association’s plan (if applicable). The OCC may decline to consider proposals that are not based on a significant change in circumstances or are repetitive or frivolous. Pending a decision on reconsideration, the OCC’s original decision and any plan required E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations under that decision shall continue in full force and effect. § 3.405 Relation to other actions. In lieu of, or in addition to, the procedures in this subpart, the required minimum capital ratios for a national bank or Federal savings association may be established or revised through a written agreement or cease and desist proceedings under 12 U.S.C. 1818 (b) or (c) (12 CFR 19.0 through 19.21 for national banks and 12 CFR part 109 for Federal savings associations) or as a condition for approval of an application. Subpart I—Enforcement § 3.501 Remedies. A national bank or Federal savings association that does not have or maintain the minimum capital ratios applicable to it, whether required in subpart B of this part, in a decision pursuant to subpart H of this part, in a written agreement or temporary or final order under 12 U.S.C. 1818 (b) or (c), or in a condition for approval of an application, or a national bank or Federal savings association that has failed to submit or comply with an acceptable plan to attain those ratios, will be subject to such administrative action or sanctions as the OCC considers appropriate. These sanctions may include the issuance of a Directive pursuant to subpart J of this part or other enforcement action, assessment of civil money penalties, and/or the denial, conditioning, or revocation of applications. A national bank’s or Federal savings association’s failure to achieve or maintain minimum capital ratios in subpart B of this part may also be the basis for an action by the Federal Deposit Insurance Corporation to terminate Federal deposit insurance. See 12 CFR part 308, subpart F. Subpart J—Issuance of a Directive Sec. 3.601 Purpose and scope. 3.602 Notice of intent to issue a directive. 3.603 Response to notice. 3.604 Decision. 3.605 Issuance of a directive. 3.606 Change in circumstances. 3.607 Relation to other administrative actions. Subpart J—Issuance of a Directive wreier-aviles on DSK5TPTVN1PROD with RULES2 § 3.601 Purpose and scope. (a) This subpart is applicable to proceedings by the OCC to issue a directive under 12 U.S.C. 3907(b)(2) or 12 U.S.C. 1464(s), as appropriate. A directive is an order issued to a national bank or Federal savings association that does not have or maintain capital at or above the minimum ratios set forth in VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 subpart B of this part, or established for the national bank or Federal savings association under subpart H of this part, by a written agreement under 12 U.S.C. 1818(b), or as a condition for approval of an application. A directive may order the national bank or Federal savings association to: (1) Achieve the minimum capital ratios applicable to it by a specified date; (2) Adhere to a previously submitted plan to achieve the applicable capital ratios; (3) Submit and adhere to a plan acceptable to the OCC describing the means and time schedule by which the national bank or Federal savings association shall achieve the applicable capital ratios; (4) Take other action, such as reduction of assets or the rate of growth of assets, or restrictions on the payment of dividends, to achieve the applicable capital ratios; or (5) A combination of any of these or similar actions. (b) A directive issued under this rule, including a plan submitted under a directive, is enforceable in the same manner and to the same extent as an effective and outstanding cease and desist order which has become final as defined in 12 U.S.C. 1818(k). Violation of a directive may result in assessment of civil money penalties in accordance with 12 U.S.C. 3909(d). § 3.602 Notice of intent to issue a directive. The OCC will notify a national bank or Federal savings association in writing of its intention to issue a directive. The notice will state: (a) Reasons for issuance of the directive; and (b) The proposed contents of the directive. § 3.603 Response to notice. (a) A national bank or Federal savings association may respond to the notice by stating why a directive should not be issued and/or by proposing alternative contents for the directive. The response should include any matters which the national bank or Federal savings association would have the OCC consider in deciding whether to issue a directive and/or what the contents of the directive should be. The response may include a plan for achieving the minimum capital ratios applicable to the national bank or Federal savings association. The response must be in writing and delivered to the designated OCC official within 30 days after the date on which the national bank or Federal savings association received the PO 00000 Frm 00255 Fmt 4701 Sfmt 4700 62271 notice. The OCC may shorten the 30-day time period: (1) When, in the opinion of the OCC, the condition of the national bank or Federal savings association so requires, provided that the national bank or Federal savings association shall be informed promptly of the new time period; (2) With the consent of the national bank or Federal savings association; or (3) When the national bank or Federal savings association already has advised the OCC that it cannot or will not achieve its applicable minimum capital ratios. (b) In its discretion, the OCC may extend the time period for good cause. (c) Failure to respond within 30 days or such other time period as may be specified by the OCC shall constitute a waiver of any objections to the proposed directive. § 3.604 Decision. After the closing date of the national bank’s or Federal savings association’s response period, or receipt of the national bank’s or Federal savings association’s response, if earlier, the OCC will consider the national bank’s or Federal savings association’s response, and may seek additional information or clarification of the response. Thereafter, the OCC will determine whether or not to issue a directive, and if one is to be issued, whether it should be as originally proposed or in modified form. § 3.605 Issuance of a directive. (a) A directive will be served by delivery to the national bank or Federal savings association. It will include or be accompanied by a statement of reasons for its issuance. (b) A directive is effective immediately upon its receipt by the national bank or Federal savings association, or upon such later date as may be specified therein, and shall remain effective and enforceable until it is stayed, modified, or terminated by the OCC. § 3.606 Change in circumstances. Upon a change in circumstances, a national bank or Federal savings association may request the OCC to reconsider the terms of its directive or may propose changes in the plan to achieve the national bank’s or Federal savings association’s applicable minimum capital ratios. The OCC also may take such action on its own motion. The OCC may decline to consider requests or proposals that are not based on a significant change in circumstances or are repetitive or frivolous. Pending a decision on reconsideration, the E:\FR\FM\11OCR2.SGM 11OCR2 62272 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations directive and plan shall continue in full force and effect. § 3.607 Relation to other administrative actions. A directive may be issued in addition to, or in lieu of, any other action authorized by law, including cease and desist proceedings, civil money penalties, or the conditioning or denial of applications. The OCC also may, in its discretion, take any action authorized by law, in lieu of a directive, in response to a national bank’s or Federal savings association’s failure to achieve or maintain the applicable minimum capital ratios. ■ 5c. Add a new Subpart K to read as follows: Subpart K—Interpretations wreier-aviles on DSK5TPTVN1PROD with RULES2 § 3.701 Capital and surplus. For purposes of determining statutory limits that are based on the amount of a national bank’s capital and/or surplus, the provisions of this section are to be used, rather than the definitions of capital contained in subparts A through J of this part. (a) Capital. The term capital as used in provisions of law relating to the capital of national banks shall include the amount of common stock outstanding and unimpaired plus the amount of perpetual preferred stock outstanding and unimpaired. (b) Capital Stock. The term capital stock as used in provisions of law relating to the capital stock of national banks, other than 12 U.S.C. 101, 177, and 178 shall have the same meaning as the term capital set forth in paragraph (a) of this section. (c) Surplus. The term surplus as used in provisions of law relating to the surplus of national banks means the sum of paragraphs (c)(1), (2), (3), and (4) of this section: (1) Capital surplus; undivided profits; reserves for contingencies and other capital reserves (excluding accrued dividends on perpetual and limited life preferred stock); net worth certificates issued pursuant to 12 U.S.C. 1823(i); minority interests in consolidated subsidiaries; and allowances for loan and lease losses; minus intangible assets; (2) Mortgage servicing assets; (3) Mandatory convertible debt to the extent of 20 percent of the sum of paragraphs (a) and (c) (1) and (2) of this section; (4) Other mandatory convertible debt, limited life preferred stock and subordinated notes and debentures to the extent set forth in paragraph (f)(2) of this section. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (d) Unimpaired surplus fund. The term unimpaired surplus fund as used in provisions of law relating to the unimpaired surplus fund of national banks shall have the same meaning as the term surplus set forth in paragraph (c) of this section. (e) Definitions. (1) Allowance for loan and lease losses means the balance of the valuation reserve on December 31, 1968, plus additions to the reserve charged to operations since that date, less losses charged against the allowance net of recoveries. (2) Capital surplus means the total of those accounts reflecting: (i) Amounts paid in in excess of the par or stated value of capital stock; (ii) Amounts contributed to the national bank other than for capital stock; (iii) Amounts transferred from undivided profits pursuant to 12 U.S.C. 60; and (iv) Other amounts transferred from undivided profits. (3) Intangible assets means those purchased assets that are to be reported as intangible assets in accordance with the Instructions—Consolidated Reports of Condition and Income (Call Report). (4) Limited life preferred stock means preferred stock which has a maturity or which may be redeemed at the option of the holder. (5) Mandatory convertible debt means subordinated debt instruments which unqualifiedly require the issuer to exchange either common or perpetual preferred stock for such instruments by a date at or before the maturity of the instrument. The maturity of these instruments must be 12 years or less. In addition, the instrument must meet the requirements of paragraphs (f)(1)(i) through (v) of this section for subordinated notes and debentures or other requirements published by the OCC. (6) Minority interest in consolidated subsidiaries means the portion of equity capital accounts of all consolidated subsidiaries of the national bank that is allocated to minority shareholders of such subsidiaries. (7) Mortgage servicing assets means the national bank-owned rights to service for a fee mortgage loans that are owned by others. (8) Perpetual preferred stock means preferred stock that does not have a stated maturity date and cannot be redeemed at the option of the holder. (f) Requirements and restrictions: Limited life preferred stock, mandatory convertible debt, and other subordinated debt—(1) Requirements. Issues of limited life preferred stock and subordinated notes and debentures PO 00000 Frm 00256 Fmt 4701 Sfmt 4700 (except mandatory convertible debt) shall have original weighted average maturities of at least five years to be included in the definition of surplus. In addition, a subordinated note or debenture must also: (i) Be subordinated to the claims of depositors; (ii) State on the instrument that it is not a deposit and is not insured by the FDIC; (iii) Be unsecured; (iv) Be ineligible as collateral for a loan by the issuing national bank; (v) Provide that once any scheduled payments of principal begin, all scheduled payments shall be made at least annually and the amount repaid in each year shall be no less than in the prior year; and (vi) Provide that no prepayment (including payment pursuant to an acceleration clause or redemption prior to maturity) shall be made without prior OCC approval unless the national bank remains an eligible bank, as defined in 12 CFR 5.3(g), after the prepayment. (2) Restrictions. The total amount of mandatory convertible debt not included in paragraph (c)(3) of this section, limited life preferred stock, and subordinated notes and debentures considered as surplus is limited to 50 percent of the sum of paragraphs (a) and (c) (1), (2) and (3) of this section. (3) Reservation of authority. The OCC expressly reserves the authority to waive the requirements and restrictions set forth in paragraphs (f)(1) and (2) of this section, in order to allow the inclusion of other limited life preferred stock, mandatory convertible notes and subordinated notes and debentures in the capital base of any national bank for capital adequacy purposes or for purposes of determining statutory limits. The OCC further expressly reserves the authority to impose more stringent conditions than those set forth in paragraphs (f)(1) and (2) of this section to exclude any component of tier 1 or tier 2 capital, in whole or in part, as part of a national bank’s capital and surplus for any purpose. (g) Transitional rules. (1) Equity commitment notes approved by the OCC as capital and issued prior to April 15, 1985, may continue to be included in paragraph (c)(3) of this section. All other instruments approved by the OCC as capital and issued prior to April 15, 1985, are to be included in paragraph (c)(4) of this section. (2) Intangible assets (other than mortgage servicing assets) purchased prior to April 15, 1985, and accounted for in accordance with OCC instructions, may continue to be included as surplus up to 25 percent of E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations the sum of paragraphs (a) and (c)(1) of this section. ■ 6. Add subparts A through G to part 3, as set forth at the end of the common preamble. Appendix C to Part 3 [Removed] 7. Remove appendix C. 8. Subparts A through G, as set forth at the end of the common preamble, are amended as follows: ■ A. Remove ‘‘[AGENCY]’’ and add ‘‘OCC’’ in its place, wherever it appears; ■ B. Remove ‘‘[BANK]’’ and add ‘‘national bank or Federal savings association’’ in its place, wherever it appears; ■ C. Remove ‘‘[BANKS]’’ and ‘‘[BANK]s’’ and add ‘‘national banks and Federal savings associations’’ in their places, wherever they appear; ■ D. Remove ‘‘[BANK]’s’’ and add ‘‘national bank’s or Federal savings association’s’’ in their places, wherever they appear; ■ E. Remove ‘‘[PART]’’ and add ‘‘part’’ in its place, wherever it appears; and ■ F. Remove ‘‘[REGULATORY REPORT]’’ and add ‘‘Call Report’’ in its place, wherever it appears; ■ G. Remove ‘‘[other Federal banking agencies]’’ wherever it appears and add ‘‘Federal Deposit Insurance Corporation and Federal Reserve Board’’ in its place; ■ 9. In § 3.1: ■ A. In paragraph (e), remove ‘‘[12 CFR 3.404, (OCC); 12 CFR 263.202 (Board)]’’ and add ‘‘§ 3.404’’ in its place; ■ B. In paragraph (f)(1)(ii)(A), remove ‘‘[12 CFR part 3, appendix A and, if applicable, 12 CFR part 3, subpart F (national banks), or 12 CFR part 167 and, if applicable, 12 CFR part 3, subpart F (Federal savings associations)(OCC); 12 CFR part 225, appendix A (Board)]’’ and add ‘‘appendix A to this part and, if applicable, subpart F of this part (national banks), or 12 CFR part 167 and, if applicable, subpart F of this part (Federal savings associations)’’ in its place; ■ C. In footnote 1 in paragraph (f)(1)(ii)(A), remove ‘‘[12 CFR part 3, appendix A, Sec. 3 and, if applicable, 12 CFR part 3, subpart F (national banks), or 12 CFR part 167 and, if applicable, 12 CFR part 3, subpart F (Federal savings associations) (OCC);, 12 CFR parts 208 and 225, and, if applicable, appendix E to this part (state member banks or bank holding companies, respectively (Board)]’’ and add ‘‘appendix A to this part, Sec. 3 and, if applicable, subpart F of this part (national banks), or 12 CFR part 167 and, if applicable, subpart F of this part (Federal savings associations)’’ in its place; ■ wreier-aviles on DSK5TPTVN1PROD with RULES2 ■ VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 D. In paragraph (f)(1)(ii)(B), remove ‘‘[12 CFR part 3, appendix B, section 4(a)(3) (national banks) (OCC); 12 CFR parts 208 or 225, appendix E, section 4(a)(3) (state member banks or bank holding companies, respectively) (Board); and 12 CFR part 325, appendix C, section 4(a)(3) (state nonmember banks and state savings associations)]’’ and add ‘‘appendix B to this part, section 4(a)(3) (national banks)’’ in its place. ■ E. In paragraph (f)(1)(ii)(C), remove ‘‘[12 CFR part 3, appendix A, and, if applicable, appendix B (national banks), or 12 CFR part 167 (Federal savings associations) (OCC)); 12 CFR parts 208 or 225, appendix A, and, if applicable, appendix E (state member banks or bank holding companies, respectively) (Board)]’’ and add in its place ‘‘appendix A to this part, and, if applicable, appendix B to this part (national banks), or 12 CFR part 167 (Federal savings associations) ■ F. In footnote 2 in paragraph (f)(1)(ii)(C), remove ‘‘[12 CFR part 3, appendix A, Sec. 3, appendix A, section 3 and, if applicable, 12 CFR part 3, appendix B (national banks), or 12 CFR part 167 (Federal savings associations) (OCC); 12 CFR parts 208 and 225, appendix A and, if applicable, appendix E (state member banks or bank holding companies, respectively) (Board)]’’ and add ‘‘appendix A to this part and, if applicable, subpart F of this part (national banks), or 12 CFR part 167 and, if applicable, subpart F of this part (Federal savings associations)’’ in its place; and ■ G. Add paragraph (f)(4). The addition and revision read as follows: ■ § 3.1 Purpose, applicability, reservations of authority, and timing. * * * * * (f) * * * (4) No national bank or Federal savings association that is not an advanced approaches bank or advanced approaches savings association is subject to this part 3 until January 1, 2015. ■ 10. Section 3.2 is amended by: ■ A. Adding definitions of ‘‘Core capital’’, ‘‘Federal savings association’’, and ’’ Tangible capital means’’ in alphabetical order; ■ B. In paragraph (2)(i) of the definition of ‘‘high volatility commercial real estate (HVCRE) exposure’’, remove ‘‘[12 CFR part 25 (national bank), 12 CFR part 195 (Federal savings association) (OCC); 12 CFR part 228 (Board)]’’ and add ‘‘12 CFR parts 25 (national banks) and 195 (Federal savings associations)’’ in its place; PO 00000 Frm 00257 Fmt 4701 Sfmt 4700 62273 C. In paragraph (2)(ii) of the definition of ‘‘high volatility commercial real estate (HVCRE) exposure’’, remove ‘‘[12 CFR part 25.12(g)(3) (national banks) and 12 CFR part 195.12(g)(3) (Federal savings associations) (OCC); 12 CFR part 208.22(a)(3) or 228.12(g)(3) (Board)]’’ and add ‘‘12 CFR 25.12(g)(3) (national banks) and 12 CFR 195.12(g)(3) (Federal savings associations)’’ in its place; ■ D. In paragraph (4)(i) of the definition of ‘‘high volatility commercial real estate (HVCRE) exposure’’, remove ‘‘[12 CFR part 34, subpart D (national banks) and 12 CFR part 160, subparts A and B (Federal savings associations) (OCC); 12 CFR part 208, appendix C (Board)]’’ and add ‘‘12 CFR part 34, subpart D (national banks) and 12 CFR part 160, subparts A and B (Federal savings associations)’’ in its place; and ■ E. In paragraph (10)(ii) of the definition of ‘‘traditional securitization’’, remove ‘‘[12 CFR 9.18 (national bank) and 12 CFR 151.40 (Federal saving association) (OCC); 12 CFR 208.34 (Board)]’’ and add ‘‘12 CFR 9.18 (national banks), 12 CFR 151.40 (Federal saving associations)’’ in its place. The additions read as follows: ■ § 3.2 Definitions. * * * * * Core capital means tier 1 capital, as calculated in accordance with subpart B of this part. * * * * * Federal savings association means an insured Federal savings association or an insured Federal savings bank chartered under section 5 of the Home Owners’ Loan Act of 1933. * * * * * Tangible capital means the amount of core capital (tier 1 capital), as calculated in accordance with subpart B of this part, plus the amount of outstanding perpetual preferred stock (including related surplus) not included in tier 1 capital. * * * * * ■ 11. Section 3.10,is amended by: ■ A. Adding paragraphs (a)(6), (b)(5), and (c)(5) to read as follows; ■ B. In paragraph (d)(1), removing ‘‘[12 CFR 3.10 (national banks), 12 CFR 167.3(c) (Federal savings associations) and 12 CFR 208.4 (state member banks)]’’ and adding ‘‘this section (national banks), 12 CFR 167.3(c) (Federal savings associations)’’ in its place. The additions read as follows: § 3.10 Minimum capital requirements. (a) * * * (6) For Federal savings associations, a tangible capital ratio of 1.5 percent. E:\FR\FM\11OCR2.SGM 11OCR2 62274 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (b) * * * (5) Federal savings association tangible capital ratio. A Federal savings association’s tangible capital ratio is the ratio of the Federal savings association’s core capital (tier 1 capital) to average total assets as calculated under this subpart B. For purposes of this paragraph (b)(5), the term ‘‘total assets’’ means ‘‘total assets’’ as defined in part 6, subpart A of this chapter, subject to subpart G of this part. (c) * * * (5) Federal savings association tangible capital ratio. A Federal savings association’s tangible capital ratio is the ratio of the Federal savings association’s core capital (tier 1 capital) to average total assets as calculated under this subpart B. For purposes of this paragraph (c)(5), the term ‘‘total assets’’ means ‘‘total assets’’ as defined in part 6, subpart A of this chapter, subject to subpart G of this part. * * * * * § 3.11 [Amended] 12. In § 3.11, in paragraph (a)(4)(v), remove ‘‘12 CFR part 3, subparts H and I; 12 CFR part 5.46, 12 CFR part 5, subpart E; 12 CFR part 6 (OCC); 12 CFR 225.4; 12 CFR 225.8; 12 CFR 263.202 (Board)’’ and add ‘‘subparts H and I of this part; 12 CFR 5.46, 12 CFR part 5, subpart E; 12 CFR part 6’’ in its place; ■ 13. Section 3.20 is amended by: ■ A. Revising paragraphs (b)(1)(v) and (c)(1)(viii); ■ B. In paragraph (c)(3), removing ‘‘[12 CFR part 3, appendix A (national banks), 12 CFR 167 (Federal savings associations) (OCC); 12 CFR part 208, appendix A, 12 CFR part 225, appendix A (Board)]’’ and add ‘‘appendix A to this part (national banks), 12 CFR part 167 (Federal savings associations)’’ in its place; and ■ C. In paragraph (d)(4), removing ‘‘12 CFR part 3, appendix A, 12 CFR 167 (OCC); 12 CFR part 208, appendix A, 12 CFR part 225, appendix A (Board)’’ and adding ‘‘appendix A to this part, 12 CFR part 167’’ in its place. The revisions read as follows: ■ § 3.20 Capital components and eligibility criteria for regulatory capital instruments. wreier-aviles on DSK5TPTVN1PROD with RULES2 * * * * * (b) * * * (1) * * * (v) Any cash dividend payments on the instrument are paid out of the [BANK]’s net income or retained earnings and are not subject to a limit imposed by the contractual terms governing the instrument. * * * * * (c) * * * VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (1) * * * (viii) Any cash dividend payments on the instrument are paid out of the [BANK]’s net income or retained earnings and are not subject to a limit imposed by the contractual terms governing the instrument. * * * * * ■ 14. Section 3.22 is amended by adding paragraph (a)(8) to read as follows: § 3.22 Regulatory capital adjustments and deductions. (a) * * * (8)(i) A Federal savings association must deduct the aggregate amount of its outstanding investments (both equity and debt) in, and extensions of credit to, subsidiaries that are not includable subsidiaries as defined in paragraph (a)(8)(iv) of this section and may not consolidate the assets and liabilities of the subsidiary with those of the Federal savings association. Any such deductions shall be deducted from assets and common equity tier 1 except as provided in paragraphs (a)(8)(ii) and (iii) of this section. (ii) If a Federal savings association has any investments (both debt and equity) in, or extensions or credit to, one or more subsidiaries engaged in any activity that would not fall within the scope of activities in which includable subsidiaries as defined in paragraph (a)(8)(iv) of this section may engage, it must deduct such investments and extensions of credit from assets and, thus, common equity tier 1 in accordance with paragraph (a)(8)(i) of this section. (iii) If a Federal savings association holds a subsidiary (either directly or through a subsidiary) that is itself a domestic depository institution, the OCC may, in its sole discretion upon determining that the amount of common equity tier 1 that would be required would be higher if the assets and liabilities of such subsidiary were consolidated with those of the parent Federal savings association than the amount that would be required if the parent Federal savings association’s investment were deducted pursuant to paragraphs (a)(8)(i) and (ii) of this section, consolidate the assets and liabilities of that subsidiary with those of the parent Federal savings association in calculating the capital adequacy of the parent Federal savings association, regardless of whether the subsidiary would otherwise be an includable subsidiary as defined in paragraph (a)(8)(iv) of this section. (iv) For purposes of this section, the term includable subsidiary means a subsidiary of a Federal savings association that: PO 00000 Frm 00258 Fmt 4701 Sfmt 4700 (A) Is engaged solely in activities not impermissible for a national bank; (B) Is engaged in activities not permissible for a national bank, but only if acting solely as agent for its customers and such agency position is clearly documented in the Federal savings association’s files; (C) Is engaged solely in mortgagebanking activities; (D)(1) Is itself an insured depository institution or a company the sole investment of which is an insured depository institution; and (2) Was acquired by the parent Federal savings association prior to May 1, 1989; or (E) Was a subsidiary of any Federal savings association existing as a Federal savings association on August 9, 1989: (1) That was chartered prior to October 15, 1982, as a savings bank or a cooperative bank under state law; or (2) That acquired its principal assets from an association that was chartered prior to October 15, 1982, as a savings bank or a cooperative bank under state law. * * * * * § 3.42 [Amended] 15. In § 3.42(h)(1)(iv) and (h)(3), remove ‘‘[12 CFR 6.4 (OCC); 12 CFR 208.43 (Board)]’’ and add ‘‘12 CFR 6.4’’ in its place. ■ § 3.100 [Amended] 16. In § 3.100(b)(2), remove ‘‘[12 CFR 3.404 (OCC), 12 CFR 263.202 (Board), and 12 CFR 324.5 (FDIC)]’’ and add ‘‘12 CFR 3.404’’ in its place. ■ § 3.142 [Amended] 17. Section 3.142(k)(1)(iv) is amended by removing ‘‘[12 CFR 6.4 (OCC); 12 CFR 208.43 (Board)]’’ and by adding ‘‘12 CFR 6.4’’ in its place. ■ § 3.201 [Amended] 18. In § 3.201(c)(1), remove ‘‘[12 CFR 3.404, 12 CFR 263.202, 12 CFR 324.5(c)]’’ and add ‘‘12 CFR 3.404’’ in its place. ■ § 3.300 [Amended] 19. Section 3.300 is amended: A. In paragraph (b)(1) introductory text, by removing ‘‘§ l.22(a)(1)–(7)’’ and adding ‘‘§ 3.22(a)(1)–(8)’’ in its place; ■ B. In paragraph (b)(1)(i), by removing at the end of the paragraph, ‘‘and financial subsidiaries (§ l.22(a)(7)).’’ and adding in its place the phrase ‘‘and financial subsidiaries (§ 3.22(a)(7)), and nonincludable subsidiaries of a Federal savings association (§ 3.22(a)(8)).’’; and in Table 2 to § 3.300, adding at the end of the heading in the second column the phrase ‘‘and (8)’’; ■ ■ E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations C. By removing and reserving paragraphs (c)(1) through (c)(3); and ■ D. In paragraph (e), by removing ‘‘[12 CFR Part 6 (OCC); 12 CFR 208 (Board)]’’, and adding ‘‘12 CFR part 6’’ in its place. ■ PART 5—RULES, POLICIES, AND PROCEDURES FOR CORPORATE ACTIVITIES 20. The authority citation for part 5 continues to read as follows: ■ Authority: 12 U.S.C. 1 et seq., 93a, 215a– 2, 215a–3, 481, and section 5136A of the Revised Statutes (12 U.S.C. 24a). 21. Section 5.39 is amended by revising paragraph (h)(1) and republishing paragraph (h)(2) to read as follows: ■ § 5.39 Financial subsidiaries. * * * * * (h) * * * (1) For purposes of determining regulatory capital the national bank may not consolidate the assets and liabilities of a financial subsidiary with those of the bank and must deduct the aggregate amount of its outstanding equity investment, including retained earnings, in its financial subsidiaries from regulatory capital as provided by § 3.22(a)(7) of this chapter; (2) Any published financial statement of the national bank shall, in addition to providing information prepared in accordance with generally accepted accounting principles, separately present financial information for the bank in the manner provided in paragraph (h)(1) of this section; * * * * * ■ 22. Part 6 is revised to read as follows: PART 6—PROMPT CORRECTIVE ACTION wreier-aviles on DSK5TPTVN1PROD with RULES2 Subpart A—Capital Categories Sec. 6.1 Authority, purpose, scope, other supervisory authority, disclosure of capital categories, and transition procedures. 6.2 Definitions. 6.3 Notice of capital category. 6.4 Capital measures and capital category definition. 6.5 Capital restoration plan. 6.6 Mandatory and discretionary supervisory actions. Subpart B—Directives To Take Prompt Corrective Action 6.20 Scope. 6.21 Notice of intent to issue a directive. 6.22 Response to notice. 6.23 Decision and issuance of a prompt corrective action directive. 6.24 Request for modification or rescission of directive. 6.25 Enforcement of directive. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 Authority: 12 U.S.C. 93a, 1831o, 5412(b)(2)(B). Subpart A—Capital Categories § 6.1 Authority, purpose, scope, other supervisory authority, disclosure of capital categories, and transition procedures. (a) Authority. This part is issued by the Office of the Comptroller of the Currency (OCC) pursuant to section 38 (section 38) of the Federal Deposit Insurance Act (FDI Act) as added by section 131 of the Federal Deposit Insurance Corporation Improvement Act of 1991 (Pub. L. 102–242, 105 Stat. 2236 (1991)) (12 U.S.C. 1831o). (b) Purpose. Section 38 of the FDI Act establishes a framework of supervisory actions for insured depository institutions that are not adequately capitalized. The principal purpose of this subpart is to define, for insured national banks and insured Federal savings associations, the capital measures and capital levels, and for insured Federal branches, comparable asset-based measures and levels, that are used for determining the supervisory actions authorized under section 38 of the FDI Act. This part 6 also establishes procedures for submission and review of capital restoration plans and for issuance and review of directives and orders pursuant to section 38. (c) Scope. This subpart implements the provisions of section 38 of the FDI Act as they apply to insured national banks, insured Federal branches, and insured Federal savings associations. Certain of these provisions also apply to officers, directors, and employees of these insured institutions. Other provisions apply to any company that controls an insured national bank, insured Federal branch, or insured Federal savings association and to the affiliates of an insured national bank, insured Federal branch, or insured Federal savings association. (d) Other supervisory authority. Neither section 38 nor this part in any way limits the authority of the OCC under any other provision of law to take supervisory actions to address unsafe or unsound practices, deficient capital levels, violations of law, unsafe or unsound conditions, or other practices. Action under section 38 of the FDI Act and this part may be taken independently of, in conjunction with, or in addition to any other enforcement action available to the OCC, including issuance of cease and desist orders, capital directives, approval or denial of applications or notices, assessment of civil money penalties, or any other actions authorized by law. (e) Disclosure of capital categories. The assignment of an insured national PO 00000 Frm 00259 Fmt 4701 Sfmt 4700 62275 bank, insured Federal branch, or insured Federal savings association under this subpart within a particular capital category is for purposes of implementing and applying the provisions of section 38. Unless permitted by the OCC or otherwise required by law, no national bank or Federal savings association may state in any advertisement or promotional material its capital category under this subpart or that the OCC or any other Federal banking agency has assigned the national bank or Federal savings association to a particular capital category. (f) Transition procedures—(1) Definitions applicable before January 1, 2015, for certain national banks and Federal savings associations. Before January 1, 2015, notwithstanding any other requirement in this subpart and with respect to any national bank that is not an advanced approaches bank and any Federal savings association that is not an advanced approaches Federal savings association: (i) The definitions of leverage ratio, tangible equity, tier 1 capital, tier 1 riskbased capital, and total risk-based capital as calculated or defined under appendix A to part 3 of this chapter, remain in effect for purposes of this subpart; and (ii) The definition of total assets means quarterly average total assets as reported in a national bank’s or Federal savings association’s Consolidated Reports of Condition and Income (Call Report), minus intangible assets except mortgage servicing assets as provided in the definition of tangible equity. The OCC reserves the right to require a national bank or Federal savings association to compute and maintain its capital ratios on the basis of actual, rather than average, total assets when computing tangible equity. (2) Timing. On January 1, 2015 and thereafter, the calculation of the definitions of common equity tier 1 capital, the common equity tier 1 riskbased capital ratio, the leverage ratio, the supplementary leverage ratio, tangible equity, tier 1 capital, the tier 1 risk-based capital ratio, total assets, total leverage exposure, the total risk-based capital ratio, and total risk-weighted assets under this subpart is subject to the timing provisions at 12 CFR § 3.1(f) and the transitions at 12 CFR part 3, subpart G. § 6.2 Definitions. For purposes of this subpart, except as modified in this section or unless the context otherwise requires, the terms used have the same meanings as set E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62276 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations forth in section 38 and section 3 of the FDI Act. Advanced approaches national bank or advanced approaches Federal savings association means a national bank or Federal savings association that is subject to subpart E of part 3 of this chapter. Common equity tier 1 capital means common equity tier 1 capital, as defined in accordance with the OCC’s definition in subpart A of part 3 of this chapter. Common equity tier 1 risk-based capital ratio means the ratio of common equity tier 1 capital to total riskweighted assets, as calculated in accordance with subpart B of part 3 of this chapter, as applicable. Control. (1) Control has the same meaning assigned to it in section 2 of the Bank Holding Company Act (12 U.S.C. 1841), and the term controlled shall be construed consistently with the term control. (2) Exclusion for fiduciary ownership. No insured depository institution or company controls another insured depository institution or company by virtue of its ownership or control of shares in a fiduciary capacity. Shares shall not be deemed to have been acquired in a fiduciary capacity if the acquiring insured depository institution or company has sole discretionary authority to exercise voting rights with respect thereto. (3) Exclusion for debts previously contracted. No insured depository institution or company controls another insured depository institution or company by virtue of its ownership or control of shares acquired in securing or collecting a debt previously contracted in good faith, until two years after the date of acquisition. The two-year period may be extended at the discretion of the appropriate Federal banking agency for up to three one-year periods. Controlling person means any person having control of an insured depository institution and any company controlled by that person. Federal savings association means an insured Federal savings association or an insured Federal savings bank chartered under section 5 of the Home Owners’ Loan Act of 1933. Leverage ratio means the ratio of tier 1 capital to average total consolidated assets, as calculated in accordance with subpart B of part 3 of this chapter.30 30 Before January 1, 2015, the leverage ratio of a national bank or Federal savings association that is not an advanced approaches national bank or advanced approaches Federal savings association is the ratio of tier 1 capital to average total consolidated assets, as calculated in accordance with appendix A to part 3 of this chapter. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 Management fee means any payment of money or provision of any other thing of value to a company or individual for the provision of management services or advice to the national bank or Federal savings association or related overhead expenses, including payments related to supervisory, executive, managerial, or policymaking functions, other than compensation to an individual in the individual’s capacity as an officer or employee of the national bank or Federal savings association. National bank means all insured national banks and all insured Federal branches, except where otherwise provided in this subpart. Supplementary leverage ratio means the ratio of tier 1 capital to total leverage exposure, as calculated in accordance with subpart B of part 3 of this chapter. Tangible equity means the amount of tier 1 capital, as calculated in accordance with subpart B of part 3 of this chapter, plus the amount of outstanding perpetual preferred stock (including related surplus) not included in tier 1 capital.31 Tier 1 capital means the amount of tier 1 capital as defined in subpart B of part 3 of this chapter.32 Tier 1 risk-based capital ratio means the ratio of tier 1 capital to riskweighted assets, as calculated in accordance with subpart B of part 3 of this chapter.33 Total assets means quarterly average total assets as reported in a national bank’s or Federal savings association’s Consolidated Reports of Condition and Income (Call Report), minus any 31 Before January 1, 2015, the tangible equity of a national bank or Federal savings association that is not an advanced approaches national bank or advanced approaches Federal savings association is the amount of tier 1 capital elements as defined in appendix A to part 3 of this chapter, plus the amount of outstanding cumulative perpetual preferred stock (including related surplus) minus all intangible assets except mortgage servicing assets to the extent permitted in tier 1 capital, as calculated in accordance with appendix A to part 3 of this chapter. The OCC reserves the right to require a national bank or Federal savings association to compute and maintain its capital ratios on the basis of actual, rather than average, total assets when computing tangible equity. 32 Before January 1, 2015, the tier 1 capital of a national bank or Federal savings association that is not an advanced approaches national bank or advanced approaches Federal savings association (as an advanced approaches national bank or advanced approaches Federal savings association is defined in this § 6.2) is calculated in accordance with appendix A to part 3 of this chapter. 33 Before January 1, 2015, the tier 1 risk-based capital ratio of a national bank or Federal savings association that is not an advanced approaches national bank or advanced approaches Federal savings association (as an advanced approaches national bank or advanced approaches Federal savings association is defined in this § 6.2) is calculated in accordance with appendix A to part 3 of this chapter. PO 00000 Frm 00260 Fmt 4701 Sfmt 4700 deductions as provided in § 3.22(a), (c), and (d) of this chapter. The OCC reserves the right to require a national bank or Federal savings association to compute and maintain its capital ratios on the basis of actual, rather than average, total assets when computing tangible equity.34 Total leverage exposure means the total leverage exposure, as calculated in accordance with subpart B of part 3 of this chapter. Total risk-based capital ratio means the ratio of total capital to total riskweighted assets, as calculated in accordance with subpart B of part 3 of this chapter.35 Total risk-weighted assets means standardized total risk-weighted assets, and for an advanced approaches national bank or advanced approaches Federal savings association also includes advanced approaches total risk-weighted assets, as defined in subpart B of part 3 of this chapter. § 6.3 Notice of capital category. (a) Effective date of determination of capital category. A national bank or Federal savings association shall be deemed to be within a given capital category for purposes of section 38 of the FDI Act and this part as of the date the national bank or Federal savings association is notified of, or is deemed to have notice of, its capital category pursuant to paragraph (b) of this section. (b) Notice of capital category. A national bank or Federal savings association shall be deemed to have been notified of its capital levels and its capital category as of the most recent date: (1) A Consolidated Reports of Condition and Income (Call Report) is required to be filed with the OCC; 34 Before January 1, 2015, total assets means, for a national bank or Federal savings association that is not an advanced approaches national bank or advanced approaches Federal savings association (as an advanced approaches national bank or advanced approaches Federal savings association is defined in this § 6.2), quarterly average total assets as reported in a bank’s or savings association’s Call Report, minus all intangible assets except mortgage servicing assets to the extent permitted in tier 1 capital, as calculated in accordance with appendix A to part 3 of this chapter. The OCC reserves the right to require a national bank or Federal savings association to compute and maintain its capital ratios on the basis of actual, rather than average, total assets when computing tangible equity. 35 Before January 1, 2015, the total risk-based capital ratio of a national bank or Federal savings association that is not an advanced approaches national bank or advanced approaches Federal savings association (as an advanced approaches national bank or advanced approaches Federal savings association is defined in this § 6.2) is calculated in accordance with appendix A to part 3 of this chapter. E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (2) A final report of examination is delivered to the national bank or Federal savings association; or (3) Written notice is provided by the OCC to the national bank or Federal savings association of its capital category for purposes of section 38 of the FDI Act and this part or that the national bank’s or Federal savings association’s capital category has changed pursuant to paragraph (c) of this section, or § 6.4(e) and with respect to national banks, subpart M of part 19 of this chapter, and with respect to Federal savings associations § 165.8 of this chapter. (c) Adjustments to reported capital levels and capital category—(1) Notice of adjustment by national bank or Federal savings association. A national bank or Federal savings association shall provide the OCC with written notice that an adjustment to the national bank’s or Federal savings association’s capital category may have occurred no later than 15 calendar days following the date that any material event has occurred that would cause the national bank or Federal savings association to be placed in a lower capital category from the category assigned to the national bank or Federal savings association for purposes of section 38 and this part on the basis of the national bank’s or Federal savings association’s most recent Call Report or report of examination. (2) Determination to change capital category. After receiving notice pursuant to paragraph (c)(1) of this section, the OCC shall determine whether to change the capital category of the national bank or Federal savings association and shall notify the national bank or Federal savings association of the OCC’s determination. wreier-aviles on DSK5TPTVN1PROD with RULES2 § 6.4 Capital measures and capital category definition. (a) Capital measures—(1) Capital measures applicable before January 1, 2015. On or before December 31, 2014, for purposes of section 38 and this part, the relevant capital measures for all national banks and Federal savings associations are: (i) Total Risk-Based Capital Measure: the total risk-based capital ratio; (ii) Tier 1 Risk-Based Capital Measure: the tier 1 risk-based capital ratio; and (iii) Leverage Measure: the leverage ratio. (2) Capital measures applicable on and after January 1, 2015. On January 1, 2015 and thereafter, for purposes of section 38 and this part, the relevant capital measures are: (i) Total Risk-Based Capital Measure: the total risk-based capital ratio; VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (ii) Tier 1 Risk-Based Capital Measure: the tier 1 risk-based capital ratio; (iii) Common Equity Tier 1 Capital Measure: the common equity tier 1 riskbased capital ratio; and (iv) The Leverage Measure: (A) The leverage ratio; and (B) With respect to an advanced approaches national bank or advanced approaches Federal savings association, on January 1, 2018, and thereafter, the supplementary leverage ratio. (b) Capital categories applicable before January 1, 2015. On or before December 31, 2014, for purposes of the provisions of section 38 and this part, a national bank or Federal savings association shall be deemed to be: (1) Well capitalized if: (i) Total Risk-Based Capital Measure: the national bank or Federal savings association has a total risk-based capital ratio of 10.0 percent or greater; (ii) Tier 1 Risk-Based Capital Measure: the national bank or Federal savings association has a tier 1 risk-based capital ratio of 6.0 percent or greater; (iii) Leverage Ratio: the national bank or Federal savings association has a leverage ratio of 5.0 percent or greater; and (iv) The national bank or Federal savings association is not subject to any written agreement, order or capital directive, or prompt corrective action directive issued by the OCC or the former OTS pursuant to section 8 of the FDI Act, the International Lending Supervision Act of 1983 (12 U.S.C. 3907), the Home Owners’ Loan Act (12 U.S.C. 1464(t)(6)(A)(ii)), or section 38 of the FDI Act, or any regulation thereunder, to meet and maintain a specific capital level for any capital measure. (2) Adequately capitalized if: (i) Total Risk-Based Capital Measure: the national bank or Federal savings association has a total risk-based capital ratio of 8.0 percent or greater; (ii) Tier 1 Risk-Based Capital Measure: the national bank or Federal savings association has a tier 1 risk-based capital ratio of 4.0 percent or greater; (iii) Leverage Ratio: (A) The national bank or Federal savings association has a leverage ratio of 4.0 percent or greater; or (B) The national bank or Federal savings association has a leverage ratio of 3.0 percent or greater if the national bank or Federal savings association is rated composite 1 under the CAMELS rating system in the most recent examination of the national bank and or Federal savings association; and (iv) Does not meet the definition of a ‘‘well capitalized’’ national bank or Federal savings association. PO 00000 Frm 00261 Fmt 4701 Sfmt 4700 62277 (3) Undercapitalized if: (i) Total Risk-Based Capital Measure: the national bank or Federal savings association has a total risk-based capital ratio of less than 8.0 percent; or (ii) Tier 1 Risk-Based Capital Measure: the national bank or Federal savings association has a tier 1 risk-based capital ratio of less than 4.0 percent; or (iii) Leverage Ratio: (A) Except as provided in paragraph (b)(2)(iii)(B) of this section, the national bank or Federal savings association has a leverage ratio of less than 4.0 percent; or (B) The national bank or Federal savings association has a leverage ratio of less than 3.0 percent, if the national bank or Federal savings association is rated composite 1 under the CAMELS rating system in the most recent examination of the national bank or Federal savings association. (4) Significantly undercapitalized if: (i) Total Risk-Based Capital Measure: the national bank or Federal savings association has a total risk-based capital ratio of less than 6.0 percent; or (ii) Tier 1 Risk-Based Capital Measure: the national bank or Federal savings association has a tier 1 risk-based capital ratio of less than 3.0 percent; or (iii) Leverage Ratio: the national bank or Federal savings association has a leverage ratio of less than 3.0 percent. (5) Critically undercapitalized if the national bank or Federal savings association has a ratio of tangible equity to total assets that is equal to or less than 2.0 percent. (c) Capital categories applicable on and after January 1, 2015. On January 1, 2015, and thereafter, for purposes of the provisions of section 38 and this part, a national bank or Federal savings association shall be deemed to be: (1) Well capitalized if: (i) Total Risk-Based Capital Measure: the national bank or Federal savings association has a total risk-based capital ratio of 10.0 percent or greater; (ii) Tier 1 Risk-Based Capital Measure: the national bank or Federal savings association has a tier 1 risk-based capital ratio of 8.0 percent or greater; (iii) Common Equity Tier 1 Capital Measure: the national bank or Federal savings association has a common equity tier 1 risk-based capital ratio of 6.5 percent or greater; (iv) Leverage Ratio: the national bank or Federal savings association has a leverage ratio of 5.0 or greater; and (v) The national bank or Federal savings association is not subject to any written agreement, order or capital directive, or prompt corrective action directive issued by the OCC pursuant to section 8 of the FDI Act, the E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62278 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations International Lending Supervision Act of 1983 (12 U.S.C. 3907), the Home Owners’ Loan Act (12 U.S.C. 1464(t)(6)(A)(ii)), or section 38 of the FDI Act, or any regulation thereunder, to meet and maintain a specific capital level for any capital measure. (2) Adequately capitalized if: (i) Total Risk-Based Capital Measure: the national bank or Federal savings association has a total risk-based capital ratio of 8.0 percent or greater; (ii) Tier 1 Risk-Based Capital Measure: the national bank or Federal savings association has a tier 1 risk-based capital ratio of 6.0 percent or greater; (iii) Common Equity Tier 1 Capital Measure: the national bank or Federal savings association has a common equity tier 1 risk-based capital ratio of 4.5 percent or greater; (iv) Leverage Measure: (A) The national bank or Federal savings association has a leverage ratio of 4.0 percent or greater; and (B) With respect to an advanced approaches national bank or advanced approaches Federal savings association, on January 1, 2018 and thereafter, the national bank or Federal savings association has an supplementary leverage ratio of 3.0 percent or greater; and (v) The national bank or Federal savings association does not meet the definition of a ‘‘well capitalized’’ national bank or Federal savings association. (3) Undercapitalized if: (i) Total Risk-Based Capital Measure: the national bank or Federal savings association has a total risk-based capital ratio of less than 8.0 percent; (ii) Tier 1 Risk-Based Capital Measure: the national bank or Federal savings association has a tier 1 risk-based capital ratio of less than 6.0 percent; (iii) Common Equity Tier 1 Capital Measure: the national bank or Federal savings association has a common equity tier 1 risk-based capital ratio of less than 4.5 percent; or (iv) Leverage Measure: (A) The national bank or Federal savings association has a leverage ratio of less than 4.0 percent; or (B) With respect to an advanced approaches national bank or advanced approaches Federal savings association, on January 1, 2018, and thereafter, the national bank or Federal savings association has a supplementary leverage ratio of less than 3.0 percent. (4) Significantly undercapitalized if: (i) Total Risk-Based Capital Measure: the national bank or Federal savings association has a total risk-based capital ratio of less than 6.0 percent; (ii) Tier 1 Risk-Based Capital Measure: the national bank or Federal savings VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 association has a tier 1 risk-based capital ratio of less than 4.0 percent; (iii) Common Equity Tier 1 Capital Measure: the national bank or Federal savings association has a common equity tier 1 risk-based capital ratio of less than 3.0 percent; or (iv) Leverage Ratio: the national bank or Federal savings association has a leverage ratio of less than 3.0 percent. (5) Critically undercapitalized if the national bank or Federal savings association has a ratio of tangible equity to total assets that is equal to or less than 2.0 percent. (d) Capital categories for insured Federal branches. For purposes of the provisions of section 38 of the FDI Act and this part, an insured Federal branch shall be deemed to be: (1) Well capitalized if the insured Federal branch: (i) Maintains the pledge of assets required under 12 CFR 347.209; and (ii) Maintains the eligible assets prescribed under 12 CFR 347.210 at 108 percent or more of the preceding quarter’s average book value of the insured branch’s third-party liabilities; and (iii) Has not received written notification from: (A) The OCC to increase its capital equivalency deposit pursuant to § 28.15 of this chapter, or to comply with asset maintenance requirements pursuant to § 28.20 of this chapter; or (B) The FDIC to pledge additional assets pursuant to 12 CFR 347.209 or to maintain a higher ratio of eligible assets pursuant to 12 CFR 347.210. (2) Adequately capitalized if the insured Federal branch: (i) Maintains the pledge of assets prescribed under 12 CFR 347.209; (ii) Maintains the eligible assets prescribed under 12 CFR 347.210 at 106 percent or more of the preceding quarter’s average book value of the insured branch’s third-party liabilities; and (iii) Does not meet the definition of a well capitalized insured Federal branch. (3) Undercapitalized if the insured Federal branch: (i) Fails to maintain the pledge of assets required under 12 CFR 347.209; or (ii) Fails to maintain the eligible assets prescribed under 12 CFR 347.210 at 106 percent or more of the preceding quarter’s average book value of the insured branch’s third-party liabilities. (4) Significantly undercapitalized if it fails to maintain the eligible assets prescribed under 12 CFR 347.210 at 104 percent or more of the preceding quarter’s average book value of the insured Federal branch’s third-party liabilities. PO 00000 Frm 00262 Fmt 4701 Sfmt 4700 (5) Critically undercapitalized if it fails to maintain the eligible assets prescribed under 12 CFR 347.210 at 102 percent or more of the preceding quarter’s average book value of the insured Federal branch’s third-party liabilities. (e) Reclassification based on supervisory criteria other than capital. The OCC may reclassify a well capitalized national bank or Federal savings association as adequately capitalized and may require an adequately capitalized or an undercapitalized national bank or Federal savings association to comply with certain mandatory or discretionary supervisory actions as if the national bank or Federal savings association were in the next lower capital category (except that the OCC may not reclassify a significantly undercapitalized national bank or Federal savings association as critically undercapitalized) (each of these actions are hereinafter referred to generally as reclassifications) in the following circumstances: (1) Unsafe or unsound condition. The OCC has determined, after notice and opportunity for hearing pursuant to subpart M of part 19 of this chapter with respect to national banks and § 165.8 of this chapter with respect to Federal savings associations, that the national bank or Federal savings association is in unsafe or unsound condition; or (2) Unsafe or unsound practice. The OCC has determined, after notice and opportunity for hearing pursuant to subpart M of part 19 of this chapter with respect to national banks and § 165.8 of this chapter with respect to Federal savings associations, that in the most recent examination of the national bank or Federal savings association, the national bank or Federal savings association received, and has not corrected a less-than-satisfactory rating for any of the categories of asset quality, management, earnings, or liquidity. § 6.5 Capital restoration plan. (a) Schedule for filing plan—(1) In general. A national bank or Federal savings association shall file a written capital restoration plan with the OCC within 45 days of the date that the national bank or Federal savings association receives notice or is deemed to have notice that the national bank or Federal savings association is undercapitalized, significantly undercapitalized, or critically undercapitalized, unless the OCC notifies the national bank or Federal savings association in writing that the plan is to be filed within a different period. An adequately capitalized national bank or Federal savings E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations association that has been required, pursuant to § 6.4 and subpart M of part 19 of this chapter with respect to national banks, and §§ 6.4 and 165.8 of this chapter with respect to Federal savings associations, to comply with supervisory actions as if the national bank or Federal savings association were undercapitalized is not required to submit a capital restoration plan solely by virtue of the reclassification. (2) Additional capital restoration plans. Notwithstanding paragraph (a)(1) of this section, a national bank or Federal savings association that has already submitted and is operating under a capital restoration plan approved under section 38 and this subpart is not required to submit an additional capital restoration plan based on a revised calculation of its capital measures or a reclassification of the institution pursuant to § 6.4 and subpart M of part 19 of this chapter with respect to national banks and §§ 6.4 and 165.8 of this chapter with respect to Federal savings associations, unless the OCC notifies the national bank or Federal savings association that it must submit a new or revised capital plan. A national bank or Federal savings association that is notified that it must submit a new or revised capital restoration plan shall file the plan in writing with the OCC within 45 days of receiving such notice, unless the OCC notifies the national bank or Federal savings association in writing that the plan must be filed within a different period. (b) Contents of plan. All financial data submitted in connection with a capital restoration plan shall be prepared in accordance with the instructions provided on the Call Report, unless the OCC instructs otherwise. The capital restoration plan shall include all of the information required to be filed under section 38(e)(2) of the FDI Act. A national bank or Federal savings association that is required to submit a capital restoration plan as the result of a reclassification of the national bank or Federal savings association, pursuant to § 6.4 and subpart M of part 19 of this chapter with respect to national banks, and §§ 6.4 and 165.8 of this chapter with respect to Federal savings associations, shall include a description of the steps the national bank or Federal savings association will take to correct the unsafe or unsound condition or practice. No plan shall be accepted unless it includes any performance guarantee described in section 38(e)(2)(C) of that Act by each company that controls the national bank or Federal savings association. (c) Review of capital restoration plans. Within 60 days after receiving a capital VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 restoration plan under this subpart, the OCC shall provide written notice to the national bank or Federal savings association of whether the plan has been approved. The OCC may extend the time within which notice regarding approval of a plan shall be provided. (d) Disapproval of capital restoration plan. If a capital restoration plan is not approved by the OCC, the national bank or Federal savings association shall submit a revised capital restoration plan within the time specified by the OCC. Upon receiving notice that its capital restoration plan has not been approved, any undercapitalized national bank or Federal savings association (as defined in § 6.4) shall be subject to all of the provisions of section 38 and this part applicable to significantly undercapitalized institutions. These provisions shall be applicable until such time as a new or revised capital restoration plan submitted by the national bank or Federal savings association has been approved by the OCC. (e) Failure to submit a capital restoration plan. A national bank or Federal savings association that is undercapitalized (as defined in § 6.4) and that fails to submit a written capital restoration plan within the period provided in this section shall, upon the expiration of that period, be subject to all of the provisions of section 38 and this part applicable to significantly undercapitalized national banks or Federal savings associations. (f) Failure to implement a capital restoration plan. Any undercapitalized national bank or Federal savings association that fails, in any material respect, to implement a capital restoration plan shall be subject to all of the provisions of section 38 and this part applicable to significantly undercapitalized national banks or Federal savings associations. (g) Amendment of capital restoration plan. A national bank or Federal savings association that has submitted an approved capital restoration plan may, after prior written notice to and approval by the OCC, amend the plan to reflect a change in circumstance. Until such time as a proposed amendment has been approved, the national bank or Federal savings association shall implement the capital restoration plan as approved prior to the proposed amendment. (h) Notice to FDIC. Within 45 days of the effective date of OCC approval of a capital restoration plan, or any amendment to a capital restoration plan, the OCC shall provide a copy of the plan or amendment to the Federal Deposit Insurance Corporation. PO 00000 Frm 00263 Fmt 4701 Sfmt 4700 62279 (i) Performance guarantee by companies that control a national bank or Federal savings association—(1) Limitation on liability—(i) Amount limitation. The aggregate liability under the guarantee provided under section 38 and this subpart for all companies that control a specific national bank or Federal savings association that is required to submit a capital restoration plan under this subpart shall be limited to the lesser of: (A) An amount equal to 5.0 percent of the national bank’s or Federal savings association’s total assets at the time the national bank or Federal savings association was notified or deemed to have notice that the national bank or Federal savings association was undercapitalized; or (B) The amount necessary to restore the relevant capital measures of the national bank or Federal savings association to the levels required for the national bank or Federal savings association to be classified as adequately capitalized, as those capital measures and levels are defined at the time that the national bank or Federal savings association initially fails to comply with a capital restoration plan under this subpart. (ii) Limit on duration. The guarantee and limit of liability under section 38 and this subpart shall expire after the OCC notifies the national bank or Federal savings association that it has remained adequately capitalized for each of four consecutive calendar quarters. The expiration or fulfillment by a company of a guarantee of a capital restoration plan shall not limit the liability of the company under any guarantee required or provided in connection with any capital restoration plan filed by the same national bank or Federal savings association after expiration of the first guarantee. (iii) Collection on guarantee. Each company that controls a given national bank or Federal savings association shall be jointly and severally liable for the guarantee for such national bank or Federal savings association as required under section 38 and this subpart, and the OCC may require payment of the full amount of that guarantee from any or all of the companies issuing the guarantee. (2) Failure to provide guarantee. In the event that a national bank or Federal savings association that is controlled by any company submits a capital restoration plan that does not contain the guarantee required under section 38(e)(2) of the FDI Act, the national bank or Federal savings association shall, upon submission of the plan, be subject to the provisions of section 38 and this part that are applicable to E:\FR\FM\11OCR2.SGM 11OCR2 62280 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations national banks or Federal savings associations that have not submitted an acceptable capital restoration plan. (3) Failure to perform guarantee. Failure by any company that controls a national bank or Federal savings association to perform fully its guarantee of any capital plan shall constitute a material failure to implement the plan for purposes of section 38(f) of the FDI Act. Upon such failure, the national bank or Federal savings association shall be subject to the provisions of section 38 and this part that are applicable to national banks or Federal savings associations that have failed in a material respect to implement a capital restoration plan. (j) Enforcement of capital restoration plan. The failure of a national bank or Federal savings association to implement, in any material respect, a capital restoration plan required under section 38 and this section shall subject the national bank or Federal savings association to the assessment of civil money penalties pursuant to section 8(i)(2)(A) of the FDI Act. wreier-aviles on DSK5TPTVN1PROD with RULES2 § 6.6 Mandatory and discretionary supervisory actions. (a) Mandatory supervisory actions— (1) Provisions applicable to all national banks and Federal savings associations. All national banks and Federal savings associations are subject to the restrictions contained in section 38(d) of the FDI Act on payment of distributions and management fees. (2) Provisions applicable to undercapitalized, significantly undercapitalized, and critically undercapitalized national banks or Federal savings associations. Immediately upon receiving notice or being deemed to have notice, as provided in § 6.3, that the national bank or Federal savings association is undercapitalized, significantly undercapitalized, or critically undercapitalized, the national bank or Federal savings association shall become subject to the provisions of section 38 of the FDI Act: (i) Restricting payment of distributions and management fees (section 38(d)); (ii) Requiring that the OCC monitor the condition of the national bank or Federal savings association (section 38(e)(1)); (iii) Requiring submission of a capital restoration plan within the schedule established in this subpart (section 38(e)(2)); (iv) Restricting the growth of the national bank’s or Federal savings association’s assets (section 38(e)(3)); and VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (v) Requiring prior approval of certain expansion proposals (section 38(e)(4)). (3) Additional provisions applicable to significantly undercapitalized, and critically undercapitalized national banks or Federal savings associations. In addition to the provisions of section 38 of the FDI Act described in paragraph (a)(2) of this section, immediately upon receiving notice or being deemed to have notice, as provided in this subpart, that the national bank or Federal savings association is significantly undercapitalized, or critically undercapitalized, or that the national bank or Federal savings association is subject to the provisions applicable to institutions that are significantly undercapitalized because it has failed to submit or implement, in any material respect, an acceptable capital restoration plan, the national bank or Federal savings association shall become subject to the provisions of section 38 of the FDI Act that restrict compensation paid to senior executive officers of the institution (section 38(f)(4)). (4) Additional provisions applicable to critically undercapitalized national banks or Federal savings associations. In addition to the provisions of section 38 of the FDI Act described in paragraphs (a)(2) and (3) of this section, immediately upon receiving notice or being deemed to have notice, as provided in § 6.3, that the national bank or Federal savings association is critically undercapitalized, the national bank or Federal savings association shall become subject to the provisions of section 38 of the FDI Act: (i) Restricting the activities of the national bank or Federal savings association (section 38 (h)(1)); and (ii) Restricting payments on subordinated debt of the national bank or Federal savings association (section 38 (h)(2)). (b) Discretionary supervisory actions. In taking any action under section 38 that is within the OCC’s discretion to take in connection with a national bank or Federal savings association that is deemed to be undercapitalized, significantly undercapitalized, or critically undercapitalized, or has been reclassified as undercapitalized or significantly undercapitalized; an officer or director of such national bank or Federal savings association; or a company that controls such national bank or Federal savings association, the OCC shall follow the procedures for issuing directives under subpart B of this part and subpart N of part 19 of this chapter with respect to national banks and subpart B of this part and § 165.9 of this chapter with respect to Federal savings associations, unless otherwise PO 00000 Frm 00264 Fmt 4701 Sfmt 4700 provided in section 38 of the FDI Act or this part. Subpart B—Directives To Take Prompt Corrective Action § 6.20 Scope. The rules and procedures set forth in this subpart apply to insured national banks, insured Federal branches, Federal savings associations, and senior executive officers and directors of national banks and Federal savings associations that are subject to the provisions of section 38 of the Federal Deposit Insurance Act (section 38) and subpart A of this part. § 6.21 Notice of intent to issue a directive. (a) Notice of intent to issue a directive—(1) In general. The OCC shall provide an undercapitalized, significantly undercapitalized, or critically undercapitalized national bank or Federal savings association prior written notice of the OCC’s intention to issue a directive requiring such national bank, Federal savings association, or company to take actions or to follow proscriptions described in section 38 that are within the OCC’s discretion to require or impose under section 38 of the FDI Act, including section 38(e)(5), (f)(2), (f)(3), or (f)(5). The national bank or Federal savings association shall have such time to respond to a proposed directive as provided under § 6.22. (2) Immediate issuance of final directive. If the OCC finds it necessary in order to carry out the purposes of section 38 of the FDI Act, the OCC may, without providing the notice prescribed in paragraph (a)(1) of this section, issue a directive requiring a national bank or Federal savings association immediately to take actions or to follow proscriptions described in section 38 that are within the OCC’s discretion to require or impose under section 38 of the FDI Act, including section 38(e)(5), (f)(2), (f)(3), or (f)(5). A national bank or Federal savings association that is subject to such an immediately effective directive may submit a written appeal of the directive to the OCC. Such an appeal must be received by the OCC within 14 calendar days of the issuance of the directive, unless the OCC permits a longer period. The OCC shall consider any such appeal, if filed in a timely matter, within 60 days of receiving the appeal. During such period of review, the directive shall remain in effect unless the OCC, in its sole discretion, stays the effectiveness of the directive. (b) Contents of notice. A notice of intention to issue a directive shall include: E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (1) A statement of the national bank’s or Federal savings association’s capital measures and capital levels; (2) A description of the restrictions, prohibitions or affirmative actions that the OCC proposes to impose or require; (3) The proposed date when such restrictions or prohibitions would be effective or the proposed date for completion of such affirmative actions; and (4) The date by which the national bank or Federal savings association subject to the directive may file with the OCC a written response to the notice. § 6.22 Response to notice. (a) Time for response. A national bank or Federal savings association may file a written response to a notice of intent to issue a directive within the time period set by the OCC. The date shall be at least 14 calendar days from the date of the notice unless the OCC determines that a shorter period is appropriate in light of the financial condition of the national bank or Federal savings association or other relevant circumstances. (b) Content of response. The response should include: (1) An explanation why the action proposed by the OCC is not an appropriate exercise of discretion under section 38; (2) Any recommended modification of the proposed directive; and (3) Any other relevant information, mitigating circumstances, documentation, or other evidence in support of the position of the national bank or Federal savings association regarding the proposed directive. (c) Failure to file response. Failure by a national bank or Federal savings association to file with the OCC, within the specified time period, a written response to a proposed directive shall constitute a waiver of the opportunity to respond and shall constitute consent to the issuance of the directive. § 6.24 Request for modification or rescission of directive. Any national bank or Federal savings association that is subject to a directive under this subpart may, upon a change in circumstances, request in writing that the OCC reconsider the terms of the directive, and may propose that the directive be rescinded or modified. Unless otherwise ordered by the OCC, the directive shall continue in place while such request is pending before the OCC. § 6.25 Enforcement of directive. (a) Judicial remedies. Whenever a national bank or Federal savings association fails to comply with a directive issued under section 38, the OCC may seek enforcement of the directive in the appropriate United States district court pursuant to section 8(i)(1) of the FDI Act. (b) Administrative remedies. Pursuant to section 8(i)(2)(A) of the FDI Act, the OCC may assess a civil money penalty against any national bank or Federal savings association that violates or otherwise fails to comply with any final directive issued under section 38 and against any institution-affiliated party who participates in such violation or noncompliance. (c) Other enforcement action. In addition to the actions described in paragraphs (a) and (b) of this section, the OCC may seek enforcement of the provisions of section 38 or this part through any other judicial or administrative proceeding authorized by law. PART 165—PROMPT CORRECTIVE ACTION 23. The authority citation for part 165 continues to read as follows: ■ Authority: 12 U.S.C. 1831o, 5412(b)(2)(B). §§ 165.1 through 165.7 Reserved] [Removed and wreier-aviles on DSK5TPTVN1PROD with RULES2 (a) OCC consideration of response. After considering the response, the OCC may: (1) Issue the directive as proposed or in modified form; (2) Determine not to issue the directive and so notify the national bank or Federal savings association; or (3) Seek additional information or clarification of the response from the national bank or Federal savings association, or any other relevant source. (b) [Reserved] 24. Sections 165.1 through 165.7 are removed and reserved. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 § 165.8 [Amended] 25. Section 165.8 is amended in paragraphs (a)(1)(i)(A) introductory text and (a)(1)(ii) by removing the phrases ‘‘§ 165.4(c) of this part’’ and ‘‘§ 165.4(c)(1)’’ respectively, and adding in their place the phrase ‘‘12 CFR 6.4(d)’’. ■ § 165.9 [Amended] 26a. Section 165.9(a) is amended by removing ‘‘section 165.7’’ and adding in its place ‘‘subpart B of part 6 of this chapter’’. ■ PO 00000 Frm 00265 Fmt 4701 [Removed and Reserved] 26b. Section 165.10 is removed and reserved. ■ PART 167—CAPITAL 27. The authority citation for part 167 continues to read as follows: ■ Authority: 12 U.S.C. 1462, 1462a, 1463, 1464, 1467a, 1828 (note), 5412(b)(2)(B). Appendix C to Part 167 [REMOVED] 28. Under the authority of 12 U.S.C. 93a and 5412(b)(2)(B), Appendix C to part 167 is removed. ■ Board of Governors of the Federal Reserve System 12 CFR CHAPTER II Authority and Issuance For the reasons set forth in the common preamble, parts 208, 217, and 225 of chapter II of title 12 of the Code of Federal Regulations are amended as follows: PART 208—MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL RESERVE SYSTEM (REGULATION H) 29. The authority citation for part 208 is revised to read as follows: ■ Authority: 12 U.S.C. 24, 36, 92a, 93a, 248(a), 248(c), 321–338a, 371d, 461, 481–486, 601, 611, 1814, 1816, 1818, 1820(d)(9), 1833(j), 1828(o), 1831, 1831o, 1831p–1, 1831r–1, 1831w, 1831x, 1835a, 1882, 2901– 2907, 3105, 3310, 3331–3351, 3905–3909, and 5371; 15 U.S.C. 78b, 78I(b), 78l(i), 780– 4(c)(5), 78q, 78q–1, and 78w, 1681s, 1681w, 6801, and 6805; 31 U.S.C. 5318; 42 U.S.C. 4012a, 4104a, 4104b, 4106 and 4128. Subpart A—General Membership and Branching Requirements 29a. In § 208.2, revise paragraph (d) to read as follows: ■ § 208.2 Definitions. * ■ § 6.23 Decision and issuance of a prompt corrective action directive. § 165.10 62281 Sfmt 4700 * * * * (d) Capital stock and surplus means, unless otherwise provided in this part, or by statute, tier 1 and tier 2 capital included in a member bank’s risk-based capital (as defined in § 217.2 of Regulation Q) and the balance of a member bank’s allowance for loan and lease losses not included in its tier 2 capital for calculation of risk-based capital, based on the bank’s most recent Report of Condition and Income filed under 12 U.S.C. 324.2 * * * * * 2 Before January 1, 2015, capital stock and surplus for a member bank that is not an advanced approaches bank (as defined in § 208.41) means E:\FR\FM\11OCR2.SGM Continued 11OCR2 62282 § 208.3 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations [Amended] 29b. In § 208.3 (a), redesignate footnote 2 as footnote 3: ■ 29c. Revise § 208.4 to read as follows: ■ § 208.4 Capital adequacy. (a) Adequacy. A member bank’s capital, calculated in accordance with part 217, shall be at all times adequate in relation to the character and condition liabilities and other corporate responsibilities.4 If at any time, in light of all the circumstances, the bank’s capital appears inadequate in relation to its assets, liabilities, and responsibilities, the bank shall increase the amount of its capital, within such period as the Board deems reasonable, to an amount which, in the judgment of the Board, shall be adequate. (b) Standards for evaluating capital adequacy. Standards and measures, by which the Board evaluates the capital adequacy of member banks for riskbased capital purposes and for leverage measurement purposes, are located in part 217 of this chapter.5 § 208.5 [Amended] 29d. In § 208.5. redesignate footnotes 3 and 4 as footnotes 6 and 7 respectively. ■ Subpart B—Investments and Loans § 208.21 [Amended] 29e. In § 208.21,redesignate footnote 5 as footnote 8. ■ 29f. In § 208.23, revise paragraph (c) to read as follows: ■ § 208.23 Agricultural loan loss amortization. * * * * (c) Accounting for amortization. Any bank that is permitted to amortize losses in accordance with paragraph (b) of this section may restate its capital and other relevant accounts and account for future authorized deferrals and authorization in accordance with the instructions to wreier-aviles on DSK5TPTVN1PROD with RULES2 * unless otherwise provided in this part, or by statute, tier 1 and tier 2 capital included in a member bank’s risk-based capital (under the guidelines in appendix A of this part) and the balance of a member bank’s allowance for loan and lease losses not included in its tier 2 capital for calculation of risk-based capital, based on the bank’s most recent consolidated Report of Condition and Income filed under 12 U.S.C. 324. 4 Before January 1, 2015, the capital of a member bank that is not an advanced approaches bank (as defined in § 208.41) is calculated in accordance with appendices A, B, and E to this part, as applicable. 5 Before January 1, 2015, the standards and measures by which the Board evaluates the capital adequacy of member banks that are not advanced approaches banks (as defined in § 208.41) for riskbased capital purposes and for leverage measurement purposes are located in appendices A, B, and E to this part, as applicable. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 the FFIEC Consolidated Reports of Condition and Income. Any resulting increase in the capital account shall be included in capital pursuant to part 217 of this chapter. * * * * * capital ratio, and total risk-weighted assets under this subpart is subject to the timing provisions at 12 CFR 217.1(f) and the transitions at 12 CFR part 217, subpart G. ■ 32. Revise § 208.41 to read as follows: § 208.24 § 208.41 Definitions for purposes of this subpart. [Amended] 29g. In § 208.24(a)(3), redesignate footnote 6 as footnote 9. ■ Subpart D—Prompt Corrective Action 30–31. Add paragraph (e) to § 208.40 to read as follows: ■ § 208.40 Authority, purpose, scope, other supervisory authority, and disclosure of capital categories. * * * * * (e) Transition procedures—(1) Definitions applicable before January 1, 2015, for certain banks. Before January 1, 2015, notwithstanding any other requirement in this subpart and with respect to any bank that is not an advanced approaches bank: (i) The definitions of leverage ratio, tier 1 capital, tier 1 risk-based capital, and total risk-based capital as calculated or defined under Appendix A to this part or Appendix B to this part, as applicable, remain in effect for purposes of this subpart; (ii) The definition of total assets means quarterly average total assets as reported in a bank’s Report of Condition and Income (Call Report), minus all intangible assets except mortgage servicing assets to the extent that the Federal Reserve determines that mortgage servicing assets may be included in calculating the bank’s tier 1 capital. At its discretion the Federal Reserve may calculate total assets using a bank’s period-end assets rather than quarterly average assets; and (iii) The definition of tangible equity of a member bank that is not an advanced approaches bank is the amount of core capital elements as defined in appendix A to this part, plus the amount of outstanding cumulative perpetual preferred stock (including related surplus) minus all intangible assets except mortgage servicing assets to the extent that the Board determines that mortgage servicing assets may be included in calculating the bank’s tier 1 capital, as calculated in accordance with Appendix A to this part. (2) Timing. The calculation of the definitions of common equity tier 1 capital, the common equity tier 1 riskbased capital ratio, the leverage ratio, the supplementary leverage ratio, tangible equity, tier 1 capital, the tier 1 risk-based capital ratio, total assets, total leverage exposure, the total risk-based PO 00000 Frm 00266 Fmt 4701 Sfmt 4700 For purposes of this subpart, except as modified in this section or unless the context otherwise requires, the terms used have the same meanings as set forth in section 38 and section 3 of the FDI Act. (a) Advanced approaches bank means a bank that is described in § 217.100(b)(1) of Regulation Q (12 CFR 217.100(b)(1)). (b) Bank means an insured depository institution as defined in section 3 of the FDI Act (12 U.S.C. 1813). (c) Common equity tier 1 capital means the amount of capital as defined in § 217.2 of Regulation Q (12 CFR 217.2). (d) Common equity tier 1 risk-based capital ratio means the ratio of common equity tier 1 capital to total riskweighted assets, as calculated in accordance with § 217.10(b)(1) or § 217.10(c)(1) of Regulation Q (12 CFR 217.10(b)(1), 12 CFR 217.10(c)(1)), as applicable. (e) Control—(1) Control has the same meaning assigned to it in section 2 of the Bank Holding Company Act (12 U.S.C. 1841), and the term controlled shall be construed consistently with the term control. (2) Exclusion for fiduciary ownership. No insured depository institution or company controls another insured depository institution or company by virtue of its ownership or control of shares in a fiduciary capacity. Shares shall not be deemed to have been acquired in a fiduciary capacity if the acquiring insured depository institution or company has sole discretionary authority to exercise voting rights with respect to the shares. (3) Exclusion for debts previously contracted. No insured depository institution or company controls another insured depository institution or company by virtue of its ownership or control of shares acquired in securing or collecting a debt previously contracted in good faith, until two years after the date of acquisition. The two-year period may be extended at the discretion of the appropriate Federal banking agency for up to three one-year periods. (f) Controlling person means any person having control of an insured depository institution and any company controlled by that person. E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with RULES2 (g) Leverage ratio means the ratio of tier 1 capital to average total consolidated assets, as calculated in accordance with § 217.10 of Regulation Q (12 CFR 217.10).10 (h) Management fee means any payment of money or provision of any other thing of value to a company or individual for the provision of management services or advice to the bank, or related overhead expenses, including payments related to supervisory, executive, managerial, or policy making functions, other than compensation to an individual in the individual’s capacity as an officer or employee of the bank. (i) Supplementary leverage ratio means the ratio of tier 1 capital to total leverage exposure, as calculated in accordance with § 217.10 of Regulation Q (12 CFR 217.10). (j) Tangible equity means the amount of tier 1 capital, plus the amount of outstanding perpetual preferred stock (including related surplus) not included in tier 1 capital.11 (k) Tier 1 capital means the amount of capital as defined in § 217.20 of Regulation Q (12 CFR 217.20).12 (l) Tier 1 risk-based capital ratio means the ratio of tier 1 capital to total risk-weighted assets, as calculated in accordance with § 217.10(b)(2) or § 217.10(c)(2) of Regulation Q (12 CFR 217.10(b)(2), 12 CFR 217.10(c)(2)), as applicable.13 (m) Total assets means quarterly average total assets as reported in a bank’s Call Report, minus items deducted from tier 1 capital. At its discretion the Federal Reserve may calculate total assets using a bank’s period-end assets rather than quarterly average assets.14 10 Before January 1, 2015, the leverage ratio of a member bank that is not an advanced approaches bank is the ratio of tier 1 capital to average total consolidated assets, as calculated in accordance with Appendix B to this part. 11 Before January 1, 2015, the tangible equity of a member bank that is not an advanced approaches bank is the amount of core capital elements as defined in appendix A to this part, plus the amount of outstanding cumulative perpetual preferred stock (including related surplus) minus all intangible assets except mortgage servicing assets to the extent that the Board determines that mortgage servicing assets may be included in calculating the bank’s tier 1 capital, as calculated in accordance with Appendix A to this part. 12 Before January 1, 2015, the tier 1 capital of a member bank that is not an advanced approaches bank (as defined in § 208.41) is calculated in accordance with Appendix A to this part. 13 Before January 1, 2015, the tier 1 risk-based capital ratio of a member bank that is not an advanced approaches bank (as defined in § 208.41) is calculated in accordance with Appendix A to this part. 14 Before January 1, 2015, total assets means, for a member bank that is not an advanced approaches bank (as defined in § 208.41), quarterly average total VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (n) Total leverage exposure means the total leverage exposure, as calculated in accordance with § 217.11 of Regulation Q (12 CFR 217.11). (o) Total risk-based capital ratio means the ratio of total capital to total risk-weighted assets, as calculated in accordance with § 217.10(b)(3) or § 217.10(c)(3) of Regulation Q (12 CFR 217.10(b)(3), 12 CFR 217.10(c)(3)), as applicable.15 (p) Total risk-weighted assets means standardized total risk-weighted assets, and for an advanced approaches bank also includes advanced approaches total risk-weighted assets, as defined in § 217.2 of Regulation Q (12 CFR 217.2). ■ 33. In § 208.43, revise paragraphs (a) and (b), redesignate paragraph (c) as paragraph (d), and add a new paragraph (c) to read as follows: § 208.43 Capital measures and capital category definitions. (a) Capital measures. (1) Capital measures applicable before January 1, 2015. On or before December 31, 2014, for purposes of section 38 and this subpart, the relevant capital measures for all banks are: (i) Total Risk-Based Capital Measure: the total risk-based capital ratio; (ii) Tier 1 Risk-Based Capital Measure: the tier 1 risk-based capital ratio; and (iii) Leverage Measure: the leverage ratio. (2) Capital measures applicable after January 1, 2015. On January 1, 2015, and thereafter, for purposes of section 38 and this subpart, the relevant capital measures are: (i) Total Risk-Based Capital Measure: The total risk-based capital ratio; (ii) Tier 1 Risk-Based Capital Measure: the tier 1 risk-based capital ratio; (iii) Common Equity Tier 1 Capital Measure: the common equity tier 1 riskbased capital ratio; and (iv) Leverage Measure: (A) The leverage ratio, and (B) With respect to an advanced approaches bank, on January 1, 2018, and thereafter, the supplementary leverage ratio. (b) Capital categories applicable before January 1, 2015. On or before December 31, 2014, for purposes of assets as reported in a bank’s Call Report, minus all intangible assets except mortgage servicing assets to the extent that the Federal Reserve determines that mortgage servicing assets may be included in calculating the bank’s tier 1 capital. At its discretion the Federal Reserve may calculate total assets using a bank’s period-end assets rather than quarterly average assets. 15 Before January 1, 2015, the total risk-based capital ratio of a member bank that is not an advanced approaches bank (as defined in § 208.41) is calculated in accordance with appendix A to this part. PO 00000 Frm 00267 Fmt 4701 Sfmt 4700 62283 section 38 of the FDI Act and this subpart, a member bank is deemed to be: (1) ‘‘Well capitalized’’ if: (i) Total Risk-Based Capital Measure: the bank has a total risk-based capital ratio of 10.0 percent or greater; (ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-based capital ratio of 6.0 percent or greater; (iii) Leverage Measure: the bank has a leverage ratio of 5.0 percent or greater; and (iv) The bank is not subject to any written agreement, order, capital directive, or prompt corrective action directive issued by the Board pursuant to section 8 of the FDI Act, the International Lending Supervision Act of 1983 (12 U.S.C. 3907), or section 38 of the FDI Act, or any regulation thereunder, to meet and maintain a specific capital level for any capital measure. (2) ‘‘Adequately capitalized’’ if: (i) Total Risk-Based Capital Measure: the bank has a total risk-based capital ratio of 8.0 percent or greater; (ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-based capital ratio of 4.0 percent or greater; (iii) Leverage Measure: (A) The bank has a leverage ratio of 4.0 percent or greater; or (B) The bank has a leverage ratio of 3.0 percent or greater if the bank is rated composite 1 under the CAMELS rating system in the most recent examination of the bank and is not experiencing or anticipating any significant growth; and (iv) Does not meet the definition of a ‘‘well capitalized’’ bank. (3) ‘‘Undercapitalized’’ if: (i) Total Risk-Based Capital Measure: the bank has a total risk-based capital ratio of less than 8.0 percent; (ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-based capital ratio of less than 4.0 percent; or (iii) Leverage Measure: (A) Except as provided in paragraph (b)(2)(iii)(B) of this section, the bank has a leverage ratio of less than 4.0 percent; or (B) The bank has a leverage ratio of less than 3.0 percent, if the bank is rated composite 1 under the CAMELS rating system in the most recent examination of the bank and is not experiencing or anticipating significant growth. (4) ‘‘Significantly undercapitalized’’ if: (i) Total Risk-Based Capital Measure: the bank has a total risk-based capital ratio of less than 6.0 percent; or (ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-based capital ratio of less than 3.0 percent; or (iii) Leverage Measure: the bank has a leverage ratio of less than 3.0 percent. E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62284 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (5) ‘‘Critically undercapitalized’’ if the bank has a ratio of tangible equity to total assets that is equal to or less than 2.0 percent. (c) Capital categories applicable to advanced approaches banks and to all member banks on and after January 1, 2015. On January 1, 2015, and thereafter, for purposes of section 38 and this subpart, a member bank is deemed to be: (1) ‘‘Well capitalized’’ if: (i) Total Risk-Based Capital Measure: the bank has a total risk-based capital ratio of 10.0 percent or greater; (ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-based capital ratio of 8.0 percent or greater; (iii) Common Equity Tier 1 Capital Measure: the bank has a common equity tier 1 risk-based capital ratio of 6.5 percent or greater; (iv) Leverage Measure: the bank has a leverage ratio of 5.0 or greater; and (v) The bank is not subject to any written agreement, order, capital directive, or prompt corrective action directive issued by the Board pursuant to section 8 of the FDI Act, the International Lending Supervision Act of 1983 (12 U.S.C. 3907), or section 38 of the FDI Act, or any regulation thereunder, to meet and maintain a specific capital level for any capital measure. (2) ‘‘Adequately capitalized’’ if: (i) Total Risk-Based Capital Measure: the bank has a total risk-based capital ratio of 8.0 percent or greater; (ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-based capital ratio of 6.0 percent or greater; (iii) Common Equity Tier 1 Capital Measure: the bank has a common equity tier 1 risk-based capital ratio of 4.5 percent or greater; (iv) Leverage Measure: (A) The bank has a leverage ratio of 4.0 percent or greater; and (B) With respect to an advanced approaches bank, on January 1, 2018, and thereafter, the bank has a supplementary leverage ratio of 3.0 percent or greater; and (v) The bank does not meet the definition of a ‘‘well capitalized’’ bank. (3) ‘‘Undercapitalized’’ if: (i) Total Risk-Based Capital Measure: the bank has a total risk-based capital ratio of less than 8.0 percent; (ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-based capital ratio of less than 6.0 percent; (iii) Common Equity Tier 1 Capital Measure: the bank has a common equity tier 1 risk-based capital ratio of less than 4.5 percent; or (iv) Leverage Measure: (A) The bank has a leverage ratio of less than 4.0 percent; or VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (B) With respect to an advanced approaches bank, on January 1, 2018, and thereafter, the bank has a supplementary leverage ratio of less than 3.0 percent. (4) ‘‘Significantly undercapitalized’’ if: (i) Total Risk-Based Capital Measure: the bank has a total risk-based capital ratio of less than 6.0 percent; (ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-based capital ratio of less than 4.0 percent; (iii) Common Equity Tier 1 Capital Measure: the bank has a common equity tier 1 risk-based capital ratio of less than 3.0 percent; or (iv) Leverage Measure: the bank has a leverage ratio of less than 3.0 percent. (5) ‘‘Critically undercapitalized’’ if the bank has a ratio of tangible equity to total assets that is equal to or less than 2.0 percent. * * * * * § 208.111 Subpart G—Financial Subsidiaries of State Member Banks * 34–35. In § 208.73: A. Revise the heading in paragraph (a). ■ B. Redesignate paragraphs (b) through (e) as paragraphs (c) through (f); and add new paragraph (b). The revision and addition read as follows: ■ ■ § 208.73 What additional provisions are applicable to state member banks with financial subsidiaries? (a) Capital deduction required prior to January 1, 2015, for state member banks that are not advanced approaches banks (as defined in § 208.41). * * * (b) Capital requirements for advanced approaches banks (as defined in § 208.41) and, after January 1, 2015, all state member banks. Beginning on January 1, 2014, for a state member bank that is an advanced approaches bank, and beginning on January 1, 2015 for all state member banks, a state member bank that controls or holds an interest in a financial subsidiary must comply with the rules set forth in § 217.22(a)(7) of Regulation Q (12 CFR 217.22(a)(7)) in determining its compliance with applicable regulatory capital standards (including the well capitalized standard of § 208.71(a)(1)). * * * * * § 208.77 [Amended] 36a. In § 208.77, remove and reserve paragraph (c). ■ § 208.102 [Amended] 36b. In § 208.102, redesignate footnote 7 as footnote 16. ■ PO 00000 Frm 00268 Fmt 4701 Sfmt 4700 [Amended] 36c. In § 208.111, redesignate footnotes 8 and 9 as footnotes 17 and 18 respectively. ■ Appendix A to Part 208—[Removed and Reserved] 37. Effective January 1, 2015, appendix A to part 208 is removed and reserved. ■ Appendix B to Part 208—[Removed and Reserved] 38. Effective January 1, 2015, appendix B to part 208 is removed and reserved. ■ 39. In Appendix C to part 208, under Loans In Excess of the Supervisory Loan-To-Value Limits, footnote 2 is revised to read as follows: ■ Appendix C to Part 208—Interagency Guidelines for Real Estate Lending Policies * * * * 2 For advanced approaches banks (as defined in 12 CFR 208.41) and, after January 1, 2015, for all state member banks, the term ‘‘total capital’’ refers to that term as defined in subpart A of 12 CFR part 217. For insured state nonmember banks and state savings associations, ‘‘total capital’’ refers to that term defined in subpart A of 12 CFR part 324. For national banks and Federal savings associations, the term ‘‘total capital’’ refers to that term as defined in subpart A of 12 CFR part 3. Prior to January 1, 2015, for state member banks that are not advanced approaches banks (as defined in 12 CFR 208.41), the term ‘‘total capital’’ means ‘‘total risk-based capital’’ as defined in appendix A to 12 CFR part 208. For insured state nonmember banks, ‘‘total capital’’ refers to that term described in table I of appendix A to 12 CFR part 325. For national banks, the term ‘‘total capital’’ is defined at 12 CFR 3.2(e). For savings associations, the term ‘‘total capital’’ is defined at 12 CFR 567.5(c) * * * * * Appendix E to Part 208—[Removed and Reserved] 40. Effective January 1, 2015, appendix E to part 208 is removed and reserved. ■ Appendix F to Part 208—[Removed and Reserved] 41. Effective January 1, 2014, Appendix F to part 208 is removed and reserved. ■ PART 217—CAPITAL ADEQUACY OF BANK HOLDING COMPANIES, SAVINGS AND LOAN HOLDING COMPANIES, AND STATE MEMBER BANKS (REGULATION Q) 42. The authority citation for part 217 is added to read as follows: ■ E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations Authority: 12 U.S.C. 248(a), 321–338a, 481–486, 1462a, 1467a, 1818, 1828, 1831n, 1831o, 1831p–l, 1831w, 1835, 1844(b), 1851, 3904, 3906–3909, 4808, 5365, 5371. 43. Add Part 217 as set forth at the end of the common preamble. ■ 44. Part 217 is amended as set forth below: ■ A. Remove ‘‘[AGENCY]’’ and add ‘‘Board’’ in its place wherever it appears. ■ B. Remove ‘‘[BANK]’’ and add ‘‘Board-regulated institution’’ in its place wherever it appears. ■ C. Remove ‘‘[BANKS]’’ and ‘‘[BANK]s’’ and add ‘‘Board-regulated institutions’’ in its place, wherever they appear; ■ D. Remove ‘‘[BANK]’s’’ and add ‘‘Board-regulated institution’s’’ in their place, wherever they appear; ■ E. Remove ‘‘[PART]’’ and add ‘‘part’’ wherever it appears. ■ F. Remove ‘‘[REGULATORY REPORT]’’ wherever it appears and add in its place ‘‘Call Report, for a state member bank, or the Consolidated Financial Statements for Bank Holding Companies (FR Y–9C), for a bank holding company or savings and loan holding company, as applicable’’ in § l.10(b)(4) and ‘‘Call Report, for a state member bank, or FR Y–9C, for a bank holding company or savings and loan holding company, as applicable’’ every time thereafter; ■ G. Remove ‘‘[other Federal banking agencies]’’ wherever it appears and add ‘‘Federal Deposit Insurance Corporation and Office of the Comptroller of the Currency’’ in its place’’. ■ 45. In § 217.1, ■ A. Revise paragraphs (a) and (b) and (c)(1); ■ B. Redesignate paragraphs (c)(2) through (c)(4) as paragraphs (c)(3) through (c)(5) respectively; ■ C. Add new paragraph (c)(2); ■ D. Revise paragraphs (e) and (f)(1)(ii)(A) through (C); and ■ E. Add new paragraph (f)(4) to read as follows: ■ wreier-aviles on DSK5TPTVN1PROD with RULES2 § 217.1 Purpose, applicability, and reservations of authority. (a) Purpose. This part establishes minimum capital requirements and overall capital adequacy standards for entities described in paragraph (c)(1) of this section. This part includes methodologies for calculating minimum capital requirements, public disclosure requirements related to the capital requirements, and transition provisions for the application of this part. (b) Limitation of authority. Nothing in this part shall be read to limit the authority of the Board to take action VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 62285 under other provisions of law, including action to address unsafe or unsound practices or conditions, deficient capital levels, or violations of law or regulation, under section 8 of the Federal Deposit Insurance Act, section 8 of the Bank Holding Company Act, or section 10 of the Home Owners’ Loan Act. (c) Applicability. (1) This part applies on a consolidated basis to every Boardregulated institution that is: (i) A state member bank; (ii) A bank holding company domiciled in the United States that is not subject to 12 CFR part 225, appendix C, provided that the Board may by order apply any or all of this part 217 to any bank holding company, based on the institution’s size, level of complexity, risk profile, scope of operations, or financial condition; or (iii) A covered savings and loan holding company domiciled in the United States. For purposes of compliance with the capital adequacy requirements and calculations in this part, savings and loan holding companies that do not file the FR Y–9C should follow the instructions to the FR Y–9C. (2) Minimum capital requirements and overall capital adequacy standards. Each Board-regulated institution must calculate its minimum capital requirements and meet the overall capital adequacy standards in subpart B of this part. * * * * * (e) Notice and response procedures. In making a determination under this section, the Board will apply notice and response procedures in the same manner and to the same extent as the notice and response procedures in 12 CFR 263.202. (f) * * * (1) * * * (ii) * * * (A) Calculate risk-weighted assets in accordance with the general risk-based capital rules under 12 CFR parts 208 or 225, appendix A, and, if applicable, appendix E (state member banks or bank holding companies, respectively) 1 and substitute such risk-weighted assets for standardized total risk-weighted assets for purposes of § 217.10; (B) If applicable, calculate general market risk equivalent assets in accordance with 12 CFR parts 208 or 225, appendix E, section 4(a)(3) (state member banks or bank holding companies, respectively) and substitute such general market risk equivalent assets for standardized market riskweighted assets for purposes of § 217.20(d)(3); and (C) Substitute the corresponding provision or provisions of 12 CFR parts 208 or 225, appendix A, and, if applicable, appendix E (state member banks or bank holding companies, respectively) for any reference to subpart D of this part in: § 217.121(c); § 217.124(a) and (b); § 217.144(b); § 217.154(c) and (d); § 217.202(b) (definition of covered position in paragraph (b)(3)(iv)); and § 217.211(b); 2 * * * * * (4) This part shall not apply until January 1, 2015, to any Board-regulated institution that is not an advanced approaches Board-regulated institution or to any covered savings and loan holding company. ■ 46. In § 217.2: ■ A. Add definitions of ‘‘Board’’, ‘‘Board-regulated institution’’, ‘‘nonguaranteed separate account’’, ‘‘policy loan’’, ‘‘state bank’’, and ‘‘state member bank or member bank’’ in alphabetical order; ■ B. Add paragraphs (12) and (13) to the definition of ‘‘corporate exposure’’; ■ C. Revise paragraphs (2)(i), (2)(ii) and (4)(i) of the definition of ‘‘high volatility commercial real estate (HVCRE) exposure’’, paragraph (4) of the definition of ‘‘pre-sold construction loan’’, paragraph (1) of the definition of ‘‘total leverage exposure’’, and paragraph (10)(ii) of the definition of ‘‘traditional securitization’’. The additions and revisions read as follows: * * * * * 1 For the purpose of calculating its general riskbased capital ratios from January 1, 2014 to December 31, 2014, an advanced approaches Boardregulated institution shall adjust, as appropriate, its risk-weighted asset measure (as that amount is calculated under 12 CFR parts 208 and 225, and, if applicable, appendix E (state member banks or bank holding companies, respectively) in the general risk-based capital rules) by excluding those assets that are deducted from its regulatory capital under § 217.22. 2 In addition, for purposes of § 217.201(c)(3), from January 1, 2014 to December 31, 2014, for any circumstance in which the Board may require a Board-regulated institution to calculate risk-based capital requirements for specific positions or portfolios under subpart D of this part, the Board will instead require the Board-regulated institution to make such calculations according to 12 CFR parts 208 and 225, appendix A and, if applicable, appendix E (state member banks or bank holding companies, respectively). PO 00000 Frm 00269 Fmt 4701 Sfmt 4700 § 217.2 Definitions. * * * * * Board means the Board of Governors of the Federal Reserve System. Board-regulated institution means a state member bank, bank holding company, or savings and loan holding company. * * * * * Corporate exposure * * * E:\FR\FM\11OCR2.SGM 11OCR2 wreier-aviles on DSK5TPTVN1PROD with RULES2 62286 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (12) A policy loan; or (13) A separate account. * * * * * High volatility commercial real estate (HVCRE) exposure * * * (2) * * * (i) Would qualify as an investment in community development under 12 U.S.C. 338a or 12 U.S.C. 24 (Eleventh), as applicable, or as a ‘‘qualified investment’’ under 12 CFR part 228, and (ii) Is not an ADC loan to any entity described in 12 CFR 208.22(a)(3) or 228.12(g)(3), unless it is otherwise described in paragraph (1), (2)(i), (3) or (4) of this definition; * * * * * (4) * * * (i) The loan-to-value ratio is less than or equal to the applicable maximum supervisory loan-to-value ratio in the Board’s real estate lending standards at 12 CFR part 208, appendix C; * * * * * Non-guaranteed separate account means a separate account where the insurance company: (1) Does not contractually guarantee either a minimum return or account value to the contract holder; and (2) Is not required to hold reserves (in the general account) pursuant to its contractual obligations to a policyholder. * * * * * Policy loan means a loan by an insurance company to a policy holder pursuant to the provisions of an insurance contract that is secured by the cash surrender value or collateral assignment of the related policy or contract. A policy loan includes: (1) A cash loan, including a loan resulting from early payment benefits or accelerated payment benefits, on an insurance contract when the terms of contract specify that the payment is a policy loan secured by the policy; and (2) An automatic premium loan, which is a loan that is made in accordance with policy provisions which provide that delinquent premium payments are automatically paid from the cash value at the end of the established grace period for premium payments. * * * * * Pre-sold construction loan means * * * (4) The purchaser has not terminated the contract; however, if the purchaser terminates the sales contract, the Board must immediately apply a 100 percent risk weight to the loan and report the revised risk weight in the next quarterly Call Report, for a state member bank, or the FR Y–9C, for a bank holding VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 company or savings and loan holding company, as applicable, * * * * * State bank means any bank incorporated by special law of any State, or organized under the general laws of any State, or of the United States, including a Morris Plan bank, or other incorporated banking institution engaged in a similar business. State member bank or member bank means a state bank that is a member of the Federal Reserve System. * * * * * Total leverage exposure * * * (1) The balance sheet carrying value of all of the Board-regulated institution’s on-balance sheet assets, as reported on the Call Report, for a state member bank, or the FR Y–9C, for a bank holding company or savings and loan holding company, as applicable, less amounts deducted from tier 1 capital under § 217.22 (a), (c) and (d); Traditional securitization * * * (10) * * * (ii) A collective investment fund (as defined in 12 CFR 208.34); * * * * * ■ 47. In § 217.10, revise paragraph (d) to read as follows: current calendar quarter, based on the Board-regulated institution’s quarterly Call Report, for a state member bank, or the FR Y–9C, for a bank holding company or savings and loan holding company, as applicable, net of any distributions and associated tax effects not already reflected in net income. Net income, as reported in the Call Report or the FR Y–9C, as applicable, reflects discretionary bonus payments and certain distributions that are expense items (and their associated tax effects). * * * * * (4) * * * (v) Other limitations on distributions. Additional limitations on distributions may apply to a Board-regulated institution under 12 CFR 225.4, 12 CFR 225.8, and 12 CFR 263.202. * * * * * ■ 49. In § 217.20: ■ A. Revise paragraphs (b)(1)(v), (c)(1)(viii), (c)(3), and (e)(2); and ■ B. In paragraph (d)(4), remove ’’ [12 CFR part 3, appendix A, 12 CFR 167 (OCC); 12 CFR part 208, appendix A, 12 CFR part 225, appendix A (Board)]’’ and add ‘‘12 CFR part 208, appendix A, 12 CFR part 225, appendix A’’ in its place. The revisions read as follows: § 217.10 § 217.20 Capital components and eligibility criteria for regulatory capital instruments. Minimum capital requirements. * * * * * (d) Capital adequacy. (1) Notwithstanding the minimum requirements in this part, a Boardregulated institution must maintain capital commensurate with the level and nature of all risks to which the Board-regulated institution is exposed. The supervisory evaluation of the Board-regulated institution’s capital adequacy is based on an individual assessment of numerous factors, including the character and condition of the institution’s assets and its existing and prospective liabilities and other corporate responsibilities. (2) A Board-regulated institution must have a process for assessing its overall capital adequacy in relation to its risk profile and a comprehensive strategy for maintaining an appropriate level of capital. ■ 48. In § 217.11, revise paragraphs (a)(2)(i) and (a)(4)(v) to read as follows: § 217.11 Capital conservation buffer and countercyclical capital buffer amount. * * * * * (a) * * * (2) * * * (i) Eligible retained income. The eligible retained income of a Boardregulated institution is the Boardregulated institution’s net income for the four calendar quarters preceding the PO 00000 Frm 00270 Fmt 4701 Sfmt 4700 * * * * * (b) * * * (1) * * * (v) Any cash dividend payments on the instrument are paid out of the Board-regulated institution’s net income, retained earnings, or surplus related to common stock, and are not subject to a limit imposed by the contractual terms governing the instrument. State member banks are subject to other legal restrictions on reductions in capital resulting from cash dividends, including out of the capital surplus account, under 12 U.S.C. 324 and 12 CFR 208.5. * * * * * (c) * * * (1) * * * (viii) Any distributions on the instrument are paid out of the Boardregulated institution’s net income, retained earnings, or surplus related to other additional tier 1 capital instruments. State member banks are subject to other legal restrictions on reductions in capital resulting from cash dividends, including out of the capital surplus account, under 12 U.S.C. 324 and 12 CFR 208.5. * * * * * (3) Any and all instruments that qualified as tier 1 capital under the Board’s general risk-based capital rules E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations under 12 CFR part 208, appendix A or 12 CFR part 225, appendix A, as then in effect, that were issued under the Small Business Jobs Act of 2010 10 or prior to October 4, 2010, under the Emergency Economic Stabilization Act of 2008.11 * * * * * (e) * * * (2) When considering whether a Board-regulated institution may include a regulatory capital element in its common equity tier 1 capital, additional tier 1 capital, or tier 2 capital, the Federal Reserve Board will consult with the FDIC and OCC. * * * * * ■ 50. In § 217.22, revise paragraphs (a)(7), (b)(2)(ii) through (b)(2)(iii), and (b)(2)(iv) introductory text, add paragraph (b)(3), and revise paragraph (d)(1)(i) to read as follows: § 217.22 Regulatory capital adjustments and deductions. wreier-aviles on DSK5TPTVN1PROD with RULES2 * * * * * (a) * * * (7) Financial subsidiaries. (i) A state member bank must deduct the aggregate amount of its outstanding equity investment, including retained earnings, in its financial subsidiaries (as defined in 12 CFR 208.77) and may not consolidate the assets and liabilities of a financial subsidiary with those of the state member bank. (ii) No other deduction is required under § 217.22(c) for investments in the capital instruments of financial subsidiaries. (b) * * * (2) * * * (ii) A Board-regulated institution that is not an advanced approaches Boardregulated institution must make its AOCI opt-out election in the Call Report, for a state member bank, FR Y– 9C or FR Y–9SP, as applicable, for bank holding companies or savings and loan holding companies, filed by the Boardregulated institution for the first reporting period after the Boardregulated institution is required to comply with subpart A of this part as set forth in § 217.1(f). (iii) Each depository institution subsidiary of a Board-regulated institution that is not an advanced approaches Board-regulated institution must elect the same option as the Boardregulated institution pursuant to paragraph (b)(2). (iv) With prior notice to the Board, a Board-regulated institution resulting from a merger, acquisition, or purchase transaction may make a new AOCI opt10 Public 11 Public Law 111–240; 124 Stat. 2504 (2010). Law 110–343, 122 Stat. 3765 (2008). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 out election in the Call Report (for a state member bank), or FR Y–9C or FR Y–9SP, as applicable (for bank holding companies or savings and loan holding companies) filed by the resulting Boardregulated institution for the first reporting period after it is required to comply with subpart A of this part as set forth in § 217.1(f) if: * * * * * (3) Regulatory capital requirement for insurance underwriting risks. A bank holding company or savings and loan holding company must deduct an amount equal to the regulatory capital requirement for insurance underwriting risks established by the regulator of any insurance underwriting activities of the company. The bank holding company or savings and loan holding company must take the deduction 50 percent from tier 1 capital and 50 percent from tier 2 capital. If the amount deductible from tier 2 capital exceeds the Boardregulated institution’s tier 2 capital, the Board-regulated institution must deduct the excess from tier 1 capital. * * * * * (d) * * * (1) * * * (i) DTAs arising from temporary differences that the Board-regulated institution could not realize through net operating loss carrybacks, net of any related valuation allowances and net of DTLs, in accordance paragraph (e) of this section. A Board-regulated institution is not required to deduct from the sum of its common equity tier 1 capital elements DTAs (net of any related valuation allowances and net of DTLs, in accordance with § 217.22(e)) arising from timing differences that the Board-regulated institution could realize through net operating loss carrybacks. The Board-regulated institution must risk weight these assets at 100 percent. For a state member bank that is a member of a consolidated group for tax purposes, the amount of DTAs that could be realized through net operating loss carrybacks may not exceed the amount that the state member bank could reasonably expect to have refunded by its parent holding company. * * * * * ■ 51. In § 217.32, revise paragraphs (g)(1)(ii), (k) introductory text, (l)(1) and (l)(6) introductory text, and add new paragraph (m) to read as follows: § 217.32 General risk weights. * * * * * (g) * * * (1) * * * (ii) Is made in accordance with prudent underwriting standards, PO 00000 Frm 00271 Fmt 4701 Sfmt 4700 62287 including relating to the loan amount as a percent of the appraised value of the property; A Board-regulated institution must base all estimates of a property’s value on an appraisal or evaluation of the property that satisfies subpart E of 12 CFR part 208. * * * * * (k) Past due exposures. Except for an exposure to a sovereign entity or a residential mortgage exposure or a policy loan, if an exposure is 90 days or more past due or on nonaccrual: * * * * * (l) Other assets. (1)(i) A bank holding company or savings and loan holding company must assign a zero percent risk weight to cash owned and held in all offices of subsidiary depository institutions or in transit, and to gold bullion held in a subsidiary depository institution’s own vaults, or held in another depository institution’s vaults on an allocated basis, to the extent the gold bullion assets are offset by gold bullion liabilities. (ii) A state member bank must assign a zero percent risk weight to cash owned and held in all offices of the state member bank or in transit; to gold bullion held in the state member bank’s own vaults or held in another depository institution’s vaults on an allocated basis, to the extent the gold bullion assets are offset by gold bullion liabilities; and to exposures that arise from the settlement of cash transactions (such as equities, fixed income, spot foreign exchange and spot commodities) with a central counterparty where there is no assumption of ongoing counterparty credit risk by the central counterparty after settlement of the trade and associated default fund contributions. * * * * * (6) Notwithstanding the requirements of this section, a state member bank may assign an asset that is not included in one of the categories provided in this section to the risk weight category applicable under the capital rules applicable to bank holding companies and savings and loan holding companies under this part, provided that all of the following conditions apply: * * * * * (m) Insurance assets—(1) Assets held in a separate account. (i) A bank holding company or savings and loan holding company must risk-weight the individual assets held in a separate account that does not qualify as a nonguaranteed separate account as if the individual assets were held directly by the bank holding company or savings and loan holding company. E:\FR\FM\11OCR2.SGM 11OCR2 62288 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations (ii) A bank holding company or savings and loan holding company must assign a zero percent risk weight to an asset that is held in a non-guaranteed separate account. (2) Policy loans. A bank holding company or savings and loan holding company must assign a 20 percent risk weight to a policy loan. ■ 52. In § 217.42: ■ A. Revise paragraph (h)(1)(iv); and ■ B. In paragraph (h)(3), remove ‘‘[12 CFR 6.4 (OCC); 12 CFR 208.43 (Board)]’’ and add ‘‘12 CFR 208.43’’ in its pace. The revision reads as follows: § 217.42 Risk-weighted assets for securitization exposures. * * * * * (h) * * * (1) * * * (iv)(A) In the case of a state member bank, the bank is well capitalized, as defined in 12 CFR 208.43. For purposes of determining whether a state member bank is well capitalized for purposes of this paragraph (h), the state member bank’s capital ratios must be calculated without regard to the capital treatment for transfers of small-business obligations under this paragraph (h). (B) In the case of a bank holding company or savings and loan holding company, the bank holding company or savings and loan holding company is well capitalized, as defined in 12 CFR 225.2. For purposes of determining whether a bank holding company or savings and loan holding company is well capitalized for purposes of this paragraph (h), the bank holding company or savings and loan holding company’s capital ratios must be calculated without regard to the capital treatment for transfers of small-business obligations with recourse specified in paragraph (k)(1) of this section. * * * * * ■ 53. In § 217.52, revise paragraph (b)(3)(i) to read as follows: § 217.52 Simple risk-weight approach (SRWA). wreier-aviles on DSK5TPTVN1PROD with RULES2 * * * * * (b) * * * (3) * * * (i) Community development equity exposures. (A) For state member banks and bank holding companies, an equity exposure that qualifies as a community development investment under 12 U.S.C. 24 (Eleventh), excluding equity exposures to an unconsolidated small business investment company and equity exposures held through a consolidated small business investment company described in section 302 of the Small Business Investment Act of 1958 (15 U.S.C. 682). VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 (B) For savings and loan holding companies, an equity exposure that is designed primarily to promote community welfare, including the welfare of low- and moderate-income communities or families, such as by providing services or employment, and excluding equity exposures to an unconsolidated small business investment company and equity exposures held through a small business investment company described in section 302 of the Small Business Investment Act of 1958 (15 U.S.C. 682). * * * * * ■ 54. In § 217.100, revise paragraphs (b)(1) introductory text, (b)(1)(i) through (iii), and (b)(2) to read as follows: § 217.100 Purpose, applicability, and principle of conservatism. * * * * * (b) Applicability. (1) This subpart applies to: (i) A top-tier bank holding company or savings and loan holding company domiciled in the United States that: (A) Is not a consolidated subsidiary of another bank holding company or savings and loan holding company that uses 12 CFR part 217, subpart E, to calculate its risk-based capital requirements; and (B) That: (1) Has total consolidated assets (excluding assets held by an insurance underwriting subsidiary), as defined on schedule HC–K of the FR Y–9C, equal to $250 billion or more; (2) Has consolidated total on-balance sheet foreign exposure at the most recent year-end equal to $10 billion (excluding exposures held by an insurance underwriting subsidiary). Total on-balance sheet foreign exposure equals total cross-border claims less claims with head office or guarantor located in another country plus redistributed guaranteed amounts to the country of head office or guarantor plus local country claims on local residents plus revaluation gains on foreign exchange and derivative products, calculated in accordance with the Federal Financial Institutions Examination Council (FFIEC) 009 Country Exposure Report); or (3) Has a subsidiary depository institution that is required, or has elected, to use 12 CFR part 3, subpart E (OCC), 12 CFR part 217, subpart E (Board), or 12 CFR part 325, subpart E (FDIC) to calculate its risk-based capital requirements; (ii) A state member bank that: (A) Has total consolidated assets, as reported on the most recent year-end Consolidated Report of Condition and PO 00000 Frm 00272 Fmt 4701 Sfmt 4700 Income (Call Report), equal to $250 billion or more; (B) Has consolidated total on-balance sheet foreign exposure at the most recent year-end equal to $10 billion or more (where total on-balance sheet foreign exposure equals total crossborder claims less claims with head office or guarantor located in another country plus redistributed guaranteed amounts to the country of head office or guarantor plus local country claims on local residents plus revaluation gains on foreign exchange and derivative products, calculated in accordance with the Federal Financial Institutions Examination Council (FFIEC) 009 Country Exposure Report); (C) Is a subsidiary of a depository institution that uses 12 CFR part 3, subpart E (OCC), 12 CFR part 217, subpart E (Board), or 12 CFR part 325, subpart E (FDIC) to calculate its riskbased capital requirements; or (D) Is a subsidiary of a bank holding company or savings and loan holding company that uses 12 CFR part 217, subpart E, to calculate its risk-based capital requirements; and (iii) Any Board-regulated institution that elects to use this subpart to calculate its risk-based capital requirements. * * * * * (2) A bank that is subject to this subpart shall remain subject to this subpart unless the Board determines in writing that application of this subpart is not appropriate in light of the Boardregulated institution’s asset size, level of complexity, risk profile, or scope of operations. In making a determination under this paragraph (b), the Board will apply notice and response procedures in the same manner and to the same extent as the notice and response procedures in 12 CFR 263.202. * * * * * ■ 55. In § 217.121, revise paragraph (a) to read as follows: § 217.121 Qualification process. (a) Timing. (1) A Board-regulated institution that is described in § 217.100(b)(1)(i) and (ii) must adopt a written implementation plan no later than six months after the date the Board-regulated institution meets a criterion in that section. The implementation plan must incorporate an explicit start date no later than 36 months after the date the Boardregulated institution meets at least one criterion under § 217.100(b)(1)(i) and (ii). The Board may extend the start date. (2) A Board-regulated institution that elects to be subject to this subpart under E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations § 217.101(b)(1)(iii) must adopt a written implementation plan. * * * * * ■ 56. In § 217.122(g), revise paragraph (g)(3)(ii) to read as follows: § 217.122 Qualification requirements. * * * * * (g) * * * (3) * * * (ii) With the prior written approval of the Board, a state member bank may generate an estimate of its operational risk exposure using an alternative approach to that specified in paragraph (g)(3)(i) of this section. A state member bank proposing to use such an alternative operational risk quantification system must submit a proposal to the Board. In determining whether to approve a state member bank’s proposal to use an alternative operational risk quantification system, the Board will consider the following principles: (A) Use of the alternative operational risk quantification system will be allowed only on an exception basis, considering the size, complexity, and risk profile of the state member bank; (B) The state member bank must demonstrate that its estimate of its operational risk exposure generated under the alternative operational risk quantification system is appropriate and can be supported empirically; and (C) A state member bank must not use an allocation of operational risk capital requirements that includes entities other than depository institutions or the benefits of diversification across entities. * * * * * ■ 57. In § 217.131, revise paragraph (b) and paragraphs (e)(3)(i) and (ii), and add a new paragraph (e)(5) to read as follows: § 217.131 Mechanics for calculating total wholesale and retail risk-weighted assets. wreier-aviles on DSK5TPTVN1PROD with RULES2 * * * * * (b) Phase 1—Categorization. The Board-regulated institution must determine which of its exposures are wholesale exposures, retail exposures, securitization exposures, or equity exposures. The Board-regulated institution must categorize each retail exposure as a residential mortgage exposure, a QRE, or another retail exposure. The Board-regulated institution must identify which wholesale exposures are HVCRE exposures, sovereign exposures, OTC derivative contracts, repo-style transactions, eligible margin loans, eligible purchased wholesale exposures, cleared transactions, default fund VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 contributions, and unsettled transactions to which § 217.136 applies, and eligible guarantees or eligible credit derivatives that are used as credit risk mitigants. The Board-regulated institution must identify any on-balance sheet asset that does not meet the definition of a wholesale, retail, equity, or securitization exposure, any nonmaterial portfolio of exposures described in paragraph (e)(4) of this section, and for bank holding companies and savings and loan holding companies, any on-balance sheet asset that is held in a non-guaranteed separate account. * * * * * (e) * * * (3) * * * (i) A bank holding company or savings and loan holding company may assign a risk-weighted asset amount of zero to cash owned and held in all offices of subsidiary depository institutions or in transit; and for gold bullion held in a subsidiary depository institution’s own vaults, or held in another depository institution’s vaults on an allocated basis, to the extent the gold bullion assets are offset by gold bullion liabilities. (ii) A state member bank may assign a risk-weighted asset amount to cash owned and held in all offices of the state member bank or in transit and for gold bullion held in the state member bank’s own vaults, or held in another depository institution’s vaults on an allocated basis, to the extent the gold bullion assets are offset by gold bullion liabilities. * * * * * (5) Assets held in non-guaranteed separate accounts. The risk-weighted asset amount for an on-balance sheet asset that is held in a non-guaranteed separate account is zero percent of the carrying value of the asset. ■ 58. In § 217.142, revise the section heading and paragraph (k)(1)(iv) to read as follows: § 217.142 Risk-based capital requirement for securitization exposures. * * * * * (k) * * * (1) * * * (iv)(A) In the case of a state member bank, the bank is well capitalized, as defined in section 208.43 of this chapter. For purposes of determining whether a state member bank is well capitalized for purposes of this paragraph, the state member bank’s capital ratios must be calculated without regard to the capital treatment for transfers of small-business obligations with recourse specified in this paragraph (k)(1). PO 00000 Frm 00273 Fmt 4701 Sfmt 4700 62289 (B) In the case of a bank holding company or savings and loan holding company, the bank holding company or savings and loan holding company is well capitalized, as defined in 12 CFR 225.2. For purposes of determining whether a bank holding company or savings and loan holding company is well capitalized for purposes of this paragraph, the bank holding company or savings and loan holding company’s capital ratios must be calculated without regard to the capital treatment for transfers of small-business obligations with recourse specified in this paragraph (k)(1). * * * * * ■ 59. In § 217.152, revise paragraph (b)(3)(i) to read as follows: § 217.152 (SRWA). Simple risk weight approach * * * * * (b) * * * (3) * * * (i) Community development equity exposures. (A) For state member banks and bank holding companies, an equity exposure that qualifies as a community development investment under 12 U.S.C. 24 (Eleventh), excluding equity exposures to an unconsolidated small business investment company and equity exposures held through a consolidated small business investment company described in section 302 of the Small Business Investment Act of 1958 (15 U.S.C. 682). (B) For savings and loan holding companies, an equity exposure that is designed primarily to promote community welfare, including the welfare of low- and moderate-income communities or families, such as by providing services or employment, and excluding equity exposures to an unconsolidated small business investment company and equity exposures held through a small business investment company described in section 302 of the Small Business Investment Act of 1958 (15 U.S.C. 682). * * * * * ■ 60. In § 217.201: ■ A. Revise paragraph (b)(1) introductory text. ■ B. In paragraph (c)(1), remove [12 CFR 3.404, 12 CFR 263.202, 12 CFR 325.6(c)]’’ and add ‘‘12 CFR 263.202’’ in its place. The revision reads as follows: § 217.201 Purpose, applicability, and reservation of authority. * * * * * (b) Applicability. (1) This subpart applies to any Board-regulated institution with aggregate trading assets E:\FR\FM\11OCR2.SGM 11OCR2 62290 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations and trading liabilities (as reported in the Board-regulated institution’s most recent quarterly Call Report, for a state member bank, or FR Y–9C, for a bank holding company or savings and loan holding company, as applicable, any savings and loan holding company that does not file the FR Y–9C should follow the instructions to the FR Y–9C) equal to: * * * * * ■ 61. In § 217.202(b): ■ A. Revise the introductory text of paragraph (1) of the definition of ‘‘covered position’’; and ■ B. In paragraph (10)(i) of the definition of ‘‘securitzation’’, remove ‘‘[12 CFR 208.34 (Board), 12 CFR 9.18 (OCC)]’’ and adding in its place ‘‘12 CFR 208.34’’. The revision reads as follows: § 217.202 Definitions. * * * * * Covered position means the following positions: (1) A trading asset or trading liability (whether on- or off-balance sheet),27 as reported on Schedule RC–D of the Call Report or Schedule HC–D of the FR Y– 9C (any savings and loan holding companies that does not file the FR Y– 9C should follow the instructions to the FR Y–9C), that meets the following conditions: * * * * * ■ 62. In § 217.300, revise paragraph (c)(1), revise the heading to paragraph (c)(3), add introductory text to paragraph (c)(3), revise paragraph (e), and add new paragraph (f), to read as follows: § 217. 300 Transitions. wreier-aviles on DSK5TPTVN1PROD with RULES2 * * * * * (c) * * * (1) Depository institution holding companies with total consolidated assets of more than $15 billion as of December 31, 2009 that were not mutual holding companies prior to May 19, 2010. The transition provisions in this paragraph (c)(1) apply to debt or equity instruments that do not meet the criteria for additional tier 1 or tier 2 capital instruments in § 217.20, but that were issued and included in tier 1 or tier 2 capital, respectively (or, in the case of a savings and loan holding company, would have been included in tier 1 or tier 2 capital if the savings and loan holding company had been subject to the general risk-based capital rules under 12 CFR part 225, appendix A), prior to May 19, 2010 (non-qualifying 27 Securities subject to repurchase and lending agreements are included as if they are still owned by the lender. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 capital instruments), and that were issued by a depository institution holding company with total consolidated assets greater than or equal to $15 billion as of December 31, 2009 that was not a mutual holding company prior to May 19, 2010 (2010 MHC) (depository institution holding company of $15 billion or more). * * * * * (3) Transition adjustments to AOCI. From January 1, 2014 through December 31, 2017, a Board-regulated institution that has not made an AOCI opt-out election under § 217.22(b)(2) must adjust common equity tier 1 capital with respect to the aggregate amount of unrealized gains on available-for-sale preferred stock classified as an equity security under GAAP and available-forsale equity exposures, plus net unrealized gains or losses on availablefor-sale securities that are not preferred stock classified as equity securities under GAAP or equity exposures, plus any amounts recorded in AOCI attributed to defined benefit postretirement plans resulting from the initial and subsequent application of the relevant GAAP standards that pertain to such plans (excluding, at the Boardregulated institution’s option, the portion relating to pension assets deducted under § 217.22(a)(5)), plus accumulated net unrealized gains or losses on cash flow hedges related to items that are reported on the balance sheet at fair value included in AOCI, plus net unrealized gains or losses on held-to-maturity securities that are included in AOCI (the transition AOCI adjustment amount) as reported on the Board-regulated institution’s most recent Call Report, for a state member bank, or the FR Y–9C, for a bank holding company or savings and loan holding company, as applicable, as follows: * * * * * (e) Prompt corrective action. For purposes of 12 CFR part 208, subpart D, a Board-regulated institution must calculate its capital measures and tangible equity ratio in accordance with the transition provisions in this section. (f) Until July 21, 2015, this part will not apply to any bank holding company subsidiary of a foreign banking organization that is currently relying on Supervision and Regulation Letter SR 01–01 issued by the Board (as in effect on May 19, 2010). PART 225—BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL (REGULATION Y) 63. The authority citation for part 225 continues to read as follows: ■ PO 00000 Frm 00274 Fmt 4701 Sfmt 4700 Authority: 12 U.S.C. 1817(j)(13), 1818, 1828(o), 1831i, 1831p–1, 1843(c)(8), 1844(b), 1972(1), 3106, 3108, 3310, 3331–3351, 3907, and 3909; 15 U.S.C. 1681s, 1681w, 6801 and 6805. Subpart A—General Provisions 64. Effective January 1, 2015, in § 225.1, remove and reserve paragraphs (c)(12), (c)(13) and (c)(15) to read as follows: ■ § 225.1 Authority, purpose, and scope. * * * * * (c) * * * (12) [Reserved] * * * * * (14) [Reserved] (15) [Reserved] * * * * * ■ 65. In § 225.2, revise paragraphs (r)(1)(i) and (ii) to read as follows: § 225.2 Definitions. * * * * * (r) * * * (1) * * * (i) On a consolidated basis, the bank holding company maintains a total riskbased capital ratio of 10.0 percent or greater, as defined in 12 CFR 217.10; 3 (ii) On a consolidated basis, the bank holding company maintains a tier 1 riskbased capital ratio of 6.0 percent or greater, as defined in 12 CFR 217.10; 4 and * * * * * ■ 66. In § 225.4, revise paragraph (b)(4)(ii) to read as follows: § 225.4 Corporate practices. * * * * * (b) * * * (4) * * * (ii) In determining whether a proposal constitutes an unsafe or unsound practice, the Board shall consider whether the bank holding company’s financial condition, after giving effect to the proposed purchase or redemption, meets the financial standards applied by the Board under section 3 of the BHC Act, including 12 CFR part 217,1 and the Board’s Policy Statement for Small 3 Before January 1, 2015, the total risk-based capital ratio of a bank holding company that is not an advanced approaches bank holding company (as defined in 12 CFR 217.100(b)(1)) is calculated in accordance with appendix A to this part. 4 Before January 1, 2015, the tier 1 risk-based capital ratio of a bank holding company that is not an advanced approaches bank holding company (as defined in 12 CFR 217.100(b)(1)) is calculated in accordance with appendix A to this part. 1 Before January 1, 2015, the Board will consider the financial standards at 12 CFR part 225 appendices A, C, and E for a bank holding company that is not an advanced approaches bank holding company. E:\FR\FM\11OCR2.SGM 11OCR2 Federal Register / Vol. 78, No. 198 / Friday, October 11, 2013 / Rules and Regulations Bank Holding Companies (appendix C of this part). * * * * * Subpart B—Acquisition of Bank Securities or Assets 67a. In § 225.12: a. In paragraph (d)(3)(i)(B), redesignate footnote 1 as footnote 2; ■ b. Revise paragraph (d)(2)(iv) and add a new footnote 1 to read as follows: ■ ■ § 225.12 Transactions not requiring Board approval. * * * * * (d) * * * (2) * * * (iv) Both before and after the transaction, the acquiring bank holding company meets the requirements of 12 CFR part 217; 1 * * * * * (8) * * * (v) The acquiring company, after giving effect to the transaction, meets the requirements of 12 CFR part 217, and the Board has not previously notified the acquiring company that it may not acquire assets under the exemption in this paragraph (d).1 * * * * * § 225.23 [Amended] 68b. In § 225.23, redesignate footnote 1 as footnote 2. ■ § 225.28 68c. In § 225.23, redesignate footnotes 2 through 18 as footnotes 3 through 19 respectively. ■ Subpart J—Merchant Banking Investments ■ § 225.17 § 225.172 What are the holding periods permitted for merchant banking investments? [Amended] 67b. In § 225.14, redesignate footnote 2 as footnote 3. [Amended] 67c. In § 225.17, redesignate footnotes 3 through 5 as footnotes 4 through 6 respectively. ■ Subpart C—Nonbanking Activities and Acquisitions by Bank Holding Companies 68a. In § 225.22, revise paragraph (d)(8)(v) and add footnote 1 to read as follows: ■ § 225.22 Exempt nonbanking activities and acquisitions. * * * (d) * * * * * wreier-aviles on DSK5TPTVN1PROD with RULES2 1 Or before January 1, 2015, if the acquiring company, after giving effect to the transaction, meets the requirements of appendix A to this part, and the Board has not previously notified the acquiring company that it may not acquire assets under the exemption in this paragraph. VerDate Mar<15>2010 13:14 Oct 10, 2013 Jkt 232001 ■ * * * * * (b) * * * (6) * * * (i) * * * (A) Higher than the maximum marginal tier 1 capital charge applicable under part 217 to merchant banking investments held by that financial holding company; 1 and * * * * * 1 Before January 1, 2015, the maximum marginal tier 1 capital charge applicable to merchant banking investments held by a financial holding company that is not an advanced approaches bank holding company (as defined in 12 CFR 217.100(b)(1)) is calculated in accordance with appendix A to this part. 1 Before January 1, 2015, the Board will consider the financial standards at 12 CFR part 225 appendices A, C, and E for a bank holding company that is not an advanced approaches bank holding company. PO 00000 Frm 00275 Fmt 4701 Appendix A to Part 225—Capital Adequacy Guidelines for Bank Holding Companies: Risk-Based Measure 70. Effective January 1, 2019, appendix A to part 225 is removed and reserved. ■ Appendix B to Part 225—Capital Adequacy Guidelines for Bank Holding Companies and State Member Banks: Leverage Measure [Removed and Reserved] 71. Appendix B to part 225 is removed and reserved. ■ [Amended] 69. In § 225.172, revise paragraph (b)(6)(i)(A) and add footnote 1 to read as follows: § 225.14 62291 Sfmt 9990 Appendix D to Part 225—Capital Adequacy Guidelines for Bank Holding Companies: Tier 1 Leverage Measure 72. Effective January 1, 2015, appendix D to part 225 is removed and reserved. ■ Appendix E to Part 225—Capital Adequacy Guidelines for Bank Holding Companies: Market Risk Measure 73. Effective January 1, 2015, Appendix E to part 225 is removed and reserved. ■ Appendix G to Part 225—Capital Adequacy Guidelines for Bank Holding Companies: Internal-Ratings-Based and Advanced Measurement Approaches 74. Effective January 1, 2014, Appendix G to part 225 is removed and reserved. ■ Dated: July 9, 2013. Thomas J. Curry, Comptroller of the Currency. By order of the Board of Governors of the Federal Reserve System, August 30, 2013. Robert deV. Frierson, Secretary of the Board. [FR Doc. 2013–21653 Filed 10–10–13; 8:45 a.m.] BILLING CODE 4810–33–P E:\FR\FM\11OCR2.SGM 11OCR2

Agencies

[Federal Register Volume 78, Number 198 (Friday, October 11, 2013)]
[Rules and Regulations]
[Pages 62017-62291]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-21653]



[[Page 62017]]

Vol. 78

Friday,

No. 198

October 11, 2013

Part II





Department of the Treasury





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Office of the Comptroller of the Currency





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12 CFR Parts 3, 5, 6, et al.





Federal Reserve System





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12 CFR Parts 208, 217, and 225





Regulatory Capital Rules: Regulatory Capital, Implementation of Basel 
III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, 
Standardized Approach for Risk-weighted Assets, Market Discipline and 
Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, 
and Market Risk Capital Rule; Final Rule

Federal Register / Vol. 78 , No. 198 / Friday, October 11, 2013 / 
Rules and Regulations

[[Page 62018]]


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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Parts 3, 5, 6, 165, and 167

[Docket ID OCC-2012-0008]
RIN 1557-AD46
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FEDERAL RESERVE SYSTEM

12 CFR Parts 208, 217, and 225

[Docket No. R-1442; Regulations H, Q, and Y]
RIN 7100-AD 87


Regulatory Capital Rules: Regulatory Capital, Implementation of 
Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective 
Action, Standardized Approach for Risk-weighted Assets, Market 
Discipline and Disclosure Requirements, Advanced Approaches Risk-Based 
Capital Rule, and Market Risk Capital Rule

AGENCY: Office of the Comptroller of the Currency, Treasury; and the 
Board of Governors of the Federal Reserve System.

ACTION: Final rule.

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SUMMARY: The Office of the Comptroller of the Currency (OCC) and Board 
of Governors of the Federal Reserve System (Board), are adopting a 
final rule that revises their risk-based and leverage capital 
requirements for banking organizations. The final rule consolidates 
three separate notices of proposed rulemaking that the OCC, Board, and 
FDIC published in the Federal Register on August 30, 2012, with 
selected changes. The final rule implements a revised definition of 
regulatory capital, a new common equity tier 1 minimum capital 
requirement, a higher minimum tier 1 capital requirement, and, for 
banking organizations subject to the advanced approaches risk-based 
capital rules, a supplementary leverage ratio that incorporates a 
broader set of exposures in the denominator. The final rule 
incorporates these new requirements into the agencies' prompt 
corrective action (PCA) framework. In addition, the final rule 
establishes limits on a banking organization's capital distributions 
and certain discretionary bonus payments if the banking organization 
does not hold a specified amount of common equity tier 1 capital in 
addition to the amount necessary to meet its minimum risk-based capital 
requirements. Further, the final rule amends the methodologies for 
determining risk-weighted assets for all banking organizations, and 
introduces disclosure requirements that would apply to top-tier banking 
organizations domiciled in the United States with $50 billion or more 
in total assets. The final rule also adopts changes to the agencies' 
regulatory capital requirements that meet the requirements of section 
171 and section 939A of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act.
    The final rule also codifies the agencies' regulatory capital 
rules, which have previously resided in various appendices to their 
respective regulations, into a harmonized integrated regulatory 
framework. In addition, the OCC is amending the market risk capital 
rule (market risk rule) to apply to Federal savings associations, and 
the Board is amending the advanced approaches and market risk rules to 
apply to top-tier savings and loan holding companies domiciled in the 
United States, except for certain savings and loan holding companies 
that are substantially engaged in insurance underwriting or commercial 
activities, as described in this preamble.

DATES: Effective date: January 1, 2014, except that the amendments to 
Appendixes A, B and E to 12 CFR Part 208, 12 CFR 225.1, and Appendixes 
D and E to Part 225 are effective January 1, 2015, and the amendment to 
Appendix A to 12 CFR Part 225 is effective January 1, 2019. Mandatory 
compliance date: January 1, 2014 for advanced approaches banking 
organizations that are not savings and loan holding companies; January 
1, 2015 for all other covered banking organizations.

FOR FURTHER INFORMATION CONTACT:
    OCC: Margot Schwadron, Senior Risk Expert, (202) 649-6982; David 
Elkes, Risk Expert, (202) 649-6984; Mark Ginsberg, Risk Expert, (202) 
649-6983, Capital Policy; or Ron Shimabukuro, Senior Counsel; Patrick 
Tierney, Special Counsel; Carl Kaminski, Senior Attorney; or Kevin 
Korzeniewski, Attorney, Legislative and Regulatory Activities Division, 
(202) 649-5490, Office of the Comptroller of the Currency, 400 7th 
Street SW., Washington, DC 20219.
    Board: Anna Lee Hewko, Deputy Associate Director, (202) 530-6260; 
Thomas Boemio, Manager, (202) 452-2982; Constance M. Horsley, Manager, 
(202) 452-5239; Juan C. Climent, Senior Supervisory Financial Analyst, 
(202) 872-7526; or Elizabeth MacDonald, Senior Supervisory Financial 
Analyst, (202) 475-6316, Capital and Regulatory Policy, Division of 
Banking Supervision and Regulation; or Benjamin McDonough, Senior 
Counsel, (202) 452-2036; April C. Snyder, Senior Counsel, (202) 452-
3099; Christine Graham, Senior Attorney, (202) 452-3005; or David 
Alexander, Senior Attorney, (202) 452-2877, Legal Division, Board of 
Governors of the Federal Reserve System, 20th and C Streets NW., 
Washington, DC 20551. For the hearing impaired only, Telecommunication 
Device for the Deaf (TDD), (202) 263-4869.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction
II. Summary of the Three Notices of Proposed Rulemaking
    A. The Basel III Notice of Proposed Rulemaking
    B. The Standardized Approach Notice of Proposed Rulemaking
    C. The Advanced Approaches Notice of Proposed Rulemaking
III. Summary of General Comments on the Basel III Notice of Proposed 
Rulemaking and on the Standardized Approach Notice of Proposed 
Rulemaking; Overview of the Final Rule
    A. General Comments on the Basel III Notice of Proposed 
Rulemaking and on the Standardized Approach Notice of Proposed 
Rulemaking
    1. Applicability and Scope
    2. Aggregate Impact
    3. Competitive Concerns
    4. Costs
    B. Comments on Particular Aspects of the Basel III Notice of 
Proposed Rulemaking and on the Standardized Approach Notice of 
Proposed Rulemaking
    1. Accumulated Other Comprehensive Income
    2. Residential Mortgages
    3. Trust Preferred Securities for Smaller Banking Organizations
    4. Insurance Activities
    C. Overview of the Final Rule
    D. Timeframe for Implementation and Compliance
IV. Minimum Regulatory Capital Ratios, Additional Capital 
Requirements, and Overall Capital Adequacy
    A. Minimum Risk-Based Capital Ratios and Other Regulatory 
Capital Provisions
    B. Leverage Ratio
    C. Supplementary Leverage Ratio for Advanced Approaches Banking 
Organizations
    D. Capital Conservation Buffer
    E. Countercyclical Capital Buffer
    F. Prompt Corrective Action Requirements
    G. Supervisory Assessment of Overall Capital Adequacy
    H. Tangible Capital Requirement for Federal Savings Associations
V. Definition of Capital
    A. Capital Components and Eligibility Criteria for Regulatory 
Capital Instruments
    1. Common Equity Tier 1 Capital

[[Page 62019]]

    2. Additional Tier 1 Capital
    3. Tier 2 Capital
    4. Capital Instruments of Mutual Banking Organizations
    5. Grandfathering of Certain Capital Instruments
    6. Agency Approval of Capital Elements
    7. Addressing the Point of Non-Viability Requirements Under 
Basel III
    8. Qualifying Capital Instruments Issued by Consolidated 
Subsidiaries of a Banking Organization
    9. Real Estate Investment Trust Preferred Capital
    B. Regulatory Adjustments and Deductions
    1. Regulatory Deductions From Common Equity Tier 1 Capital
    a. Goodwill and Other Intangibles (Other Than Mortgage Servicing 
Assets)
    b. Gain-on-sale Associated With a Securitization Exposure
    c. Defined Benefit Pension Fund Net Assets
    d. Expected Credit Loss That Exceeds Eligible Credit Reserves
    e. Equity Investments in Financial Subsidiaries
    f. Deduction for Subsidiaries of Savings Associations That 
Engage in Activities That Are Not Permissible for National Banks
    2. Regulatory Adjustments to Common Equity Tier 1 Capital
    a. Accumulated Net Gains and Losses on Certain Cash-Flow Hedges
    b. Changes in a Banking Organization's Own Credit Risk
    c. Accumulated Other Comprehensive Income
    d. Investments in Own Regulatory Capital Instruments
    e. Definition of Financial Institution
    f. The Corresponding Deduction Approach
    g. Reciprocal Crossholdings in the Capital Instruments of 
Financial Institutions
    h. Investments in the Banking Organization's Own Capital 
Instruments or in the Capital of Unconsolidated Financial 
Institutions
    i. Indirect Exposure Calculations
    j. Non-Significant Investments in the Capital of Unconsolidated 
Financial Institutions
    k. Significant Investments in the Capital of Unconsolidated 
Financial Institutions That Are Not in the Form of Common Stock
    l. Items Subject to the 10 and 15 Percent Common Equity Tier 1 
Capital Threshold Deductions
    m. Netting of Deferred Tax Liabilities Against Deferred Tax 
Assets and Other Deductible Assets
    3. Investments in Hedge Funds and Private Equity Funds Pursuant 
to Section 13 of the Bank Holding Company Act
VI. Denominator Changes Related to the Regulatory Capital Changes
VII. Transition Provisions
    A. Transitions Provisions for Minimum Regulatory Capital Ratios
    B. Transition Provisions for Capital Conservation and 
Countercyclical Capital Buffers
    C. Transition Provisions for Regulatory Capital Adjustments and 
Deductions
    1. Deductions for Certain Items Under Section 22(a) of the Final 
Rule
    2. Deductions for Intangibles Other Than Goodwill and Mortgage 
Servicing Assets
    3. Regulatory Adjustments Under Section 22(b)(1) of the Final 
Rule
    4. Phase-out of Current Accumulated Other Comprehensive Income 
Regulatory Capital Adjustments
    5. Phase-out of Unrealized Gains on Available for Sale Equity 
Securities in Tier 2 Capital
    6. Phase-in of Deductions Related to Investments in Capital 
Instruments and to the Items Subject to the 10 and 15 Percent Common 
Equity Tier 1 Capital Deduction Thresholds (Sections 22(c) and 
22(d)) of the Final Rule
    D. Transition Provisions for Non-qualifying Capital Instruments
    1. Depository Institution Holding Companies With Less Than $15 
Billion in Total Consolidated Assets as of December 31, 2009 and 
2010 Mutual Holding Companies
    2. Depository Institutions
    3. Depository Institution Holding Companies With $15 Billion or 
More in Total Consolidated Assets as of December 31, 2009 That Are 
Not 2010 Mutual Holding Companies
    4. Merger and Acquisition Transition Provisions
    5. Phase-out Schedule for Surplus and Non-Qualifying Minority 
Interest
VIII. Standardized Approach for Risk-weighted Assets
    A. Calculation of Standardized Total Risk-weighted Assets
    B. Risk-weighted Assets for General Credit Risk
    1. Exposures to Sovereigns
    2. Exposures to Certain Supranational Entities and Multilateral 
Development Banks
    3. Exposures to Government-sponsored Enterprises
    4. Exposures to Depository Institutions, Foreign Banks, and 
Credit Unions
    5. Exposures to Public-sector Entities
    6. Corporate Exposures
    7. Residential Mortgage Exposures
    8. Pre-sold Construction Loans and Statutory Multifamily 
Mortgages
    9. High-volatility Commercial Real Estate
    10. Past-Due Exposures
    11. Other Assets
    C. Off-balance Sheet Items
    1. Credit Conversion Factors
    2. Credit-Enhancing Representations and Warranties
    D. Over-the-Counter Derivative Contracts
    E. Cleared Transactions
    1. Definition of Cleared Transaction
    2. Exposure Amount Scalar for Calculating for Client Exposures
    3. Risk Weighting for Cleared Transactions
    4. Default Fund Contribution Exposures
    F. Credit Risk Mitigation
    1. Guarantees and Credit Derivatives
    a. Eligibility Requirements
    b. Substitution Approach
    c. Maturity Mismatch Haircut
    d. Adjustment for Credit Derivatives Without Restructuring as a 
Credit Event
    e. Currency Mismatch Adjustment
    f. Multiple Credit Risk Mitigants
    2. Collateralized Transactions
    a. Eligible Collateral
    b. Risk-management Guidance for Recognizing Collateral
    c. Simple Approach
    d. Collateral Haircut Approach
    e. Standard Supervisory Haircuts
    f. Own Estimates of Haircuts
    g. Simple Value-at-Risk and Internal Models Methodology
    G. Unsettled Transactions
    H. Risk-weighted Assets for Securitization Exposures
    1. Overview of the Securitization Framework and Definitions
    2. Operational Requirements
    a. Due Diligence Requirements
    b. Operational Requirements for Traditional Securitizations
    c. Operational Requirements for Synthetic Securitizations
    d. Clean-up Calls
    3. Risk-weighted Asset Amounts for Securitization Exposures
    a. Exposure Amount of a Securitization Exposure
    b. Gains-on-sale and Credit-enhancing Interest-only Strips
    c. Exceptions Under the Securitization Framework
    d. Overlapping Exposures
    e. Servicer Cash Advances
    f. Implicit Support
    4. Simplified Supervisory Formula Approach
    5. Gross-up Approach
    6. Alternative Treatments for Certain Types of Securitization 
Exposures
    a. Eligible Asset-backed Commercial Paper Liquidity Facilities
    b. A Securitization Exposure in a Second-loss Position or Better 
to an Asset-Backed Commercial Paper Program
    7. Credit Risk Mitigation for Securitization Exposures
    8. N^th-to-default Credit Derivatives
IX. Equity Exposures
    A. Definition of Equity Exposure and Exposure Measurement
    B. Equity Exposure Risk Weights
    C. Non-significant Equity Exposures
    D. Hedged Transactions
    E. Measures of Hedge Effectiveness
    F. Equity Exposures to Investment Funds
    1. Full Look-Through Approach
    2. Simple Modified Look-Through Approach
    3. Alternative Modified Look-Through Approach
X. Insurance-related Activities
    A. Policy Loans
    B. Separate Accounts
    C. Additional Deductions--Insurance Underwriting Subsidiaries
XI. Market Discipline and Disclosure Requirements
    A. Proposed Disclosure Requirements
    B. Frequency of Disclosures
    C. Location of Disclosures and Audit Requirements
    D. Proprietary and Confidential Information
    E. Specific Public Disclosure Requirements
XII. Risk-Weighted Assets--Modifications to the Advanced Approaches
    A. Counterparty Credit Risk
    1. Recognition of Financial Collateral

[[Page 62020]]

    a. Financial Collateral
    b. Revised Supervisory Haircuts
    2. Holding Periods and the Margin Period of Risk
    3. Internal Models Methodology
    a. Recognition of Wrong-Way Risk
    b. Increased Asset Value Correlation Factor
    4. Credit Valuation Adjustments
    a. Simple Credit Valuation Adjustment Approach
    b. Advanced Credit Valuation Adjustment Approach
    5. Cleared Transactions (Central Counterparties)
    6. Stress Period for Own Estimates
    B. Removal of Credit Ratings
    1. Eligible Guarantor
    2. Money Market Fund Approach
    3. Modified Look-through Approaches for Equity Exposures to 
Investment Funds
    C. Revisions to the Treatment of Securitization Exposures
    1. Definitions
    2. Operational Criteria for Recognizing Risk Transference in 
Traditional Securitizations
    3. The Hierarchy of Approaches
    4. Guarantees and Credit Derivatives Referencing a 
Securitization Exposure
    5. Due Diligence Requirements for Securitization Exposures
    6. Nth-to-Default Credit Derivatives
    D. Treatment of Exposures Subject to Deduction
    E. Technical Amendments to the Advanced Approaches Rule
    1. Eligible Guarantees and Contingent U.S. Government Guarantees
    2. Calculation of Foreign Exposures for Applicability of the 
Advanced Approaches--Insurance Underwriting Subsidiaries
    3. Calculation of Foreign Exposures for Applicability of the 
Advanced Approaches--Changes to Federal Financial Institutions 
Examination Council 009
    4. Applicability of the Final Rule
    5. Change to the Definition of Probability of Default Related to 
Seasoning
    6. Cash Items in Process of Collection
    7. Change to the Definition of Qualifying Revolving Exposure
    8. Trade-related Letters of Credit
    9. Defaulted Exposures That Are Guaranteed by the U.S. 
Government
    10. Stable Value Wraps
    11. Treatment of Pre-Sold Construction Loans and Multi-Family 
Residential Loans
    F. Pillar 3 Disclosures
    1. Frequency and Timeliness of Disclosures
    2. Enhanced Securitization Disclosure Requirements
    3. Equity Holdings That Are Not Covered Positions
XIII. Market Risk Rule
XIV. Additional OCC Technical Amendments
XV. Abbreviations
XVI. Regulatory Flexibility Act
XVII. Paperwork Reduction Act
XVIII. Plain Language
XIX. OCC Unfunded Mandates Reform Act of 1995 Determinations

I. Introduction

    On August 30, 2012, the Office of the Comptroller of the Currency 
(OCC) the Board of Governors of the Federal Reserve System (Board) 
(collectively, the agencies), and the Federal Deposit Insurance 
Corporation (FDIC) published in the Federal Register three joint 
notices of proposed rulemaking seeking public comment on revisions to 
their risk-based and leverage capital requirements and on methodologies 
for calculating risk-weighted assets under the standardized and 
advanced approaches (each, a proposal, and together, the NPRs, the 
proposed rules, or the proposals).\1\ The proposed rules, in part, 
reflected agreements reached by the Basel Committee on Banking 
Supervision (BCBS) in ``Basel III: A Global Regulatory Framework for 
More Resilient Banks and Banking Systems'' (Basel III), including 
subsequent changes to the BCBS's capital standards and recent BCBS 
consultative papers.\2\ Basel III is intended to improve both the 
quality and quantity of banking organizations' capital, as well as to 
strengthen various aspects of the international capital standards for 
calculating regulatory capital. The proposed rules also reflect aspects 
of the Basel II Standardized Approach and other Basel Committee 
standards.
---------------------------------------------------------------------------

    \1\ 77 FR 52792 (August 30, 2012); 77 FR 52888 (August 30, 
2012); 77 FR 52978 (August 30, 2012).
    \2\ Basel III was published in December 2010 and revised in June 
2011. The text is available at https://www.bis.org/publ/bcbs189.htm. 
The BCBS is a committee of banking supervisory authorities, which 
was established by the central bank governors of the G-10 countries 
in 1975. More information regarding the BCBS and its membership is 
available at https://www.bis.org/bcbs/about.htm. Documents issued by 
the BCBS are available through the Bank for International 
Settlements Web site at https://www.bis.org.
---------------------------------------------------------------------------

    The proposals also included changes consistent with the Dodd-Frank 
Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act); 
\3\ would apply the risk-based and leverage capital rules to top-tier 
savings and loan holding companies (SLHCs) domiciled in the United 
States; and would apply the market risk capital rule (the market risk 
rule) \4\ to Federal and state savings associations (as appropriate 
based on trading activity).
---------------------------------------------------------------------------

    \3\ Public Law 111-203, 124 Stat. 1376, 1435-38 (2010).
    \4\ The agencies' and the FDIC's market risk rule is at 12 CFR 
part 3, appendix B (OCC); 12 CFR parts 208 and 225, appendix E 
(Board); and 12 CFR part 325, appendix C (FDIC).
---------------------------------------------------------------------------

    The NPR titled ``Regulatory Capital Rules: Regulatory Capital, 
Implementation of Basel III, Minimum Regulatory Capital Ratios, Capital 
Adequacy, Transition Provisions, and Prompt Corrective Action'' \5\ 
(the Basel III NPR), provided for the implementation of the Basel III 
revisions to international capital standards related to minimum capital 
requirements, regulatory capital, and additional capital ``buffer'' 
standards to enhance the resilience of banking organizations to 
withstand periods of financial stress. (Banking organizations include 
national banks, state member banks, Federal savings associations, and 
top-tier bank holding companies domiciled in the United States not 
subject to the Board's Small Bank Holding Company Policy Statement (12 
CFR part 225, appendix C)), as well as top-tier savings and loan 
holding companies domiciled in the United States, except certain 
savings and loan holding companies that are substantially engaged in 
insurance underwriting or commercial activities, as described in this 
preamble.) The proposal included transition periods for many of the 
requirements, consistent with Basel III and the Dodd-Frank Act. The NPR 
titled ``Regulatory Capital Rules: Standardized Approach for Risk-
weighted Assets; Market Discipline and Disclosure Requirements'' \6\ 
(the Standardized Approach NPR), would revise the methodologies for 
calculating risk-weighted assets in the agencies' and the FDIC's 
general risk-based capital rules \7\ (the general risk-based capital 
rules), incorporating aspects of the Basel II standardized approach,\8\ 
and establish alternative standards of creditworthiness in place of 
credit ratings, consistent with section 939A of the Dodd-Frank Act.\9\ 
The proposed minimum capital requirements in section 10(a) of the Basel 
III NPR, as determined using the standardized capital ratio 
calculations in section 10(b), would establish minimum capital 
requirements that would be the ``generally applicable'' capital 
requirements for purpose of section 171 of the Dodd-Frank Act.\10\
---------------------------------------------------------------------------

    \5\ 77 FR 52792 (August 30, 2012).
    \6\ 77 FR 52888 (August 30, 2012).
    \7\ The agencies' and the FDIC's general risk-based capital 
rules are at 12 CFR part 3, appendix A (national banks) and 12 CFR 
part 167 (Federal savings associations) (OCC); 12 CFR parts 208 and 
225, appendix A (Board); and 12 CFR part 325, appendix A, and 12 CFR 
part 390, subpart Z (FDIC). The general risk-based capital rules are 
supplemented by the market risk rule.
    \8\ See BCBS, ``International Convergence of Capital Measurement 
and Capital Standards: A Revised Framework,'' (June 2006), available 
at https://www.bis.org/publ/bcbs128.htm (Basel II).
    \9\ See section 939A of the Dodd-Frank Act (15 U.S.C. 78o-7 
note).
    \10\ See 77 FR 52856 (August 30, 2012).
---------------------------------------------------------------------------

    The NPR titled ``Regulatory Capital Rules: Advanced Approaches 
Risk-Based Capital Rule; Market Risk Capital

[[Page 62021]]

Rule'' \11\ (the Advanced Approaches NPR) included proposed changes to 
the agencies' and the FDIC's current advanced approaches risk-based 
capital rules (the advanced approaches rule) \12\ to incorporate 
applicable provisions of Basel III and the ``Enhancements to the Basel 
II framework'' (2009 Enhancements) published in July 2009 \13\ and 
subsequent consultative papers, to remove references to credit ratings, 
to apply the market risk rule to savings associations and SLHCs, and to 
apply the advanced approaches rule to SLHCs meeting the scope of 
application of those rules. Taken together, the three proposals also 
would have restructured the agencies' and the FDIC's regulatory capital 
rules (the general risk-based capital rules, leverage rules,\14\ market 
risk rule, and advanced approaches rule) into a harmonized, codified 
regulatory capital framework.
---------------------------------------------------------------------------

    \11\ 77 FR 52978 (August 30, 2012).
    \12\ The agencies' and the FDIC's advanced approaches rules are 
at 12 CFR part 3, appendix C (national banks) and 12 CFR part 167, 
appendix C (Federal savings associations) (OCC); 12 CFR part 208, 
appendix F, and 12 CFR part 225, appendix G (Board); 12 CFR part 
325, appendix D, and 12 CFR part 390, subpart Z, appendix A (FDIC). 
The advanced approaches rules are supplemented by the market risk 
rule.
    \13\ See ``Enhancements to the Basel II framework'' (July 2009), 
available at https://www.bis.org/publ/bcbs157.htm.
    \14\ The agencies' and the FDIC's tier 1 leverage rules are at 
12 CFR 3.6(b) and 3.6(c) (national banks) and 167.6 (Federal savings 
associations) (OCC); 12 CFR part 208, appendix B, and 12 CFR part 
225, appendix D (Board); and 12 CFR 325.3, and 390.467 (FDIC).
---------------------------------------------------------------------------

    The agencies are adopting the Basel III NPR, Standardized Approach 
NPR, and Advanced Approaches NPR in this final rule, with certain 
changes to the proposals, as described further below. (The Board 
approved this final rule on July 2, 2013, and the OCC approved this 
final rule on July 9, 2013. The FDIC approved a similar regulation as 
an interim final rule on July 9, 2013.) This final rule applies to all 
banking organizations currently subject to minimum capital 
requirements, including national banks, state member banks, state 
nonmember banks, state and Federal savings associations, top-tier bank 
holding companies (BHCs) that are domiciled in the United States and 
are not subject to the Board's Small Bank Holding Company Policy 
Statement, and top-tier SLHCs that are domiciled in the United States 
and that do not engage substantially in insurance underwriting or 
commercial activities, as discussed further below (together, banking 
organizations). Generally, BHCs with total consolidated assets of less 
than $500 million (small BHCs) remain subject to the Board's Small Bank 
Holding Company Policy Statement.\15\
---------------------------------------------------------------------------

    \15\ See 12 CFR part 225, appendix C (Small Bank Holding Company 
Policy Statement).
---------------------------------------------------------------------------

    Certain aspects of this final rule apply only to banking 
organizations subject to the advanced approaches rule (advanced 
approaches banking organizations) or to banking organizations with 
significant trading activities, as further described below.
    Likewise, the enhanced disclosure requirements in the final rule 
apply only to banking organizations with $50 billion or more in total 
consolidated assets. Consistent with section 171 of the Dodd-Frank Act, 
a BHC subsidiary of a foreign banking organization that is currently 
relying on the Board's Supervision and Regulation Letter (SR) 01-1 is 
not required to comply with the requirements of the final rule until 
July 21, 2015. Thereafter, all top-tier U.S.-domiciled BHC subsidiaries 
of foreign banking organizations will be required to comply with the 
final rule, subject to applicable transition arrangements set forth in 
subpart G of the rule.\16\ The final rule reorganizes the agencies' 
regulatory capital rules into a harmonized, codified regulatory capital 
framework.
---------------------------------------------------------------------------

    \16\ See section 171(b)(4)(E) of the Dodd-Frank Act (12 U.S.C. 
5371(b)(4)(E)); see also SR 01-1 (January 5, 2001), available at 
https://www.federalreserve.gov/boarddocs/srletters/2001/sr0101.htm. 
In addition, the Board has proposed to apply specific enhanced 
capital standards to certain U.S. subsidiaries of foreign banking 
organizations beginning on July 1, 2015, under the proposed notice 
of rulemaking issued by the Board to implement sections 165 and 166 
of the Dodd-Frank Act. See 77 FR 76628, 76640, 76681-82 (December 
28, 2012).
---------------------------------------------------------------------------

    As under the proposal, the minimum capital requirements in section 
10(a) of the final rule, as determined using the standardized capital 
ratio calculations in section 10(b), which apply to all banking 
organizations, establish the ``generally applicable'' capital 
requirements under section 171 of the Dodd-Frank Act.\17\
---------------------------------------------------------------------------

    \17\ See note 12, supra. Risk-weighted assets calculated under 
the market risk framework in subpart F of the final rule are 
included in calculations of risk-weighted assets both under the 
standardized approach and the advanced approaches.
---------------------------------------------------------------------------

    Under the final rule, as under the proposal, in order to determine 
its minimum risk-based capital requirements, an advanced approaches 
banking organization that has completed the parallel run process and 
that has received notification from its primary Federal supervisor 
pursuant to section 121(d) of subpart E must determine its minimum 
risk-based capital requirements by calculating the three risk-based 
capital ratios using total risk-weighted assets under the standardized 
approach and, separately, total risk-weighted assets under the advanced 
approaches.\18\ The lower ratio for each risk-based capital requirement 
is the ratio the banking organization must use to determine its 
compliance with the minimum capital requirement.\19\ These enhanced 
prudential standards help ensure that advanced approaches banking 
organizations, which are among the largest and most complex banking 
organizations, have capital adequate to address their more complex 
operations and risks.
---------------------------------------------------------------------------

    \18\ The banking organization must also use its advanced-
approaches-adjusted total to determine its total risk-based capital 
ratio.
    \19\ See section 10(c) of the final rule.
---------------------------------------------------------------------------

II. Summary of the Three Notices of Proposed Rulemaking

A. The Basel III Notice of Proposed Rulemaking

    As discussed in the proposals, the recent financial crisis 
demonstrated that the amount of high-quality capital held by banking 
organizations was insufficient to absorb the losses generated over that 
period. In addition, some non-common stock capital instruments included 
in tier 1 capital did not absorb losses to the extent previously 
expected. A lack of clear and easily understood disclosures regarding 
the characteristics of regulatory capital instruments, as well as 
inconsistencies in the definition of capital across jurisdictions, 
contributed to difficulties in evaluating a banking organization's 
capital strength. Accordingly, the BCBS assessed the international 
capital framework and, in 2010, published Basel III, a comprehensive 
reform package designed to improve the quality and quantity of 
regulatory capital and build additional capacity into the banking 
system to absorb losses in times of market and economic stress. On 
August 30, 2012, the agencies and the FDIC published the NPRs in the 
Federal Register to revise regulatory capital requirements, as 
discussed above. As proposed, the Basel III NPR generally would have 
applied to all U.S. banking organizations.
    Consistent with Basel III, the Basel III NPR would have required 
banking organizations to comply with the following minimum capital 
ratios: (i) A new requirement for a ratio of common equity tier 1 
capital to risk-weighted assets (common equity tier 1 capital ratio) of 
4.5 percent; (ii) a ratio of tier 1 capital to risk-weighted assets 
(tier 1 capital ratio) of 6 percent, increased from 4 percent; (iii) a 
ratio of total capital to risk-weighted assets (total capital ratio) of 
8 percent; (iv) a ratio of

[[Page 62022]]

tier 1 capital to average total consolidated assets (leverage ratio) of 
4 percent; and (v) for advanced approaches banking organizations only, 
an additional requirement that the ratio of tier 1 capital to total 
leverage exposure (supplementary leverage ratio) be at least 3 percent.
    The Basel III NPR also proposed implementation of a capital 
conservation buffer equal to 2.5 percent of risk-weighted assets above 
the minimum risk-based capital ratio requirements, which could be 
expanded by a countercyclical capital buffer for advanced approaches 
banking organizations under certain circumstances. If a banking 
organization failed to hold capital above the minimum capital ratios 
and proposed capital conservation buffer (as potentially expanded by 
the countercyclical capital buffer), it would be subject to certain 
restrictions on capital distributions and discretionary bonus payments. 
The proposed countercyclical capital buffer was designed to take into 
account the macro-financial environment in which large, internationally 
active banking organizations function. The countercyclical capital 
buffer could be implemented if the agencies and the FDIC determined 
that credit growth in the economy became excessive. As proposed, the 
countercyclical capital buffer would initially be set at zero, and 
could expand to as much as 2.5 percent of risk-weighted assets.
    The Basel III NPR proposed to apply a 4 percent minimum leverage 
ratio requirement to all banking organizations (computed using the new 
definition of capital), and to eliminate the exceptions for banking 
organizations with strong supervisory ratings or subject to the market 
risk rule. The Basel III NPR also proposed to require advanced 
approaches banking organizations to satisfy a minimum supplementary 
leverage ratio requirement of 3 percent, measured in a manner 
consistent with the international leverage ratio set forth in Basel 
III. Unlike the agencies' current leverage ratio requirement, the 
proposed supplementary leverage ratio incorporates certain off-balance 
sheet exposures in the denominator.
    To strengthen the quality of capital, the Basel III NPR proposed 
more conservative eligibility criteria for regulatory capital 
instruments. For example, the Basel III NPR proposed that trust 
preferred securities (TruPS) and cumulative perpetual preferred 
securities, which were tier-1-eligible instruments (subject to limits) 
at the BHC level, would no longer be includable in tier 1 capital under 
the proposal and would be gradually phased out from tier 1 capital. The 
proposal also eliminated the existing limitations on the amount of tier 
2 capital that could be recognized in total capital, as well as the 
limitations on the amount of certain capital instruments (for example, 
term subordinated debt) that could be included in tier 2 capital.
    In addition, the proposal would have required banking organizations 
to include in common equity tier 1 capital accumulated other 
comprehensive income (AOCI) (with the exception of gains and losses on 
cash-flow hedges related to items that are not fair-valued on the 
balance sheet), and also would have established new limits on the 
amount of minority interest a banking organization could include in 
regulatory capital. The proposal also would have established more 
stringent requirements for several deductions from and adjustments to 
regulatory capital, including with respect to deferred tax assets 
(DTAs), investments in a banking organization's own capital instruments 
and the capital instruments of other financial institutions, and 
mortgage servicing assets (MSAs). The proposed revisions would have 
been incorporated into the regulatory capital ratios in the prompt 
corrective action (PCA) framework for depository institutions.

B. The Standardized Approach Notice of Proposed Rulemaking

    The Standardized Approach NPR proposed changes to the agencies' and 
the FDIC's general risk-based capital rules for determining risk-
weighted assets (that is, the calculation of the denominator of a 
banking organization's risk-based capital ratios). The proposed changes 
were intended to revise and harmonize the agencies' and the FDIC's 
rules for calculating risk-weighted assets, enhance risk sensitivity, 
and address weaknesses in the regulatory capital framework identified 
over recent years, including by strengthening the risk sensitivity of 
the regulatory capital treatment for, among other items, credit 
derivatives, central counterparties (CCPs), high-volatility commercial 
real estate, and collateral and guarantees.
    In the Standardized Approach NPR, the agencies and the FDIC also 
proposed alternatives to credit ratings for calculating risk-weighted 
assets for certain assets, consistent with section 939A of the Dodd-
Frank Act. These alternatives included methodologies for determining 
risk-weighted assets for exposures to sovereigns, foreign banks, and 
public sector entities, securitization exposures, and counterparty 
credit risk. The Standardized Approach NPR also proposed to include a 
framework for risk weighting residential mortgages based on 
underwriting and product features, as well as loan-to-value (LTV) 
ratios, and disclosure requirements for top-tier banking organizations 
domiciled in the United States with $50 billion or more in total 
assets, including disclosures related to regulatory capital 
instruments.

C. The Advanced Approaches Notice of Proposed Rulemaking

    The Advanced Approaches NPR proposed revisions to the advanced 
approaches rule to incorporate certain aspects of Basel III, the 2009 
Enhancements, and subsequent consultative papers. The proposal also 
would have implemented relevant provisions of the Dodd-Frank Act, 
including section 939A (regarding the use of credit ratings in agency 
regulations),\20\ and incorporated certain technical amendments to the 
existing requirements. In addition, the Advanced Approaches NPR 
proposed to codify the market risk rule in a manner similar to the 
codification of the other regulatory capital rules under the proposals.
---------------------------------------------------------------------------

    \20\ See section 939A of Dodd-Frank Act (15 U.S.C. 78o-7 note).
---------------------------------------------------------------------------

    Consistent with Basel III and the 2009 Enhancements, under the 
Advanced Approaches NPR, the agencies and the FDIC proposed further 
steps to strengthen capital requirements for internationally active 
banking organizations. This NPR would have required advanced approaches 
banking organizations to hold more appropriate levels of capital for 
counterparty credit risk, credit valuation adjustments (CVA), and 
wrong-way risk; would have strengthened the risk-based capital 
requirements for certain securitization exposures by requiring advanced 
approaches banking organizations to conduct more rigorous credit 
analysis of securitization exposures; and would have enhanced the 
disclosure requirements related to those exposures.
    The Board proposed to apply the advanced approaches rule to SLHCs, 
and the agencies and the FDIC proposed to apply the market risk rule to 
SLHCs and to state and Federal savings associations.

[[Page 62023]]

III. Summary of General Comments on the Basel III Notice of Proposed 
Rulemaking and on the Standardized Approach Notice of Proposed 
Rulemaking; Overview of the Final Rule

A. General Comments on the Basel III Notice of Proposed Rulemaking and 
on the Standardized Approach Notice of Proposed Rulemaking

    Each agency received over 2,500 public comments on the proposals 
from banking organizations, trade associations, supervisory 
authorities, consumer advocacy groups, public officials (including 
members of the U.S. Congress), private individuals, and other 
interested parties. Overall, while most commenters supported more 
robust capital standards and the agencies' and the FDIC's efforts to 
improve the resilience of the banking system, many commenters expressed 
concerns about the potential costs and burdens of various aspects of 
the proposals, particularly for smaller banking organizations. A 
substantial number of commenters also requested withdrawal of, or 
significant revisions to, the proposals. A few commenters argued that 
new capital rules were not necessary at this time. Some commenters 
requested that the agencies and the FDIC perform additional studies of 
the economic impact of part or all of the proposed rules. Many 
commenters asked for additional time to transition to the new 
requirements. A more detailed discussion of the comments provided on 
particular aspects of the proposals is provided in the remainder of 
this preamble.
1. Applicability and Scope
    The agencies and the FDIC received a significant number of comments 
regarding the proposed scope and applicability of the Basel III NPR and 
the Standardized Approach NPR. The majority of comments submitted by or 
on behalf of community banking organizations requested an exemption 
from the proposals. These commenters suggested basing such an exemption 
on a banking organization's asset size--for example, total assets of 
less than $500 million, $1 billion, $10 billion, $15 billion, or $50 
billion--or on its risk profile or business model. Under the latter 
approach, the commenters suggested providing an exemption for banking 
organizations with balance sheets that rely less on leverage, short-
term funding, or complex derivative transactions.
    In support of an exemption from the proposed rule for community 
banking organizations, a number of commenters argued that the proposed 
revisions to the definition of capital would be overly conservative and 
would prohibit some of the instruments relied on by community banking 
organizations from satisfying regulatory capital requirements. Many of 
these commenters stated that, in general, community banking 
organizations have less access to the capital markets relative to 
larger banking organizations and could increase capital only by 
accumulating retained earnings. Owing to slow economic growth and 
relatively low earnings among community banking organizations, the 
commenters asserted that implementation of the proposal would be 
detrimental to their ability to serve local communities while providing 
reasonable returns to shareholders. Other commenters requested 
exemptions from particular sections of the proposed rules, such as 
maintaining capital against transactions with particular 
counterparties, or based on transaction types that they considered 
lower-risk, such as derivative transactions hedging interest rate risk.
    The commenters also argued that application of the Basel III NPR 
and Standardized Approach NPR to community banking organizations would 
be unnecessary and inappropriate for the business model and risk 
profile of such organizations. These commenters asserted that Basel III 
was designed for large, internationally-active banking organizations in 
response to a financial crisis attributable primarily to those 
institutions. Accordingly, the commenters were of the view that 
community banking organizations require a different capital framework 
with less stringent capital requirements, or should be allowed to 
continue to use the general risk-based capital rules. In addition, many 
commenters, in particular minority depository institutions (MDIs), 
mutual banking organizations, and community development financial 
institutions (CDFIs), expressed concern regarding their ability to 
raise capital to meet the increased minimum requirements in the current 
environment and upon implementation of the proposed definition of 
capital. One commenter asked for an exemption from all or part of the 
proposed rules for CDFIs, indicating that the proposal would 
significantly reduce the availability of capital for low- and moderate-
income communities. Another commenter stated that the U.S. Congress has 
a policy of encouraging the creation of MDIs and expressed concern that 
the proposed rules contradicted this purpose.
    In contrast, however, a few commenters supported the proposed 
application of the Basel III NPR to all banking organizations. For 
example, one commenter stated that increasing the quality and quantity 
of capital at all banking organizations would create a more resilient 
financial system and discourage inappropriate risk-taking by forcing 
banking organizations to put more of their own ``skin in the game.'' 
This commenter also asserted that the proposed scope of the Basel III 
NPR would reduce the probability and impact of future financial crises 
and support the objectives of sustained growth and high employment. 
Another commenter favored application of the Basel III NPR to all 
banking organizations to ensure a level playing field among banking 
organizations within the same competitive market.
    Comments submitted by or on behalf of banking organizations that 
are engaged primarily in insurance activities also requested an 
exemption from the Basel III NPR and the Standardized Approach NPR to 
recognize differences in their business model compared with those of 
more traditional banking organizations. According to the commenters, 
the activities of these organizations are fundamentally different from 
traditional banking organizations and have a unique risk profile. One 
commenter expressed concern that the Basel III NPR focuses primarily on 
assets in the denominator of the risk-based capital ratio as the 
primary basis for determining capital requirements, in contrast to 
capital requirements for insurance companies, which are based on the 
relationship between a company's assets and liabilities. Similarly, 
other commenters expressed concern that bank-centric rules would 
conflict with the capital requirements of state insurance regulators 
and provide regulatory incentives for unsound asset-liability 
mismatches. Several commenters argued that the U.S. Congress intended 
that banking organizations primarily engaged in insurance activities 
should be covered by different capital regulations that accounted for 
the characteristics of insurance activities. These commenters, 
therefore, encouraged the agencies and the FDIC to recognize capital 
requirements adopted by state insurance regulators. Further, commenters 
asserted that the agencies and the FDIC did not appropriately consider 
regulatory capital requirements for insurance-based banking 
organizations

[[Page 62024]]

whose banking operations are a small part of their overall operations.
    Some SLHC commenters that are substantially engaged in commercial 
activities also asserted that the proposals would be inappropriate in 
scope as proposed and asked that capital rules not be applied to them 
until an intermediate holding company regime could be established. They 
also requested that any capital regime applicable to them be tailored 
to take into consideration their commercial operations and that they be 
granted longer transition periods.
    As noted above, small BHCs are exempt from the final rule 
(consistent with the proposals and section 171 of the Dodd-Frank Act) 
and continue to be subject to the Board's Small Bank Holding Company 
Policy Statement. Comments submitted on behalf of SLHCs with assets 
less than $500 million requested an analogous exemption to that for 
small BHCs. These commenters argued that section 171 of the Dodd-Frank 
Act does not prohibit such an exemption for small SLHCs.
2. Aggregate Impact
    A majority of the commenters expressed concern regarding the 
potential aggregate impact of the proposals, together with other 
provisions of the Dodd-Frank Act. Some of these commenters urged the 
agencies and the FDIC to withdraw the proposals and to conduct a 
quantitative impact study (QIS) to assess the potential aggregate 
impact of the proposals on banking organizations and the overall U.S. 
economy. Many commenters argued that the proposals would have 
significant negative consequences for the financial services industry. 
According to the commenters, by requiring banking organizations to hold 
more capital and increase risk weighting on some of their assets, as 
well as to meet higher risk-based and leverage capital measures for 
certain PCA categories, the proposals would negatively affect the 
banking sector. Commenters cited, among other potential consequences of 
the proposals: restricted job growth; reduced lending or higher-cost 
lending, including to small businesses and low-income or minority 
communities; limited availability of certain types of financial 
products; reduced investor demand for banking organizations' equity; 
higher compliance costs; increased mergers and consolidation activity, 
specifically in rural markets, because banking organizations would need 
to spread compliance costs among a larger customer base; and diminished 
access to the capital markets resulting from reduced profit and from 
dividend restrictions associated with the capital buffers. The 
commenters also asserted that the recovery of the U.S. economy would be 
impaired by the proposals as a result of reduced lending by banking 
organizations that the commenters believed would be attributable to the 
higher costs of regulatory compliance. In particular, the commenters 
expressed concern that a contraction in small-business lending would 
adversely affect job growth and employment.
3. Competitive Concerns
    Many commenters raised concerns that implementation of the 
proposals would create an unlevel playing field between banking 
organizations and other financial services providers. For example, a 
number of commenters expressed concern that credit unions would be able 
to gain market share from banking organizations by offering similar 
products at substantially lower costs because of differences in 
taxation combined with potential costs from the proposals. The 
commenters also argued that other financial service providers, such as 
foreign banks with significant U.S. operations, members of the Federal 
Farm Credit System, and entities in the shadow banking industry, would 
not be subject to the proposed rule and, therefore, would have a 
competitive advantage over banking organizations. These commenters also 
asserted that the proposals could cause more consumers to choose lower-
cost financial products from the unregulated, nonbank financial sector.
4. Costs
    Commenters representing all types of banking organizations 
expressed concern that the complexity and implementation cost of the 
proposals would exceed their expected benefits. According to these 
commenters, implementation of the proposals would require software 
upgrades for new internal reporting systems, increased employee 
training, and the hiring of additional employees for compliance 
purposes. Some commenters urged the agencies and the FDIC to recognize 
that compliance costs have increased significantly over recent years 
due to other regulatory changes and to take these costs into 
consideration. As an alternative, some commenters encouraged the 
agencies and the FDIC to consider a simple increase in the minimum 
regulatory capital requirements, suggesting that such an approach would 
provide increased protection to the Deposit Insurance Fund and increase 
safety and soundness without adding complexity to the regulatory 
capital framework.

B. Comments on Particular Aspects of the Basel III Notice of Proposed 
Rulemaking and on the Standardized Approach Notice of Proposed 
Rulemaking

    In addition to the general comments described above, the agencies 
and the FDIC received a significant number of comments on four 
particular elements of the proposals: the requirement to include most 
elements of AOCI in regulatory capital; the new framework for risk 
weighting residential mortgages; the requirement to phase out TruPS 
from tier 1 capital for all banking organizations; and the application 
of the rule to BHCs and SLHCs (collectively, depository institution 
holding companies) with substantial insurance and commercial 
activities.
1. Accumulated Other Comprehensive Income
    AOCI generally includes accumulated unrealized gains and losses on 
certain assets and liabilities that have not been included in net 
income, yet are included in equity under U.S. generally accepted 
accounting principles (GAAP) (for example, unrealized gains and losses 
on securities designated as available-for-sale (AFS)). Under the 
agencies' and the FDIC's general risk-based capital rules, most 
components of AOCI are not reflected in a banking organization's 
regulatory capital. In the proposed rule, consistent with Basel III, 
the agencies and the FDIC proposed to require banking organizations to 
include the majority of AOCI components in common equity tier 1 
capital.
    The agencies and the FDIC received a significant number of comments 
on the proposal to require banking organizations to recognize AOCI in 
common equity tier 1 capital. Generally, the commenters asserted that 
the proposal would introduce significant volatility in banking 
organizations' capital ratios due in large part to fluctuations in 
benchmark interest rates, and would result in many banking 
organizations moving AFS securities into a held-to-maturity (HTM) 
portfolio or holding additional regulatory capital solely to mitigate 
the volatility resulting from temporary unrealized gains and losses in 
the AFS securities portfolio. The commenters also asserted that the 
proposed rules would likely impair lending and negatively affect 
banking organizations' ability to manage liquidity and interest rate 
risk and to maintain compliance with legal lending limits. Commenters 
representing community banking organizations in

[[Page 62025]]

particular asserted that they lack the sophistication of larger banking 
organizations to use certain risk-management techniques for hedging 
interest rate risk, such as the use of derivative instruments.
2. Residential Mortgages
    The Standardized Approach NPR would have required banking 
organizations to place residential mortgage exposures into one of two 
categories to determine the applicable risk weight. Category 1 
residential mortgage exposures were defined to include mortgage 
products with underwriting and product features that have demonstrated 
a lower risk of default, such as consideration and documentation of a 
borrower's ability to repay, and generally excluded mortgage products 
that included terms or other characteristics that the agencies and the 
FDIC have found to be indicative of higher credit risk, such as 
deferral of repayment of principal. Residential mortgage exposures with 
higher risk characteristics were defined as category 2 residential 
mortgage exposures. The agencies and the FDIC proposed to apply 
relatively lower risk weights to category 1 residential mortgage 
exposures, and higher risk weights to category 2 residential mortgage 
exposures. The proposal provided that the risk weight assigned to a 
residential mortgage exposure also depended on its LTV ratio.
    The agencies and the FDIC received a significant number of comments 
objecting to the proposed treatment for one-to-four family residential 
mortgages and requesting retention of the mortgage treatment in the 
agencies' and the FDIC's general risk-based capital rules. Commenters 
generally expressed concern that the proposed treatment would inhibit 
lending to creditworthy borrowers and could jeopardize the recovery of 
a still-fragile housing market. Commenters also criticized the 
distinction between category 1 and category 2 mortgages, asserting that 
the characteristics proposed for each category did not appropriately 
distinguish between lower- and higher-risk products and would adversely 
impact certain loan products that performed relatively well even during 
the recent crisis. Commenters also highlighted concerns regarding 
regulatory burden and the uncertainty of other regulatory initiatives 
involving residential mortgages. In particular, these commenters 
expressed considerable concern regarding the potential cumulative 
impact of the proposed new mortgage requirements combined with the 
Dodd-Frank Act's requirements relating to the definitions of qualified 
mortgage and qualified residential mortgage \21\ and asserted that when 
considered together with the proposed mortgage treatment, the combined 
effect could have an adverse impact on the mortgage industry.
---------------------------------------------------------------------------

    \21\ See, e.g., the definition of ``qualified mortgage'' in 
section 1412 of the Dodd-Frank Act (15 U.S.C. 129C) and ``qualified 
residential mortgage'' in section 941(e)(4) of the Dodd-Frank Act 
(15 U.S.C. 78o-11(e)(4)).
---------------------------------------------------------------------------

3. Trust Preferred Securities for Smaller Banking Organizations
    The proposed rules would have required all banking organizations to 
phase-out TruPS from tier 1 capital under either a 3- or 10-year 
transition period based on the organization's total consolidated 
assets. The proposal would have required banking organizations with 
more than $15 billion in total consolidated assets (as of December 31, 
2009) to phase-out of tier 1 capital any non-qualifying capital 
instruments (such as TruPS and cumulative preferred shares) issued 
before May 19, 2010. The exclusion of non-qualifying capital 
instruments would have taken place incrementally over a three-year 
period beginning on January 1, 2013. Section 171 provides an exception 
that permits banking organizations with total consolidated assets of 
less than $15 billion as of December 31, 2009, and banking 
organizations that were mutual holding companies as of May 19, 2010 
(2010 MHCs), to include in tier 1 capital all TruPS (and other 
instruments that could no longer be included in tier 1 capital pursuant 
to the requirements of section 171) that were issued prior to May 19, 
2010.\22\ However, consistent with Basel III and the general policy 
purpose of the proposed revisions to regulatory capital, the agencies 
and the FDIC proposed to require banking organizations with total 
consolidated assets less than $15 billion as of December 31, 2009 and 
2010 MHCs to phase out their non-qualifying capital instruments from 
regulatory capital over ten years.\23\
---------------------------------------------------------------------------

    \22\ Specifically, section 171 provides that deductions of 
instruments ``that would be required'' under the section are not 
required for depository institution holding companies with total 
consolidated assets of less than $15 billion as of December 31, 2009 
and 2010 MHCs. See 12 U.S.C. 5371(b)(4)(C).
    \23\ See 12 U.S.C. 5371(b)(5)(A). While section 171 of the Dodd-
Frank Act requires the agencies to establish minimum risk-based and 
leverage capital requirements subject to certain limitations, the 
agencies and the FDIC retain their general authority to establish 
capital requirements under other laws and regulations, including 
under the National Bank Act, 12 U.S.C. 1, et seq., Federal Reserve 
Act, Federal Deposit Insurance Act, Bank Holding Company Act, 
International Lending Supervision Act, 12 U.S.C. 3901, et seq., and 
Home Owners Loan Act, 12 U.S.C. 1461, et seq.
---------------------------------------------------------------------------

    Many commenters representing community banking organizations 
criticized the proposal's phase-out schedule for TruPS and encouraged 
the agencies and the FDIC to grandfather TruPS in tier 1 capital to the 
extent permitted by section 171 of the Dodd-Frank Act. Commenters 
asserted that this was the intent of the U.S. Congress, including this 
provision in the statute. These commenters also asserted that this 
aspect of the proposal would unduly burden community banking 
organizations that have limited ability to raise capital, potentially 
impairing the lending capacity of these banking organizations.
4. Insurance Activities
    The agencies and the FDIC received numerous comments from SLHCs, 
trade associations, insurance companies, and members of the U.S. 
Congress on the proposed capital requirements for SLHCs, in particular 
those with significant insurance activities. As noted above, commenters 
raised concerns that the proposed requirements would apply what are 
perceived as bank-centric consolidated capital requirements to these 
entities. Commenters suggested incorporating insurance risk-based 
capital requirements established by the state insurance regulators into 
the Board's consolidated risk-based capital requirements for the 
holding company, or including certain insurance risk-based metrics 
that, in the commenters' view, would measure the risk of insurance 
activities more accurately. A few commenters asked the Board to conduct 
an additional cost-benefit analysis prior to implementing the proposed 
capital requirements for this subset of SLHCs. In addition, several 
commenters expressed concern with the burden associated with the 
proposed requirement to prepare financial statements according to GAAP, 
because a few SLHCs with substantial insurance operations only prepare 
financial statements according to Statutory Accounting Principles 
(SAP). These commenters noted that the Board has accepted non-GAAP 
financial statements from foreign entities in the past for certain non-
consolidated reporting requirements related to the foreign subsidiaries 
of U.S. banking organizations.\24\
---------------------------------------------------------------------------

    \24\ See form FR 2314.
---------------------------------------------------------------------------

    Some commenters stated that the proposal presents serious issues in 
light

[[Page 62026]]

of the McCarran-Ferguson Act.\25\ These commenters stated that section 
171 of the Dodd-Frank Act does not specifically refer to the business 
of insurance. Further, the commenters asserted that the proposal 
disregards the state-based regulatory capital and reserving regimes 
applicable to insurance companies and thus would impair the solvency 
laws enacted by the states for the purpose of regulating insurance. The 
commenters also said that the proposal would alter the risk-management 
practices and other aspects of the insurance business conducted in 
accordance with the state laws, in contravention of the McCarran-
Ferguson Act. Some commenters also cited section 502 of the Dodd-Frank 
Act, asserting that it continues the primacy of state regulation of 
insurance companies.\26\
---------------------------------------------------------------------------

    \25\ The McCarran-Ferguson Act provides that ``[N]o act of 
Congress shall be construed to invalidate, impair, or supersede any 
law enacted by any State for the purpose of regulating the business 
of insurance . . . unless such Act specifically relates to the 
business of insurance.'' 15 U.S.C. 1012.
    \26\ 31 U.S.C. 313(f).
---------------------------------------------------------------------------

C. Overview of the Final Rule

    The final rule will replace the agencies' general risk-based 
capital rules, advanced approaches rule, market risk rule, and leverage 
rules in accordance with the transition provisions described below. 
After considering the comments received, the agencies have made 
substantial modifications in the final rule to address specific 
concerns raised by commenters regarding the cost, complexity, and 
burden of the proposals.
    During the recent financial crisis, lack of confidence in the 
banking sector increased banking organizations' cost of funding, 
impaired banking organizations' access to short-term funding, depressed 
values of banking organizations' equities, and required many banking 
organizations to seek government assistance. Concerns about banking 
organizations arose not only because market participants expected steep 
losses on banking organizations' assets, but also because of 
substantial uncertainty surrounding estimated loss rates, and thus 
future earnings. Further, heightened systemic risks, falling asset 
values, and reduced credit availability had an adverse impact on 
business and consumer confidence, significantly affecting the overall 
economy. The final rule addresses these weaknesses by helping to ensure 
a banking and financial system that will be better able to absorb 
losses and continue to lend in future periods of economic stress. This 
important benefit in the form of a safer, more resilient, and more 
stable banking system is expected to substantially outweigh any short-
term costs that might result from the final rule.
    In this context, the agencies are adopting most aspects of the 
proposals, including the minimum risk-based capital requirements, the 
capital conservation and countercyclical capital buffers, and many of 
the proposed risk weights. The agencies have also decided to apply most 
aspects of the Basel III NPR and Standardized Approach NPR to all 
banking organizations, with some significant changes. Implementing the 
final rule in a consistent fashion across the banking system will 
improve the quality and increase the level of regulatory capital, 
leading to a more stable and resilient system for banking organizations 
of all sizes and risk profiles. The improved resilience will enhance 
their ability to continue functioning as financial intermediaries, 
including during periods of financial stress and reduce risk to the 
deposit insurance fund and to the financial system. The agencies 
believe that, together, the revisions to the proposals meaningfully 
address the commenters' concerns regarding the potential implementation 
burden of the proposals.
    The agencies have considered the concerns raised by commenters and 
believe that it is important to take into account and address 
regulatory costs (and their potential effect on banking organizations' 
role as financial intermediaries in the economy) when the agencies 
establish or revise regulatory requirements. In developing regulatory 
capital requirements, these concerns are considered in the context of 
the agencies' broad goals--to enhance the safety and soundness of 
banking organizations and promote financial stability through robust 
capital standards for the entire banking system.
    The agencies participated in the development of a number of studies 
to assess the potential impact of the revised capital requirements, 
including participating in the BCBS's Macroeconomic Assessment Group as 
well as its QIS, the results of which were made publicly available by 
the BCBS upon their completion.\27\ The BCBS analysis suggested that 
stronger capital requirements help reduce the likelihood of banking 
crises while yielding positive net economic benefits.\28\ To evaluate 
the potential reduction in economic output resulting from the new 
framework, the analysis assumed that banking organizations replaced 
debt with higher-cost equity to the extent needed to comply with the 
new requirements, that there was no reduction in the cost of equity 
despite the reduction in the riskiness of banking organizations' 
funding mix, and that the increase in funding cost was entirely passed 
on to borrowers. Given these assumptions, the analysis concluded there 
would be a slight increase in the cost of borrowing and a slight 
decrease in the growth of gross domestic product. The analysis 
concluded that this cost would be more than offset by the benefit to 
gross domestic product resulting from a reduced likelihood of prolonged 
economic downturns associated with a banking system whose lending 
capacity is highly vulnerable to economic shocks.
---------------------------------------------------------------------------

    \27\ See ``Assessing the macroeconomic impact of the transition 
to stronger capital and liquidity requirements'' (MAG Analysis), 
Attachment E, also available at: https://www.bis.orpublIothp12.pdf. 
See also ``Results of the comprehensive quantitative impact study,'' 
Attachment F, also available at: https://www.bis.org/publ/bcbs186.pdf.
    \28\ See ``An assessment of the long-term economic impact of 
stronger capital and liquidity requirements,'' Executive Summary, 
pg. 1, Attachment G.
---------------------------------------------------------------------------

    The agencies' analysis also indicates that the overwhelming 
majority of banking organizations already have sufficient capital to 
comply with the final rule. In particular, the agencies estimate that 
over 95 percent of all insured depository institutions would be in 
compliance with the minimums and buffers established under the final 
rule if it were fully effective immediately. The final rule will help 
to ensure that these banking organizations maintain their capacity to 
absorb losses in the future. Some banking organizations may need to 
take advantage of the transition period in the final rule to accumulate 
retained earnings, raise additional external regulatory capital, or 
both. As noted above, however, the overwhelming majority of banking 
organizations have sufficient capital to comply with the final rule, 
and the agencies believe that the resulting improvements to the 
stability and resilience of the banking system outweigh any costs 
associated with its implementation.
    The final rule includes some significant revisions from the 
proposals in response to commenters' concerns, particularly with 
respect to the treatment of AOCI; residential mortgages; tier 1 non-
qualifying capital instruments such as TruPS issued by smaller 
depository institution holding companies; the applicability of the rule 
to SLHCs with substantial insurance or commercial activities; and the

[[Page 62027]]

implementation timeframes. The timeframes for compliance are described 
in the next section and more detailed discussions of modifications to 
the proposals are provided in the remainder of the preamble.
    Consistent with the proposed rules, the final rule requires all 
banking organizations to recognize in regulatory capital all components 
of AOCI, excluding accumulated net gains and losses on cash-flow hedges 
that relate to the hedging of items that are not recognized at fair 
value on the balance sheet. However, while the agencies believe that 
the proposed AOCI treatment results in a regulatory capital measure 
that better reflects banking organizations' actual loss absorption 
capacity at a specific point in time, the agencies recognize that for 
many banking organizations, the volatility in regulatory capital that 
could result from the proposals could lead to significant difficulties 
in capital planning and asset-liability management. The agencies also 
recognize that the tools used by larger, more complex banking 
organizations for managing interest rate risk are not necessarily 
readily available for all banking organizations.
    Accordingly, under the final rule, and as discussed in more detail 
in section V.B of this preamble, a banking organization that is not 
subject to the advanced approaches rule may make a one-time election 
not to include most elements of AOCI in regulatory capital under the 
final rule and instead effectively use the existing treatment under the 
general risk-based capital rules that excludes most AOCI elements from 
regulatory capital (AOCI opt-out election). Such a banking organization 
must make its AOCI opt-out election in the banking organization's 
Consolidated Reports of Condition and Income (Call Report) or FR Y-9 
series report filed for the first reporting period after the banking 
organization becomes subject to the final rule. Consistent with 
regulatory capital calculations under the agencies' general risk-based 
capital rules, a banking organization that makes an AOCI opt-out 
election under the final rule must adjust common equity tier 1 capital 
by: (1) Subtracting any net unrealized gains and adding any net 
unrealized losses on AFS securities; (2) subtracting any unrealized 
losses on AFS preferred stock classified as an equity security under 
GAAP and AFS equity exposures; (3) subtracting any accumulated net 
gains and adding any accumulated net losses on cash-flow hedges; (4) 
subtracting amounts recorded in AOCI attributed to defined benefit 
postretirement plans resulting from the initial and subsequent 
application of the relevant GAAP standards that pertain to such plans 
(excluding, at the banking organization's option, the portion relating 
to pension assets deducted under section 22(a)(5) of the final rule); 
and (5) subtracting any net unrealized gains and adding any net 
unrealized losses on held-to-maturity securities that are included in 
AOCI. Consistent with the general risk-based capital rules, common 
equity tier 1 capital includes any net unrealized losses on AFS equity 
securities and any foreign currency translation adjustment. A banking 
organization that makes an AOCI opt-out election may incorporate up to 
45 percent of any net unrealized gains on AFS preferred stock 
classified as an equity security under GAAP and AFS equity exposures 
into its tier 2 capital.
    A banking organization that does not make an AOCI opt-out election 
on the Call Report or applicable FR Y-9 report filed for the first 
reporting period after the banking organization becomes subject to the 
final rule will be required to recognize AOCI (excluding accumulated 
net gains and losses on cash-flow hedges that relate to the hedging of 
items that are not recognized at fair value on the balance sheet) in 
regulatory capital as of the first quarter in which it calculates its 
regulatory capital requirements under the final rule and continuing 
thereafter.
    The agencies have decided not to adopt the proposed treatment of 
residential mortgages. The agencies have considered the commenters' 
observations about the burden of calculating the risk weights for 
banking organizations' existing mortgage portfolios, and have taken 
into account the commenters' concerns that the proposal did not 
properly assess the use of different mortgage products across different 
types of markets in establishing the proposed risk weights. The 
agencies are also particularly mindful of comments regarding the 
potential effect of the proposal and other mortgage-related rulemakings 
on credit availability. In light of these considerations, as well as 
others raised by commenters, the agencies have decided to retain in the 
final rule the current treatment for residential mortgage exposures 
under the general risk-based capital rules.
    Consistent with the general risk-based capital rules, the final 
rule assigns a 50 or 100 percent risk weight to exposures secured by 
one-to-four family residential properties. Generally, residential 
mortgage exposures secured by a first lien on a one-to-four family 
residential property that are prudently underwritten and that are 
performing according to their original terms receive a 50 percent risk 
weight. All other one- to four-family residential mortgage loans, 
including exposures secured by a junior lien on residential property, 
are assigned a 100 percent risk weight. If a banking organization holds 
the first and junior lien(s) on a residential property and no other 
party holds an intervening lien, the banking organization must treat 
the combined exposure as a single loan secured by a first lien for 
purposes of assigning a risk weight.
    The agencies also considered comments on the proposal to require 
banking organizations with total consolidated assets less than $15 
billion as of December 31, 2009, and 2010 MHCs, to phase out their non-
qualifying tier 1 capital instruments from regulatory capital over ten 
years. Although the agencies continue to believe that TruPS do not 
absorb losses sufficiently to be included in tier 1 capital as a 
general matter, the agencies are also sensitive to the difficulties 
community banking organizations often face when issuing new capital 
instruments and are aware of the importance their capacity to lend can 
play in local economies. Therefore, the final rule permanently 
grandfathers non-qualifying capital instruments in the tier 1 capital 
of depository institution holding companies with total consolidated 
assets of less than $15 billion as of December 31, 2009, and 2010 MHCs 
(subject to limits). Non-qualifying capital instruments under the final 
rule include TruPS and cumulative perpetual preferred stock issued 
before May 19, 2010, that BHCs included in tier 1 capital under the 
limitations for restricted capital elements in the general risk-based 
capital rules.
    After considering the comments received from SLHCs substantially 
engaged in commercial activities or insurance underwriting activities, 
the Board has decided to consider further the development of 
appropriate capital requirements for these companies, taking into 
consideration information provided by commenters as well as information 
gained through the supervisory process. The Board will explore further 
whether and how the proposed rule should be modified for these 
companies in a manner consistent with section 171 of the Dodd-Frank Act 
and safety and soundness concerns.
    Consequently, as defined in the final rule, a covered SLHC that is 
subject to the final rule (covered SLHC) is a top-tier SLHC other than 
a top-tier SLHC that meets the exclusion criteria set forth in the 
definition. With respect to commercial activities, a top-tier SLHC that 
is a grandfathered unitary savings

[[Page 62028]]

and loan holding company (as defined in section 10(c)(9)(A) of the Home 
Owners' Loan Act (HOLA)) \29\ is not a covered SLHC if as of June 30 of 
the previous calendar year, either 50 percent or more of the total 
consolidated assets of the company or 50 percent of the revenues of the 
company on an enterprise-wide basis (as calculated under GAAP) were 
derived from activities that are not financial in nature under section 
4(k) of the Bank Holding Company Act.\30\ This exclusion is similar to 
the exemption from reporting on the form FR Y-9C for grandfathered 
unitary savings and loan holding companies with significant commercial 
activities and is designed to capture those SLHCs substantially engaged 
in commercial activities.\31\
---------------------------------------------------------------------------

    \29\ 12 U.S.C. 1461 et seq.
    \30\ 12 U.S.C. 1843(k).
    \31\ See 76 FR 81935 (December 29, 2011).
---------------------------------------------------------------------------

    The Board is excluding grandfathered unitary savings and loan 
holding companies that meet these criteria from the capital 
requirements of the final rule while it continues to contemplate a 
proposal for SLHC intermediate holding companies. Under section 626 of 
the Dodd-Frank Act, the Board may require a grandfathered unitary 
savings and loan holding company to establish and conduct all or a 
portion of its financial activities in or through an intermediate 
holding company and the intermediate holding company itself becomes an 
SLHC subject to Board supervision and regulation.\32\ The Board 
anticipates that it will release a proposal for public comment on 
intermediate holding companies in the near term that would specify the 
criteria for establishing and transferring activities to intermediate 
holding companies, consistent with section 626 of the Dodd-Frank Act, 
and propose to apply the Board's capital requirements in this final 
rule to such intermediate holding companies.
---------------------------------------------------------------------------

    \32\ See section 626 of the Dodd-Frank Act (12 U.S.C. 1467b).
---------------------------------------------------------------------------

    Under the final rule, top-tier SLHCs that are substantially engaged 
in insurance underwriting activities are also excluded from the 
definition of ``covered SLHC'' and the requirements of the final rule. 
SLHCs that are themselves insurance underwriting companies (as defined 
in the final rule) are excluded from the definition.\33\ Also excluded 
are SLHCs that, as of June 30 of the previous calendar year, held 25 
percent or more of their total consolidated assets in insurance 
underwriting subsidiaries (other than assets associated with insurance 
underwriting for credit risk). Under the final rule, the calculation of 
total consolidated assets for this purpose must generally be in 
accordance with GAAP. Many SLHCs that are substantially engaged in 
insurance underwriting activities do not calculate total consolidated 
assets under GAAP. Therefore, the Board has determined to allow 
estimated calculations at this time for the purposes of determining 
whether a company is excluded from the definition of ``covered SLHC,'' 
subject to possible review and adjustment by the Board. The Board 
expects to implement a framework for SLHCs that are not subject to the 
final rule by the time covered SLHCs must comply with the final rule in 
2015. The final rule also contains provisions applicable to insurance 
underwriting activities conducted within a BHC or covered SLHC. These 
provisions are effective as part of the final rule.
---------------------------------------------------------------------------

    \33\ The final rule defines ``insurance underwriting company'' 
to mean an insurance company, as defined in section 201 of the Dodd-
Frank Act (12 U.S.C. 5381), that engages in insurance underwriting 
activities. This definition includes companies engaged in insurance 
underwriting activities that are subject to regulation by a State 
insurance regulator and covered by a State insurance company 
insolvency law.
---------------------------------------------------------------------------

D. Timeframe for Implementation and Compliance

    In order to give covered SLHCs and non-internationally active 
banking organizations more time to comply with the final rule and 
simplify their transition to the new regime, the final rule will 
require compliance from different types of organizations at different 
times. Generally, and as described in further detail below, banking 
organizations that are not subject to the advanced approaches rule must 
begin complying with the final rule on January 1, 2015, whereas 
advanced approaches banking organizations must begin complying with the 
final rule on January 1, 2014. The agencies believe that advanced 
approaches banking organizations have the sophistication, 
infrastructure, and capital markets access to implement the final rule 
earlier than either banking organizations that do not meet the asset 
size or foreign exposure threshold for application of those rules or 
covered SLHCs that have not previously been subject to consolidated 
capital requirements.
    A number of commenters requested that the agencies and the FDIC 
clarify the point at which a banking organization that meets the asset 
size or foreign exposure threshold for application of the advanced 
approaches rule becomes subject to subpart E of the proposed rule, and 
thus all of the provisions that apply to an advanced approaches banking 
organization. In particular, commenters requested that the agencies and 
the FDIC clarify whether subpart E of the proposed rule only applies to 
those banking organizations that have completed the parallel run 
process and that have received notification from their primary Federal 
supervisor pursuant to section 121(d) of subpart E, or whether subpart 
E would apply to all banking organizations that meet the relevant 
thresholds without reference to completion of the parallel run process.
    The final rule provides that an advanced approaches banking 
organization is one that meets the asset size or foreign exposure 
thresholds for or has opted to apply the advanced approaches rule, 
without reference to whether that banking organization has completed 
the parallel run process and has received notification from its primary 
Federal supervisor pursuant to section 121(d) of subpart E of the final 
rule. The agencies have also clarified in the final rule when 
completion of the parallel run process and receipt of notification from 
the primary Federal supervisor pursuant to section 121(d) of subpart E 
is necessary for an advanced approaches banking organization to comply 
with a particular aspect of the rules. For example, only an advanced 
approaches banking organization that has completed parallel run and 
received notification from its primary Federal supervisor under section 
121(d) of subpart E must make the disclosures set forth under subpart E 
of the final rule. However, an advanced approaches banking organization 
must recognize most components of AOCI in common equity tier 1 capital 
and must meet the supplementary leverage ratio when applicable without 
reference to whether the banking organization has completed its 
parallel run process.
    Beginning on January 1, 2015, banking organizations that are not 
subject to the advanced approaches rule, as well as advanced approaches 
banking organizations that are covered SLHCs, become subject to: The 
revised definitions of regulatory capital; the new minimum regulatory 
capital ratios; and the regulatory capital adjustments and deductions 
according to the transition provisions.\34\ All banking organizations 
must begin calculating standardized total risk-weighted assets in 
accordance with subpart D of the final rule, and if applicable, the 
revised

[[Page 62029]]

market risk rule under subpart F, on January 1, 2015.\35\
---------------------------------------------------------------------------

    \34\ Prior to January 1, 2015, such banking organizations, other 
than covered SLHCs, must continue to use the agencies' general risk-
based capital rules and tier 1 leverage rules.
    \35\ The revised PCA thresholds, discussed further in section 
IV.E of this preamble, become effective for all insured depository 
institutions on January 1, 2015.
---------------------------------------------------------------------------

    Beginning on January 1, 2014, advanced approaches banking 
organizations that are not SLHCs must begin the transition period for 
the revised minimum regulatory capital ratios, definitions of 
regulatory capital, and regulatory capital adjustments and deductions 
established under the final rule. The revisions to the advanced 
approaches risk-weighted asset calculations will become effective on 
January 1, 2014.
    From January 1, 2014 to December 31, 2014, an advanced approaches 
banking organization that is on parallel run must calculate risk-
weighted assets using the general risk-based capital rules and 
substitute such risk-weighted assets for its standardized total risk-
weighted assets for purposes of determining its risk-based capital 
ratios. An advanced approaches banking organization on parallel run 
must also calculate advanced approaches total risk-weighted assets 
using the advanced approaches rule in subpart E of the final rule for 
purposes of confidential reporting to its primary Federal supervisor on 
the Federal Financial Institutions Examination Council's (FFIEC) 101 
report. An advanced approaches banking organization that has completed 
the parallel run process and that has received notification from its 
primary Federal supervisor pursuant to section 121(d) of subpart E will 
calculate its risk-weighted assets using the general risk-based capital 
rules and substitute such risk-weighted assets for its standardized 
total risk-weighted assets and also calculate advanced approaches total 
risk-weighted assets using the advanced approaches rule in subpart E of 
the final rule for purposes of determining its risk-based capital 
ratios from January 1, 2014 to December 31, 2014. Regardless of an 
advanced approaches banking organization's parallel run status, on 
January 1, 2015, the banking organization must begin to apply subpart 
D, and if applicable, subpart F, of the final rule to determine its 
standardized total risk-weighted assets.
    The transition period for the capital conservation and 
countercyclical capital buffers for all banking organizations will 
begin on January 1, 2016.
    A banking organization that is required to comply with the market 
risk rule must comply with the revised market risk rule (subpart F) as 
of the same date that it must comply with other aspects of the rule for 
determining its total risk-weighted assets.

------------------------------------------------------------------------
                                              Banking organizations not
                                               subject to the advanced
                   Date                      approaches rule and banking
                                               organizations that are
                                                   covered SLHCs *
------------------------------------------------------------------------
January 1, 2015...........................  Begin compliance with the
                                             revised minimum regulatory
                                             capital ratios and begin
                                             the transition period for
                                             the revised definitions of
                                             regulatory capital and the
                                             revised regulatory capital
                                             adjustments and deductions.
                                            Begin compliance with the
                                             standardized approach for
                                             determining risk-weighted
                                             assets.
January 1, 2016...........................  Begin the transition period
                                             for the capital
                                             conservation and
                                             countercyclical capital
                                             buffers.
------------------------------------------------------------------------


 
                                             Advanced approaches banking
                   Date                      organizations that are not
                                                       SLHCs *
------------------------------------------------------------------------
January 1, 2014...........................  Begin the transition period
                                             for the revised minimum
                                             regulatory capital ratios,
                                             definitions of regulatory
                                             capital, and regulatory
                                             capital adjustments and
                                             deductions.
                                            Begin compliance with the
                                             revised advanced approaches
                                             rule for determining risk-
                                             weighted assets.
January 1, 2015...........................  Begin compliance with the
                                             standardized approach for
                                             determining risk-weighted
                                             assets.
January 1, 2016...........................  Begin the transition period
                                             for the capital
                                             conservation and
                                             countercyclical capital
                                             buffers.
------------------------------------------------------------------------
* If applicable, banking organizations must use the calculations in
  subpart F of the final rule (market risk) concurrently with the
  calculation of risk-weighted assets according either to subpart D
  (standardized approach) or subpart E (advanced approaches) of the
  final rule.

IV. Minimum Regulatory Capital Ratios, Additional Capital Requirements, 
and Overall Capital Adequacy

A. Minimum Risk-Based Capital Ratios and Other Regulatory Capital 
Provisions

    Consistent with Basel III, the proposed rule would have required 
banking organizations to comply with the following minimum capital 
ratios: a common equity tier 1 capital to risk-weighted assets ratio of 
4.5 percent; a tier 1 capital to risk-weighted assets ratio of 6 
percent; a total capital to risk-weighted assets ratio of 8 percent; a 
leverage ratio of 4 percent; and for advanced approaches banking 
organizations only, a supplementary leverage ratio of 3 percent. The 
common equity tier 1 capital ratio is a new minimum requirement 
designed to ensure that banking organizations hold sufficient high-
quality regulatory capital that is available to absorb losses on a 
going-concern basis. The proposed capital ratios would apply to a 
banking organization on a consolidated basis.
    The agencies received a substantial number of comments on the 
proposed minimum risk-based capital requirements. Several commenters 
supported the proposal to increase the minimum tier 1 risk-based 
capital requirement. Other commenters commended the agencies and the 
FDIC for proposing to implement a minimum capital requirement that 
focuses primarily on common equity. These commenters argued that common 
equity is the strongest form of capital and that the proposed minimum 
common equity tier 1 capital ratio of 4.5 percent would promote the 
safety and soundness of the banking industry.
    Other commenters provided general support for the proposed 
increases in minimum risk-based capital requirements, but expressed 
concern that the proposals could present unique challenges to mutual 
institutions because they can only raise common equity through retained 
earnings. A number of commenters asserted that the objectives of the 
proposal could be achieved through regulatory mechanisms other than the 
proposed risk-based capital requirements, including enhanced safety and 
soundness examinations, more stringent underwriting standards, and 
alternative measures of capital.
    Other commenters objected to the proposed increase in the minimum 
tier 1 capital ratio and the implementation of a common equity tier 1 
capital ratio. One commenter indicated that increases in regulatory 
capital ratios would severely limit growth at many community banking 
organizations and could encourage consolidation through mergers and 
acquisitions. Other commenters stated that for banks under $750 million 
in total assets, increased

[[Page 62030]]

compliance costs would not allow them to provide a reasonable return to 
shareholders, and thus would force them to consolidate. Several 
commenters urged the agencies and the FDIC to recognize community 
banking organizations' limited access to the capital markets and 
related difficulties raising capital to comply with the proposal.
    One banking organization indicated that implementation of the 
common equity tier 1 capital ratio would significantly reduce its 
capacity to grow and recommended that the proposal recognize 
differences in the risk and complexity of banking organizations and 
provide favorable, less stringent requirements for smaller and non-
complex institutions. Another commenter suggested that the proposed 
implementation of an additional risk-based capital ratio would confuse 
market observers and recommended that the agencies and the FDIC 
implement a regulatory capital framework that allows investors and the 
market to ascertain regulatory capital from measures of equity derived 
from a banking organization's balance sheet.
    Other commenters expressed concern that the proposed common equity 
tier 1 capital ratio would disadvantage MDIs relative to other banking 
organizations. According to the commenters, in order to retain their 
minority-owned status, MDIs historically maintain a relatively high 
percentage of non-voting preferred stockholders that provide long-term, 
stable sources of capital. Any public offering to increase common 
equity tier 1 capital levels would dilute the minority investors owning 
the common equity of the MDI and could potentially compromise the 
minority-owned status of such institutions. One commenter asserted 
that, for this reason, the implementation of the Basel III NPR would be 
contrary to the statutory mandate of section 308 of the Financial 
Institutions, Reform, Recovery and Enforcement Act (FIRREA).\36\ 
Accordingly, the commenters encouraged the agencies and the FDIC to 
exempt MDIs from the proposed common equity tier 1 capital ratio 
requirement.
---------------------------------------------------------------------------

    \36\ 12 U.S.C. 1463 note.
---------------------------------------------------------------------------

    The agencies believe that all banking organizations must have an 
adequate amount of loss-absorbing capital to continue to lend to their 
communities during times of economic stress, and therefore have decided 
to implement the regulatory capital requirements, including the minimum 
common equity tier 1 capital requirement, as proposed. For the reasons 
described in the NPR, including the experience during the crisis with 
lower quality capital instruments, the agencies do not believe it is 
appropriate to maintain the general risk-based capital rules or to rely 
on the supervisory process or underwriting standards alone. 
Accordingly, the final rule maintains the minimum common equity tier 1 
capital to total risk-weighted assets ratio of 4.5 percent. The 
agencies have decided not to pursue the alternative regulatory 
mechanisms suggested by commenters, as such alternatives would be 
difficult to implement consistently across banking organizations and 
would not necessarily fulfill the objective of increasing the amount 
and quality of regulatory capital for all banking organizations.
    In view of the concerns expressed by commenters with respect to 
MDIs, the agencies and the FDIC evaluated the risk-based and leverage 
capital levels of MDIs to determine whether the final rule would 
disproportionately impact such institutions. This analysis found that 
of the 178 MDIs in existence as of March 31, 2013, 12 currently are not 
well capitalized for PCA purposes, whereas (according to the agencies' 
and the FDIC's estimates) 14 would not be considered well capitalized 
for PCA purposes under the final rule if it were fully implemented 
without transition today. Accordingly, the agencies do not believe that 
the final rule would disproportionately impact MDIs and are not 
adopting any exemptions or special provisions for these institutions. 
While the agencies recognize MDIs may face impediments in meeting the 
common equity tier 1 capital ratio, the agencies believe that the 
improvements to the safety and soundness of these institutions through 
higher capital standards are warranted and consistent with their 
obligations under section 308 of FIRREA. As a prudential matter, the 
agencies have a long-established regulatory policy that banking 
organizations should hold capital commensurate with the level and 
nature of the risks to which they are exposed, which may entail holding 
capital significantly above the minimum requirements, depending on the 
nature of the banking organization's activities and risk profile. 
Section IV.G of this preamble describes the requirement for overall 
capital adequacy of banking organizations and the supervisory 
assessment of capital adequacy.
    Furthermore, consistent with the agencies' authority under the 
general risk-based capital rules and the proposals, section 1(d) of the 
final rule includes a reservation of authority that allows a banking 
organization's primary Federal supervisor to require the banking 
organization to hold a greater amount of regulatory capital than 
otherwise is required under the final rule, if the supervisor 
determines that the regulatory capital held by the banking organization 
is not commensurate with its credit, market, operational, or other 
risks. In exercising reservation of authority under the rule, the 
agencies expect to consider the size, complexity, risk profile, and 
scope of operations of the banking organization; and whether any public 
benefits would be outweighed by risk to an insured depository 
institution or to the financial system.

B. Leverage Ratio

    The proposals would require a banking organization to satisfy a 
leverage ratio of 4 percent, calculated using the proposed definition 
of tier 1 capital and the banking organization's average total 
consolidated assets, minus amounts deducted from tier 1 capital. The 
agencies and the FDIC also proposed to eliminate the exception in the 
agencies' and the FDIC's leverage rules that provides for a minimum 
leverage ratio of 3 percent for banking organizations with strong 
supervisory ratings or BHCs that are subject to the market risk rule.
    The agencies and the FDIC received a number of comments on the 
proposed leverage ratio applicable to all banking organizations. 
Several of these commenters supported the proposed leverage ratio, 
stating that it serves as a simple regulatory standard that constrains 
the ability of a banking organization to leverage its equity capital 
base. Some of the commenters encouraged the agencies and the FDIC to 
consider an alternative leverage ratio measure of tangible common 
equity to tangible assets, which would exclude non-common stock 
elements from the numerator and intangible assets from the denominator 
of the ratio and thus, according to these commenters, provide a more 
reliable measure of a banking organization's viability in a crisis.
    A number of commenters criticized the proposed removal of the 3 
percent exception to the minimum leverage ratio requirement for certain 
banking organizations. One of these commenters argued that removal of 
this exception is unwarranted in view of the cumulative impact of the 
proposals and that raising the minimum leverage ratio requirement for 
the strongest banking organizations may lead to a deleveraging by the 
institutions most able to extend credit in a safe and sound manner. In 
addition, the commenters cautioned the agencies and the FDIC that a 
restrictive leverage measure, together with more stringent

[[Page 62031]]

risk-based capital requirements, could magnify the potential impact of 
an economic downturn.
    Several commenters suggested modifications to the minimum leverage 
ratio requirement. One commenter suggested increasing the minimum 
leverage ratio requirement for all banking organizations to 6 percent, 
whereas another commenter recommended a leverage ratio requirement as 
high as 20 percent. Another commenter suggested a tiered approach, with 
minimum leverage ratio requirements of 6.25 percent and 8.5 percent for 
community banking organizations and large banking organizations, 
respectively. According to this commenter, such an approach could be 
based on the risk characteristics of a banking organization, including 
liquidity, asset quality, and local deposit levels, as well as its 
supervisory rating. Another commenter suggested a fluid leverage ratio 
requirement that would adjust based on certain macroeconomic variables. 
Under such an approach, the agencies and the FDIC could require banking 
organizations to meet a minimum leverage ratio of 10 percent under 
favorable economic conditions and a 6 percent leverage ratio during an 
economic contraction.
    In addition, a number of commenters encouraged the agencies and the 
FDIC to reconsider the scope of exposures that banking organizations 
include in the denominator of the leverage ratio, which is based on 
average total consolidated assets under GAAP. Several of these 
commenters criticized the proposed minimum leverage ratio requirement 
because it would not include an exemption for certain exposures that 
are unique to banking organizations engaged in insurance activities. 
Specifically, these commenters encouraged the Board to consider 
excluding assets held in separate accounts and stated that such assets 
are not available to satisfy the claims of general creditors and do not 
affect the leverage position of an insurance company. A few commenters 
asserted that the inclusion of separate account assets in the 
calculation of the leverage ratio stands in contrast to the agencies' 
and the FDIC's treatment of banking organization's trust accounts, 
bank-affiliated mutual funds, and bank-maintained common and collective 
investment funds. In addition, some of these commenters argued for a 
partial exclusion of trading account assets supporting insurance 
liabilities because, according to these commenters, the risks 
attributable to these assets accrue to contract owners.
    The agencies continue to believe that a minimum leverage ratio 
requirement of 4 percent for all banking organizations is appropriate 
in light of its role as a complement to the risk-based capital ratios. 
The proposed leverage ratio is more conservative than the current 
leverage ratio because it incorporates a more stringent definition of 
tier 1 capital. In addition, the agencies believe that it is 
appropriate for all banking organizations, regardless of their 
supervisory rating or trading activities, to meet the same minimum 
leverage ratio requirements. As a practical matter, the agencies 
generally have found a leverage ratio of less than 4 percent to be 
inconsistent with a supervisory composite rating of ``1.'' Modifying 
the scope of the leverage ratio measure or implementing a fluid or 
tiered approach for the minimum leverage ratio requirement would create 
additional operational complexity and variability in a minimum ratio 
requirement that is intended to place a constraint on the maximum 
degree to which a banking organization can leverage its equity base. 
Accordingly, the final rule retains the existing minimum leverage ratio 
requirement of 4 percent and removes the 3 percent leverage ratio 
exception as of January 1, 2014 for advanced approaches banking 
organizations and as of January 1, 2015 for all other banking 
organizations.
    With respect to including separate account assets in the leverage 
ratio denominator, the Board continues to consider this issue together 
with other issues raised by commenters regarding the regulatory capital 
treatment of insurance activities. The final rule continues to include 
separate account assets in total assets, consistent with the proposal 
and the leverage ratio rule for BHCs.

C. Supplementary Leverage Ratio for Advanced Approaches Banking 
Organizations

    As part of Basel III, the BCBS introduced a minimum leverage ratio 
requirement of 3 percent (the Basel III leverage ratio) as a backstop 
measure to the risk-based capital requirements, designed to improve the 
resilience of the banking system worldwide by limiting the amount of 
leverage that a banking organization may incur. The Basel III leverage 
ratio is defined as the ratio of tier 1 capital to a combination of on- 
and off-balance sheet exposures.
    As discussed in the Basel III NPR, the agencies and the FDIC 
proposed the supplementary leverage ratio only for advanced approaches 
banking organizations because these banking organizations tend to have 
more significant amounts of off-balance sheet exposures that are not 
captured by the current leverage ratio. Under the proposal, consistent 
with Basel III, advanced approaches banking organizations would be 
required to maintain a minimum supplementary leverage ratio of 3 
percent of tier 1 capital to on- and off-balance sheet exposures (total 
leverage exposure).
    The agencies and the FDIC received a number of comments on the 
proposed supplementary leverage ratio. Several commenters stated that 
the proposed supplementary leverage ratio is unnecessary in light of 
the minimum leverage ratio requirement applicable to all banking 
organizations. These commenters stated that the implementation of the 
supplementary leverage ratio requirement would create market confusion 
as to the inter-relationships among the ratios and as to which ratio 
serves as the binding constraint for an individual banking 
organization. One commenter noted that an advanced approaches banking 
organization would be required to calculate eight distinct regulatory 
capital ratios (common equity tier 1, tier 1, and total capital to 
risk-weighted assets under the advanced approaches and the standardized 
approach, as well as two leverage ratios) and encouraged the agencies 
and the FDIC to streamline the application of regulatory capital 
ratios. In addition, commenters suggested that the agencies and the 
FDIC postpone the implementation of the supplementary leverage ratio 
until January 1, 2018, after the international supervisory monitoring 
process is complete, and to collect supplementary leverage ratio 
information on a confidential basis until then.
    At least one commenter encouraged the agencies and the FDIC to 
consider extending the application of the proposed supplementary 
leverage ratio on a case-by-case basis to banking organizations with 
total assets of between $50 billion and $250 billion, stating that such 
institutions may have significant off-balance sheet exposures and 
engage in a substantial amount of repo-style transactions. Other 
commenters suggested increasing the proposed supplementary leverage 
ratio requirement to at least 8 percent for BHCs, under the Board's 
authority in section 165 of the Dodd-Frank Act to implement enhanced 
capital requirements for systemically important financial 
institutions.\37\
---------------------------------------------------------------------------

    \37\ See section 165 of the Dodd-Frank Act, 12 U.S.C. 5365.
---------------------------------------------------------------------------

    With respect to specific aspects of the supplementary leverage 
ratio, some

[[Page 62032]]

commenters criticized the methodology for the total leverage exposure. 
Specifically, one commenter expressed concern that using GAAP as the 
basis for determining a banking organization's total leverage exposure 
would exclude a wide range of off-balance sheet exposures, including 
derivatives and securities lending transactions, as well as permit 
extensive netting. To address these issues, the commenter suggested 
requiring advanced approaches banking organizations to determine their 
total leverage exposure using International Financial Reporting 
Standards (IFRS), asserting that it restricts netting and, relative to 
GAAP, requires the recognition of more off-balance sheet securities 
lending transactions.
    Several commenters criticized the proposed incorporation of off-
balance sheet exposures into the total leverage exposure. One commenter 
argued that including unfunded commitments in the total leverage 
exposure runs counter to the purpose of the supplementary leverage 
ratio as an on-balance sheet measure of capital that complements the 
risk-based capital ratios. This commenter was concerned that the 
proposed inclusion of unfunded commitments would result in a 
duplicative assessment against banking organizations when the 
forthcoming liquidity ratio requirements are implemented in the United 
States. The commenter noted that the proposed 100 percent credit 
conversion factor for all unfunded commitments is not appropriately 
calibrated to the vastly different types of commitments that exist 
across the industry. If the supplementary leverage ratio is retained in 
the final rule, the commenter requested that the agencies and the FDIC 
align the credit conversion factors for unfunded commitments under the 
supplementary leverage ratio and any forthcoming liquidity ratio 
requirements.
    Another commenter encouraged the agencies and the FDIC to allow 
advanced approaches banking organizations to exclude from total 
leverage exposure the notional amount of any unconditionally 
cancellable commitment. According to this commenter, unconditionally 
cancellable commitments are not credit exposures because they can be 
extinguished at any time at the sole discretion of the issuing entity. 
Therefore, the commenter argued, the inclusion of these commitments 
could potentially distort a banking organization's measure of total 
leverage exposure.
    A few commenters requested that the agencies and the FDIC exclude 
off-balance sheet trade finance instruments from the total leverage 
exposure, asserting that such instruments are based on underlying 
client transactions (for example, a shipment of goods) and are 
generally short-term. The commenters argued that trade finance 
instruments do not create excessive systemic leverage and that they are 
liquidated by fulfillment of the underlying transaction and payment at 
maturity. Another commenter requested that the agencies and the FDIC 
apply the same credit conversion factors to trade finance instruments 
as under the general risk-based capital rules--that is, 20 percent of 
the notional value for trade-related contingent items that arise from 
the movement of goods, and 50 percent of the notional value for 
transaction-related contingent items, including performance bonds, bid 
bonds, warranties, and performance standby letters of credit. According 
to this commenter, such an approach would appropriately consider the 
low-risk characteristics of these instruments and ensure price 
stability in trade finance.
    Several commenters supported the proposed treatment for repo-style 
transactions (including repurchase agreements, securities lending and 
borrowing transactions, and reverse repos). These commenters stated 
that securities lending transactions are fully collateralized and 
marked to market daily and, therefore, the on-balance sheet amounts 
generated by these transactions appropriately capture the exposure for 
purposes of the supplementary leverage ratio. These commenters also 
supported the proposed treatment for indemnified securities lending 
transactions and encouraged the agencies and the FDIC to retain this 
treatment in the final rule. Other commenters stated that the proposed 
measurement of repo-style transactions is not sufficiently conservative 
and recommended that the agencies and the FDIC implement a methodology 
that includes in total leverage exposure the notional amounts of these 
transactions.
    A few commenters raised concerns about the proposed methodology for 
determining the exposure amount of derivative contracts. Some 
commenters criticized the agencies and the FDIC for not allowing 
advanced approaches banking organizations to use the internal models 
methodology to calculate the exposure amount for derivative contracts. 
According to these commenters, the agencies and the FDIC should align 
the methods for calculating exposure for derivative contracts for 
purposes of the supplementary leverage ratio and the advanced 
approaches risk-based capital ratios to more appropriately reflect the 
risk-management activities of advanced approaches banking organizations 
and to measure these exposures consistently across the regulatory 
capital ratios. At least one commenter requested clarification of the 
proposed treatment of collateral received in connection with derivative 
contracts. This commenter also encouraged the agencies and the FDIC to 
permit recognition of eligible collateral for purposes of reducing 
total leverage exposure, consistent with proposed legislation in other 
BCBS member jurisdictions.
    The introduction of an international leverage ratio requirement in 
the Basel III capital framework is an important development that would 
provide a consistent leverage ratio measure across internationally-
active institutions. Furthermore, the supplementary leverage ratio is 
reflective of the on- and off-balance sheet activities of large, 
internationally active banking organizations. Accordingly, consistent 
with Basel III, the final rule implements for reporting purposes the 
proposed supplementary leverage ratio for advanced approaches banking 
organizations starting on January 1, 2015 and requires advanced 
approaches banking organizations to comply with the minimum 
supplementary leverage ratio requirement starting on January 1, 2018. 
Public reporting of the supplementary leverage ratio during the 
international supervisory monitoring period is consistent with the 
international implementation timeline and enables transparency and 
comparability of reporting the leverage ratio requirement across 
jurisdictions.
    The agencies are not applying the supplementary leverage ratio 
requirement to banking organizations that are not subject to the 
advanced approaches rule in the final rule. Applying the supplementary 
leverage ratio routinely could create operational complexity for 
smaller banking organizations that are not internationally active, and 
that generally do not have off-balance sheet activities that are as 
extensive as banking organizations that are subject to the advanced 
approaches rule. The agencies note that the final rule imposes risk-
based capital requirements on all repo-style transactions and otherwise 
imposes constraints on all banking organizations' off-balance sheet 
exposures.
    With regard to the commenters' views to require the use of IFRS for 
purposes of the supplementary leverage ratio, the agencies note that 
the use of GAAP in the final rule as a starting point to

[[Page 62033]]

measure exposure of certain derivatives and repo-style transactions, 
has the advantage of maintaining consistency between regulatory capital 
calculations and regulatory reporting, the latter of which must be 
consistent with GAAP or, if another accounting principle is used, no 
less stringent than GAAP.\38\
---------------------------------------------------------------------------

    \38\ See 12 U.S.C. 1831n(a)(2).
---------------------------------------------------------------------------

    In response to the commenters' views regarding the scope of the 
total leverage exposure, the agencies note that the supplementary 
leverage ratio is intended to capture on- and off-balance sheet 
exposures of a banking organization. Commitments represent an agreement 
to extend credit and thus including commitments (both funded and 
unfunded) in the supplementary leverage ratio is consistent with its 
purpose to measure the on- and off-balance sheet leverage of a banking 
organization, as well as with safety and soundness principles. 
Accordingly, the agencies believe that total leverage exposure should 
include banking organizations' off-balance sheet exposures, including 
all loan commitments that are not unconditionally cancellable, 
financial standby letters of credit, performance standby letters of 
credit, and commercial and other similar letters of credit.
    The proposal to include unconditionally cancellable commitments in 
the total leverage exposure recognizes that a banking organization may 
extend credit under the commitment before it is cancelled. If the 
banking organization exercises its option to cancel the commitment, its 
total leverage exposure amount with respect to the commitment will be 
limited to any extension of credit prior to cancellation. The proposal 
considered banking organizations' ability to cancel such commitments 
and, therefore, limited the amount of unconditionally cancellable 
commitments included in total leverage exposure to 10 percent of the 
notional amount of such commitments.
    The agencies note that the credit conversion factors used in the 
supplementary leverage ratio and in any forthcoming liquidity ratio 
requirements have been developed to serve the purposes of the 
respective frameworks and may not be identical. Similarly, the 
commenters' proposed modifications to credit conversion factors for 
trade finance transactions would be inconsistent with the purpose of 
the supplementary leverage ratio--to capture all off-balance sheet 
exposures of banking organizations in a primarily non-risk-based 
manner.
    For purposes of incorporating derivative contracts in the total 
leverage exposure, the proposal would require all advanced approaches 
banking organizations to use the same methodology to measure such 
exposures. The proposed approach provides a uniform measure of exposure 
for derivative contracts across banking organizations, without regard 
to their models. Accordingly, the agencies do not believe a banking 
organization should be permitted to use internal models to measure the 
exposure amount of derivative contracts for purposes of the 
supplementary leverage ratio.
    With regard to commenters requesting a modification of the proposed 
treatment for repo-style transactions, the agencies do not believe that 
the proposed modifications are warranted at this time because 
international discussions and quantitative analysis of the exposure 
measure for repo-style transactions are still ongoing.
    The agencies are continuing to work with the BCBS to assess the 
Basel III leverage ratio, including its calibration and design, as well 
as the impact of any differences in national accounting frameworks 
material to the denominator of the Basel III leverage ratio. The 
agencies will consider any changes to the supplementary leverage ratio 
as the BCBS revises the Basel III leverage ratio.
    Therefore, the agencies have adopted the proposed supplementary 
leverage ratio in the final rule without modification. An advanced 
approaches banking organization must calculate the supplementary 
leverage ratio as the simple arithmetic mean of the ratio of the 
banking organization's tier 1 capital to total leverage exposure as of 
the last day of each month in the reporting quarter. The agencies also 
note that collateral may not be applied to reduce the potential future 
exposure (PFE) amount for derivative contracts.
    Under the final rule, total leverage exposure equals the sum of the 
following:
    (1) The balance sheet carrying value of all of the banking 
organization's on-balance sheet assets less amounts deducted from tier 
1 capital under section 22(a), (c), and (d) of the final rule;
    (2) The PFE amount for each derivative contract to which the 
banking organization is a counterparty (or each single-product netting 
set of such transactions) determined in accordance with section 34 of 
the final rule, but without regard to section 34(b);
    (3) 10 percent of the notional amount of unconditionally 
cancellable commitments made by the banking organization; and
    (4) The notional amount of all other off-balance sheet exposures of 
the banking organization (excluding securities lending, securities 
borrowing, reverse repurchase transactions, derivatives and 
unconditionally cancellable commitments).
    Advanced approaches banking organizations must maintain a minimum 
supplementary leverage ratio of 3 percent beginning on January 1, 2018, 
consistent with Basel III. However, as noted above, beginning on 
January 1, 2015, advanced approaches banking organizations must 
calculate and report their supplementary leverage ratio.

D. Capital Conservation Buffer

    During the recent financial crisis, some banking organizations 
continued to pay dividends and substantial discretionary bonuses even 
as their financial condition weakened. Such capital distributions had a 
significant negative impact on the overall strength of the banking 
sector. To encourage better capital conservation by banking 
organizations and to enhance the resilience of the banking system, the 
proposed rule would have limited capital distributions and 
discretionary bonus payments for banking organizations that do not hold 
a specified amount of common equity tier 1 capital in addition to the 
amount of regulatory capital necessary to meet the minimum risk-based 
capital requirements (capital conservation buffer), consistent with 
Basel III. In this way, the capital conservation buffer is intended to 
provide incentives for banking organizations to hold sufficient capital 
to reduce the risk that their capital levels would fall below their 
minimum requirements during a period of financial stress.
    The proposed rules incorporated a capital conservation buffer 
composed of common equity tier 1 capital in addition to the minimum 
risk-based capital requirements. Under the proposal, a banking 
organization would need to hold a capital conservation buffer in an 
amount greater than 2.5 percent of total risk-weighted assets (plus, 
for an advanced approaches banking organization, 100 percent of any 
applicable countercyclical capital buffer amount) to avoid limitations 
on capital distributions and discretionary bonus payments to executive 
officers, as defined in the proposal. The proposal provided that the 
maximum dollar amount that a banking organization could pay out in the 
form of capital distributions or discretionary bonus payments during 
the current calendar quarter (the maximum payout amount)

[[Page 62034]]

would be equal to a maximum payout ratio, multiplied by the banking 
organization's eligible retained income, as discussed below. The 
proposal provided that a banking organization with a buffer of more 
than 2.5 percent of total risk-weighted assets (plus, for an advanced 
approaches banking organization, 100 percent of any applicable 
countercyclical capital buffer), would not be subject to a maximum 
payout amount. The proposal clarified that the agencies and the FDIC 
reserved the ability to restrict capital distributions under other 
authorities and that restrictions on capital distributions and 
discretionary bonus payments associated with the capital conservation 
buffer would not be part of the PCA framework. The calibration of the 
buffer is supported by an evaluation of the loss experience of U.S. 
banking organizations as part of an analysis conducted by the BCBS, as 
well as by evaluation of historical levels of capital at U.S. banking 
organizations.\39\
---------------------------------------------------------------------------

    \39\ ``Calibrating regulatory capital requirements and buffers: 
A top-down approach.'' Basel Committee on Banking Supervision, 
October, 2010, available at www.bis.org.
---------------------------------------------------------------------------

    The agencies and the FDIC received a significant number of comments 
on the proposed capital conservation buffer. In general, the commenters 
characterized the capital conservation buffer as overly conservative, 
and stated that the aggregate amount of capital that would be required 
for a banking organization to avoid restrictions on dividends and 
discretionary bonus payments under the proposed rule exceeded the 
amount required for a safe and prudent banking system. Commenters 
expressed concern that the capital conservation buffer could disrupt 
the priority of payments in a banking organization's capital structure, 
as any restrictions on dividends would apply to both common and 
preferred stock. Commenters also questioned the appropriateness of 
restricting a banking organization that fails to comply with the 
capital conservation buffer from paying dividends or bonus payments if 
it has established and maintained cash reserves to cover future 
uncertainty. One commenter supported the establishment of a formal 
mechanism for banking organizations to request agency approval to make 
capital distributions even if doing so would otherwise be restricted 
under the capital conservation buffer.
    Other commenters recommended an exemption from the proposed capital 
conservation buffer for certain types of banking organizations, such as 
community banking organizations, banking organizations organized in 
mutual form, and rural BHCs that rely heavily on bank stock loans for 
growth and expansion purposes. Commenters also recommended a wide range 
of institutions that should be excluded from the buffer based on a 
potential size threshold, such as banking organizations with total 
consolidated assets of less than $250 billion. Commenters also 
recommended that S-corporations be exempt from the proposed capital 
conservation buffer because under the U.S. Internal Revenue Code, S-
corporations are not subject to a corporate-level tax; instead, S-
corporation shareholders must report income and pay income taxes based 
on their share of the corporation's profit or loss. An S-corporation 
generally declares a dividend to help shareholders pay their tax 
liabilities that arise from reporting their share of the corporation's 
profits. According to some commenters, the proposal disadvantaged S-
corporations because shareholders of S-corporations would be liable for 
tax on the S-corporation's net income, and the S-corporation may be 
prohibited from making a dividend to these shareholders to fund the tax 
payment.
    One commenter criticized the proposed composition of the capital 
conservation buffer (which must consist solely of common equity tier 1 
capital) and encouraged the agencies and the FDIC to allow banking 
organizations to include noncumulative perpetual preferred stock and 
other tier 1 capital instruments. Several commenters questioned the 
empirical basis for a capital conservation buffer of 2.5 percent, and 
encouraged the agencies and the FDIC to provide a quantitative analysis 
for the proposal. One commenter suggested application of the capital 
conservation buffer only during economic downturn scenarios, consistent 
with the agencies' and the FDIC's objective to restrict dividends and 
discretionary bonus payments during these periods. According to this 
commenter, a banking organization that fails to maintain a sufficient 
capital conservation buffer during periods of economic stress also 
could be required to submit a plan to increase its capital.
    After considering these comments, the agencies have decided to 
maintain common equity tier 1 capital as the basis of the capital 
conservation buffer and to apply the capital conservation buffer to all 
types of banking organizations at all times. Application of the buffer 
to all types of banking organizations and maintenance of a capital 
buffer during periods of market and economic stability is appropriate 
to encourage sound capital management and help ensure that banking 
organizations will maintain adequate amounts of loss-absorbing capital 
going forward, strengthening the ability of the banking system to 
continue serving as a source of credit to the economy in times of 
stress. A buffer framework that restricts dividends and discretionary 
bonus payments only for certain types of banking organizations or only 
during an economic contraction would not achieve these objectives. 
Similarly, basing the capital conservation buffer on the most loss-
absorbent form of capital is most consistent with the purpose of the 
capital conservation buffer as it helps to ensure that the buffer can 
be used effectively by banking organizations at a time when they are 
experiencing losses.
    The agencies recognize that S-corporation banking organizations 
structure their tax payments differently from C corporations. However, 
the agencies note that this distinction results from S-corporations' 
pass-through taxation, in which profits are not subject to taxation at 
the corporate level, but rather at the shareholder level. The agencies 
are charged with evaluating the capital levels and safety and soundness 
of the banking organization. At the point where a decrease in the 
organization's capital triggers dividend restrictions, the agencies 
believe that capital should stay within the banking organization. S-
corporation shareholders may receive a benefit from pass-through 
taxation, but with that benefit comes the risk that the corporation has 
no obligation to make dividend distributions to help shareholders pay 
their tax liabilities. Therefore, the final rule does not exempt S-
corporations from the capital conservation buffer.
    Accordingly, under the final rule a banking organization must 
maintain a capital conservation buffer of common equity tier 1 capital 
in an amount greater than 2.5 percent of total risk-weighted assets 
(plus, for an advanced approaches banking organization, 100 percent of 
any applicable countercyclical capital buffer amount) to avoid being 
subject to limitations on capital distributions and discretionary bonus 
payments to executive officers.
    The proposal defined eligible retained income as a banking 
organization's net income (as reported in the banking organization's 
quarterly regulatory reports) for the four calendar quarters preceding 
the current calendar quarter, net of any capital distributions and 
associated tax effects not already reflected in net income. The 
agencies and the FDIC received a number of comments regarding the 
proposed

[[Page 62035]]

definition of eligible retained income, which is used to calculate the 
maximum payout amount. Some commenters suggested that the agencies and 
the FDIC limit capital distributions based on retained earnings instead 
of eligible retained income, citing the Board's Regulation H as an 
example of this regulatory practice.\40\ Several commenters 
representing banking organizations organized as S-corporations 
recommended revisions to the definition of eligible retained income so 
that it would be net of pass-through tax distributions to shareholders 
that have made a pass-through election for tax purposes, allowing S-
corporation shareholders to pay their tax liability notwithstanding any 
dividend restrictions resulting from failure to comply with the capital 
conservation buffer. Some commenters suggested that the definition of 
eligible retained income be adjusted for items such as goodwill 
impairment that are captured in the definition of ``net income'' for 
regulatory reporting purposes but which do not affect regulatory 
capital.
---------------------------------------------------------------------------

    \40\ See 12 CFR part 208.
---------------------------------------------------------------------------

    The final rule adopts the proposed definition of eligible retained 
income without change. The agencies believe the commenters' suggested 
modifications to the definition of eligible retained income would add 
complexity to the final rule and in some cases may be counter-
productive by weakening the incentives of the capital conservation 
buffer. The agencies note that the definition of eligible retained 
income appropriately accounts for impairment charges, which reduce 
eligible retained income but also reduce the balance sheet amount of 
goodwill that is deducted from regulatory capital. Further, the 
proposed definition of eligible retained income, which is based on net 
income as reported in the banking organization's quarterly regulatory 
reports, reflects a simple measure of a banking organization's recent 
performance upon which to base restrictions on capital distributions 
and discretionary payments to executive officers. For the same reasons 
as described above regarding the application of the capital 
conservation buffer to S-corporations generally, the agencies have 
determined that the definition of eligible retained income should not 
be modified to address the tax-related concerns raised by commenters 
writing on behalf of S-corporations.
    The proposed rule generally defined a capital distribution as a 
reduction of tier 1 or tier 2 capital through the repurchase or 
redemption of a capital instrument or by other means; a dividend 
declaration or payment on any tier 1 or tier 2 capital instrument if 
the banking organization has full discretion to permanently or 
temporarily suspend such payments without triggering an event of 
default; or any similar transaction that the primary Federal supervisor 
determines to be in substance a distribution of capital.
    Commenters provided suggestions on the definition of ``capital 
distribution.'' One commenter requested that a ``capital distribution'' 
be defined to exclude any repurchase or redemption to the extent the 
capital repurchased or redeemed was replaced in a contemporaneous 
transaction by the issuance of capital of an equal or higher quality 
tier. The commenter maintained that the proposal would unnecessarily 
penalize banking organizations that redeem capital but 
contemporaneously replace such capital with an equal or greater amount 
of capital of an equivalent or higher quality. In response to comments, 
and recognizing that redeeming capital instruments that are replaced 
with instruments of the same or similar quality does not weaken a 
banking organization's overall capital position, the final rule 
provides that a redemption or repurchase of a capital instrument is not 
a distribution provided that the banking organization fully replaces 
that capital instrument by issuing another capital instrument of the 
same or better quality (that is, more subordinate) based on the final 
rule's eligibility criteria for capital instruments, and provided that 
such issuance is completed within the same calendar quarter the banking 
organization announces the repurchase or redemption. For purposes of 
this definition, a capital instrument is issued at the time that it is 
fully paid in. For purposes of the final rule, the agencies changed the 
defined term from ``capital distribution'' to ``distribution'' to avoid 
confusion with the term ``capital distribution'' used in the Board's 
capital plan rule.\41\
---------------------------------------------------------------------------

    \41\ See 12 CFR 225.8.
---------------------------------------------------------------------------

    The proposed rule defined discretionary bonus payment as a payment 
made to an executive officer of a banking organization (as defined 
below) that meets the following conditions: the banking organization 
retains discretion as to the fact of the payment and as to the amount 
of the payment until the payment is awarded to the executive officer; 
the amount paid is determined by the banking organization without prior 
promise to, or agreement with, the executive officer; and the executive 
officer has no contractual right, express or implied, to the bonus 
payment.
    The agencies and the FDIC received a number of comments on the 
proposed definition of discretionary bonus payments to executive 
officers. One commenter expressed concern that the proposed definition 
of discretionary bonus payment may not be effective unless the agencies 
and the FDIC provided clarification as to the type of payments covered, 
as well as the timing of such payments. This commenter asked whether 
the proposed rule would prohibit the establishment of a pre-funded 
bonus pool with mandatory distributions and sought clarification as to 
whether non-cash compensation payments, such as stock options, would be 
considered a discretionary bonus payment.
    The final rule's definition of discretionary bonus payment is 
unchanged from the proposal. The agencies note that if a banking 
organization prefunds a pool for bonuses payable under a contract, the 
bonus pool is not discretionary and, therefore, is not subject to the 
capital conservation buffer limitations. In addition, the definition of 
discretionary bonus payment does not include non-cash compensation 
payments that do not affect capital or earnings such as, in some cases, 
stock options.
    Commenters representing community banking organizations maintained 
that the proposed restrictions on discretionary bonus payments would 
disproportionately impact such institutions' ability to attract and 
retain qualified employees. One commenter suggested revising the 
proposed rule so that a banking organization that fails to satisfy the 
capital conservation buffer would be restricted from making a 
discretionary bonus payment only to the extent it exceeds 15 percent of 
the employee's salary, asserting that this would prevent excessive 
bonus payments while allowing community banking organizations 
flexibility to compensate key employees. The final rule does not 
incorporate this suggestion. The agencies note that the potential 
limitations and restrictions under the capital conservation buffer 
framework do not automatically translate into a prohibition on 
discretionary bonus payments. Instead, the overall dollar amount of 
dividends and bonuses to executive officers is capped based on how 
close the banking organization's regulatory capital ratios are to its 
minimum capital ratios and on the earnings of the banking organization 
that are available for distribution. This approach provides appropriate

[[Page 62036]]

incentives for capital conservation while preserving flexibility for 
institutions to decide how to allocate income available for 
distribution between discretionary bonus payments and other 
distributions.
    The proposal defined executive officer as a person who holds the 
title or, without regard to title, salary, or compensation, performs 
the function of one or more of the following positions: President, 
chief executive officer, executive chairman, chief operating officer, 
chief financial officer, chief investment officer, chief legal officer, 
chief lending officer, chief risk officer, or head of a major business 
line, and other staff that the board of directors of the banking 
organization deems to have equivalent responsibility.\42\
---------------------------------------------------------------------------

    \42\ See 76 FR 21170 (April 14, 2011) for a comparable 
definition of ``executive officer.''
---------------------------------------------------------------------------

    Commenters generally supported a more restrictive definition of 
executive officer, arguing that the definition of executive officer 
should be no broader than the definition under the Board's Regulation 
O,\43\ which governs any extension of credit between a member bank and 
an executive officer, director, or principal shareholder. Some 
commenters, however, favored a more expansive definition of executive 
officer, with one commenter supporting the inclusion of directors of 
the banking organization or directors of any of the banking 
organization's affiliates, any other person in control of the banking 
organization or the banking organizations' affiliates, and any person 
in control of a major business line. In accordance with the agencies' 
objective to include those individuals within a banking organization 
with the greatest responsibility for the organization's financial 
condition and risk exposure, the final rule maintains the definition of 
executive officer as proposed.
---------------------------------------------------------------------------

    \43\ See 12 CFR part 215.
---------------------------------------------------------------------------

    Under the proposal, advanced approaches banking organizations would 
have calculated their capital conservation buffer (and any applicable 
countercyclical capital buffer amount) using their advanced approaches 
total risk-weighted assets. Several commenters supported this aspect of 
the proposal, and one stated that the methodologies for calculating 
risk-weighted assets under the advanced approaches rule would more 
effectively capture the individual risk profiles of such banking 
organizations, asserting further that advanced approaches banking 
organizations would face a competitive disadvantage relative to foreign 
banking organizations if they were required to use standardized total 
risk-weighted assets to determine compliance with the capital 
conservation buffer. In contrast, another commenter suggested that 
advanced approaches banking organizations be allowed to use the 
advanced approaches methodologies as the basis for calculating the 
capital conservation buffer only when it would result in a more 
conservative outcome than under the standardized approach in order to 
maintain competitive equity domestically. Another commenter expressed 
concerns that the capital conservation buffer is based only on risk-
weighted assets and recommended additional application of a capital 
conservation buffer to the leverage ratio to avoid regulatory arbitrage 
opportunities and to accomplish the agencies' and the FDIC's stated 
objective of ensuring that banking organizations have sufficient 
capital to absorb losses.
    The final rule requires that advanced approaches banking 
organizations that have completed the parallel run process and that 
have received notification from their primary Federal supervisor 
pursuant to section 121(d) of subpart E use their risk-based capital 
ratios under section 10 of the final rule (that is, the lesser of the 
standardized and the advanced approaches ratios) as the basis for 
calculating their capital conservation buffer (and any applicable 
countercyclical capital buffer). The agencies believe such an approach 
is appropriate because it is consistent with how advanced approaches 
banking organizations compute their minimum risk-based capital ratios.
    Many commenters discussed the interplay between the proposed 
capital conservation buffer and the PCA framework. Some commenters 
encouraged the agencies and the FDIC to reset the buffer requirement to 
two percent of total risk-weighted assets in order to align it with the 
margin between the ``adequately-capitalized'' category and the ``well-
capitalized'' category under the PCA framework. Similarly, some 
commenters characterized the proposal as confusing because a banking 
organization could be considered well capitalized for PCA purposes, but 
at the same time fail to maintain a sufficient capital conservation 
buffer and be subject to restrictions on capital distributions and 
discretionary bonus payments. These commenters encouraged the agencies 
and the FDIC to remove the capital conservation buffer for purposes of 
the final rule, and instead use their existing authority to impose 
restrictions on dividends and discretionary bonus payments on a case-
by-case basis through formal enforcement actions. Several commenters 
stated that compliance with a capital conservation buffer that operates 
outside the traditional PCA framework adds complexity to the final 
rule, and suggested increasing minimum capital requirements if the 
agencies and the FDIC determine they are currently insufficient. 
Specifically, one commenter encouraged the agencies and the FDIC to 
increase the minimum total risk-based capital requirement to 10.5 
percent and remove the capital conservation buffer from the rule.
    The capital conservation buffer has been designed to give banking 
organizations the flexibility to use the buffer while still being well 
capitalized. Banking organizations that maintain their risk-based 
capital ratios at least 50 basis points above the well capitalized PCA 
levels will not be subject to any restrictions imposed by the capital 
conservation buffer, as applicable. As losses begin to accrue or a 
banking organization's risk-weighted assets begin to grow such that the 
capital ratios of a banking organization are below the capital 
conservation buffer but above the well capitalized thresholds, the 
incremental limitations on distributions are unlikely to affect planned 
capital distributions or discretionary bonus payments but may provide a 
check on rapid expansion or other activities that would weaken the 
organization's capital position.
    Under the final rule, the maximum payout ratio is the percentage of 
eligible retained income that a banking organization is allowed to pay 
out in the form of distributions and discretionary bonus payments, each 
as defined under the rule, during the current calendar quarter. The 
maximum payout ratio is determined by the banking organization's 
capital conservation buffer as calculated as of the last day of the 
previous calendar quarter.
    A banking organization's capital conservation buffer is the lowest 
of the following ratios: (i) The banking organization's common equity 
tier 1 capital ratio minus its minimum common equity tier 1 capital 
ratio; (ii) the banking organization's tier 1 capital ratio minus its 
minimum tier 1 capital ratio; and (iii) the banking organization's 
total capital ratio minus its minimum total capital ratio. If the 
banking organization's common equity tier 1, tier 1 or total capital 
ratio is less than or equal to its minimum common equity tier 1, tier 1 
or total capital ratio, respectively, the banking organization's 
capital conservation buffer is zero.
    The mechanics of the capital conservation buffer under the final 
rule are unchanged from the proposal. A

[[Page 62037]]

banking organization's maximum payout amount for the current calendar 
quarter is equal to the banking organization's eligible retained 
income, multiplied by the applicable maximum payout ratio, in 
accordance with Table 1. A banking organization with a capital 
conservation buffer that is greater than 2.5 percent (plus, for an 
advanced approaches banking organization, 100 percent of any applicable 
countercyclical capital buffer) is not subject to a maximum payout 
amount as a result of the application of this provision. However, a 
banking organization may otherwise be subject to limitations on capital 
distributions as a result of supervisory actions or other laws or 
regulations.\44\
---------------------------------------------------------------------------

    \44\ See, e.g., 12 U.S.C. 56, 60, and 1831o(d)(1) and 12 CFR 
part 3, subparts H and I, 12 CFR part 5.46, 12 CFR part 5, subpart 
E, and 12 CFR part 6 (national banks) and 12 U.S.C. 1467a(f) and 
1467a(m)(B)(i)(III) and 12 CFR part 165 (Federal savings 
associations); see also 12 CFR 225.8 (Board).
---------------------------------------------------------------------------

    Table 1 illustrates the relationship between the capital 
conservation buffer and the maximum payout ratio. The maximum dollar 
amount that a banking organization is permitted to pay out in the form 
of distributions or discretionary bonus payments during the current 
calendar quarter is equal to the maximum payout ratio multiplied by the 
banking organization's eligible retained income. The calculation of the 
maximum payout amount is made as of the last day of the previous 
calendar quarter and any resulting restrictions apply during the 
current calendar quarter.

                       Table 1--Capital Conservation Buffer and Maximum Payout Ratio \45\
----------------------------------------------------------------------------------------------------------------
Capital conservation buffer (as a percentage
   of standardized or advanced total risk-    Maximum payout ratio (as a percentage of eligible retained income)
       weighted assets, as applicable)
----------------------------------------------------------------------------------------------------------------
Greater than 2.5 percent....................  No payout ratio limitation applies.
Less than or equal to 2.5 percent, and        60 percent.
 greater than 1.875 percent.
Less than or equal to 1.875 percent, and      40 percent.
 greater than 1.25 percent.
Less than or equal to 1.25 percent, and       20 percent.
 greater than 0.625 percent.
Less than or equal to 0.625 percent.........  0 percent.
----------------------------------------------------------------------------------------------------------------

    Table 1 illustrates  that the capital conservation buffer 
requirements are divided into equal quartiles, each associated with 
increasingly stringent limitations on distributions and discretionary 
bonus payments to executive officers as the capital conservation buffer 
approaches zero. As described in the next section, each quartile 
expands proportionately for advanced approaches banking organizations 
when the countercyclical capital buffer amount is greater than zero. In 
a scenario where a banking organization's risk-based capital ratios 
fall below its minimum risk-based capital ratios plus 2.5 percent of 
total risk-weighted assets, the maximum payout ratio also would 
decline. A banking organization that becomes subject to a maximum 
payout ratio remains subject to restrictions on capital distributions 
and certain discretionary bonus payments until it is able to build up 
its capital conservation buffer through retained earnings, raising 
additional capital, or reducing its risk-weighted assets. In addition, 
as a general matter, a banking organization cannot make distributions 
or certain discretionary bonus payments during the current calendar 
quarter if the banking organization's eligible retained income is 
negative and its capital conservation buffer was less than 2.5 percent 
as of the end of the previous quarter.
---------------------------------------------------------------------------

    \45\ Calculations in this table are based on the assumption that 
the countercyclical capital buffer amount is zero.
---------------------------------------------------------------------------

    Compliance with the capital conservation buffer is determined prior 
to any distribution or discretionary bonus payment. Therefore, a 
banking organization with a capital buffer of more than 2.5 percent is 
not subject to any restrictions on distributions or discretionary bonus 
payments even if such distribution or payment would result in a capital 
buffer of less than or equal to 2.5 percent in the current calendar 
quarter. However, to remain free of restrictions for purposes of any 
subsequent quarter, the banking organization must restore capital to 
increase the buffer to more than 2.5 percent prior to any distribution 
or discretionary bonus payment in any subsequent quarter.
    In the proposal, the agencies and the FDIC solicited comment on the 
impact, if any, of prohibiting a banking organization that is subject 
to a maximum payout ratio of zero percent from making a penny dividend 
to common stockholders. One commenter stated that such banking 
organizations should be permitted to pay a penny dividend on their 
common stock notwithstanding the limitations imposed by the capital 
conservation buffer. This commenter maintained that the inability to 
pay any dividend on common stock could make it more difficult to 
attract equity investors such as pension funds that often are required 
to invest only in institutions that pay a quarterly dividend. While the 
agencies did not incorporate a blanket exemption for penny dividends on 
common stock, under the final rule, as under the proposal, the primary 
Federal supervisor may permit a banking organization to make a 
distribution or discretionary bonus payment if the primary Federal 
supervisor determines that such distribution or payment would not be 
contrary to the purpose of the capital conservation buffer or the 
safety and soundness of the organization. In making such 
determinations, the primary Federal supervisor would consider the 
nature of and circumstances giving rise to the request.

E. Countercyclical Capital Buffer

    The proposed rule introduced a countercyclical capital buffer 
applicable to advanced approaches banking organizations to augment the 
capital conservation buffer during periods of excessive credit growth. 
Under the proposed rule, the countercyclical capital buffer would have 
required advanced approaches banking organizations to hold additional 
common equity tier 1 capital during specific, agency-determined periods 
in order to avoid limitations on distributions and discretionary bonus 
payments. The agencies and the FDIC requested comment on the 
countercyclical capital buffer and, specifically, on any factors that 
should be considered for purposes of determining whether to activate 
it. One commenter encouraged the agencies and the FDIC to consider 
readily available indicators of economic growth, employment levels, and 
financial sector profits. This commenter stated generally that the 
agencies and the FDIC should activate the countercyclical capital

[[Page 62038]]

buffer during periods of general economic growth or high financial 
sector profits, instead of reserving it only for periods of ``excessive 
credit growth.''
    Other commenters did not support using the countercyclical capital 
buffer as a macroeconomic tool. One commenter encouraged the agencies 
and the FDIC not to include the countercyclical capital buffer in the 
final rule and, instead, rely on the Board's longstanding authority 
over monetary policy to mitigate excessive credit growth and potential 
asset bubbles. Another commenter questioned the buffer's effectiveness 
and encouraged the agencies and the FDIC to conduct a QIS prior to its 
implementation. One commenter recommended expanding the applicability 
of the proposed countercyclical capital buffer on a case-by-case basis 
to institutions with total consolidated assets between $50 and $250 
billion. Another commenter, however, supported the application of the 
countercyclical capital buffer only to institutions with total 
consolidated assets above $250 billion.
    The Dodd-Frank Act requires the agencies to consider the use of 
countercyclical aspects of capital regulation, and the countercyclical 
capital buffer is an explicitly countercyclical element of capital 
regulation.\46\ The agencies note that implementation of the 
countercyclical capital buffer for advanced approaches banking 
organizations is an important part of the Basel III framework, which 
aims to enhance the resilience of the banking system and reduce 
systemic vulnerabilities. The agencies believe that the countercyclical 
capital buffer is most appropriately applied only to advanced 
approaches banking organizations because, generally, such organizations 
are more interconnected with other financial institutions. Therefore, 
the marginal benefits to financial stability from a countercyclical 
capital buffer function should be greater with respect to such 
institutions. Application of the countercyclical capital buffer only to 
advanced approaches banking organizations also reflects the fact that 
making cyclical adjustments to capital requirements may produce smaller 
financial stability benefits and potentially higher marginal costs for 
smaller banking organizations. The countercyclical capital buffer is 
designed to take into account the macro-financial environment in which 
banking organizations function and to protect the banking system from 
the systemic vulnerabilities that may build-up during periods of 
excessive credit growth, which may potentially unwind in a disorderly 
way, causing disruptions to financial institutions and ultimately 
economic activity.
---------------------------------------------------------------------------

    \46\ Section 616(a), (b), and (c) of the Dodd-Frank Act, 
codified at 12 U.S.C. 1844(b), 1464a(g)(1), and 3907(a)(1).
    .
---------------------------------------------------------------------------

    The countercyclical capital buffer aims to protect the banking 
system and reduce systemic vulnerabilities in two ways. First, the 
accumulation of a capital buffer during an expansionary phase could 
increase the resilience of the banking system to declines in asset 
prices and consequent losses that may occur when the credit conditions 
weaken. Specifically, when the credit cycle turns following a period of 
excessive credit growth, accumulated capital buffers act to absorb the 
above-normal losses that a banking organization likely would face. 
Consequently, even after these losses are realized, banking 
organizations would remain healthy and able to access funding, meet 
obligations, and continue to serve as credit intermediaries. Second, a 
countercyclical capital buffer also may reduce systemic vulnerabilities 
and protect the banking system by mitigating excessive credit growth 
and increases in asset prices that are not supported by fundamental 
factors. By increasing the amount of capital required for further 
credit extensions, a countercyclical capital buffer may limit excessive 
credit.\47\ Thus, the agencies believe that the countercyclical capital 
buffer is an appropriate macroeconomic tool and are including it in the 
final rule. One commenter expressed concern that the proposed rule 
would not require the agencies and the FDIC to activate the 
countercyclical capital buffer pursuant to a joint, interagency 
determination. This commenter encouraged the agencies and the FDIC to 
adopt an interagency process for activating the buffer for purposes of 
the final rule. As discussed in the Basel III NPR, the agencies and the 
FDIC anticipate making such determinations jointly. Because the 
countercyclical capital buffer amount would be linked to the condition 
of the overall U.S. financial system and not the characteristics of an 
individual banking organization, the agencies expect that the 
countercyclical capital buffer amount would be the same at the 
depository institution and holding company levels. The agencies and the 
FDIC solicited comment on the appropriateness of the proposed 12-month 
prior notification period for the countercyclical capital buffer 
amount. One commenter expressed concern regarding the potential for the 
agencies and the FDIC to activate the countercyclical capital buffer 
without providing banking organizations sufficient notice, and 
specifically requested the implementation of a prior notification 
requirement of not less than 12 months for purposes of the final rule.
---------------------------------------------------------------------------

    \47\ The operation of the countercyclical capital buffer is also 
consistent with sections 616(a), (b), and (c) of the Dodd-Frank Act, 
codified at 12 U.S.C. 1844(b), 1464a(g)(1), and 3907(a)(1).
---------------------------------------------------------------------------

    In general, to provide banking organizations with sufficient time 
to adjust to any changes to the countercyclical capital buffer under 
the final rule, the agencies and the FDIC expect to announce an 
increase in the U.S. countercyclical capital buffer amount with an 
effective date at least 12 months after their announcement. However, if 
the agencies and the FDIC determine that a more immediate 
implementation is necessary based on economic conditions, the agencies 
may require an earlier effective date. The agencies and the FDIC will 
follow the same procedures in adjusting the countercyclical capital 
buffer applicable for exposures located in foreign jurisdictions.
    For purposes of the final rule, consistent with the proposal, a 
decrease in the countercyclical capital buffer amount will be effective 
on the day following announcement of the final determination or the 
earliest date permissible under applicable law or regulation, whichever 
is later. In addition, the countercyclical capital buffer amount will 
return to zero percent 12 months after its effective date, unless the 
agencies and the FDIC announce a decision to maintain the adjusted 
countercyclical capital buffer amount or adjust it again before the 
expiration of the 12-month period.
    The countercyclical capital buffer augments the capital 
conservation buffer by up to 2.5 percent of a banking organization's 
total risk-weighted assets. Consistent with the proposal, the final 
rule requires an advanced approaches banking organization to determine 
its countercyclical capital buffer amount by calculating the weighted 
average of the countercyclical capital buffer amounts established for 
the national jurisdictions where the banking organization has private 
sector credit exposures. The contributing weight assigned to a 
jurisdiction's countercyclical capital buffer amount is calculated by 
dividing the total risk-weighted assets for the banking organization's 
private sector credit exposures located in the jurisdiction by the 
total risk-weighted assets for all of the banking

[[Page 62039]]

organization's private sector credit exposures.
    Under the proposed rule, private sector credit exposure was defined 
as an exposure to a company or an individual that is included in credit 
risk-weighted assets, not including an exposure to a sovereign entity, 
the Bank for International Settlements, the European Central Bank, the 
European Commission, the International Monetary Fund, a multilateral 
development bank (MDB), a public sector entity (PSE), or a Government-
sponsored Enterprise (GSE). While the proposed definition excluded 
covered positions with specific risk under the market risk rule, the 
agencies and the FDIC explicitly recognized that they should be 
included in the measure of risk-weighted assets for private-sector 
exposures and asked a question regarding how to incorporate these 
positions in the measure of risk-weighted assets, particularly for 
positions for which a banking organization uses models to measure 
specific risk. The agencies and the FDIC did not receive comments on 
this question.
    The final rule includes covered positions under the market risk 
rule in the definition of private sector credit exposure. Thus, a 
private sector credit exposure is an exposure to a company or an 
individual, not including an exposure to a sovereign entity, the Bank 
for International Settlements, the European Central Bank, the European 
Commission, the International Monetary Fund, an MDB, a PSE, or a GSE. 
The final rule is also more specific than the proposal regarding how to 
calculate risk-weighted assets for private sector credit exposures, and 
harmonizes that calculation with the advanced approaches banking 
organization's determination of its capital conservation buffer 
generally. An advanced approaches banking organization is subject to 
the countercyclical capital buffer regardless of whether it has 
completed the parallel run process and received notification from its 
primary Federal supervisor pursuant to section 121(d) of the rule. The 
methodology an advanced approaches banking organization must use for 
determining risk-weighted assets for private sector credit exposures 
must be the methodology that the banking organization uses to determine 
its risk-based capital ratios under section 10 of the final rule. 
Notwithstanding this provision, the risk-weighted asset amount for a 
private sector credit exposure that is a covered position is its 
specific risk add-on, as determined under the market risk rule's 
standardized measurement method for specific risk, multiplied by 12.5. 
The agencies chose this methodology because it allows the specific risk 
of a position to be allocated to the position's geographic location in 
a consistent manner across banking organizations.
    Consistent with the proposal, under the final rule the geographic 
location of a private sector credit exposure (that is not a 
securitization exposure) is the national jurisdiction where the 
borrower is located (that is, where the borrower is incorporated, 
chartered, or similarly established or, if it is an individual, where 
the borrower resides). If, however, the decision to issue the private 
sector credit exposure is based primarily on the creditworthiness of a 
protection provider, the location of the non-securitization exposure is 
the location of the protection provider. The location of a 
securitization exposure is the location of the underlying exposures, 
determined by reference to the location of the borrowers on those 
exposures. If the underlying exposures are located in more than one 
national jurisdiction, the location of a securitization exposure is the 
national jurisdiction where the underlying exposures with the largest 
aggregate unpaid principal balance are located.
    Table 2 illustrates how an advanced approaches banking organization 
calculates its weighted average countercyclical capital buffer amount. 
In the following example, the countercyclical capital buffer 
established in the various jurisdictions in which the banking 
organization has private sector credit exposures is reported in column 
A. Column B contains the banking organization's risk-weighted asset 
amounts for the private sector credit exposures in each jurisdiction. 
Column C shows the contributing weight for each countercyclical capital 
buffer amount, which is calculated by dividing each of the rows in 
column B by the total for column B. Column D shows the contributing 
weight applied to each countercyclical capital buffer amount, 
calculated as the product of the corresponding contributing weight 
(column C) and the countercyclical capital buffer set by each 
jurisdiction's national supervisor (column A). The sum of the rows in 
column D shows the banking organization's weighted average 
countercyclical capital buffer, which is 1.4 percent of risk-weighted 
assets.

     Table 2--Example of Weighted Average Buffer Calculation for an Advanced Approaches Banking Organization
----------------------------------------------------------------------------------------------------------------
                                                                 Banking                          Contributing
                                           Countercyclical   organization's                      weight applied
                                           capital buffer     risk-weighted     Contributing         to each
                                            amount set by      assets for     weight (column B/  countercyclical
                                              national       private sector    column B total)   capital buffer
                                             supervisor     credit exposures                    amount (column A
                                              (percent)           ($b)                             * column C)
                                                       (A)               (B)               (C)               (D)
----------------------------------------------------------------------------------------------------------------
Non-U.S. jurisdiction 1.................               2.0               250              0.29               0.6
Non-U.S. jurisdiction 2.................               1.5               100              0.12               0.2
U.S.....................................                 1               500              0.59               0.6
                                         -----------------------------------------------------------------------
    Total...............................  ................               850              1.00               1.4
----------------------------------------------------------------------------------------------------------------

    The countercyclical capital buffer expands a banking organization's 
capital conservation buffer range for purposes of determining the 
banking organization's maximum payout ratio. For instance, if an 
advanced approaches banking organization's countercyclical capital 
buffer amount is equal to zero percent of total risk-weighted assets, 
the banking organization must maintain a buffer of greater than 2.5 
percent of total risk-weighted assets to avoid restrictions

[[Page 62040]]

on its distributions and discretionary bonus payments. However, if its 
countercyclical capital buffer amount is equal to 2.5 percent of total 
risk-weighted assets, the banking organization must maintain a buffer 
of greater than 5 percent of total risk-weighted assets to avoid 
restrictions on its distributions and discretionary bonus payments.
    As another example, if the advanced approaches banking  
organization from the example in Table 2 above has a capital 
conservation buffer of 2.0 percent, and each of the jurisdictions in 
which it has private sector credit exposures sets its countercyclical 
capital buffer amount equal to zero, the banking organization would be 
subject to a maximum payout ratio of 60 percent. If, instead, each 
country sets its countercyclical capital buffer amount as shown in 
Table 2, resulting in a countercyclical capital buffer amount of 1.4 
percent of total risk-weighted assets, the banking organization's 
capital conservation buffer ranges would be expanded as shown in Table 
3 below. As a result, the banking organization would now be subject to 
a stricter 40 percent maximum payout ratio based on its capital 
conservation buffer of 2.0 percent.
---------------------------------------------------------------------------

    \48\ Calculations in this table are based on the assumption that 
the countercyclical capital buffer amount is 1.4 percent of risk-
weighted assets, per the example in Table 2.

                       Table 3--Capital Conservation Buffer and Maximum Payout Ratio \48\
----------------------------------------------------------------------------------------------------------------
 Capital conservation buffer as expanded by
  the countercyclical capital buffer amount   Maximum payout ratio (as a percentage of eligible retained income)
                from Table 2
----------------------------------------------------------------------------------------------------------------
Greater than 3.9 percent (2.5 percent + 100   No payout ratio limitation applies.
 percent of the countercyclical capital
 buffer of 1.4).
Less than or equal to 3.9 percent, and        60 percent.
 greater than 2.925 percent (1.875 percent
 plus 75 percent of the countercyclical
 capital buffer of 1.4).
Less than or equal to 2.925 percent, and      40 percent.
 greater than 1.95 percent (1.25 percent
 plus 50 percent of the countercyclical
 capital buffer of 1.4).
Less than or equal to 1.95 percent, and       20 percent.
 greater than 0.975 percent (.625 percent
 plus 25 percent of the countercyclical
 capital buffer of 1.4).
Less than or equal to 0.975 percent.........  0 percent.
----------------------------------------------------------------------------------------------------------------

    The countercyclical capital buffer amount under the final rule for 
U.S. credit exposures is initially set to zero, but it could increase 
if the agencies and the FDIC determine that there is excessive credit 
in the markets that could lead to subsequent wide-spread market 
failures. Generally, a zero percent countercyclical capital buffer 
amount will reflect an assessment that economic and financial 
conditions are consistent with a period of little or no excessive ease 
in credit markets associated with no material increase in system-wide 
credit risk. A 2.5 percent countercyclical capital buffer amount will 
reflect an assessment that financial markets are experiencing a period 
of excessive ease in credit markets associated with a material increase 
in system-wide credit risk.

F. Prompt Corrective Action Requirements

    All insured depository institutions, regardless of total asset size 
or foreign exposure, currently are required to compute PCA capital 
levels using the agencies' and the FDIC's general risk-based capital 
rules, as supplemented by the market risk rule. Section 38 of the 
Federal Deposit Insurance Act directs the federal banking agencies and 
the FDIC to resolve the problems of insured depository institutions at 
the least cost to the Deposit Insurance Fund.\49\ To facilitate this 
purpose, the agencies and the FDIC have established five regulatory 
capital categories in the PCA regulations that include capital 
thresholds for the leverage ratio, tier 1 risk-based capital ratio, and 
the total risk-based capital ratio for insured depository institutions. 
These five PCA categories under section 38 of the Act and the PCA 
regulations are: ``well capitalized,'' ``adequately capitalized,'' 
``undercapitalized,'' ``significantly undercapitalized,'' and 
``critically undercapitalized.'' Insured depository institutions that 
fail to meet these capital measures are subject to increasingly strict 
limits on their activities, including their ability to make capital 
distributions, pay management fees, grow their balance sheet, and take 
other actions.\50\ Insured depository institutions are expected to be 
closed within 90 days of becoming ``critically undercapitalized,'' 
unless their primary Federal supervisor takes such other action as that 
primary Federal supervisor determines, with the concurrence of the 
FDIC, would better achieve the purpose of PCA.\51\
---------------------------------------------------------------------------

    \49\ 12 U.S.C. 1831o.
    \50\ 12 U.S.C. 1831o(e)-(i). See 12 CFR part 6 (national banks) 
and 12 CFR part 165 (Federal savings associations) (OCC); 12 CFR 
part 208, subpart D (Board).
    \51\ 12 U.S.C. 1831o(g)(3).
---------------------------------------------------------------------------

    The proposal maintained the structure of the PCA framework while 
increasing some of the thresholds for the PCA capital categories and 
adding the proposed common equity tier 1 capital ratio. For example, 
under the proposed rule, the thresholds for adequately capitalized 
banking organizations would be equal to the minimum capital 
requirements. The risk-based capital ratios for well capitalized 
banking organizations under PCA would continue to be two percentage 
points higher than the ratios for adequately-capitalized banking 
organizations, and the leverage ratio for well capitalized banking 
organizations under PCA would be one percentage point higher than for 
adequately-capitalized banking organizations. Advanced approaches 
banking organizations that are insured depository institutions also 
would be required to satisfy a supplementary leverage ratio of 3 
percent in order to be considered adequately capitalized. While the 
proposed PCA levels do not incorporate the capital conservation buffer, 
the PCA and capital conservation buffer frameworks would complement 
each other to ensure that banking organizations hold an adequate amount 
of common equity tier 1 capital.
    The agencies and the FDIC received a number of comments on the 
proposed PCA framework. Several commenters suggested modifications to 
the proposed PCA levels, particularly with respect to the leverage 
ratio. For example, a few commenters encouraged the agencies and the 
FDIC to increase the adequately-capitalized and well capitalized 
categories for the leverage ratio to six percent or more and eight 
percent or

[[Page 62041]]

more, respectively. According to one commenter, such thresholds would 
more closely align with the actual leverage ratios of many state-
charted depository institutions.
    Another commenter expressed concern regarding the operational 
complexity of the proposed PCA framework in view of the addition of the 
common equity tier 1 capital ratio and the interaction of the PCA 
framework and the capital conservation buffer. For example, under the 
proposed rule a banking organization could be well capitalized for PCA 
purposes and, at the same time, be subject to restrictions on dividends 
and bonus payments. Other banking organizations expressed concern that 
the proposed PCA levels would adversely affect their ability to lend 
and generate income. This, according to a commenter, also would reduce 
net income and return-on-equity.
    The agencies believe the capital conservation buffer complements 
the PCA framework--the former works to keep banking organizations above 
the minimum capital ratios, whereas the latter imposes increasingly 
stringent consequences on depository institutions, particularly as they 
fall below the minimum capital ratios. Because the capital conservation 
buffer is designed to absorb losses in stressful periods, the agencies 
believe it is appropriate for a depository institution to be able to 
use some of its capital conservation buffer without being considered 
less than well capitalized for PCA purposes.
    A few comments pertained specifically to issues affecting BHCs and 
SLHCs. A commenter encouraged the Board to require an advanced 
approaches banking organization, including a BHC, to use the advanced 
approaches rule for determining whether it is well capitalized for PCA 
purposes. This commenter maintained that neither the Bank Holding 
Company Act \52\ nor section 171 of the Dodd-Frank Act requires an 
advanced approaches banking organization to use the lower of its 
minimum ratios as calculated under the general risk-based capital rules 
and the advanced approaches rule to determine well capitalized status. 
Another commenter requested clarification from the Board that section 
171 of the Dodd-Frank Act does not apply to determinations regarding 
whether a BHC is a financial holding company under Board regulations. 
In order to elect to be a financial holding company under the Bank 
Holding Company Act, as amended by section 616 of the Dodd-Frank Act, a 
BHC and all of its depository institution subsidiaries must be well 
capitalized and well managed. The final rule does not establish the 
standards for determining whether a BHC is ``well-capitalized.''
---------------------------------------------------------------------------

    \52\ 12 U.S.C. 1841, et seq.
---------------------------------------------------------------------------

    Consistent with the proposal, the final rule augments the PCA 
capital categories by introducing a common equity tier 1 capital 
measure for four of the five PCA categories (excluding the critically 
undercapitalized PCA category).\53\ In addition, the final rule revises 
the three current risk-based capital measures for four of the five PCA 
categories to reflect the final rule's changes to the minimum risk-
based capital ratios, as provided in the agency-specific revisions to 
the agencies' PCA regulations. All banking organizations that are 
insured depository institutions will remain subject to leverage measure 
thresholds using the current leverage ratio in the form of tier 1 
capital to average total consolidated assets. In addition, the final 
rule amends the PCA leverage measure for advanced approaches depository 
institutions to include the supplementary leverage ratio that 
explicitly applies to the ``adequately capitalized'' and 
``undercapitalized'' capital categories.
---------------------------------------------------------------------------

    \53\ 12 U.S.C. 1831o(c)(1)(B)(i).
---------------------------------------------------------------------------

    All insured depository institutions must comply with the revised 
PCA thresholds beginning on January 1, 2015. Consistent with transition 
provisions in the proposed rules, the supplementary leverage measure 
for advanced approaches banking organizations that are insured 
depository institutions becomes effective on January 1, 2018. Changes 
to the definitions of the individual capital components that are used 
to calculate the relevant capital measures under PCA are governed by 
the transition arrangements discussed in section VIII.3 below. Thus, 
the changes to these definitions, including any deductions from or 
adjustments to regulatory capital, automatically flow through to the 
definitions in the PCA framework.
    Table 4 sets forth the risk-based capital and leverage ratio 
thresholds under the final rule for each of the PCA capital categories 
for all insured depository institutions. For each PCA category except 
critically undercapitalized, an insured depository institution must 
satisfy a minimum common equity tier 1 capital ratio, in addition to a 
minimum tier 1 risk-based capital ratio, total risk-based capital 
ratio, and leverage ratio. In addition to the aforementioned 
requirements, advanced approaches banking organizations that are 
insured depository institutions are also subject to a supplementary 
leverage ratio.

                                                                   Table 4--PCA Levels for All Insured Depository Institutions
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                  Common equity          Leverage measure
                                                   Total risk-                     tier 1 RBC   ---------------------------------
                                                  based capital    Tier 1 RBC        measure
                  PCA category                    (RBC) measure   measure (tier  (common equity                   Supplementary                          PCA requirements
                                                   (total RBC      1 RBC ratio     tier 1 RBC    Leverage ratio   leverage ratio
                                                     ratio--       (percent))         ratio         (percent)      (percent) *
                                                   (percent))                      (percent))
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Well capitalized...............................            >=10             >=8           >=6.5             >=5   Not applicable  Unchanged from current rule *
Adequately-capitalized.........................             >=8             >=6           >=4.5             >=4            >=3.0  *
Undercapitalized...............................              <8              <6            <4.5              <4            <3.00  *
Significantly undercapitalized.................              <6              <4              <3              <3   Not applicable  *
                                                ----------------------------------------------------------------
Critically undercapitalized....................    Tangible equity (defined as tier 1 capital plus non-tier 1     Not applicable  *
                                                         perpetual preferred stock) to total assets <=2
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
* The supplementary leverage ratio as a PCA requirement applies only to advanced approaches banking organizations that are insured depository institutions. The supplementary leverage ratio
  also applies to advanced approaches bank holding companies, although not in the form of a PCA requirement.


[[Page 62042]]

    To be well capitalized for purposes of the final rule, an insured 
depository institution must maintain a total risk-based capital ratio 
of 10 percent or more; a tier 1 capital ratio of 8 percent or more; a 
common equity tier 1 capital ratio of 6.5 percent or more; and a 
leverage ratio of 5 percent or more. An adequately-capitalized 
depository institution must maintain a total risk-based capital ratio 
of 8 percent or more; a tier 1 capital ratio of 6 percent or more; a 
common equity tier 1 capital ratio of 4.5 percent or more; and a 
leverage ratio of 4 percent or more.
    An insured depository institution is undercapitalized under the 
final rule if its total capital ratio is less than 8 percent, if its 
tier 1 capital ratio is less than 6 percent, its common equity tier 1 
capital ratio is less than 4.5 percent, or its leverage ratio is less 
than 4 percent. If an institution's tier 1 capital ratio is less than 4 
percent, or its common equity tier 1 capital ratio is less than 3 
percent, it would be considered significantly undercapitalized. The 
other numerical capital ratio thresholds for being significantly 
undercapitalized remain unchanged from the current rules.\54\
---------------------------------------------------------------------------

    \54\ Under current PCA standards, in order to qualify as well-
capitalized, an insured depository institution must not be subject 
to any written agreement, order, capital directive, or prompt 
corrective action directive issued by its primary Federal regulator 
pursuant to section 8 of the Federal Deposit Insurance Act, the 
International Lending Supervision Act of 1983, or section 38 of the 
Federal Deposit Insurance Act, or any regulation thereunder. See 12 
CFR 6.4(b)(1)(iv) (national banks), 12 CFR 165.4(b)(1)(iv) (Federal 
savings associations) (OCC); 12 CFR 208.43(b)(1)(iv) (Board). The 
final rule does not change this requirement.
---------------------------------------------------------------------------

    The determination of whether an insured depository institution is 
critically undercapitalized for PCA purposes is based on its ratio of 
tangible equity to total assets.\55\ This is a statutory requirement 
within the PCA framework, and the experience of the recent financial 
crisis has confirmed that tangible equity is of critical importance in 
assessing the viability of an insured depository institution. Tangible 
equity for PCA purposes is currently defined as including core capital 
elements,\56\ which consist of: (1) Common stockholder's equity, (2) 
qualifying noncumulative perpetual preferred stock (including related 
surplus), and (3) minority interest in the equity accounts of 
consolidated subsidiaries; plus outstanding cumulative preferred 
perpetual stock; minus all intangible assets except mortgage servicing 
rights to the extent permitted in tier 1 capital. The current PCA 
definition of tangible equity does not address the treatment of DTAs in 
determining whether an insured depository institution is critically 
undercapitalized.
---------------------------------------------------------------------------

    \55\ See 12 U.S.C. 1831o(c)(3)(A) and (B), which for purposes of 
the ``critically undercapitalized'' PCA category requires the ratio 
of tangible equity to total assets to be set at an amount ``not less 
than 2 percent of total assets.''
    \56\ The OCC notes that under the OCC's PCA rule with respect to 
national banks, the definition of tangible equity does not use the 
term ``core capital elements.'' 12 CFR 6.2(g).
---------------------------------------------------------------------------

    Consistent with the proposal, the final rule revises the 
calculation of the capital measure for the critically undercapitalized 
PCA category by revising the definition of tangible equity to consist 
of tier 1 capital, plus outstanding perpetual preferred stock 
(including related surplus) not included in tier 1 capital. The revised 
definition more appropriately aligns the calculation of tangible equity 
with the calculation of tier 1 capital generally for regulatory capital 
requirements. Assets included in a banking organization's equity under 
GAAP, such as DTAs, are included in tangible equity only to the extent 
that they are included in tier 1 capital. The agencies believe this 
modification promotes consistency and provides for clearer boundaries 
across and between the various PCA categories.
    In addition to the changes described in this section, the OCC 
proposed to integrate its PCA rules for national banks and Federal 
savings associations. Specifically, the OCC proposed to make 12 CFR 
part 6 applicable to Federal savings associations, and to rescind the 
current PCA rules in 12 CFR part 165 governing Federal savings 
associations, with the exception of Sec.  165.8 (Procedures for 
reclassifying a federal savings association based on criteria other 
than capital), and Sec.  165.9 (Order to dismiss a director or senior 
executive officer). The OCC proposed to retain Sec. Sec.  165.8 and 
165.9 because those sections relate to enforcement procedures and the 
procedural rules in 12 CFR part 19 do not apply to Federal savings 
associations at this time. Therefore, the OCC must retain Sec. Sec.  
165.8 and 165.9. Finally, the proposal also made non-substantive, 
technical amendments to part 6 and Sec. Sec.  165.8 and 165.9.
    The OCC received no comments on these proposed changes and 
therefore is adopting these proposed amendments as final, with minor 
technical edits. The OCC notes that, consistent with the proposal, as 
part of the integration of Federal savings associations, Federal 
savings associations will now calculate tangible equity based on 
average total assets rather than period-end total assets.

G. Supervisory Assessment of Overall Capital Adequacy

    Capital helps to ensure that individual banking organizations can 
continue to serve as credit intermediaries even during times of stress, 
thereby promoting the safety and soundness of the overall U.S. banking 
system. The agencies' general risk-based capital rules indicate that 
the capital requirements are minimum standards generally based on broad 
credit-risk considerations.\57\ The risk-based capital ratios under 
these rules do not explicitly take account of the quality of individual 
asset portfolios or the range of other types of risk to which banking 
organizations may be exposed, such as interest-rate, liquidity, market, 
or operational risks.\58\
---------------------------------------------------------------------------

    \57\ See 12 CFR part 3, App. A, Sec. 1(b)(1) (national banks) 
and 12 CFR part 167.3(b) and (c) (Federal savings associations) 
(OCC); 12 CFR 208.4 (state member banks).
    \58\ The risk-based capital ratios of a banking organization 
subject to the market risk rule do include capital requirements for 
the market risk of covered positions, and the risk-based capital 
ratios calculated using advanced approaches total risk-weighted 
assets for an advanced approaches banking organization that has 
completed the parallel run process and received notification from 
its primary Federal supervisor pursuant to section 121(d) do include 
a capital requirement for operational risks.
---------------------------------------------------------------------------

    A banking organization is generally expected to have internal 
processes for assessing capital adequacy that reflect a full 
understanding of its risks and to ensure that it holds capital 
corresponding to those risks to maintain overall capital adequacy.\59\ 
The nature of such capital adequacy assessments should be commensurate 
with banking organizations' size, complexity, and risk-profile. 
Consistent with longstanding practice, supervisory assessment of 
capital adequacy will take account of whether a banking organization 
plans appropriately to maintain an adequate level of capital given its 
activities and risk profile, as well as risks and other factors that 
can affect a banking organization's financial condition, including, for 
example, the level and severity of problem assets and its exposure to 
operational and interest rate risk, and significant asset 
concentrations. For this reason, a supervisory assessment of capital 
adequacy may differ significantly from conclusions that might be drawn 
solely from the level of a banking organization's regulatory capital 
ratios.
---------------------------------------------------------------------------

    \59\ The Basel framework incorporates similar requirements under 
Pillar 2 of Basel II.
---------------------------------------------------------------------------

    In light of these considerations, as a prudential matter, a banking 
organization is generally expected to operate with capital positions 
well

[[Page 62043]]

above the minimum risk-based ratios and to hold capital commensurate 
with the level and nature of the risks to which it is exposed, which 
may entail holding capital significantly above the minimum 
requirements. For example, banking organizations contemplating 
significant expansion proposals are expected to maintain strong capital 
levels substantially above the minimum ratios and should not allow 
significant diminution of financial strength below these strong levels 
to fund their expansion plans. Banking organizations with high levels 
of risk are also expected to operate even further above minimum 
standards. In addition to evaluating the appropriateness of a banking 
organization's capital level given its overall risk profile, the 
supervisory assessment takes into account the quality and trends in a 
banking organization's capital composition, including the share of 
common and non-common-equity capital elements.
    Some commenters stated that they manage their capital so that they 
operate with a buffer over the minimum and that examiners expect such a 
buffer. These commenters expressed concern that examiners will expect 
even higher capital levels, such as a buffer in addition to the new 
higher minimums and capital conservation buffer (and countercyclical 
capital buffer, if applicable). Consistent with the longstanding 
approach employed by the agencies in their supervision of banking 
organizations, section 10(d) of the final rule maintains and reinforces 
supervisory expectations by requiring that a banking organization 
maintain capital commensurate with the level and nature of all risks to 
which it is exposed and that a banking organization have a process for 
assessing its overall capital adequacy in relation to its risk profile, 
as well as a comprehensive strategy for maintaining an appropriate 
level of capital.
    The supervisory evaluation of a banking organization's capital 
adequacy, including compliance with section 10(d), may include such 
factors as whether the banking organization is newly chartered, 
entering new activities, or introducing new products. The assessment 
also would consider whether a banking organization is receiving special 
supervisory attention, has or is expected to have losses resulting in 
capital inadequacy, has significant exposure due to risks from 
concentrations in credit or nontraditional activities, or has 
significant exposure to interest rate risk, operational risk, or could 
be adversely affected by the activities or condition of a banking 
organization's holding company or other affiliates.
    Supervisors also evaluate the comprehensiveness and effectiveness 
of a banking organization's capital planning in light of its activities 
and capital levels. An effective capital planning process involves an 
assessment of the risks to which a banking organization is exposed and 
its processes for managing and mitigating those risks, an evaluation of 
its capital adequacy relative to its risks, and consideration of the 
potential impact on its earnings and capital base from current and 
prospective economic conditions.\60\ While the elements of supervisory 
review of capital adequacy would be similar across banking 
organizations, evaluation of the level of sophistication of an 
individual banking organization's capital adequacy process would be 
commensurate with the banking organization's size, sophistication, and 
risk profile, similar to the current supervisory practice.
---------------------------------------------------------------------------

    \60\ See, e.g., SR 09-4, Applying Supervisory Guidance and 
Regulations on the Payment of Dividends, Stock Redemptions, and 
Stock Repurchases at Bank Holding Companies (Board); see also OCC 
Bulletin 2012-16, Guidance for Evaluating Capital Planning and 
Adequacy.
---------------------------------------------------------------------------

H. Tangible Capital Requirement for Federal Savings Associations

    As part of the OCC's overall effort to integrate the regulatory 
requirements for national banks and Federal savings associations, the 
OCC proposed to include a tangible capital requirement for Federal 
savings associations.\61\ Under section 5(t)(2)(B) of HOLA,\62\ Federal 
savings associations are required to maintain tangible capital in an 
amount not less than 1.5 percent of total assets.\63\ This statutory 
requirement is implemented in the OCC's current capital rules 
applicable to Federal savings associations at 12 CFR 167.9.\64\ Under 
that rule, tangible capital is defined differently from other capital 
measures, such as tangible equity in current 12 CFR part 165.
---------------------------------------------------------------------------

    \61\ Under Title III of the Dodd-Frank Act, the OCC assumed all 
functions of the Office of Thrift Supervision (OTS) and the Director 
of the OTS relating to Federal savings associations. As a result, 
the OCC has responsibility for the ongoing supervision, examination 
and regulation of Federal savings associations as of the transfer 
date of July 21, 2011. The Act also transfers to the OCC the 
rulemaking authority of the OTS relating to all savings 
associations, both state and Federal for certain rules. Section 
312(b)(2)(B)(i) (codified at 12 U.S.C. 5412(b)(2)(B)(i)). The FDIC 
has rulemaking authority for the capital and PCA rules pursuant to 
section 38 of the FDI Act (12 U.S.C. 1831n) and section 5(t)(1)(A) 
of the Home Owners' Loan Act (12 U.S.C.1464(t)(1)(A)).
    \62\ 12 U.S.C. 1464(t).
    \63\ ``Tangible capital'' is defined in section 5(t)(9)(B) of 
HOLA to mean ``core capital minus any intangible assets (as 
intangible assets are defined by the Comptroller of the Currency for 
national banks.)'' 12 U.S.C. 1464(t)(9)(B). Section 5(t)(9)(A) of 
HOLA defines ``core capital'' to mean ``core capital as defined by 
the Comptroller of the Currency for national banks, less any 
unidentifiable intangible assets [goodwill]'' unless the OCC 
prescribes a more stringent definition. 12 U.S.C. 1464(t)(9)(A).
    \64\ 54 FR 49649 (Nov. 30, 1989).
---------------------------------------------------------------------------

    After reviewing HOLA, the OCC determined that a unique regulatory 
definition of tangible capital is not necessary to satisfy the 
requirement of the statute. Therefore, the OCC is defining ``tangible 
capital'' as the amount of tier 1 capital plus the amount of 
outstanding perpetual preferred stock (including related surplus) not 
included in tier 1 capital. This definition mirrors the proposed 
definition of ``tangible equity'' for PCA purposes.\65\ While the OCC 
recognizes that the terms used are not identical (``capital'' as 
compared to ``equity''), the OCC believes that this revised definition 
of tangible capital will reduce the computational burden on Federal 
savings associations in complying with this statutory mandate, as well 
as remaining consistent with both the purposes of HOLA and PCA.
---------------------------------------------------------------------------

    \65\ See 12 CFR 6.2.
---------------------------------------------------------------------------

    The final rule adopts this definition as proposed. In addition, in 
Sec.  3.10(b)(5) and (c)(5) of the proposal, the OCC defined the term 
``Federal savings association tangible capital ratio'' to mean the 
ratio of the Federal savings association's core capital (Tier 1 
capital) to total adjusted assets as calculated under subpart B of part 
3. The OCC notes that this definition is inconsistent with the proposed 
definition of the tangible equity ratio for national banks and Federal 
savings associations, at Sec.  6.4(b)(5) and (c)(5), in which the 
denominator of the ratio is quarterly average total assets. 
Accordingly, in keeping with the OCC's goal of integrating rules for 
Federal savings associations and national banks wherever possible and 
reducing implementation burden associated with a separate measure of 
tangible capital, the final rule replaces the term ``total adjusted 
assets'' in the definition of ``Federal savings association tangible 
capital ratio'' with the term ``average total assets.'' As a result of 
the changes in these definitions, Federal savings associations will no 
longer calculate the tangible capital ratio using period end total 
assets.

[[Page 62044]]

V. Definition of Capital

A. Capital Components and Eligibility Criteria for Regulatory Capital 
Instruments

1. Common Equity Tier 1 Capital
    Under the proposed rule, common equity tier 1 capital was defined 
as the sum of a banking organization's outstanding common equity tier 1 
capital instruments that satisfy the criteria set forth in section 
20(b) of the proposal, related surplus (net of treasury stock), 
retained earnings, AOCI, and common equity tier 1 minority interest 
subject to certain limitations, minus regulatory adjustments and 
deductions.
    The proposed rule set forth a list of criteria that an instrument 
would be required to meet to be included in common equity tier 1 
capital. The proposed criteria were designed to ensure that common 
equity tier 1 capital instruments do not possess features that would 
cause a banking organization's condition to further weaken during 
periods of economic and market stress. In the proposals, the agencies 
and the FDIC indicated that they believe most existing common stock 
instruments issued by U.S. banking organizations already would satisfy 
the proposed criteria.
    The proposed criteria also applied to instruments issued by banking 
organizations such as mutual banking organizations where ownership of 
the organization is not freely transferable or evidenced by 
certificates of ownership or stock. For these entities, the proposal 
provided that instruments issued by such organizations would be 
considered common equity tier 1 capital if they are fully equivalent to 
common stock instruments in terms of their subordination and 
availability to absorb losses, and do not possess features that could 
cause the condition of the organization to weaken as a going concern 
during periods of market stress.
    The agencies and the FDIC noted in the proposal that stockholders' 
voting rights generally are a valuable corporate governance tool that 
permits parties with an economic interest to participate in the 
decision-making process through votes on establishing corporate 
objectives and policy, and in electing the banking organization's board 
of directors. Therefore, the agencies believe that voting common 
stockholders' equity (net of the adjustments to and deductions from 
common equity tier 1 capital proposed under the rule) should be the 
dominant element within common equity tier 1 capital. The proposal also 
provided that to the extent that a banking organization issues non-
voting common stock or common stock with limited voting rights, the 
underlying stock must be identical to those underlying the banking 
organization's voting common stock in all respects except for any 
limitations on voting rights.
    To ensure that a banking organization's common equity tier 1 
capital would be available to absorb losses as they occur, the proposed 
rule would have required common equity tier 1 capital instruments 
issued by a banking organization to satisfy the following criteria:
    (1) The instrument is paid-in, issued directly by the banking 
organization, and represents the most subordinated claim in a 
receivership, insolvency, liquidation, or similar proceeding of the 
banking organization.
    (2) The holder of the instrument is entitled to a claim on the 
residual assets of the banking organization that is proportional with 
the holder's share of the banking organization's issued capital after 
all senior claims have been satisfied in a receivership, insolvency, 
liquidation, or similar proceeding. That is, the holder has an 
unlimited and variable claim, not a fixed or capped claim.
    (3) The instrument has no maturity date, can only be redeemed via 
discretionary repurchases with the prior approval of the banking 
organization's primary Federal supervisor, and does not contain any 
term or feature that creates an incentive to redeem.
    (4) The banking organization did not create at issuance of the 
instrument, through any action or communication, an expectation that it 
will buy back, cancel, or redeem the instrument, and the instrument 
does not include any term or feature that might give rise to such an 
expectation.
    (5) Any cash dividend payments on the instrument are paid out of 
the banking organization's net income and retained earnings and are not 
subject to a limit imposed by the contractual terms governing the 
instrument.
    (6) The banking organization has full discretion at all times to 
refrain from paying any dividends and making any other capital 
distributions on the instrument without triggering an event of default, 
a requirement to make a payment-in-kind, or an imposition of any other 
restrictions on the banking organization.
    (7) Dividend payments and any other capital distributions on the 
instrument may be paid only after all legal and contractual obligations 
of the banking organization have been satisfied, including payments due 
on more senior claims.
    (8) The holders of the instrument bear losses as they occur 
equally, proportionately, and simultaneously with the holders of all 
other common stock instruments before any losses are borne by holders 
of claims on the banking organization with greater priority in a 
receivership, insolvency, liquidation, or similar proceeding.
    (9) The paid-in amount is classified as equity under GAAP.
    (10) The banking organization, or an entity that the banking 
organization controls, did not purchase or directly or indirectly fund 
the purchase of the instrument.
    (11) The instrument is not secured, not covered by a guarantee of 
the banking organization or of an affiliate of the banking 
organization, and is not subject to any other arrangement that legally 
or economically enhances the seniority of the instrument.
    (12) The instrument has been issued in accordance with applicable 
laws and regulations. In most cases, the agencies understand that the 
issuance of these instruments would require the approval of the board 
of directors of the banking organization or, where applicable, of the 
banking organization's shareholders or of other persons duly authorized 
by the banking organization's shareholders.
    (13) The instrument is reported on the banking organization's 
regulatory financial statements separately from other capital 
instruments.
    The agencies and the FDIC requested comment on the proposed 
criteria for inclusion in common equity tier 1, and specifically on 
whether any of the criteria would be problematic, given the main 
characteristics of existing outstanding common stock instruments.
    A substantial number of comments addressed the criteria for common 
equity tier 1 capital. Generally, commenters stated that the proposed 
criteria could prevent some instruments currently included in tier 1 
capital from being included in the new common equity tier 1 capital 
measure. Commenters stated that this could create complicated and 
unnecessary burden for banking organizations that either would have to 
raise capital to meet the common equity tier 1 capital requirement or 
shrink their balance sheets by selling off or winding down assets and 
exposures. Many commenters stated that the burden of raising new 
capital would have the effect of reducing lending overall, and that it 
would be especially acute for smaller banking organizations that have 
limited access to capital markets.
    Many commenters asked the agencies and the FDIC to clarify several 
aspects of the proposed criteria. For instance, a

[[Page 62045]]

few commenters asked the agencies and the FDIC to clarify the proposed 
requirement that a common equity tier 1 capital instrument be redeemed 
only with prior approval by a banking organization's primary Federal 
supervisor. These commenters asked if this criterion would require a 
banking organization to note this restriction on the face of a 
regulatory capital instrument that it may be redeemed only with the 
prior approval of the banking organization's primary Federal 
supervisor.
    The agencies note that the requirement that common equity tier 1 
capital instruments be redeemed only with prior agency approval is 
consistent with the agencies' rules and federal law, which generally 
provide that a banking organization may not reduce its capital by 
redeeming capital instruments without receiving prior approval from its 
primary Federal supervisor.\66\ The final rule does not obligate the 
banking organization to include this restriction explicitly in the 
common equity tier 1 capital instrument's documentation. However, 
regardless of whether the instrument documentation states that its 
redemption is subject to agency approval, the banking organization must 
receive prior approval before redeeming such instruments. The agencies 
believe that the approval requirement is appropriate as it provides for 
the monitoring of the strength of a banking organization's capital 
position, and therefore, have retained the proposed requirement in the 
final rule.
---------------------------------------------------------------------------

    \66\ See 12 CFR 5.46 (national banks) and 12 CFR part 163, 
subpart E (Federal savings associations) (OCC); 12 CFR parts 208 and 
225, appendix A, section II(iii) (Board).
---------------------------------------------------------------------------

    Several commenters also expressed concern about the proposed 
requirement that dividend payments and any other distributions on a 
common equity tier 1 capital instrument may be paid only after all 
legal and contractual obligations of the banking organization have been 
satisfied, including payments due on more senior claims. Commenters 
stated that, as proposed, this requirement could be construed to 
prevent a banking organization from paying a dividend on a common 
equity tier 1 capital instrument because of obligations that have not 
yet become due or because of immaterial delays in paying trade 
creditors \67\ for obligations incurred in the ordinary course of 
business.
---------------------------------------------------------------------------

    \67\ Trade creditors, for this purpose, would include 
counterparties with whom the banking organization contracts to 
procure office space and/or supplies as well as basic services, such 
as building maintenance.
---------------------------------------------------------------------------

    The agencies note that this criterion should not prevent a banking 
organization from paying a dividend on a common equity tier 1 capital 
instrument where it has incurred operational obligations in the normal 
course of business that are not yet due or that are subject to minor 
delays for reasons unrelated to the financial condition of the banking 
organization, such as delays related to contractual or other legal 
disputes.
    A number of commenters also suggested that the proposed criteria 
providing that dividend payments may be paid only out of current and 
retained earnings potentially could conflict with state corporate law, 
including Delaware state law. According to these commenters, Delaware 
state law permits a corporation to make dividend payments out of its 
capital surplus account, even when the organization does not have 
current or retained earnings.
    The agencies observe that requiring that dividends be paid only out 
of net income and retained earnings is consistent with federal law and 
the existing regulations applicable to insured depository institutions. 
Under applicable statutes and regulations, a national bank or federal 
savings association may not declare and pay dividends in any year in an 
amount that exceeds the sum of its total net income for that year plus 
its retained net income for the preceding two years (minus certain 
transfers), unless it receives prior approval from the OCC. Therefore, 
as applied to national banks and Federal savings associations, this 
aspect of the proposal did not include any substantive changes from the 
general risk-based capital rules.\68\ Accordingly, with respect to 
national banks and savings associations, the criterion does not include 
surplus.
---------------------------------------------------------------------------

    \68\ See 12 U.S.C. 60(b) and 12 CFR 5.63 and 5.64 (national 
banks) and 12 CFR 163.143 (Federal savings associations) (OCC).
---------------------------------------------------------------------------

    However, because this criterion applies to the terms of the capital 
instrument, which is governed by state law, the Board is broadening the 
criterion in the final rule to include surplus for state-chartered 
companies under its supervision that are subject to the final rule. 
However, regardless of provisions of state law, under the Federal 
Reserve Act, state member banks are subject to the same restrictions as 
national banks that relate to the withdrawal or impairment of their 
capital stock, and the Board's regulations for state member banks 
reflect these limitations on dividend payments.\69\ It should be noted 
that restrictions may be applied to BHC dividends under the Board's 
capital plan rule for companies subject to that rule.\70\
---------------------------------------------------------------------------

    \69\ 12 CFR 208.5.
    \70\ See 12 CFR 225.8.
---------------------------------------------------------------------------

    Finally, several commenters expressed concerns about the potential 
impact of the proposed criteria on stock issued as part of certain 
employee stock ownership plans (ESOPs) (as defined under Employee 
Retirement Income Security Act of 1974 \71\ (ERISA) regulations at 29 
CFR 2550.407d-6). Under the proposed rule, an instrument would not be 
included in common equity tier 1 capital if the banking organization 
creates an expectation that it will buy back, cancel, or redeem the 
instrument, or if the instrument includes any term or feature that 
might give rise to such an expectation. Additionally, the criteria 
would prevent a banking organization from including in common equity 
tier 1 capital any instrument that is subject to any type of 
arrangement that legally or economically enhances the seniority of the 
instrument. Commenters noted that under ERISA, stock that is not 
publicly traded and issued as part of an ESOP must include a ``put 
option'' that requires the company to repurchase the stock. By 
exercising the put option, an employee can redeem the stock instrument 
upon termination of employment. Commenters noted that this put option 
clearly creates an expectation that the instrument will be redeemed and 
arguably enhances the seniority of the instrument. Therefore, the 
commenters stated that the put option could prevent a privately-held 
banking organization from including earned ESOP shares in its common 
equity tier 1 capital.
---------------------------------------------------------------------------

    \71\ 29 U.S.C. 1002, et seq.
---------------------------------------------------------------------------

    The agencies do not believe that an ERISA-mandated put option 
should prohibit ESOP shares from being included in common equity tier 1 
capital. Therefore, under the final rule, shares issued under an ESOP 
by a banking organization that is not publicly-traded are exempt from 
the criteria that the shares can be redeemed only via discretionary 
repurchases and are not subject to any other arrangement that legally 
or economically enhances their seniority, and that the banking 
organization not create an expectation that the shares will be 
redeemed. In addition to the concerns described above, because stock 
held in an ESOP is awarded by a banking organization for the retirement 
benefit of its employees, some commenters expressed concern

[[Page 62046]]

that such stock may not conform to the criterion prohibiting a banking 
organization from directly or indirectly funding a capital instrument. 
Because the agencies believe that a banking organization should have 
the flexibility to provide an ESOP as a benefit for its employees, the 
final rule provides that ESOP stock does not violate such criterion. 
Under the final rule, a banking organization's common stock held in 
trust for the benefit of employees as part of an ESOP in accordance 
with both ERISA and ERISA-related U.S. tax code requirements will 
qualify for inclusion as common equity tier 1 capital only to the 
extent that the instrument is includable as equity under GAAP and that 
it meets all other criteria of section 20(b)(1) of the final rule. 
Stock instruments held by an ESOP that are unawarded or unearned by 
employees or reported as ``temporary equity'' under GAAP (in the case 
of U.S. Securities and Exchange Commission (SEC) registrants), may not 
be counted as equity under GAAP and therefore may not be included in 
common equity tier 1 capital.
    After reviewing the comments received, the agencies have decided to 
finalize the proposed criteria for common equity tier 1 capital 
instruments, modified as discussed above. Although it is possible some 
currently outstanding common equity instruments may not meet the common 
equity tier 1 capital criteria, the agencies believe that most common 
equity instruments that are currently eligible for inclusion in banking 
organizations' tier 1 capital meet the common equity tier 1 capital 
criteria, and have not received information that would support a 
different conclusion. The agencies therefore believe that most banking 
organizations will not be required to reissue common equity instruments 
in order to comply with the final common equity tier 1 capital 
criteria. The final revised criteria for inclusion in common equity 
tier 1 capital are set forth in section 20(b)(1) of the final rule.
2. Additional Tier 1 Capital
    Consistent with Basel III, the agencies and the FDIC proposed that 
additional tier 1 capital would equal the sum of: Additional tier 1 
capital instruments that satisfy the criteria set forth in section 
20(c) of the proposal, related surplus, and any tier 1 minority 
interest that is not included in a banking organization's common equity 
tier 1 capital (subject to the proposed limitations on minority 
interest), less applicable regulatory adjustments and deductions. The 
agencies and the FDIC proposed the following criteria for additional 
tier 1 capital instruments in section 20(c):
    (1) The instrument is issued and paid-in.
    (2) The instrument is subordinated to depositors, general 
creditors, and subordinated debt holders of the banking organization in 
a receivership, insolvency, liquidation, or similar proceeding.
    (3) The instrument is not secured, not covered by a guarantee of 
the banking organization or of an affiliate of the banking 
organization, and not subject to any other arrangement that legally or 
economically enhances the seniority of the instrument.
    (4) The instrument has no maturity date and does not contain a 
dividend step-up or any other term or feature that creates an incentive 
to redeem.
    (5) If callable by its terms, the instrument may be called by the 
banking organization only after a minimum of five years following 
issuance, except that the terms of the instrument may allow it to be 
called earlier than five years upon the occurrence of a regulatory 
event (as defined in the agreement governing the instrument) that 
precludes the instrument from being included in additional tier 1 
capital or a tax event. In addition:
    (i) The banking organization must receive prior approval from its 
primary Federal supervisor to exercise a call option on the instrument.
    (ii) The banking organization does not create at issuance of the 
instrument, through any action or communication, an expectation that 
the call option will be exercised.
    (iii) Prior to exercising the call option, or immediately 
thereafter, the banking organization must either:
    (A) Replace the instrument to be called with an equal amount of 
instruments that meet the criteria under section 20(b) or (c) of the 
proposed rule (replacement can be concurrent with redemption of 
existing additional tier 1 capital instruments); or
    (B) Demonstrate to the satisfaction of its primary Federal 
supervisor that following redemption, the banking organization will 
continue to hold capital commensurate with its risk.
    (6) Redemption or repurchase of the instrument requires prior 
approval from the banking organization's primary Federal supervisor.
    (7) The banking organization has full discretion at all times to 
cancel dividends or other capital distributions on the instrument 
without triggering an event of default, a requirement to make a 
payment-in-kind, or an imposition of other restrictions on the banking 
organization except in relation to any capital distributions to holders 
of common stock.
    (8) Any capital distributions on the instrument are paid out of the 
banking organization's net income and retained earnings.
    (9) The instrument does not have a credit-sensitive feature, such 
as a dividend rate that is reset periodically based in whole or in part 
on the banking organization's credit quality, but may have a dividend 
rate that is adjusted periodically independent of the banking 
organization's credit quality, in relation to general market interest 
rates or similar adjustments.
    (10) The paid-in amount is classified as equity under GAAP.
    (11) The banking organization, or an entity that the banking 
organization controls, did not purchase or directly or indirectly fund 
the purchase of the instrument.
    (12) The instrument does not have any features that would limit or 
discourage additional issuance of capital by the banking organization, 
such as provisions that require the banking organization to compensate 
holders of the instrument if a new instrument is issued at a lower 
price during a specified time frame.
    (13) If the instrument is not issued directly by the banking 
organization or by a subsidiary of the banking organization that is an 
operating entity, the only asset of the issuing entity is its 
investment in the capital of the banking organization, and proceeds 
must be immediately available without limitation to the banking 
organization or to the banking organization's top-tier holding company 
in a form which meets or exceeds all of the other criteria for 
additional tier 1 capital instruments.\72\
---------------------------------------------------------------------------

    \72\ De minimis assets related to the operation of the issuing 
entity could be disregarded for purposes of this criterion.
---------------------------------------------------------------------------

    (14) For an advanced approaches banking organization, the governing 
agreement, offering circular, or prospectus of an instrument issued 
after January 1, 2013, must disclose that the holders of the instrument 
may be fully subordinated to interests held by the U.S. government in 
the event that the banking organization enters into a receivership, 
insolvency, liquidation, or similar proceeding.
    The proposed criteria were designed to ensure that additional tier 
1 capital instruments would be available to absorb losses on a going-
concern basis. TruPS and cumulative perpetual preferred securities, 
which are eligible for limited inclusion in tier 1 capital

[[Page 62047]]

under the general risk-based capital rules for bank holding companies, 
generally would not qualify for inclusion in additional tier 1 
capital.\73\ As explained in the proposal, the agencies believe that 
instruments that allow for the accumulation of interest payable, like 
cumulative preferred securities, are not likely to absorb losses to the 
degree appropriate for inclusion in tier 1 capital. In addition, the 
exclusion of these instruments from the tier 1 capital of depository 
institution holding companies would be consistent with section 171 of 
the Dodd-Frank Act.
---------------------------------------------------------------------------

    \73\ See 12 CFR part 225, appendix A, section II.A.1.
---------------------------------------------------------------------------

    The agencies noted in the proposal that under Basel III, 
instruments classified as liabilities for accounting purposes could 
potentially be included in additional tier 1 capital. However, the 
agencies and the FDIC proposed that an instrument classified as a 
liability under GAAP could not qualify as additional tier 1 capital, 
reflecting the agencies' and the FDIC's view that allowing only 
instruments classified as equity under GAAP in tier 1 capital helps 
strengthen the loss-absorption capabilities of additional tier 1 
capital instruments, thereby increasing the quality of the capital base 
of U.S. banking organizations.
    The agencies and the FDIC also proposed to allow banking 
organizations to include in additional tier 1 capital instruments that 
were: (1) Issued under the Small Business Jobs Act of 2010 \74\ or, 
prior to October 4, 2010, under the Emergency Economic Stabilization 
Act of 2008,\75\ and (2) included in tier 1 capital under the agencies' 
and the FDIC's general risk-based capital rules. Under the proposal, 
these instruments would be included in tier 1 capital regardless of 
whether they satisfied the proposed qualifying criteria for common 
equity tier 1 or additional tier 1 capital. The agencies and the FDIC 
explained in the proposal that continuing to permit these instruments 
to be included in tier 1 capital is important to promote financial 
recovery and stability following the recent financial crisis.\76\
---------------------------------------------------------------------------

    \74\ Public Law 111-240, 124 Stat. 2504 (2010).
    \75\ Public Law 110-343, 122 Stat. 3765 (October 3, 2008).
    \76\ See, e.g., 73 FR 43982 (July 29, 2008); see also 76 FR 
35959 (June 21, 2011).
---------------------------------------------------------------------------

    A number of commenters addressed the proposed criteria for 
additional tier 1 capital. Consistent with comments on the criteria for 
common equity tier 1 capital, commenters generally argued that imposing 
new restrictions on qualifying regulatory capital instruments would be 
burdensome for many banking organizations that would be required to 
raise additional capital or to shrink their balance sheets to phase out 
existing regulatory capital instruments that no longer qualify as 
regulatory capital under the proposed rule.
    With respect to the proposed criteria, commenters requested that 
the agencies and the FDIC make a number of changes and clarifications. 
Specifically, commenters asked the agencies and the FDIC to clarify the 
use of the term ``secured'' in criterion (3) above. In this context, a 
``secured'' instrument is an instrument that is backed by collateral. 
In order to qualify as additional tier 1 capital, an instrument may not 
be collateralized, guaranteed by the issuing organization or an 
affiliate of the issuing organization, or subject to any other 
arrangement that legally or economically enhances the seniority of the 
instrument relative to more senior claims. Instruments backed by 
collateral, guarantees, or other arrangements that affect their 
seniority are less able to absorb losses than instruments without such 
enhancements. Therefore, instruments secured by collateral, guarantees, 
or other enhancements would not be included in additional tier 1 
capital under the proposal. The agencies have adopted this criterion as 
proposed.
    Commenters also asked the agencies and the FDIC to clarify whether 
terms allowing a banking organization to convert a fixed-rate 
instrument to a floating rate in combination with a call option, 
without any increase in credit spread, would constitute an ``incentive 
to redeem'' under criterion (4). The agencies do not consider the 
conversion from a fixed rate to a floating rate (or from a floating 
rate to a fixed rate) in combination with a call option without any 
increase in credit spread to constitute an ``incentive to redeem'' for 
purposes of this criterion. More specifically, a call option combined 
with a change in reference rate where the credit spread over the second 
reference rate is equal to or less than the initial dividend rate less 
the swap rate (that is, the fixed rate paid to the call date to receive 
the second reference rate) would not be considered an incentive to 
redeem. For example, if the initial reference rate is 0.9 percent, the 
credit spread over the initial reference rate is 2 percent (that is, 
the initial dividend rate is 2.9 percent), and the swap rate to the 
call date is 1.2 percent, a credit spread over the second reference 
rate greater than 1.7 percent (2.9 percent minus 1.2 percent) would be 
considered an incentive to redeem. The agencies believe that the 
clarification above should address the commenters' concerns, and the 
agencies are retaining this criterion in the final rule as proposed.
    Several commenters noted that the proposed requirement that a 
banking organization seek prior approval from its primary Federal 
supervisor before exercising a call option is redundant with the 
existing requirement that a banking organization seek prior approval 
before reducing regulatory capital by redeeming a capital instrument. 
The agencies believe that the proposed requirement clarifies existing 
requirements and does not add any new substantive restrictions or 
burdens. Including this criterion also helps to ensure that the 
regulatory capital rules provide banking organizations a complete list 
of the requirements applicable to regulatory capital instruments in one 
location. Accordingly, the agencies have retained this requirement in 
the final rule.
    Banking industry commenters also asserted that some of the proposed 
criteria could have an adverse impact on ESOPs. Specifically, the 
commenters noted that the proposed requirement that instruments not be 
callable for at least five years after issuance could be problematic 
for compensation plans that enable a company to redeem shares after 
employment is terminated. Commenters asked the agencies and the FDIC to 
exempt from this requirement stock issued as part of an ESOP. For the 
reasons stated above in the discussion of common equity tier 1 capital 
instruments, under the final rule, additional tier 1 instruments issued 
under an ESOP by a banking organization that is not publicly traded are 
exempt from the criterion that additional tier 1 instruments not be 
callable for at least five years after issuance. Moreover, similar to 
the discussion above regarding the criteria for common equity tier 1 
capital, the agencies believe that required compliance with ERISA and 
ERISA-related tax code requirements alone should not prevent an 
instrument from being included in regulatory capital. Therefore, the 
agencies are including a provision in the final rule to clarify that 
the criterion prohibiting a banking organization from directly or 
indirectly funding a capital instrument, the criterion prohibiting a 
capital instrument from being covered by a guarantee of the banking 
organization or from being subject to an arrangement that enhances the 
seniority of the instrument, and the criterion pertaining to the 
creation of an expectation that the instrument will be redeemed, shall 
not prevent an instrument issued by a non-publicly traded banking 
organization as

[[Page 62048]]

part of an ESOP from being included in additional tier 1 capital. In 
addition, capital instruments held by an ESOP trust that are unawarded 
or unearned by employees or reported as ``temporary equity'' under GAAP 
(in the case of U.S. SEC registrants) may not be counted as equity 
under GAAP and therefore may not be included in additional tier 1 
capital.
    Commenters also asked the agencies and the FDIC to add exceptions 
for early calls within five years of issuance in the case of an 
``investment company event'' or a ``rating agency event,'' in addition 
to the proposed exceptions for regulatory and tax events. After 
considering the comments on these issues, the agencies have decided to 
revise the rule to permit a banking organization to call an instrument 
prior to five years after issuance in the event that the issuing entity 
is required to register as an investment company pursuant to the 
Investment Company Act of 1940.\77\ The agencies recognize that the 
legal and regulatory burdens of becoming an investment company could 
make it uneconomic to leave some structured capital instruments 
outstanding, and thus would permit the banking organization to call 
such instruments early.
---------------------------------------------------------------------------

    \77\ 15 U.S.C. 80 a-1 et seq.
---------------------------------------------------------------------------

    In order to ensure the loss-absorption capacity of additional tier 
1 capital instruments, the agencies have decided not to revise the rule 
to permit a banking organization to include in its additional tier 1 
capital instruments issued on or after the effective date of the rule 
that may be called prior to five years after issuance upon the 
occurrence of a rating agency event. However, understanding that many 
currently outstanding instruments have this feature, the agencies have 
decided to revise the rule to allow an instrument that may be called 
prior to five years after its issuance upon the occurrence of a rating 
agency event to be included into additional tier 1 capital, provided 
that (i) the instrument was issued and included in a banking 
organization's tier 1 capital prior to the effective date of the rule, 
and (ii) that such instrument meets all other criteria for additional 
tier 1 capital instruments under the final rule.
    In addition, a number of commenters reiterated the concern that 
restrictions on the payment of dividends from net income and current 
and retained earnings may conflict with state corporate laws that 
permit an organization to issue dividend payments from its capital 
surplus accounts. This criterion for additional tier 1 capital in the 
final rule reflects the identical final criterion for common equity 
tier 1 for the reasons discussed above with respect to common equity 
tier 1 capital.
    Commenters also noted that proposed criterion (10), which requires 
the paid-in amounts of tier 1 capital instruments to be classified as 
equity under GAAP before they may be included in regulatory capital, 
generally would prevent contingent capital instruments, which are 
classified as liabilities, from qualifying as additional tier 1 
capital. These commenters asked the agencies and the FDIC to revise the 
rules to provide that contingent capital instruments will qualify as 
additional tier 1 capital, regardless of their treatment under GAAP. 
Another commenter noted the challenges for U.S. banking organizations 
in devising contingent capital instruments that would satisfy the 
proposed criteria, and noted that if U.S. banking organizations develop 
an acceptable instrument, the instrument likely would initially be 
classified as debt instead of equity for GAAP purposes. Thus, in order 
to accommodate this possibility, the commenter urged the agencies and 
the FDIC to revise the criterion to allow the agencies and the FDIC to 
permit such an instrument in additional tier 1 capital through 
interpretive guidance or specifically in the case of a particular 
instrument.
    The agencies continue to believe that restricting tier 1 capital 
instruments to those classified as equity under GAAP will help to 
ensure those instruments' capacity to absorb losses and further 
increase the quality of U.S. banking organizations' regulatory capital. 
The agencies therefore have decided to retain this aspect of the 
proposal. To the extent that a contingent capital instrument is 
considered a liability under GAAP, a banking organization may not 
include the instrument in its tier 1 capital under the final rule. At 
such time as an instrument converts from debt to equity under GAAP, the 
instrument would then satisfy this criterion.
    In the preamble to the proposed rule, the agencies included a 
discussion regarding whether criterion (7) should be revised to require 
banking organizations to reduce the dividend payment on tier 1 capital 
instruments to a penny when a banking organization reduces dividend 
payments on a common equity tier 1 capital instrument to a penny per 
share. Such a revision would increase the capacity of additional tier 1 
instruments to absorb losses as it would permit a banking organization 
to reduce its capital distributions on additional tier 1 instruments 
without eliminating entirely its common stock dividend. Commenters 
asserted that such a revision would be unnecessary and could affect the 
hierarchy of subordination in capital instruments. Commenters also 
claimed the revision could prove burdensome as it could substantially 
increase the cost of raising capital through additional tier 1 capital 
instruments. In light of these comments the agencies have decided to 
not modify criterion (7) to accommodate the issuance of a penny 
dividend as discussed in the proposal.
    Several commenters expressed concern that criterion (7) for 
additional tier 1 capital, could affect the tier 1 eligibility of 
existing noncumulative perpetual preferred stock. Specifically, the 
commenters were concerned that such a criterion would disallow 
contractual terms of an additional tier 1 capital instrument that 
restrict payment of dividends on another capital instrument that is 
pari passu in liquidation with the additional tier 1 capital instrument 
(commonly referred to as dividend stoppers). Consistent with Basel III, 
the agencies agree that restrictions related to capital distributions 
to holders of common stock instruments and holders of other capital 
instruments that are pari passu in liquidation with such additional 
tier 1 capital instruments are acceptable, and have amended this 
criterion accordingly for purposes of the final rule.
    After considering the comments on the proposal, the agencies have 
decided to finalize the criteria for additional tier 1 capital 
instruments with the modifications discussed above. The final revised 
criteria for additional tier 1 capital are set forth in section 
20(c)(1) of the final rule. The agencies expect that most outstanding 
noncumulative perpetual preferred stock that qualifies as tier 1 
capital under the agencies' general risk-based capital rules will 
qualify as additional tier 1 capital under the final rule.
3. Tier 2 Capital
    Consistent with Basel III, under the proposed rule, tier 2 capital 
would equal the sum of: Tier 2 capital instruments that satisfy the 
criteria set forth in section 20(d) of the proposal, related surplus, 
total capital minority interest not included in a banking 
organization's tier 1 capital (subject to certain limitations and 
requirements), and limited amounts of the allowance for loan and lease 
losses (ALLL) less any applicable regulatory adjustments and 
deductions. Consistent with the general risk-based capital rules, when 
calculating its total capital ratio using

[[Page 62049]]

the standardized approach, a banking organization would be permitted to 
include in tier 2 capital the amount of ALLL that does not exceed 1.25 
percent of its standardized total risk-weighted assets which would not 
include any amount of the ALLL. A banking organization subject to the 
market risk rule would exclude its standardized market risk-weighted 
assets from the calculation.\78\ In contrast, when calculating its 
total capital ratio using the advanced approaches, a banking 
organization would be permitted to include in tier 2 capital the excess 
of its eligible credit reserves over its total expected credit loss, 
provided the amount does not exceed 0.6 percent of its credit risk-
weighted assets.
---------------------------------------------------------------------------

    \78\ A banking organization would deduct the amount of ALLL in 
excess of the amount permitted to be included in tier 2 capital, as 
well as allocated transfer risk reserves, from its standardized 
total risk-weighted risk assets.
---------------------------------------------------------------------------

    Consistent with Basel III, the agencies and the FDIC proposed the 
following criteria for tier 2 capital instruments:
    (1) The instrument is issued and paid-in.
    (2) The instrument is subordinated to depositors and general 
creditors of the banking organization.
    (3) The instrument is not secured, not covered by a guarantee of 
the banking organization or of an affiliate of the banking 
organization, and not subject to any other arrangement that legally or 
economically enhances the seniority of the instrument in relation to 
more senior claims.
    (4) The instrument has a minimum original maturity of at least five 
years. At the beginning of each of the last five years of the life of 
the instrument, the amount that is eligible to be included in tier 2 
capital is reduced by 20 percent of the original amount of the 
instrument (net of redemptions) and is excluded from regulatory capital 
when remaining maturity is less than one year. In addition, the 
instrument must not have any terms or features that require, or create 
significant incentives for, the banking organization to redeem the 
instrument prior to maturity.
    (5) The instrument, by its terms, may be called by the banking 
organization only after a minimum of five years following issuance, 
except that the terms of the instrument may allow it to be called 
sooner upon the occurrence of an event that would preclude the 
instrument from being included in tier 2 capital, or a tax event. In 
addition:
    (i) The banking organization must receive the prior approval of its 
primary Federal supervisor to exercise a call option on the instrument.
    (ii) The banking organization does not create at issuance, through 
action or communication, an expectation the call option will be 
exercised.
    (iii) Prior to exercising the call option, or immediately 
thereafter, the banking organization must either:
    (A) Replace any amount called with an equivalent amount of an 
instrument that meets the criteria for regulatory capital under section 
20 of the proposed rule; \79\ or
---------------------------------------------------------------------------

    \79\ Replacement of tier 2 capital instruments can be concurrent 
with redemption of existing tier 2 capital instruments.
---------------------------------------------------------------------------

    (B) Demonstrate to the satisfaction of the banking organization's 
primary Federal supervisor that following redemption, the banking 
organization would continue to hold an amount of capital that is 
commensurate with its risk.
    (6) The holder of the instrument must have no contractual right to 
accelerate payment of principal or interest on the instrument, except 
in the event of a receivership, insolvency, liquidation, or similar 
proceeding of the banking organization.
    (7) The instrument has no credit-sensitive feature, such as a 
dividend or interest rate that is reset periodically based in whole or 
in part on the banking organization's credit standing, but may have a 
dividend rate that is adjusted periodically independent of the banking 
organization's credit standing, in relation to general market interest 
rates or similar adjustments.
    (8) The banking organization, or an entity that the banking 
organization controls, has not purchased and has not directly or 
indirectly funded the purchase of the instrument.
    (9) If the instrument is not issued directly by the banking 
organization or by a subsidiary of the banking organization that is an 
operating entity, the only asset of the issuing entity is its 
investment in the capital of the banking organization, and proceeds 
must be immediately available without limitation to the banking 
organization or the banking organization's top-tier holding company in 
a form that meets or exceeds all the other criteria for tier 2 capital 
instruments under this section.\80\
---------------------------------------------------------------------------

    \80\ De minimis assets related to the operation of the issuing 
entity can be disregarded for purposes of this criterion.
---------------------------------------------------------------------------

    (10) Redemption of the instrument prior to maturity or repurchase 
requires the prior approval of the banking organization's primary 
Federal supervisor.
    (11) For an advanced approaches banking organization, the governing 
agreement, offering circular, or prospectus of an instrument issued 
after January 1, 2013, must disclose that the holders of the instrument 
may be fully subordinated to interests held by the U.S. government in 
the event that the banking organization enters into a receivership, 
insolvency, liquidation, or similar proceeding.
    The agencies and the FDIC also proposed to eliminate the inclusion 
of a portion of certain unrealized gains on AFS equity securities in 
tier 2 capital given that unrealized gains and losses on AFS securities 
would flow through to common equity tier 1 capital under the proposed 
rules.
    As a result of the proposed new minimum common equity tier 1 
capital requirement, higher tier 1 capital requirement, and the broader 
goal of simplifying the definition of tier 2 capital, the proposal 
eliminated the existing limitations on the amount of tier 2 capital 
that could be recognized in total capital, as well as the existing 
limitations on the amount of certain capital instruments (that is, term 
subordinated debt) that could be included in tier 2 capital.
    Finally, the agencies and the FDIC proposed to allow an instrument 
that qualified as tier 2 capital under the general risk-based capital 
rules and that was issued under the Small Business Jobs Act of 
2010,\81\ or, prior to October 4, 2010, under the Emergency Economic 
Stabilization Act of 2008, to continue to be includable in tier 2 
capital regardless of whether it met all of the proposed qualifying 
criteria.
---------------------------------------------------------------------------

    \81\ Public Law 111-240, 124 Stat. 2504 (2010).
---------------------------------------------------------------------------

    Several commenters addressed the proposed eligibility criteria for 
tier 2 capital. A few banking industry commenters asked the agencies 
and the FDIC to clarify criterion (2) above to provide that trade 
creditors are not among the class of senior creditors whose claims rank 
ahead of subordinated debt holders. In response to these comments, the 
agencies note that the intent of the final rule, with its requirement 
that tier 2 capital instruments be subordinated to depositors and 
general creditors, is to effectively retain the subordination standards 
for tier 2 capital subordinated debt under the general risk-based 
capital rules. Therefore, the agencies are clarifying that under the 
final rule, and consistent with the agencies' general risk-based 
capital rules, subordinated debt instruments that qualify as tier 2 
capital must be subordinated to general creditors, which generally 
means senior indebtedness, excluding trade creditors. Such creditors 
include at a minimum all borrowed money, similar obligations

[[Page 62050]]

arising from off-balance sheet guarantees and direct-credit 
substitutes, and obligations associated with derivative products such 
as interest rate and foreign-exchange contracts, commodity contracts, 
and similar arrangements, and, in addition, for depository 
institutions, depositors.
    In addition, one commenter noted that while many existing banking 
organizations' subordinated debt indentures contain subordination 
provisions, they may not explicitly include a subordination provision 
with respect to ``general creditors'' of the banking organization. 
Thus, they recommended that this aspect of the rules be modified to 
have only prospective application. The agencies note that if it is 
clear from an instrument's governing agreement, offering circular, or 
prospectus, that the instrument is subordinated to general creditors 
despite not specifically stating ``general creditors,'' criterion (2) 
above is satisfied (that is, criterion (2) should not be read to mean 
that the phrase ``general creditors'' must appear in the instrument's 
governing agreement, offering circular, or prospectus, as the case may 
be).
    One commenter also asked whether a debt instrument that 
automatically converts to an equity instrument within five years of 
issuance, and that satisfies all criteria for tier 2 instruments other 
than the five-year maturity requirement, would qualify as tier 2 
capital. The agencies note that because such an instrument would 
automatically convert to a permanent form of regulatory capital, the 
five-year maturity requirement would not apply and, thus, it would 
qualify as tier 2 capital. The agencies have clarified the final rule 
in this respect.
    Commenters also expressed concern about the impact of a number of 
the proposed criteria on outstanding TruPS. For example, commenters 
stated that a strict reading of criterion (3) above could exclude 
certain TruPS under which the banking organization guarantees that any 
payments made by the banking organization to the trust will be used by 
the trust to pay its obligations to security holders. However, the 
proposed rule would not have disqualified an instrument with this type 
of guarantee, which does not enhance or otherwise alter the 
subordination level of an instrument. Additionally, the commenters 
asked the agencies and the FDIC to allow in tier 2 capital instruments 
that provide for default and the acceleration of principal and interest 
if the issuer banking organization defers interest payments for five 
consecutive years. Commenters stated that these exceptions would be 
necessary to accommodate existing TruPS, which generally include such 
call, default and acceleration features.
    Commenters also asked the agencies and the FDIC to clarify the use 
of the term ``secured'' in criterion (3). As discussed above with 
respect to the criteria for additional tier 1 capital, a ``secured'' 
instrument is an instrument where payments on the instrument are 
secured by collateral. Therefore, under criterion (3), a collateralized 
instrument will not qualify as tier 2 capital. Instruments secured by 
collateral are less able to absorb losses than instruments without such 
enhancement.
    With respect to subordinated debt instruments included in tier 2 
capital, a commenter recommended eliminating criterion (4)'s proposed 
five-year amortization requirement, arguing that that it was 
unnecessary given other capital planning requirements that banking 
organizations must satisfy. The agencies declined to adopt the 
commenter's recommendation, as they believe that the proposed 
amortization schedule results in a more accurate reflection of the 
loss-absorbency of a banking organization's tier 2 capital. The 
agencies note that if a banking organization begins deferring interest 
payments on a TruPS instrument included in tier 2 capital, such an 
instrument will be treated as having a maturity of five years at that 
point and the banking organization must begin excluding the appropriate 
amount of the instrument from capital in accordance with section 
20(d)(1)(iv) of the final rule.
    Similar to the comments received on the criteria for additional 
tier 1 capital, commenters asked the agencies and the FDIC to add 
exceptions to the prohibition against call options that could be 
exercised within five years of the issuance of a capital instrument, 
specifically for an ``investment company event'' and a ``rating agency 
event.''
    Although the agencies declined to permit instruments that include 
acceleration provisions in tier 2 capital in the final rule, the 
agencies believe that the inclusion in tier 2 capital of existing 
TruPS, which allow for acceleration after five years of interest 
deferral, does not raise safety and soundness concerns. Although the 
majority of existing TruPS would not technically comply with the final 
rule's tier 2 eligibility criteria, the agencies acknowledge that the 
inclusion of existing TruPS in tier 2 capital (until they are redeemed 
or they mature) would benefit certain banking organizations until they 
are able to replace such instruments with new capital instruments that 
fully comply with the eligibility criteria of the final rule. 
Accordingly, the agencies have decided to permit non-advanced 
approaches depository institution holding companies with over $15 
billion in total consolidated assets to include in tier 2 capital TruPS 
that are phased-out of tier 1 capital in tier 2 capital. However, 
advanced approaches depository institution holding companies would not 
be allowed to permanently include existing TruPS in tier 2 capital. 
Rather, these banking organizations would include in tier 2 capital 
TruPS phased out of tier 1 capital from January 1, 2014 to year-end 
2015. From January 1, 2016 to year-end 2021, these banking 
organizations would be required to phase out TruPS from tier 2 capital 
in line with Table 9 of the transitions section of the final rule.
    As with additional tier 1 capital instruments, the final rule 
permits a banking organization to call an instrument prior to five 
years after issuance in the event that the issuing entity is required 
to register with the SEC as an investment company pursuant to the 
Investment Company Act of 1940, for the reasons discussed above with 
respect to additional tier 1 capital. Also for the reasons discussed 
above with respect to additional tier 1 capital instruments, the 
agencies have decided not to permit a banking organization to include 
in its tier 2 capital an instrument issued on or after the effective 
date of the final rule that may be called prior to five years after its 
issuance upon the occurrence of a rating agency event. However, the 
agencies have decided to allow such an instrument to be included in 
tier 2 capital, provided that the instrument was issued and included in 
a banking organization's tier 1 or tier 2 capital prior to January 1, 
2014, and that such instrument meets all other criteria for tier 2 
capital instruments under the final rule.
    In addition, similar to the comment above with respect to the 
proposed criteria for additional tier 1 capital instruments, commenters 
noted that the proposed criterion that a banking organization seek 
prior approval from its primary Federal supervisor before exercising a 
call option is redundant with the requirement that a banking 
organization seek prior approval before reducing regulatory capital by 
redeeming a capital instrument. Again, the agencies believe that this 
proposed requirement restates and clarifies existing requirements 
without adding any new substantive restrictions, and that it will help 
to ensure that the

[[Page 62051]]

regulatory capital rules provide banking organizations with a complete 
list of the requirements applicable to their regulatory capital 
instruments. Therefore, the agencies are retaining the requirement as 
proposed.
    Under the proposal, an advanced approaches banking organization may 
include in tier 2 capital the excess of its eligible credit reserves 
over expected credit loss (ECL) to the extent that such amount does not 
exceed 0.6 percent of credit risk-weighted assets, rather than 
including the amount of ALLL described above. Commenters asked the 
agencies and the FDIC to clarify whether an advanced approaches banking 
organization that is in parallel run includes in tier 2 capital its ECL 
or ALLL (as described above). To clarify, for purposes of the final 
rule, an advanced approaches banking organization will always include 
in total capital its ALLL up to 1.25 percent of (non-market risk) risk-
weighted assets when measuring its total capital relative to 
standardized risk-weighted assets. When measuring its total capital 
relative to its advanced approaches risk-weighted assets, as described 
in section 10(c)(3)(ii) of the final rule, an advanced approaches 
banking organization that has completed the parallel run process and 
that has received notification from its primary Federal supervisor 
pursuant to section 121(d) of subpart E must adjust its total capital 
to reflect its excess eligible credit reserves rather than its ALLL.
    Some commenters recommended that the agencies and the FDIC remove 
the limit on the amount of the ALLL includable in regulatory capital. 
Specifically, one commenter recommended allowing banking organizations 
to include ALLL in tier 1 capital equal to an amount of up to 1.25 
percent of total risk-weighted assets, with the balance in tier 2 
capital, so that the entire ALLL would be included in regulatory 
capital. Moreover, some commenters recommended including in tier 2 
capital the entire amount of reserves held for residential mortgage 
loans sold with recourse, given that the proposal would require a 100 
percent credit conversion factor for such loans. Consistent with the 
ALLL treatment under the general risk-based capital rules, for purposes 
of the final rule the agencies have elected to permit only limited 
amounts of the ALLL in tier 2 capital given its limited purpose of 
covering incurred rather than unexpected losses. For similar reasons, 
the agencies have further elected not to recognize in tier 2 capital 
reserves held for residential mortgage loans sold with recourse.
    As described above, a banking organization that has made an AOCI 
opt-out election may incorporate up to 45 percent of any net unrealized 
gains on AFS preferred stock classified as an equity security under 
GAAP and AFS equity exposures into its tier 2 capital.
    Some commenters requested that the eligibility criteria for tier 2 
capital be clarified with regard to surplus notes. For example, 
commenters suggested that the requirement for approval of any payment 
of principal or interest on a surplus note by the applicable insurance 
regulator is deemed to satisfy the criterion of the tier 2 capital 
instrument for prior approval for redemption of the instrument prior to 
maturity by a Federal banking agency.
    As described under the proposal, surplus notes generally are 
financial instruments issued by insurance companies that are included 
in surplus for statutory accounting purposes as prescribed or permitted 
by state laws and regulations, and typically have the following 
features: (1) The applicable state insurance regulator approves in 
advance the form and content of the note; (2) the instrument is 
subordinated to policyholders, to claimant and beneficiary claims, and 
to all other classes of creditors other than surplus note holders; and 
(3) the applicable state insurance regulator is required to approve in 
advance any interest payments and principal repayments on the 
instrument. The Board notes that a surplus note could be eligible for 
inclusion in tier 2 capital provided that the note meets the proposed 
tier 2 capital eligibility criteria. However, the Board does not 
consider approval of payments by an insurance regulator to satisfy the 
criterion for approval by a Federal banking agency. Accordingly, the 
Board has adopted the final rule without change.
    After reviewing the comments received on this issue, the agencies 
have determined to finalize the criteria for tier 2 capital instruments 
to include the aforementioned changes. The revised criteria for 
inclusion in tier 2 capital are set forth in section 20(d)(1) of the 
final rule.
4. Capital Instruments of Mutual Banking Organizations
    Under the proposed rule, the qualifying criteria for common equity 
tier 1, additional tier 1, and tier 2 capital generally would apply to 
mutual banking organizations. Mutual banking organizations and industry 
groups representing mutual banking organizations encouraged the 
agencies and the FDIC to expand the qualifying criteria for additional 
tier 1 capital to recognize certain cumulative instruments. These 
commenters stressed that mutual banking organizations, which do not 
issue common stock, have fewer options for raising regulatory capital 
relative to other types of banking organizations.
    The agencies do not believe that cumulative instruments are able to 
absorb losses sufficiently reliably to be included in tier 1 capital. 
Therefore, after considering these comments, the agencies have decided 
not to include in tier 1 capital under the final rule any cumulative 
instrument. This would include any previously-issued mutual capital 
instrument that was included in the tier 1 capital of mutual banking 
organizations under the general risk-based capital rules, but that does 
not meet the eligibility requirements for tier 1 capital under the 
final rule. These cumulative capital instruments will be subject to the 
transition provisions and phased out of the tier 1 capital of mutual 
banking organizations over time, as set forth in Table 9 of section 300 
in the final rule. However, if a mutual banking organization develops a 
new capital instrument that meets the qualifying criteria for 
regulatory capital under the final rule, such an instrument may be 
included in regulatory capital with the prior approval of the banking 
organization's primary Federal supervisor under section 20(e) of the 
final rule.
    The agencies note that the qualifying criteria for regulatory 
capital instruments under the final rule permit mutual banking 
organizations to include in regulatory capital many of their existing 
regulatory capital instruments (for example, non-withdrawable accounts, 
pledged deposits, or mutual capital certificates). The agencies believe 
that the quality and quantity of regulatory capital currently 
maintained by most mutual banking organizations should be sufficient to 
satisfy the requirements of the final rule. For those organizations 
that do not currently hold enough capital to meet the revised minimum 
requirements, the transition arrangements are designed to ease the 
burden of increasing regulatory capital over time.
5. Grandfathering of Certain Capital Instruments
    As described above, a substantial number of commenters objected to 
the proposed phase-out of non-qualifying capital instruments, including 
TruPS and cumulative perpetual preferred stock, from tier 1 capital. 
Community banking organizations in particular expressed concerns that 
the costs related to the replacement of such

[[Page 62052]]

capital instruments, which they generally characterized as safe and 
loss-absorbent, would be excessive and unnecessary. Commenters noted 
that the proposal was more restrictive than section 171 of the Dodd-
Frank Act, which requires the phase-out of non-qualifying capital 
instruments issued prior to May 19, 2010, only for depository 
institution holding companies with $15 billion or more in total 
consolidated assets as of December 31, 2009. Commenters argued that the 
agencies and the FDIC were exceeding Congressional intent by going 
beyond what was required under the Dodd-Frank Act. Commenters requested 
that the agencies and the FDIC grandfather existing TruPS and 
cumulative perpetual preferred stock issued by depository institution 
holding companies with less than $15 billion and 2010 MHCs.
    The agencies agree that under the Dodd-Frank Act the agencies have 
the flexibility to permit depository institution holding companies with 
less than $15 billion in total consolidated assets as of December 31, 
2009 and banking organizations that were mutual holding companies as of 
May 19, 2010 (2010 MHCs) to include in additional tier 1 capital TruPS 
and cumulative perpetual preferred stock issued and included in tier 1 
capital prior to May 19, 2010. Although the agencies continue to 
believe that TruPS are not sufficiently loss-absorbing to be includable 
in tier 1 capital as a general matter, the agencies are also sensitive 
to the difficulties community banking organizations often face when 
issuing new capital instruments and are aware of the importance their 
capacity to lend plays in local economies. Therefore the agencies have 
decided in the final rule to grandfather such non-qualifying capital 
instruments in tier 1 capital subject to a limit of 25 percent of tier 
1 capital elements excluding any non-qualifying capital instruments and 
after all regulatory capital deductions and adjustments applied to tier 
1 capital, which is substantially similar to the limit in the general 
risk-based capital rules. In addition, the agencies acknowledge that 
the inclusion of existing TruPS in tier 2 capital would benefit certain 
banking organizations until they are able to replace such instruments 
with new capital instruments that fully comply with the eligibility 
criteria of the final rule. Accordingly, the agencies have decided to 
permit depository institution holding companies not subject to the 
advanced approaches rule with over $15 billion in total consolidated 
assets to permanently include in tier 2 capital TruPS that are phased-
out of tier 1 capital in accordance with Table 8 of the transitions 
section of the final rule.
6. Agency Approval of Capital Elements
    The agencies and the FDIC noted in the proposal that they believe 
most existing regulatory capital instruments will continue to be 
includable in banking organizations' regulatory capital. However, over 
time, capital instruments that are equivalent in quality and capacity 
to absorb losses to existing instruments may be created to satisfy 
different market needs. Therefore, the agencies and the FDIC proposed 
to create a process to consider the eligibility of such instruments on 
a case-by-case basis. Under the proposed rule, a banking organization 
must request approval from its primary Federal supervisor before 
including a capital element in regulatory capital, unless: (i) Such 
capital element is currently included in regulatory capital under the 
agencies' and the FDIC's general risk-based capital and leverage rules 
and the underlying instrument complies with the applicable proposed 
eligibility criteria for regulatory capital instruments; or (ii) the 
capital element is equivalent, in terms of capital quality and ability 
to absorb losses, to an element described in a previous decision made 
publicly available by the banking organization's primary Federal 
supervisor.
    In the preamble to the proposal, the agencies and the FDIC 
indicated that they intend to consult each other when determining 
whether a new element should be included in common equity tier 1, 
additional tier 1, or tier 2 capital, and indicated that once one 
agency determines that a capital element may be included in a banking 
organization's common equity tier 1, additional tier 1, or tier 2 
capital, that agency would make its decision publicly available, 
including a brief description of the capital element and the rationale 
for the conclusion.
    The agencies continue to believe that it is appropriate to retain 
the flexibility necessary to consider new instruments on a case-by-case 
basis as they are developed over time to satisfy different market 
needs. The agencies have decided to move the agencies' authority in 
section 20(e)(1) of the proposal to the agencies' reservation of 
authority provision included in section 1(d)(2)(ii) of the final rule. 
Therefore, the agencies are adopting this aspect of the final rule 
substantively as proposed to create a process to consider the 
eligibility of such instruments on a permanent or temporary basis, in 
accordance with the applicable requirements in subpart C of the final 
rule (section 20(e) of the final rule).
    Section 20(e)(1) of the final rule provides that a banking 
organization must receive its primary Federal supervisor's prior 
approval to include a capital element in its common equity tier 1 
capital, additional tier 1 capital, or tier 2 capital unless that 
element: (i) Was included in the banking organization's tier 1 capital 
or tier 2 capital prior to May 19, 2010 in accordance with that 
supervisor's risk-based capital rules that were effective as of that 
date and the underlying instrument continues to be includable under the 
criteria set forth in this section; or (ii) is equivalent, in terms of 
capital quality and ability to absorb credit losses with respect to all 
material terms, to a regulatory capital element determined by that 
supervisor to be includable in regulatory capital pursuant to paragraph 
(e)(3) of section 20. In exercising this reservation of authority, the 
agencies expect to consider the requirements for capital elements in 
the final rule; the size, complexity, risk profile, and scope of 
operations of the banking organization, and whether any public benefits 
would be outweighed by risk to an insured depository institution or to 
the financial system.
7. Addressing the Point of Non-Viability Requirements Under Basel III
    During the recent financial crisis, the United States and foreign 
governments lent to, and made capital investments in, banking 
organizations. These investments helped to stabilize the recipient 
banking organizations and the financial sector as a whole. However, 
because of the investments, the recipient banking organizations' 
existing tier 2 capital instruments, and (in some cases) tier 1 capital 
instruments, did not absorb the banking organizations' credit losses 
consistent with the purpose of regulatory capital. At the same time, 
taxpayers became exposed to potential losses.
    On January 13, 2011, the BCBS issued international standards for 
all additional tier 1 and tier 2 capital instruments issued by 
internationally-active banking organizations to ensure that such 
regulatory capital instruments fully absorb losses before taxpayers are 
exposed to such losses (the Basel non-viability standard). Under the 
Basel non-viability standard, all non-common stock regulatory capital 
instruments issued by an internationally-active banking organization 
must include terms that subject the instruments to write-off or 
conversion to common

[[Page 62053]]

equity at the point at which either: (1) The write-off or conversion of 
those instruments occurs; or (2) a public sector injection of capital 
would be necessary to keep the banking organization solvent. 
Alternatively, if the governing jurisdiction of the banking 
organization has established laws that require such tier 1 and tier 2 
capital instruments to be written off or otherwise fully absorb losses 
before taxpayers are exposed to loss, the standard is already met. If 
the governing jurisdiction has such laws in place, the Basel non-
viability standard states that documentation for such instruments 
should disclose that information to investors and market participants, 
and should clarify that the holders of such instruments would fully 
absorb losses before taxpayers are exposed to loss.\82\
---------------------------------------------------------------------------

    \82\ See ``Final Elements of the Reforms to Raise the Quality of 
Regulatory Capital'' (January 2011), available at: https://www.bis.org/press/p110113.pdf.
---------------------------------------------------------------------------

    U.S. law is consistent with the Basel non-viability standard. The 
resolution regime established in Title II, section 210 of the Dodd-
Frank Act provides the FDIC with the authority necessary to place 
failing financial companies that pose a significant risk to the 
financial stability of the United States into receivership.\83\ The 
Dodd-Frank Act provides that this authority shall be exercised in a 
manner that minimizes systemic risk and moral hazard, so that (1) 
Creditors and shareholders will bear the losses of the financial 
company; (2) management responsible for the condition of the financial 
company will not be retained; and (3) the FDIC and other appropriate 
agencies will take steps necessary and appropriate to ensure that all 
parties, including holders of capital instruments, management, 
directors, and third parties having responsibility for the condition of 
the financial company, bear losses consistent with their respective 
ownership or responsibility.\84\ Section 11 of the Federal Deposit 
Insurance Act has similar provisions for the resolution of depository 
institutions.\85\ Additionally, under U.S. bankruptcy law, regulatory 
capital instruments issued by a company would absorb losses in 
bankruptcy before instruments held by more senior unsecured creditors.
---------------------------------------------------------------------------

    \83\ See 12 U.S.C. 5384.
    \84\ See 12 U.S.C. 5384.
    \85\ 12 U.S.C. 1821.
---------------------------------------------------------------------------

    Consistent with the Basel non-viability standard, under the 
proposal, additional tier 1 and tier 2 capital instruments issued by 
advanced approaches banking organizations after the date on which such 
organizations would have been required to comply with any final rule 
would have been required to include a disclosure that the holders of 
the instrument may be fully subordinated to interests held by the U.S. 
government in the event that the banking organization enters into a 
receivership, insolvency, liquidation, or similar proceeding. The 
agencies are adopting this provision of the proposed rule without 
change.
8. Qualifying Capital Instruments Issued by Consolidated Subsidiaries 
of a Banking Organization
    As highlighted during the recent financial crisis, capital issued 
by consolidated subsidiaries and not owned by the parent banking 
organization (minority interest) is available to absorb losses at the 
subsidiary level, but that capital does not always absorb losses at the 
consolidated level. Accordingly, and consistent with Basel III, the 
proposed rule revised limitations on the amount of minority interest 
that may be included in regulatory capital at the consolidated level to 
prevent highly capitalized subsidiaries from overstating the amount of 
capital available to absorb losses at the consolidated organization.
    Under the proposal, minority interest would have been classified as 
a common equity tier 1, tier 1, or total capital minority interest 
depending on the terms of the underlying capital instrument and on the 
type of subsidiary issuing such instrument. Any instrument issued by a 
consolidated subsidiary to third parties would have been required to 
satisfy the qualifying criteria under the proposal to be included in 
the banking organization's common equity tier 1, additional tier 1, or 
tier 2 capital, as appropriate. In addition, common equity tier 1 
minority interest would have been limited to instruments issued by a 
depository institution or a foreign bank that is a consolidated 
subsidiary of a banking organization.
    The proposed limits on the amount of minority interest that could 
have been included in the consolidated capital of a banking 
organization would have been based on the amount of capital held by the 
consolidated subsidiary, relative to the amount of capital the 
subsidiary would have had to hold to avoid any restrictions on capital 
distributions and discretionary bonus payments under the capital 
conservation buffer framework. For example, a subsidiary with a common 
equity tier 1 capital ratio of 8 percent that needs to maintain a 
common equity tier 1 capital ratio of more than 7 percent to avoid 
limitations on capital distributions and discretionary bonus payments 
would have been considered to have ``surplus'' common equity tier 1 
capital and, at the consolidated level, the banking organization would 
not have been able to include the portion of such surplus common equity 
tier 1 capital that is attributable to third party investors.
    In general, the amount of common equity tier 1 minority interest 
that could have been included in the common equity tier 1 capital of a 
banking organization under the proposal would have been equal to:
    (i) The common equity tier 1 minority interest of the subsidiary 
minus
    (ii) The ratio of the subsidiary's common equity tier 1 capital 
owned by third parties to the total common equity tier 1 capital of the 
subsidiary, multiplied by the difference between the common equity tier 
1 capital of the subsidiary and the lower of:
    (1) The amount of common equity tier 1 capital the subsidiary must 
hold to avoid restrictions on capital distributions and discretionary 
bonus payments, or
    (2)(a) the standardized total risk-weighted assets of the banking 
organization that relate to the subsidiary, multiplied by
    (b) The common equity tier 1 capital ratio needed by the banking 
organization subsidiary to avoid restrictions on capital distributions 
and discretionary bonus payments.
    If a subsidiary were not subject to the same minimum regulatory 
capital requirements or capital conservation buffer framework as the 
banking organization, the banking organization would have needed to 
assume, for the purposes of the calculation described above, that the 
subsidiary is in fact subject to the same minimum capital requirements 
and the same capital conservation buffer framework as the banking 
organization.
    To determine the amount of tier 1 minority interest that could be 
included in the tier 1 capital of the banking organization and the 
total capital minority interest that could be included in the total 
capital of the banking organization, a banking organization would 
follow the same methodology as the one outlined previously for common 
equity tier 1 minority interest. The proposal set forth sample 
calculations. The amount of tier 1 minority interest that could have 
been included in the additional tier 1 capital of a banking 
organization under the proposal was equivalent to the banking 
organization's tier 1 minority interest, subject to the limitations 
outlined above, less any common equity tier 1 minority interest 
included in the banking organization's

[[Page 62054]]

common equity tier 1 capital. Likewise, the amount of total capital 
minority interest that could have been included in the tier 2 capital 
of the banking organization was equivalent to its total capital 
minority interest, subject to the limitations outlined above, less any 
tier 1 minority interest that is included in the banking organization's 
tier 1 capital.
    Under the proposal, minority interest related to qualifying common 
or noncumulative perpetual preferred stock directly issued by a 
consolidated U.S. depository institution or foreign bank subsidiary, 
which is eligible for inclusion in tier 1 capital under the general 
risk-based capital rules without limitation, generally would qualify 
for inclusion in common equity tier 1 and additional tier 1 capital, 
respectively, subject to the proposed limits. However, under the 
proposal, minority interest related to qualifying cumulative perpetual 
preferred stock directly issued by a consolidated U.S. depository 
institution or foreign bank subsidiary, which is eligible for limited 
inclusion in tier 1 capital under the general risk-based capital rules, 
generally would not have qualified for inclusion in additional tier 1 
capital under the proposal.
    A number of commenters addressed the proposed limits on the 
inclusion of minority interest in regulatory capital. Commenters 
generally asserted that the proposed methodology for calculating the 
amount of minority interest that could be included in regulatory 
capital was overly complex, overly conservative, and would reduce 
incentives for bank subsidiaries to issue capital to third-party 
investors. Several commenters suggested that the agencies and the FDIC 
should adopt a more straightforward and simple approach that would 
provide a single blanket limitation on the amount of minority interest 
includable in regulatory capital. For example, one commenter suggested 
allowing a banking organization to include minority interest equal to 
18 percent of common equity tier 1 capital. Another commenter suggested 
that minority interest where shareholders have commitments to provide 
additional capital, as well as minority interest in joint ventures 
where there are guarantees or other credit enhancements, should not be 
subject to the proposed limitations.
    Commenters also objected to any limitations on the amount of 
minority interest included in the regulatory capital of a parent 
banking organization attributable to instruments issued by a subsidiary 
when the subsidiary is a depository institution. These commenters 
stated that restricting such minority interest could create a 
disincentive for depository institutions to issue capital instruments 
directly or to maintain capital at levels substantially above 
regulatory minimums. To address this concern, commenters asked the 
agencies and the FDIC to consider allowing a depository institution 
subsidiary to consider a portion of its capital above its minimum as 
not being part of its ``surplus'' capital for the purpose of 
calculating the minority interest limitation. Alternatively, some 
commenters suggested allowing depository institution subsidiaries to 
calculate surplus capital independently for each component of capital.
    Several commenters also addressed the proposed minority interest 
limitation as it would apply to subordinated debt issued by a 
depository institution. Generally, these commenters stated that the 
proposed minority interest limitation either should not apply to such 
subordinated debt, or that the limitation should be more flexible to 
permit a greater amount to be included in the total capital of the 
consolidated organization. Commenters also suggested that the agencies 
and the FDIC create an exception to the limitation for bank holding 
companies with only a single subsidiary that is a depository 
institution. These commenters indicated that the limitation should not 
apply in such a situation because a BHC that conducts all business 
through a single bank subsidiary is not exposed to losses outside of 
the activities of the subsidiary.
    Finally, some commenters pointed out that the application of the 
proposed calculation for the minority interest limitation was unclear 
in circumstances where a subsidiary depository institution does not 
have ``surplus'' capital. With respect to this comment, the agencies 
have revised the proposed rule to specifically provide that the 
minority interest limitation will not apply in circumstances where a 
subsidiary's capital ratios are equal to or below the level of capital 
necessary to meet the minimum capital requirements plus the capital 
conservation buffer. That is, in the final rule the minority interest 
limitation would apply only where a subsidiary has ``surplus'' capital.
    The agencies continue to believe that the proposed limitations on 
minority interest are appropriate, including for capital instruments 
issued by depository institution subsidiaries, tier 2 capital 
instruments, and situations in which a depository institution holding 
company conducts the majority of its business through a single 
depository institution subsidiary. As noted above, the agencies' 
experience during the recent financial crisis showed that while 
minority interest generally is available to absorb losses at the 
subsidiary level, it may not always absorb losses at the consolidated 
level. Therefore, the agencies continue to believe limitations on 
including minority interest will prevent highly-capitalized 
subsidiaries from overstating the amount of capital available to absorb 
losses at the consolidated organization. The increased safety and 
soundness benefits resulting from these limitations should outweigh any 
compliance burden issues related to the complexity of the calculations. 
Therefore, the agencies are adopting the proposed treatment of minority 
interest without change, except for the clarification described above.
9. Real Estate Investment Trust Preferred Capital
    A real estate investment trust (REIT) is a company that is required 
to invest in real estate and real estate-related assets and make 
certain distributions in order to maintain a tax-advantaged status. 
Some banking organizations have consolidated subsidiaries that are 
REITs, and such REITs may have issued capital instruments included in 
the regulatory capital of the consolidated banking organization as 
minority interest under the general risk-based capital rules.
    Under the general risk-based capital rules, preferred stock issued 
by a REIT subsidiary generally can be included in a banking 
organization's tier 1 capital as minority interest if the preferred 
stock meets the eligibility requirements for tier 1 capital.\86\ The 
agencies and the FDIC interpreted this to require that the REIT-
preferred stock be exchangeable automatically into noncumulative 
perpetual preferred stock of the banking organization under certain 
circumstances. Specifically, the primary Federal supervisor may direct 
the banking organization in writing to convert the REIT preferred stock 
into noncumulative perpetual preferred stock of the banking 
organization because the banking organization: (1) Became 
undercapitalized under the PCA regulations; \87\ (2) was placed into 
conservatorship or receivership; or (3)

[[Page 62055]]

was expected to become undercapitalized in the near term.\88\
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    \86\ 12 CFR part 325, subpart B (FDIC); 12 CFR part 3, appendix 
A, Sec. 2(a)(3) (OCC); see also Comptroller's Licensing Manual, 
Capital and Dividends, p. 14 (Nov. 2007).
    \87\ 12 CFR part 3, appendix A, section 2(a)(3) (national banks) 
and 12 CFR 167.5(a)(1)(iii) (Federal savings associations) (OCC); 12 
CFR part 208, subpart D (Board); 12 CFR part 325, subpart B, 12 CFR 
part 390, subpart Y (FDIC).
    \88\ See OCC Corporate Decision No. 97-109 (December 1997) 
available at https://www.occ.gov/static/interpretations-and-precedents/dec97/cd97-109.pdf and the Comptroller's Licensing 
Manual, Capital and Dividends available at https://www.occ.gov/static/publications/capital3.pdf; (national banks) and OTS 
Examination Handbook, Section 120, appendix A, (page A7) (September 
2010), available at https://www.occ.gov/static/news-issuances/ots/exam-handbook/ots-exam-handbook-120aa.pdf (Federal savings 
associations) (OCC); 12 CFR parts 208 and 225, appendix A (Board); 
12 CFR part 325, subpart B (state nonmember banks), and 12 CFR part 
390, subpart Y (state savings associations).
---------------------------------------------------------------------------

    Under the proposed rule, the limitations described previously on 
the inclusion of minority interest in regulatory capital would have 
applied to capital instruments issued by consolidated REIT 
subsidiaries. Specifically, preferred stock issued by a REIT subsidiary 
that met the proposed definition of an operating entity (as defined 
below) would have qualified for inclusion in the regulatory capital of 
a banking organization subject to the limitations outlined in section 
21 of the proposed rule only if the REIT preferred stock met the 
criteria for additional tier 1 or tier 2 capital instruments outlined 
in section 20 of the proposed rules. Because a REIT must distribute 90 
percent of its earnings to maintain its tax-advantaged status, a 
banking organization might be reluctant to cancel dividends on the REIT 
preferred stock. However, for a capital instrument to qualify as 
additional tier 1 capital the issuer must have the ability to cancel 
dividends. In cases where a REIT could maintain its tax status, for 
example, by declaring a consent dividend and it has the ability to do 
so, the agencies generally would consider REIT preferred stock to 
satisfy criterion (7) of the proposed eligibility criteria for 
additional tier 1 capital instruments.\89\ The agencies note that the 
ability to declare a consent dividend need not be included in the 
documentation of the REIT preferred instrument, but the banking 
organization must provide evidence to the relevant banking agency that 
it has such an ability. The agencies do not expect preferred stock 
issued by a REIT that does not have the ability to declare a consent 
dividend or otherwise cancel cash dividends to qualify as tier 1 
minority interest under the final rule; however, such an instrument 
could qualify as total capital minority interest if it meets all of the 
relevant tier 2 capital eligibility criteria under the final rule.
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    \89\ A consent dividend is a dividend that is not actually paid 
to the shareholders, but is kept as part of a company's retained 
earnings, yet the shareholders have consented to treat the dividend 
as if paid in cash and include it in gross income for tax purposes.
---------------------------------------------------------------------------

    Commenters requested clarification on whether a REIT subsidiary 
would be considered an operating entity for the purpose of the final 
rule. For minority interest issued from a subsidiary to be included in 
regulatory capital, the subsidiary must be either an operating entity 
or an entity whose only asset is its investment in the capital of the 
parent banking organization and for which proceeds are immediately 
available without limitation to the banking organization. Since a REIT 
has assets that are not an investment in the capital of the parent 
banking organization, minority interest in a REIT subsidiary can be 
included in the regulatory capital of the consolidated parent banking 
organization only if the REIT is an operating entity. For purposes of 
the final rule, an operating entity is defined as a company established 
to conduct business with clients with the intention of earning a profit 
in its own right. However, certain REIT subsidiaries currently used by 
banking organizations to raise regulatory capital are not actively 
managed for the purpose of earning a profit in their own right, and 
therefore, will not qualify as operating entities for the purpose of 
the final rule. Minority interest investments in REIT subsidiaries that 
are actively managed for purposes of earning a profit in their own 
right will be eligible for inclusion in the regulatory capital of the 
banking organization subject to the limits described in section 21 of 
the final rule. To the extent that a banking organization is unsure 
whether minority interest investments in a particular REIT subsidiary 
will be includable in the banking organization's regulatory capital, 
the organization should discuss the concern with its primary Federal 
supervisor prior to including any amount of the minority interest in 
its regulatory capital.
    Several commenters objected to the application of the limitations 
on the inclusion of minority interest resulting from noncumulative 
perpetual preferred stock issued by REIT subsidiaries. Commenters noted 
that to be included in the regulatory capital of the consolidated 
parent banking organization under the general risk-based capital rules, 
REIT preferred stock must include an exchange feature that allows the 
REIT preferred stock to absorb losses at the parent banking 
organization through the exchange of REIT preferred instruments into 
noncumulative perpetual preferred stock of the parent banking 
organization. Because of this exchange feature, the commenters stated 
that REIT preferred instruments should be included in the tier 1 
capital of the parent consolidated organization without limitation. 
Alternatively, some commenters suggested that the agencies and the FDIC 
should allow REIT preferred instruments to be included in the tier 2 
capital of the consolidated parent organization without limitation. 
Commenters also noted that in light of the eventual phase-out of TruPS 
pursuant to the Dodd-Frank Act, REIT preferred stock would be the only 
tax-advantaged means for bank holding companies to raise tier 1 
capital. According to these commenters, limiting this tax-advantaged 
option would increase the cost of doing business for many banking 
organizations.
    After considering these comments, the agencies have decided not to 
create specific exemptions to the limitations on the inclusion of 
minority interest with respect to REIT preferred instruments. As noted 
above, the agencies believe that the inclusion of minority interest in 
regulatory capital at the consolidated level should be limited to 
prevent highly-capitalized subsidiaries from overstating the amount of 
capital available to absorb losses at the consolidated organization.

B. Regulatory Adjustments and Deductions

1. Regulatory Deductions From Common Equity Tier 1 Capital
    Under the proposal, a banking organization must deduct from common 
equity tier 1 capital elements the items described in section 22 of the 
proposed rule. A banking organization would exclude the amount of these 
deductions from its total risk-weighted assets and leverage exposure. 
This section B discusses the deductions from regulatory capital 
elements as revised for purposes of the final rule.
a. Goodwill and Other Intangibles (Other Than Mortgage Servicing 
Assets)
    U.S. federal banking statutes generally prohibit the inclusion of 
goodwill (as it is an ``unidentified intangible asset'') in the 
regulatory capital of insured depository institutions.\90\ Accordingly, 
goodwill and other intangible assets have long been either fully or 
partially excluded from regulatory capital in the United States because 
of the high level of uncertainty regarding the ability of the banking 
organization to realize value from these assets, especially under

[[Page 62056]]

adverse financial conditions.\91\ Under the proposed rule, a banking 
organization was required to deduct from common equity tier 1 capital 
elements goodwill and other intangible assets other than MSAs \92\ net 
of associated deferred tax liabilities (DTLs). For purposes of this 
deduction, goodwill would have included any goodwill embedded in the 
valuation of significant investments in the capital of an 
unconsolidated financial institution in the form of common stock. This 
deduction of embedded goodwill would have applied to investments 
accounted for under the equity method.\93\ Consistent with Basel III, 
these items would have been deducted from common equity tier 1 capital 
elements. MSAs would have been subject to a different treatment under 
Basel III and the proposal, as explained below in this section.
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    \90\ 12 U.S.C. 1828(n).
    \91\ See 54 FR 4186, 4196 (January 27, 1989) (Board); 54 FR 
4168, 4175 (January 27, 1989) (OCC); 54 FR 11500, 11509 (March 21, 
1989) (FDIC).
    \92\ Examples of other intangible assets include purchased 
credit card relationships (PCCRs) and non-mortgage servicing assets.
    \93\ Under GAAP, if there is a difference between the initial 
cost basis of the investment and the amount of underlying equity in 
the net assets of the investee, the resulting difference should be 
accounted for as if the investee were a consolidated subsidiary 
(which may include imputed goodwill).
---------------------------------------------------------------------------

    One commenter sought clarification regarding the amount of goodwill 
that must be deducted from common equity tier 1 capital elements when a 
banking organization has an investment in the capital of an 
unconsolidated financial institution that is accounted for under the 
equity method of accounting under GAAP. The agencies have revised 
section 22(a)(1) in the final rule to clarify that it is the amount of 
goodwill that is embedded in the valuation of a significant investment 
in the capital of an unconsolidated financial institution in the form 
of common stock that is accounted for under the equity method, and 
reflected in the consolidated financial statements of the banking 
organization that a banking organization must deduct from common equity 
tier 1 capital elements.
    Another commenter requested clarification regarding the amount of 
embedded goodwill that a banking organization would be required to 
deduct where there are impairments to the embedded goodwill subsequent 
to the initial investment. The agencies note that, for purposes of the 
final rule, a banking organization must deduct from common equity tier 
1 capital elements any embedded goodwill in the valuation of 
significant investments in the capital of an unconsolidated financial 
institution in the form of common stock net of any related impairments 
(subsequent to the initial investment) as determined under GAAP, not 
the goodwill reported on the balance sheet of the unconsolidated 
financial institution.
    The proposal did not include a transition period for the 
implementation of the requirement to deduct goodwill from common equity 
tier 1 capital. A number of commenters expressed concern that this 
could disadvantage U.S. banking organizations relative to those in 
jurisdictions that permit such a transition period. The agencies note 
that section 221 of FIRREA (12 U.S.C. 1828(n)) requires all 
unidentifiable intangible assets (goodwill) acquired after April 12, 
1989, to be deducted from a banking organization's capital elements. 
The only exception to this requirement, permitted under 12 U.S.C. 
1464(t) (applicable to Federal savings association), has expired. 
Therefore, consistent with the requirements of section 221 of FIRREA 
and the general risk-based capital rules, the agencies believe that it 
is not appropriate to permit any goodwill to be included in a banking 
organization's capital. The final rule does not include a transition 
period for the deduction of goodwill.
b. Gain-on-Sale Associated With a Securitization Exposure
    Under the proposal, a banking organization would deduct from common 
equity tier 1 capital elements any after-tax gain-on-sale associated 
with a securitization exposure. Under the proposal, gain-on-sale was 
defined as an increase in the equity capital of a banking organization 
resulting from a securitization (other than an increase in equity 
capital resulting from the banking organization's receipt of cash in 
connection with the securitization).
    A number of commenters requested clarification that the proposed 
deduction for gain-on-sale would not require a double deduction for 
MSAs. According to the commenters, a sale of loans to a securitization 
structure that creates a gain may include an MSA that also meets the 
proposed definition of ``gain-on-sale.'' The agencies agree that a 
double deduction for MSAs is not required, and the final rule clarifies 
in the definition of ``gain-on-sale'' that a gain-on-sale excludes any 
portion of the gain that was reported by the banking organization as an 
MSA. The agencies also note that the definition of gain-on-sale was 
intended to relate only to gains associated with the sale of loans for 
the purpose of traditional securitization. Thus, the definition of 
gain-on-sale has been revised in the final rule to mean an increase in 
common equity tier 1 capital of the banking organization resulting from 
a traditional securitization except where such an increase results from 
the banking organization's receipt of cash in connection with the 
securitization or initial recognition of an MSA.
c. Defined Benefit Pension Fund Net Assets
    For banking organizations other than insured depository 
institutions, the proposal required the deduction of a net pension fund 
asset in calculating common equity tier 1 capital. A banking 
organization was permitted to make such deduction net of any associated 
DTLs. This deduction would be required where a defined benefit pension 
fund is over-funded due to the high level of uncertainty regarding the 
ability of the banking organization to realize value from such assets. 
The proposal did not require a BHC or SLHC to deduct the net pension 
fund asset of its insured depository institution subsidiary.
    The proposal provided that, with supervisory approval, a banking 
organization would not have been required to deduct defined benefit 
pension fund assets to which the banking organization had unrestricted 
and unfettered access.\94\ In this case, the proposal established that 
the banking organization would have assigned to such assets the risk 
weight they would receive if the assets underlying the plan were 
directly owned and included on the balance sheet of the banking 
organization. The proposal set forth that unrestricted and unfettered 
access would mean that a banking organization would not have been 
required to request and receive specific approval from pension 
beneficiaries each time it accessed excess funds in the plan.
---------------------------------------------------------------------------

    \94\ The FDIC has unfettered access to the pension fund assets 
of an insured depository institution's pension plan in the event of 
receivership; therefore, the agencies determined that an insured 
depository institution would not be required to deduct a net pension 
fund asset.
---------------------------------------------------------------------------

    One commenter asked whether shares of a banking organization that 
are owned by the banking organization's pension fund are subject to 
deduction. The agencies note that the final rule does not require 
deduction of banking organization shares owned by the pension fund. 
Another commenter asked for clarification regarding the treatment of an 
overfunded pension asset at an insured depository institution if the 
pension plan sponsor is the parent BHC. The agencies clarify that the 
requirement to deduct a defined benefit pension plan net asset is not 
dependent upon the sponsor of the plan; rather it is dependent upon 
whether the

[[Page 62057]]

net pension fund asset is an asset of an insured depository 
institution. The agencies and the FDIC also received questions 
regarding the appropriate risk-weight treatment for a pension fund 
asset. As discussed above, with the prior agency approval, a banking 
organization that is not an insured depository institution may elect to 
not deduct any defined benefit pension fund net asset to the extent 
such banking organization has unrestricted and unfettered access to the 
assets in that defined benefit pension fund. Any portion of the defined 
benefit pension fund net asset that is not deducted by the banking 
organization must be risk-weighted as if the banking organization 
directly holds a proportional ownership share of each exposure in the 
defined benefit pension fund. For example, if the banking organization 
has a defined benefit pension fund net asset of $10 and it has 
unfettered and unrestricted access to the assets of defined benefit 
pension fund, and assuming 20 percent of the defined benefit pension 
fund is composed of assets that are risk-weighted at 100 percent and 80 
percent is composed of assets that are risk-weighted at 300 percent, 
the banking organization would risk weight $2 at 100 percent and $8 at 
300 percent. This treatment is consistent with the full look-through 
approach described in section 53(b) of the final rule. If the defined 
benefit pension fund invests in the capital of a financial institution, 
including an investment in the banking organization's own capital 
instruments, the banking organization would risk weight the 
proportional share of such exposure in accordance with the treatment 
under subparts D or E, as appropriate.
    The agencies are adopting as final this section of the proposal 
with the changes described above.
d. Expected Credit Loss That Exceeds Eligible Credit Reserves
    The proposal required an advanced approaches banking organization 
to deduct from common equity tier 1 capital elements the amount of 
expected credit loss that exceeds the banking organization's eligible 
credit reserves.
    Commenters sought clarification that the proposed deduction would 
not apply for advanced approaches banking organizations that have not 
received the approval of their primary Federal supervisor to exit 
parallel run. The agencies agree that the deduction would not apply to 
banking organizations that have not received approval from their 
primary Federal supervisor to exit parallel run. In response, the 
agencies have revised this provision of the final rule to apply to a 
banking organization subject to subpart E of the final rule that has 
completed the parallel run process and that has received notification 
from its primary Federal supervisor under section 121(d) of the 
advanced approaches rule.
e. Equity Investments in Financial Subsidiaries
    Section 121 of the Gramm-Leach-Bliley Act allows national banks and 
insured state banks to establish entities known as financial 
subsidiaries.\95\ One of the statutory requirements for establishing a 
financial subsidiary is that a national bank or insured state bank must 
deduct any investment in a financial subsidiary from the depository 
institution's assets and tangible equity.\96\ The agencies implemented 
this statutory requirement through regulation at 12 CFR 5.39(h)(1) 
(OCC) and 12 CFR 208.73 (Board).
---------------------------------------------------------------------------

    \95\ Public Law 106-102, 113 Stat. 1338, 1373 (Nov. 12, 1999).
    \96\ 12 U.S.C. 24a(c); 12 U.S.C. 1831w(a)(2).
---------------------------------------------------------------------------

    Under section 22(a)(7) of the proposal, investments by a national 
bank or insured state bank in financial subsidiaries would be deducted 
entirely from the bank's common equity tier 1 capital.\97\ Because 
common equity tier 1 capital is a component of tangible equity, the 
proposed deduction from common equity tier 1 would have automatically 
resulted in a deduction from tangible equity. The agencies believe that 
the more conservative treatment is appropriate for financial 
subsidiaries given the risks associated with nonbanking activities, and 
are adopting this treatment as proposed. Therefore, under the final 
rule, a depository institution must deduct the aggregate amount of its 
outstanding equity investment in a financial subsidiary, including the 
retained earnings of a subsidiary from common equity tier 1 capital 
elements, and the assets and liabilities of the subsidiary may not be 
consolidated with those of the parent bank.
---------------------------------------------------------------------------

    \97\ The deduction provided for in the agencies' existing 
regulations would be removed and would exist solely in the final 
rule.
---------------------------------------------------------------------------

f. Deduction for Subsidiaries of Savings Associations That Engage in 
Activities That Are Not Permissible for National Banks
    Section 5(t)(5) \98\ of HOLA requires a separate capital 
calculation for Federal savings associations for ``investments in and 
extensions of credit to any subsidiary engaged in activities not 
permissible for a national bank.'' This statutory provision was 
implemented in the Federal savings associations' capital rules through 
a deduction from the core (tier 1) capital of the Federal savings 
association for those subsidiaries that are not ``includable 
subsidiaries.'' \99\
---------------------------------------------------------------------------

    \98\ 12 U.S.C. 1464(t)(5).
    \99\ See 12 CFR 167.1; 12 CFR 167.5(a)(2)(iv).
---------------------------------------------------------------------------

    The OCC proposed to continue the general risk-based capital 
treatment of includable subsidiaries, with some technical 
modifications. Aside from those technical modifications, the proposal 
would have transferred, without substantive change, the current general 
regulatory treatment of deducting subsidiary investments where a 
subsidiary is engaged in activities not permissible for a national 
bank. Such treatment is consistent with how a national bank deducts its 
equity investments in financial subsidiaries. The FDIC proposed an 
identical treatment for state savings associations.\100\
---------------------------------------------------------------------------

    \100\ 12 CFR 324.22.
---------------------------------------------------------------------------

    The OCC received no comments on this proposed deduction. The final 
rule adopts the proposal with one change and other minor technical 
edits, consistent with 12 U.S.C. 1464(t)(5), to clarify that the 
required deduction for a Federal savings association's investment in a 
subsidiary that is engaged in activities not permissible for a national 
bank includes extensions of credit to such a subsidiary.
2. Regulatory Adjustments to Common Equity Tier 1 Capital
a. Accumulated Net Gains and Losses on Certain Cash-Flow Hedges
    Consistent with Basel III, under the proposal, a banking 
organization would have been required to exclude from regulatory 
capital any accumulated net gains and losses on cash-flow hedges 
relating to items that are not recognized at fair value on the balance 
sheet.
    This proposed regulatory adjustment was intended to reduce the 
artificial volatility that can arise in a situation in which the 
accumulated net gain or loss of the cash-flow hedge is included in 
regulatory capital but any change in the fair value of the hedged item 
is not. The agencies and the FDIC received a number of comments on this 
proposed regulatory capital adjustment. In general, the commenters 
noted that while the intent of the adjustment is to remove an element 
that gives rise to artificial volatility in common equity, the proposed 
adjustment may actually increase volatility in the measure of common 
equity tier 1 capital. These commenters indicated that the proposed 
adjustment, together with the proposed treatment of net unrealized 
gains and losses on AFS debt securities, would create incentives for 
banking

[[Page 62058]]

organizations to avoid hedges that reduce interest rate risk; shorten 
maturity of their investments in AFS securities; or move their 
investment securities portfolio from AFS to HTM. To address these 
concerns, commenters suggested several alternatives, such as including 
all accumulated net gains and losses on cash-flow hedges in common 
equity tier 1 capital to match the proposal to include in common equity 
tier 1 capital net unrealized gains and losses on AFS debt securities; 
retaining the provisions in the agencies' and the FDIC's general risk-
based capital rules that exclude most elements of AOCI from regulatory 
capital; or using a principles-based approach to accommodate variations 
in the interest rate management techniques employed by each banking 
organization.
    Under the final rule, the agencies have retained the requirement 
that all banking organizations subject to the advanced approaches rule, 
and those banking organizations that elect to include AOCI in common 
equity tier 1 capital, must subtract from common equity tier 1 capital 
elements any accumulated net gains and must add any accumulated net 
losses on cash-flow hedges included in AOCI that relate to the hedging 
of items that are not recognized at fair value on the balance sheet. 
The agencies believe that this adjustment removes an element that gives 
rise to artificial volatility in common equity tier 1 capital as it 
would avoid a situation in which the changes in the fair value of the 
cash-flow hedge are reflected in capital but the changes in the fair 
value of the hedged item are not.
b. Changes in a Banking Organization's Own Credit Risk
    The proposal provided that a banking organization would not be 
permitted to include in regulatory capital any change in the fair value 
of a liability attributable to changes in the banking organization's 
own credit risk. In addition, the proposal would have required advanced 
approaches banking organizations to deduct the credit spread premium 
over the risk-free rate for derivatives that are liabilities. 
Consistent with Basel III, these provisions were intended to prevent a 
banking organization from recognizing increases in regulatory capital 
resulting from any change in the fair value of a liability attributable 
to changes in the banking organization's own creditworthiness. Under 
the final rule, all banking organizations not subject to the advanced 
approaches rule must deduct any cumulative gain from and add back to 
common equity tier 1 capital elements any cumulative loss attributed to 
changes in the value of a liability measured at fair value arising from 
changes in the banking organization's own credit risk. This requirement 
would apply to all liabilities that a banking organization must measure 
at fair value under GAAP, such as derivative liabilities, or for which 
the banking organization elects to measure at fair value under the fair 
value option.\101\
---------------------------------------------------------------------------

    \101\ 825-10-25 (former Financial Accounting Standards Board 
Statement No. 159).
---------------------------------------------------------------------------

    Similarly, advanced approaches banking organizations must deduct 
any cumulative gain from and add back any cumulative loss to common 
equity tier 1 capital elements attributable to changes in the value of 
a liability that the banking organization elects to measure at fair 
value under GAAP. For derivative liabilities, advanced approaches 
banking organizations must implement this requirement by deducting the 
credit spread premium over the risk-free rate.
c. Accumulated Other Comprehensive Income
    Under the agencies' general risk-based capital rules, most of the 
components of AOCI included in a company's GAAP equity are not included 
in a banking organization's regulatory capital. Under GAAP, AOCI 
includes unrealized gains and losses on certain assets and liabilities 
that are not included in net income. Among other items, AOCI includes 
unrealized gains and losses on AFS securities; other than temporary 
impairment on securities reported as HTM that are not credit-related; 
cumulative gains and losses on cash-flow hedges; foreign currency 
translation adjustments; and amounts attributed to defined benefit 
post-retirement plans resulting from the initial and subsequent 
application of the relevant GAAP standards that pertain to such plans
    Under the agencies' general risk-based capital rules, banking 
organizations do not include most amounts reported in AOCI in their 
regulatory capital calculations. Instead, they exclude these amounts by 
subtracting unrealized or accumulated net gains from, and adding back 
unrealized or accumulated net losses to, equity capital. The only 
amounts of AOCI included in regulatory capital are unrealized losses on 
AFS equity securities and foreign currency translation adjustments, 
which are included in tier 1 capital. Additionally, banking 
organizations may include up to 45 percent of unrealized gains on AFS 
equity securities in their tier 2 capital.
    In contrast, consistent with Basel III, the proposed rule required 
banking organizations to include all AOCI components in common equity 
tier 1 capital elements, except gains and losses on cash-flow hedges 
where the hedged item is not recognized on a banking organization's 
balance sheet at fair value. Unrealized gains and losses on all AFS 
securities would flow through to common equity tier 1 capital elements, 
including unrealized gains and losses on debt securities due to changes 
in valuations that result primarily from fluctuations in benchmark 
interest rates (for example, U.S. Treasuries and U.S. government agency 
debt obligations), as opposed to changes in credit risk.
    In the Basel III NPR, the agencies and the FDIC indicated that the 
proposed regulatory capital treatment of AOCI would better reflect an 
institution's actual risk. In particular, the agencies and the FDIC 
stated that while unrealized gains and losses on AFS debt securities 
might be temporary in nature and reverse over a longer time horizon 
(especially when those gains and losses are primarily attributable to 
changes in benchmark interest rates), unrealized losses could 
materially affect a banking organization's capital position at a 
particular point in time and associated risks should therefore be 
reflected in its capital ratios. In addition, the agencies and the FDIC 
observed that the proposed treatment would be consistent with the 
common market practice of evaluating a firm's capital strength by 
measuring its tangible common equity, which generally includes AOCI.
    However, the agencies and the FDIC also acknowledged that including 
unrealized gains and losses related to debt securities (especially 
those whose valuations primarily change as a result of fluctuations in 
a benchmark interest rate) could introduce substantial volatility in a 
banking organization's regulatory capital ratios. Specifically, the 
agencies and the FDIC observed that for some banking organizations, 
including unrealized losses on AFS debt securities in their regulatory 
capital calculations could mean that fluctuations in a benchmark 
interest rate could lead to changes in their PCA categories from 
quarter to quarter. Recognizing the potential impact of such 
fluctuations on regulatory capital management for some institutions, 
the agencies and the FDIC described possible alternatives to the 
proposed treatment of unrealized gains and losses on AFS debt 
securities, including an approach that would exclude from regulatory 
capital calculations those unrealized gains and losses that are

[[Page 62059]]

related to AFS debt securities whose valuations primarily change as a 
result of fluctuations in benchmark interest rates, including U.S. 
government and agency debt obligations, GSE debt obligations, and other 
sovereign debt obligations that would qualify for a zero percent risk 
weight under the standardized approach.
    A large proportion of commenters addressed the proposed treatment 
of AOCI in regulatory capital. Banking organizations of all sizes, 
banking and other industry groups, public officials (including members 
of the U.S. Congress), and other individuals strongly opposed the 
proposal to include most AOCI components in common equity tier 1 
capital.
    Specifically, commenters asserted that the agencies and the FDIC 
should not implement the proposal and should instead continue to apply 
the existing treatment for AOCI that excludes most AOCI amounts from 
regulatory capital. Several commenters stated that the accounting 
standards that require banking organizations to take a charge against 
earnings (and thus reduce capital levels) to reflect credit-related 
losses as part of other-than-temporary impairments already achieve the 
agencies' and the FDIC's goal to create regulatory capital ratios that 
provide an accurate picture of a banking organization's capital 
position, without also including AOCI in regulatory capital. For 
unrealized gains and losses on AFS debt securities that typically 
result from changes in benchmark interest rates rather than changes in 
credit risk, most commenters expressed concerns that the value of such 
securities on any particular day might not be a good indicator of the 
value of those securities for a banking organization, given that the 
banking organization could hold them until they mature and realize the 
amount due in full. Most commenters argued that the inclusion of 
unrealized gains and losses on AFS debt securities in regulatory 
capital could result in volatile capital levels and adversely affect 
other measures tied to regulatory capital, such as legal lending 
limits, especially if and when interest rates rise from their current 
historically-low levels.
    Accordingly, several commenters requested that the agencies and the 
FDIC permit banking organizations to remove from regulatory capital 
calculations unrealized gains and losses on AFS debt securities that 
have low credit risk but experience price movements based primarily on 
fluctuations in benchmark interest rates. According to commenters, 
these debt securities would include securities issued by the United 
States and other stable sovereign entities, U.S. agencies and GSEs, as 
well as some municipal entities. One commenter expressed concern that 
the proposed treatment of AOCI would lead banking organizations to 
invest excessively in securities with low volatility. Some commenters 
also suggested that unrealized gains and losses on high-quality asset-
backed securities and high-quality corporate securities should be 
excluded from regulatory capital calculations. The commenters argued 
that these adjustments to the proposal would allow regulatory capital 
to reflect unrealized gains or losses related to the credit quality of 
a banking organization's AFS debt securities.
    Additionally, commenters noted that, under the proposal, offsetting 
changes in the value of other items on a banking organization's balance 
sheet would not be recognized for regulatory capital purposes when 
interest rates change. For example, the commenters observed that 
banking organizations often hold AFS debt securities to hedge interest 
rate risk associated with deposit liabilities, which are not marked to 
fair value on the balance sheet. Therefore, requiring banking 
organizations to include AOCI in regulatory capital would mean that 
interest rate fluctuations would be reflected in regulatory capital 
only for one aspect of this hedging strategy, with the result that the 
proposed treatment could greatly overstate the economic impact that 
interest rate changes have on the safety and soundness of the banking 
organization.
    Several commenters used sample AFS securities portfolio data to 
illustrate how an upward shift in interest rates could have a 
substantial impact on a banking organization's capital levels 
(depending on the composition of its AFS portfolio and its defined 
benefit postretirement obligations). According to these commenters, the 
potential negative impact on capital levels that could follow a 
substantial increase in interest rates would place significant strains 
on banking organizations.
    To address the potential impact of incorporating the volatility 
associated with AOCI into regulatory capital, banking organizations 
also noted that they could increase their overall capital levels to 
create a buffer above regulatory minimums, hedge or reduce the 
maturities of their AFS debt securities, or shift more debt securities 
into their HTM portfolio. However, commenters asserted that these 
strategies would be complicated and costly, especially for smaller 
banking organizations, and could lead to a significant decrease in 
lending activity. Many community banking organization commenters 
observed that hedging or raising additional capital may be especially 
difficult for banking organizations with limited access to capital 
markets, while shifting more debt securities into the HTM portfolio 
would impair active management of interest rate risk positions and 
negatively impact a banking organization's liquidity position. These 
commenters also expressed concern that this could be especially 
problematic given the increased attention to liquidity by banking 
regulators and industry analysts.
    A number of commenters indicated that in light of the potential 
impact of the proposed treatment of AOCI on a banking organization's 
liquidity position, the agencies and the FDIC should, at the very 
least, postpone implementing this aspect of the proposal until after 
implementation of the BCBS's revised liquidity standards. Commenters 
suggested that postponing the implementation of the AOCI treatment 
would help to ensure that the final capital rules do not create 
disincentives for a banking organization to increase its holdings of 
high-quality liquid assets. In addition, several commenters suggested 
that the agencies and the FDIC not require banking organizations to 
include in regulatory capital unrealized gains and losses on assets 
that would qualify as ``high quality liquid assets'' under the BCBS's 
``liquidity coverage ratio'' under the Basel III liquidity framework.
    Finally, several commenters addressed the inclusion in AOCI of 
actuarial gains and losses on defined benefit pension fund obligations. 
Commenters stated that many banking organizations, particularly mutual 
banking organizations, offer defined benefit pension plans to attract 
employees because they are unable to offer stock options to employees. 
These commenters noted that actuarial gains and losses on defined 
benefit obligations represent the difference between benefit 
assumptions and, among other things, actual investment experiences 
during a given year, which is influenced predominantly by the discount 
rate assumptions used to determine the value of the plan obligation. 
The discount rate is tied to prevailing long-term interest rates at a 
point in time each year, and while market returns on the underlying 
assets of the plan and the discount rates may fluctuate year to year, 
the underlying liabilities typically are longer term--in some cases 15 
to 20 years. Therefore, changing interest rate environments

[[Page 62060]]

could lead to material fluctuations in the value of a banking 
organization's defined benefit post-retirement fund assets and 
liabilities, which in turn could create material swings in a banking 
organization's regulatory capital that would not be tied to changes in 
the credit quality of the underlying assets. Commenters stated that the 
added volatility in regulatory capital could lead some banking 
organizations to reconsider offering defined benefit pension plans.
    The agencies have considered the comments on the proposal to 
incorporate most elements of AOCI in regulatory capital, and have taken 
into account the potential effects that the proposed AOCI treatment 
could have on banking organizations and their function in the economy. 
As discussed in the proposal, the agencies believe that the proposed 
AOCI treatment results in a regulatory capital measure that better 
reflects banking organizations' actual risk at a specific point in 
time. The agencies also believe that AOCI is an important indicator 
that market observers use to evaluate the capital strength of a banking 
organization.
    However, the agencies recognize that for many banking 
organizations, the volatility in regulatory capital that could result 
from the proposal could lead to significant difficulties in capital 
planning and asset-liability management. The agencies also recognize 
that the tools used by advanced approaches banking organizations and 
other larger, more complex banking organizations for managing interest 
rate risk are not necessarily readily available to all banking 
organizations.
    Therefore, in the final rule, the agencies have decided to permit 
those banking organizations that are not subject to the advanced 
approaches risk-based capital rules to elect to calculate regulatory 
capital by using the treatment for AOCI in the agencies' general risk-
based capital rules, which excludes most AOCI amounts. Such banking 
organizations, may make a one-time, permanent election \102\ to 
effectively continue using the AOCI treatment under the general risk-
based capital rules for their regulatory calculations (``AOCI opt-out 
election'') when filing the Call Report or FR Y-9 series report for the 
first reporting period after the date upon which they become subject to 
the final rule.
---------------------------------------------------------------------------

    \102\ This one-time, opt-out selection does not cover a merger, 
acquisition or purchase transaction involving all or substantially 
all of the assets or voting stock between two banking organizations 
of which only one made an AOCI opt-out election. The resulting 
organization may make an AOCI election with prior agency approval.
---------------------------------------------------------------------------

    Pursuant to a separate notice under the Paperwork Reduction Act, 
the agencies intend to propose revisions to the Call Report and FR Y-9 
series report to implement changes in reporting items that would 
correspond to the final rule. These revisions will include a line item 
for banking organizations to indicate their AOCI opt-out election in 
their first regulatory report filed after the date the banking 
organization becomes subject to the final rule. Information regarding 
the AOCI opt-out election will be made available to the public and will 
be reflected on an ongoing basis in publicly-available regulatory 
reports. A banking organization that does not make an AOCI opt-out 
election on the Call Report or FR Y-9 series report filed for the first 
reporting period after the effective date of the final rule must 
include all AOCI components, except accumulated net gains and losses on 
cash-flow hedges related to items that are not recognized at fair value 
on the balance sheet, in regulatory capital elements starting the first 
quarter in which the banking organization calculates its regulatory 
capital requirements under the final rule.
    Consistent with regulatory capital calculations under the agencies' 
general risk-based capital rules, a banking organization that makes an 
AOCI opt-out election under the final rule must adjust common equity 
tier 1 capital elements by: (1) Subtracting any net unrealized gains 
and adding any net unrealized losses on AFS securities; (2) subtracting 
any net unrealized losses on AFS preferred stock classified as an 
equity security under GAAP and AFS equity exposures; (3) subtracting 
any accumulated net gains and adding back any accumulated net losses on 
cash-flow hedges included in AOCI; (4) subtracting amounts attributed 
to defined benefit postretirement plans resulting from the initial and 
subsequent application of the relevant GAAP standards that pertain to 
such plans (excluding, at the banking organization's option, the 
portion relating to pension assets deducted under section 22(a)(5)); 
and (5) subtracting any net unrealized gains and adding any net 
unrealized losses on held-to-maturity securities that are included in 
AOCI. In addition, consistent with the general risk-based capital 
rules, the banking organization must incorporate into common equity 
tier 1 capital any foreign currency translation adjustment. A banking 
organization may also incorporate up to 45 percent of any net 
unrealized gains on AFS preferred stock classified as an equity 
security under GAAP and AFS equity exposures into its tier 2 capital 
elements. However, the primary Federal supervisor may exclude all or a 
portion of these unrealized gains from a banking organization's tier 2 
capital under the reservation of authority provision of the final rule 
if the primary Federal supervisor determines that such preferred stock 
or equity exposures are not prudently valued.
    The agencies believe that banking organizations that apply the 
advanced approaches rule or that have opted to use the advanced 
approaches rule should already have the systems in place necessary to 
manage the added volatility resulting from the new AOCI treatment. 
Likewise, pursuant to the Dodd-Frank Act, these large, complex banking 
organizations are subject to enhanced prudential standards, including 
stress-testing requirements, and therefore should be prepared to manage 
their capital levels through the types of stressed economic 
environments, including environments with shifting interest rates, that 
could lead to substantial changes in amounts reported in AOCI. 
Accordingly, under the final rule, advanced approaches banking 
organizations will be required to incorporate all AOCI components, 
except accumulated net gains and losses on cash-flow hedges that relate 
to items that are not measured at fair value on the balance sheet, into 
their common equity tier 1 capital elements according to the transition 
provisions set forth in the final rule.
    The final rule additionally provides that in a merger, acquisition, 
or purchase transaction between two banking organizations that have 
each made an AOCI opt-out election, the surviving entity will be 
required to continue with the AOCI opt-out election, unless the 
surviving entity is an advanced approaches banking organization. 
Similarly, in a merger, acquisition, or purchase transaction between 
two banking organizations that have each not made an AOCI opt-out 
election, the surviving entity must continue implementing such 
treatment going forward. If an entity surviving a merger, acquisition, 
or purchase transaction becomes subject to the advanced approaches 
rule, it is no longer permitted to make an AOCI opt-out election and, 
therefore, must include most elements of AOCI in regulatory capital in 
accordance with the final rule.
    However, following a merger, acquisition or purchase transaction 
involving all or substantially all of the assets or voting stock 
between two banking organizations of which only

[[Page 62061]]

one made an AOCI opt-out election (and the surviving entity is not 
subject to the advanced approaches rule), the surviving entity must 
decide whether to make an AOCI opt-out election by its first regulatory 
reporting date following the consummation of the transaction.\103\ For 
example, if all of the equity of a banking organization that has made 
an AOCI opt-out election is acquired by a banking organization that has 
not made such an election, the surviving entity may make a new AOCI 
opt-out election in the Call Report or FR Y-9 series report filed for 
the first reporting period after the effective date of the merger. The 
final rule also provides the agencies with discretion to allow a new 
AOCI opt-out election where a merger, acquisition or purchase 
transaction between two banking organizations that have made different 
AOCI opt-out elections does not involve all or substantially all of the 
assets or voting stock of the purchased or acquired banking 
organization. In making such a determination, the agencies may consider 
the terms of the merger, acquisition, or purchase transaction, as well 
as the extent of any changes to the risk profile, complexity, and scope 
of operations of the banking organization resulting from the merger, 
acquisition, or purchase transaction. The agencies may also look to the 
Bank Merger Act \104\ for guidance on the types of transactions that 
would allow the surviving entity to make a new AOCI opt-out election. 
Finally, a de novo banking organization formed after the effective date 
of the final rule is required to make a decision to opt out in the 
first Call Report or FR Y-9 series report it is required to file.
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    \103\ A merger would involve ``all or substantially all'' of the 
assets or voting stock where, for example: (1) A banking 
organization buys all of the voting stock of a target banking 
organization, except for the stock of a dissenting, non-controlling 
minority shareholder; or (2) the banking organization buys all of 
the assets and major business lines of a target banking 
organization, but does not purchase a minor business line of the 
target. Circumstances in which the ``all or substantially all'' 
standard likely would not be met would be, for example: (1) A 
banking organization buys less than 80 percent of another banking 
organization; or (3) a banking organization buys only three out of 
four of another banking organization's major business lines.
    \104\ 12 U.S.C. 1828(c).
---------------------------------------------------------------------------

    The final rule also provides that if a top-tier depository 
institution holding company makes an AOCI opt-out election, any 
subsidiary insured depository institution that is consolidated by the 
depository institution holding company also must make an AOCI opt-out 
election. The agencies are concerned that if some banking organizations 
subject to regulatory capital rules under a common parent holding 
company make an AOCI opt-out election and others do not, there is a 
potential for these organizations to engage in capital arbitrage by 
choosing to book exposures or activities in the legal entity for which 
the relevant components of AOCI are treated most favorably.
    Notwithstanding the availability of the AOCI opt-out election under 
the final rule, the agencies have reserved the authority to require a 
banking organization to recognize all or some components of AOCI in 
regulatory capital if an agency determines it would be appropriate 
given a banking organization's risks under the agency's general 
reservation of authority under the final rule. The agencies will 
continue to expect each banking organization to maintain capital 
appropriate for its actual risk profile, regardless of whether it has 
made an AOCI opt-out election. Therefore, the agencies may determine 
that a banking organization with a large portfolio of AFS debt 
securities, or that is otherwise engaged in activities that expose it 
to high levels of interest-rate or other risks, should raise its common 
equity tier 1 capital level substantially above the regulatory 
minimums, regardless of whether that banking organization has made an 
AOCI opt-out election.
d. Investments in Own Regulatory Capital Instruments
    To avoid the double-counting of regulatory capital, the proposal 
would have required a banking organization to deduct the amount of its 
investments in its own capital instruments, including direct and 
indirect exposures, to the extent such instruments are not already 
excluded from regulatory capital. Specifically, the proposal would 
require a banking organization to deduct its investment in its own 
common equity tier 1, additional tier 1, and tier 2 capital instruments 
from the sum of its common equity tier 1, additional tier 1, and tier 2 
capital, respectively. In addition, under the proposal any common 
equity tier 1, additional tier 1, or tier 2 capital instrument issued 
by a banking organization that the banking organization could be 
contractually obligated to purchase also would have been deducted from 
common equity tier 1, additional tier 1, or tier 2 capital elements, 
respectively. The proposal noted that if a banking organization had 
already deducted its investment in its own capital instruments (for 
example, treasury stock) from its common equity tier 1 capital, it 
would not need to make such deductions twice.
    The proposed rule would have required a banking organization to 
look through its holdings of an index to deduct investments in its own 
capital instruments. Gross long positions in investments in its own 
regulatory capital instruments resulting from holdings of index 
securities would have been netted against short positions in the same 
underlying index. Short positions in indexes to hedge long cash or 
synthetic positions could have been decomposed to recognize the hedge. 
More specifically, the portion of the index composed of the same 
underlying exposure that is being hedged could have been used to offset 
the long position only if both the exposure being hedged and the short 
position in the index were covered positions under the market risk rule 
and the hedge was deemed effective by the banking organization's 
internal control processes which would have been assessed by the 
primary Federal supervisor of the banking organization. If the banking 
organization found it operationally burdensome to estimate the 
investment amount of an index holding, the proposal permitted the 
institution to use a conservative estimate with prior approval from its 
primary Federal supervisor. In all other cases, gross long positions 
would have been allowed to be deducted net of short positions in the 
same underlying instrument only if the short positions involved no 
counterparty risk (for example, the position was fully collateralized 
or the counterparty is a qualifying central counterparty (QCCP)).
    As discussed above, under the proposal, a banking organization 
would be required to look through its holdings of an index security to 
deduct investments in its own capital instruments. Some commenters 
asserted that the burden of the proposed look-through approach 
outweighs its benefits because it is not likely a banking organization 
would re-purchase its own stock through such indirect means. These 
commenters suggested that the agencies and the FDIC should not require 
a look-through test for index securities on the grounds that they are 
not ``covert buybacks,'' but rather are incidental positions held 
within a banking organization's trading book, often entered into on 
behalf of clients, customers or counterparties, and are economically 
hedged. However, the agencies believe that it is important to avoid the 
double-counting of regulatory capital, whether held directly or 
indirectly. Therefore, the final rule implements the look-through 
requirements of the proposal without change. In addition, consistent 
with the treatment for indirect investments in a banking organization's 
own capital

[[Page 62062]]

instruments, the agencies have clarified in the final rule that banking 
organizations must deduct synthetic exposures related to investments in 
own capital instruments.
e. Definition of Financial Institution
    Under the proposed rule, a banking organization would have been 
required to deduct an investment in the capital of an unconsolidated 
financial institution exceeding certain thresholds, as described below. 
The proposed definition of financial institution was designed to 
include entities whose activities and primary business are financial in 
nature and therefore could contribute to interconnectedness in the 
financial system. The proposed definition covered entities whose 
primary business is banking, insurance, investing, and trading, or a 
combination thereof, and included BHCs, SLHCs, nonbank financial 
institutions supervised by the Board under Title I of the Dodd-Frank 
Act, depository institutions, foreign banks, credit unions, insurance 
companies, securities firms, commodity pools, covered funds for 
purposes of section 13 of the Bank Holding Company Act and regulations 
issued thereunder, companies ``predominantly engaged'' in financial 
activities, non-U.S.-domiciled entities that would otherwise have been 
covered by the definition if they were U.S.-domiciled, and any other 
company that the agencies and the FDIC determined was a financial 
institution based on the nature and scope of its activities. The 
definition excluded GSEs and firms that were ``predominantly engaged'' 
in activities that are financial in nature but focus on community 
development, public welfare projects, and similar objectives. Under the 
proposed definition, a company would have been ``predominantly 
engaged'' in financial activities if (1) 85 percent or more of the 
total consolidated annual gross revenues (as determined in accordance 
with applicable accounting standards) of the company in either of the 
two most recent calendar years were derived, directly or indirectly, by 
the company on a consolidated basis from the activities; or (2) 85 
percent or more of the company's consolidated total assets (as 
determined in accordance with applicable accounting standards) as of 
the end of either of the two most recent calendar years were related to 
the activities.
    The proposed definition of ``financial institution'' was also 
relevant for purposes of the Advanced Approaches NPR. Specifically, the 
proposed rule would have required banking organizations to apply a 
multiplier of 1.25 to the correlation factor for wholesale exposures to 
unregulated financial institutions that generate a majority of their 
revenue from financial activities. The proposed rule also would have 
required advanced approaches banking organizations to apply a 
multiplier of 1.25 to wholesale exposures to regulated financial 
institutions with consolidated assets greater than or equal to $100 
billion.\105\
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    \105\ The definitions of regulated financial institutions and 
unregulated financial institutions are discussed in further detail 
in section XII.A of this preamble. Under the proposal, a ``regulated 
financial institution'' would include a financial institution 
subject to consolidated supervision and regulation comparable to 
that imposed on U.S. companies that are depository institutions, 
depository institution holding companies, nonbank financial 
companies supervised by the Board, broker dealers, credit unions, 
insurance companies, and designated financial market utilities.
---------------------------------------------------------------------------

    The agencies and the FDIC received a number of comments on the 
proposed definition of ``financial institution.'' Commenters expressed 
concern that the definition of a financial institution was overly broad 
and stated that it should not include investments in funds, commodity 
pools, or ERISA plans. Other commenters stated that the ``predominantly 
engaged'' test would impose significant operational burdens on banking 
organizations in determining what companies would be included in the 
proposed definition of ``financial institution.'' Commenters suggested 
that the agencies and the FDIC should risk weight such exposures, 
rather than subjecting them to a deduction from capital based on the 
definition of financial institution.
    Some of the commenters noted that many of the exposures captured by 
the financial institution definition may be risk-weighted under certain 
circumstances, and expressed concerns that overlapping regulation would 
result in confusion. For similar reasons, commenters recommended that 
the agencies and the FDIC limit the definition of financial institution 
to specific enumerated entities, such as regulated financial 
institutions, including insured depository institutions and holding 
companies, nonbank financial companies designated by the Financial 
Stability Oversight Council, insurance companies, securities holding 
companies, foreign banks, securities firms, futures commission 
merchants, swap dealers, and security based swap dealers. Other 
commenters stated that the definition should cover only those entities 
subject to consolidated regulatory capital requirements. Commenters 
also encouraged the agencies and the FDIC to adopt alternatives to the 
``predominantly engaged'' test for identifying a financial institution, 
such as the use of standard industrial classification codes or legal 
entity identifiers. Other commenters suggested that the agencies and 
the FDIC should limit the application of the ``predominantly engaged'' 
test in the definition of ``financial institution'' to companies above 
a specified size threshold. Similarly, others requested that the 
agencies and the FDIC exclude any company with total assets of less 
than $50 billion. Many commenters indicated that the broad definition 
proposed by the agencies and the FDIC was not required by Basel III and 
was unnecessary to promote systemic stability and avoid 
interconnectivity. Some commenters stated that funds covered by Section 
13 of the Bank Holding Company Act also should be excluded. Other 
commenters suggested that the agencies and the FDIC should exclude 
investment funds registered with the SEC under the Investment Company 
Act of 1940 and their foreign equivalents, while some commenters 
suggested methods of narrowing the definition to cover only leveraged 
funds. Commenters also requested that the agencies and the FDIC clarify 
that investment or financial advisory activities include providing both 
discretionary and non-discretionary investment or financial advice to 
customers, and that the definition would not capture either registered 
investment companies or investment advisers to registered funds.
    After considering the comments, the agencies have modified the 
definition of ``financial institution'' to provide more clarity around 
the scope of the definition as well as reduce operational burden. 
Separate definitions are adopted under the advanced approaches 
provisions of the final rule for ``regulated financial institution'' 
and ``unregulated financial institution'' for purposes of calculating 
the correlation factor for wholesale exposures, as discussed in section 
XII.A of this preamble.
    Under the final rule, the first paragraph of the definition of a 
financial institution includes an enumerated list of regulated 
institutions similar to the list that appeared in the first paragraph 
of the proposed definition: A BHC; SLHC; nonbank financial institution 
supervised by the Board under Title I of the Dodd-Frank Act; depository 
institution; foreign bank; credit union; industrial loan company, 
industrial bank, or other similar institution described in section 2 of 
the Bank Holding Company Act; national association, state member bank, 
or state

[[Page 62063]]

nonmember bank that is not a depository institution; insurance company; 
securities holding company as defined in section 618 of the Dodd-Frank 
Act; broker or dealer registered with the SEC; futures commission 
merchant and swap dealer, each as defined in the Commodity Exchange 
Act; or security-based swap dealer; or any designated financial market 
utility (FMU). The definition also includes foreign companies that 
would be covered by the definition if they are supervised and regulated 
in a manner similar to the institutions described above that are 
included in the first paragraph of the definition of ``financial 
institution.'' The agencies also have retained in the final definition 
of ``financial institution'' a modified version of the proposed 
``predominantly engaged'' test to capture additional entities that 
perform certain financial activities that the agencies believe 
appropriately addresses those relationships among financial 
institutions that give rise to concerns about interconnectedness, while 
reducing operational burden. Consistent with the proposal, a company is 
``predominantly engaged'' in financial activities for the purposes of 
the definition if it meets the test to the extent the following 
activities make up more than 85 percent of the company's total assets 
or gross revenues:
    (1) Lending money, securities or other financial instruments, 
including servicing loans;
    (2) Insuring, guaranteeing, indemnifying against loss, harm, 
damage, illness, disability, or death, or issuing annuities;
    (3) Underwriting, dealing in, making a market in, or investing as 
principal in securities or other financial instruments; or
    (4) Asset management activities (not including investment or 
financial advisory activities).
    In response to comments expressing concerns regarding operational 
burden and potential lack of access to necessary information in 
applying the proposed ``predominantly engaged'' test, the agencies have 
revised that portion of the definition. Now, the banking organization 
would only apply the test if it has an investment in the GAAP equity 
instruments of the company with an adjusted carrying value or exposure 
amount equal to or greater than $10 million, or if it owns more than 10 
percent of the company's issued and outstanding common shares (or 
similar equity interest). The agencies believe that this modification 
would reduce burden on banking organizations with small exposures, 
while those with larger exposures should have sufficient information as 
a shareholder to conduct the predominantly engaged analysis.\106\
---------------------------------------------------------------------------

    \106\ For advanced approaches banking organizations, for 
purposes of section 131 of the final rule, the definition of 
``unregulated financial institution'' does not include the ownership 
limitation in applying the ``predominantly engaged'' standard.
---------------------------------------------------------------------------

    In cases when a banking organization's investment in the banking 
organization exceeds one of the thresholds described above, the banking 
organization must determine whether the company is predominantly 
engaged in financial activities, in accordance with the final rule. The 
agencies believe that this modification will substantially reduce 
operational burden for banking organizations with investments in 
multiple institutions. The agencies also believe that an investment of 
$10 million in or a holding of 10 percent of the outstanding common 
shares (or equivalent ownership interest) of an entity has the 
potential to create a risk of interconnectedness, and also makes it 
reasonable for the banking organization to gain information necessary 
to understand the operations and activities of the company in which it 
has invested and to apply the proposed ``predominantly engaged'' test 
under the definition. The agencies are clarifying that, consistent with 
the proposal, investment or financial advisers (whether they provide 
discretionary or non-discretionary advisory services) are not covered 
under the definition of financial institution. The revised definition 
also specifically excludes employee benefit plans. The agencies 
believe, upon review of the comments, that employee benefit plans are 
heavily regulated under ERISA and do not present the same kind of risk 
of systemic interconnectedness that the enumerated financial 
institutions present. The revised definition also explicitly excludes 
investment funds registered with the SEC under the Investment Company 
Act of 1940, as the agencies believe that such funds create risks of 
systemic interconnectedness largely through their investments in the 
capital of financial institutions. These investments are addressed 
directly by the final rule's treatment of indirect investments in 
financial institutions. Although the revised definition does not 
specifically include commodities pools, under some circumstances a 
banking organization's investment in a commodities pool might meet the 
requirements of the modified ``predominantly engaged'' test.
    Some commenters also requested that the agencies and the FDIC 
establish an asset threshold below which an entity would not be 
included in the definition of ``financial institution.'' The agencies 
have not included such a threshold because they are concerned that it 
could create an incentive for multiple investments and aggregated 
exposures in smaller financial institutions, thereby undermining the 
rationale underlying the treatment of investments in the capital of 
unconsolidated financial institutions. The agencies believe that the 
definition of financial institution appropriately captures both large 
and small entities engaged in the core financial activities that the 
agencies believe should be addressed by the definition and associated 
deductions from capital. The agencies believe, however, that the 
modification to the ``predominantly engaged'' test, should serve to 
alleviate some of the burdens with which the commenters who made this 
point were concerned.
    Consistent with the proposal, investments in the capital of 
unconsolidated financial institutions that are held indirectly 
(indirect exposures) are subject to deduction. Under the proposal, a 
banking organization's entire investment in, for example, a registered 
investment company would have been subject to deduction from capital. 
Although those entities are excluded from the definition of financial 
institution in the final rule unless the ownership threshold is met, 
any holdings in the capital instruments of financial institutions held 
indirectly through investment funds are subject to deduction from 
capital. More generally, and as described later in this section of the 
preamble, the final rule provides an explicit mechanism for calculating 
the amount of an indirect investment subject to deduction.
f. The Corresponding Deduction Approach
    The proposals incorporated the Basel III corresponding deduction 
approach for the deductions from regulatory capital related to 
reciprocal crossholdings, non-significant investments in the capital of 
unconsolidated financial institutions, and non-common stock significant 
investments in the capital of unconsolidated financial institutions. 
Under the proposal, a banking organization would have been required to 
make any such deductions from the same component of capital for which 
the underlying instrument would qualify if it were issued by the 
banking organization itself. If a banking organization did not have a 
sufficient amount of a specific regulatory capital component against 
which to effect the deduction, the shortfall would have

[[Page 62064]]

been deducted from the next higher (that is, more subordinated) 
regulatory capital component. For example, if a banking organization 
did not have enough additional tier 1 capital to satisfy the required 
deduction, the shortfall would be deducted from common equity tier 1 
capital elements.
    Under the proposal, if the banking organization invested in an 
instrument issued by an financial institution that is not a regulated 
financial institution, the banking organization would have treated the 
instrument as common equity tier 1 capital if the instrument is common 
stock (or if it is otherwise the most subordinated form of capital of 
the financial institution) and as additional tier 1 capital if the 
instrument is subordinated to all creditors of the financial 
institution except common shareholders. If the investment is in the 
form of an instrument issued by a regulated financial institution and 
the instrument does not meet the criteria for any of the regulatory 
capital components for banking organizations, the banking organization 
would treat the instrument as: (1) Common equity tier 1 capital if the 
instrument is common stock included in GAAP equity or represents the 
most subordinated claim in liquidation of the financial institution; 
(2) additional tier 1 capital if the instrument is GAAP equity and is 
subordinated to all creditors of the financial institution and is only 
senior in liquidation to common shareholders; and (3) tier 2 capital if 
the instrument is not GAAP equity but it is considered regulatory 
capital by the primary supervisor of the financial institution.
    Some commenters sought clarification on whether, under the 
corresponding deduction approach, TruPS would be deducted from tier 1 
or tier 2 capital. In response to these comments the agencies have 
revised the final rule to clarify the deduction treatment for 
investments of non-qualifying capital instruments, including TruPS, 
under the corresponding deduction approach. The final rule includes a 
new paragraph section 22(c)(2)(iii) to provide that if an investment is 
in the form of a non-qualifying capital instrument described in section 
300(d) of the final rule, the banking organization must treat the 
instrument as a: (1) Tier 1 capital instrument if it was included in 
the issuer's tier 1 capital prior to May 19, 2010; or (2) tier 2 
capital instrument if it was included in the issuer's tier 2 capital 
(but not eligible for inclusion in the issuer's tier 1 capital) prior 
to May 19, 2010.
    In addition, to avoid a potential circularity issue (related to the 
combined impact of the treatment of ALLL and the risk-weight treatment 
for threshold items that are not deducted from common equity tier 1 
capital) in the calculation of common equity tier 1 capital, the final 
rule clarifies that banking organizations must apply any deductions 
under the corresponding deduction approach resulting from insufficient 
amounts of a specific regulatory capital component after applying any 
deductions from the items subject to the 10 and 15 percent common 
equity tier 1 capital deduction thresholds discussed further below. 
This was accomplished by removing proposed paragraph 22(c)(2)(i) from 
the corresponding deduction approach section and inserting paragraph 
22(f). Under section 22(f) of the final rule, and as noted above, if a 
banking organization does not have a sufficient amount of a specific 
component of capital to effect the required deduction under the 
corresponding deduction approach, the shortfall must be deducted from 
the next higher (that is, more subordinated) component of regulatory 
capital.
g. Reciprocal Crossholdings in the Capital Instruments of Financial 
Institutions
    A reciprocal crossholding results from a formal or informal 
arrangement between two financial institutions to swap, exchange, or 
otherwise intend to hold each other's capital instruments. The use of 
reciprocal crossholdings of capital instruments to artificially inflate 
the capital positions of each of the financial institutions involved 
would undermine the purpose of regulatory capital, potentially 
affecting the stability of such financial institutions as well as the 
financial system.
    Under the agencies' general risk-based capital rules, reciprocal 
crossholdings of capital instruments of banking organizations are 
deducted from regulatory capital. Consistent with Basel III, the 
proposal would have required a banking organization to deduct 
reciprocal crossholdings of capital instruments of other financial 
institutions using the corresponding deduction approach. The final rule 
maintains this treatment.
h. Investments in the Banking Organization's Own Capital Instruments or 
in the Capital of Unconsolidated Financial Institutions
    In the final rule, the agencies made several non-substantive 
changes to the wording in the proposal to clarify that the amount of an 
investment in the banking organization's own capital instruments or in 
the capital of unconsolidated financial institutions is the net long 
position (as calculated under section 22(h) of the final rule) of such 
investments. The final rule also clarifies how to calculate the net 
long position of these investments, especially for the case of indirect 
exposures. It is the net long position that is subject to deduction. In 
addition, the final rule generally harmonizes the recognition of 
hedging for own capital instruments and for investments in the capital 
of unconsolidated financial institutions. Under the final rule, an 
investment in a banking organization's own capital instrument is 
deducted from regulatory capital and an investment in the capital of an 
unconsolidated financial institution is subject to deduction from 
regulatory capital if such investment exceeds certain thresholds.
    An investment in the capital of an unconsolidated financial 
institution refers to the net long position (calculated in accordance 
with section 22(h) of the final rule) in an instrument that is 
recognized as capital for regulatory purposes by the primary supervisor 
of an unconsolidated regulated financial institution or in an 
instrument that is part of GAAP equity of an unconsolidated unregulated 
financial institution. It includes direct, indirect, and synthetic 
exposures to capital instruments, and excludes underwriting positions 
held by a banking organization for fewer than five business days.
    An investment in the banking organization's own capital instrument 
means a net long position calculated in accordance with section 22(h) 
of the final rule in the banking organization's own common stock 
instrument, own additional tier 1 capital instrument or own tier 2 
capital instrument, including direct, indirect or synthetic exposures 
to such capital instruments. An investment in the banking 
organization's own capital instrument includes any contractual 
obligation to purchase such capital instrument.
    The final rule also clarifies that the gross long position for an 
investment in the banking organization's own capital instrument or the 
capital of an unconsolidated financial institution that is an equity 
exposure refers to the adjusted carrying value (determined in 
accordance with section 51(b) of the final rule). For the case of an 
investment in the banking organization's own capital instrument or the 
capital of an unconsolidated financial institution that is not an 
equity exposure, the gross long position is defined as the exposure 
amount (determined in accordance with section 2 of the final rule).
    Under the proposal, the agencies and the FDIC included the 
methodology for

[[Page 62065]]

the recognition of hedging and for the calculation of the net long 
position regarding investments in the banking organization's own 
capital instruments and in investments in the capital of unconsolidated 
financial institutions in the definitions section. However, such 
methodology appears in section 22 of the final rule as the agencies 
believe it is more appropriate to include it in the adjustments and 
deductions to regulatory capital section.
    The final rule provides that the net long position is the gross 
long position in the underlying instrument (including covered positions 
under the market risk rule) net of short positions in the same 
instrument where the maturity of the short position either matches the 
maturity of the long position or has a residual maturity of at least 
one year. A banking organization may only net a short position against 
a long position in the banking organization's own capital instrument if 
the short position involves no counterparty credit risk. The long and 
short positions in the same index without a maturity date are 
considered to have matching maturities. If both the long position and 
the short position do not have contractual maturity dates, then the 
positions are considered maturity-matched. For positions that are 
reported on a banking organization's regulatory report as trading 
assets or trading liabilities, if the banking organization has a 
contractual right or obligation to sell a long position at a specific 
point in time, and the counterparty to the contract has an obligation 
to purchase the long position if the banking organization exercises its 
right to sell, this point in time may be treated as the maturity of the 
long position. Therefore, if these conditions are met, the maturity of 
the long position and the short position would be deemed to be matched 
even if the maturity of the short position is less than one year.
    Gross long positions in own capital instruments or in the capital 
instruments of unconsolidated financial institutions resulting from 
positions in an index may be netted against short positions in the same 
underlying index. Short positions in indexes that are hedging long cash 
or synthetic positions may be decomposed to recognize the hedge. More 
specifically, the portion of the index that is composed of the same 
underlying exposure that is being hedged may be used to offset the long 
position, provided both the exposure being hedged and the short 
position in the index are trading assets or trading liabilities, and 
the hedge is deemed effective by the banking organization's internal 
control processes, which the banking organization's primary Federal 
supervisor has found not to be inadequate.
    An indirect exposure results from a banking organization's 
investment in an investment fund that has an investment in the banking 
organization's own capital instrument or the capital of an 
unconsolidated financial institution. A synthetic exposure results from 
a banking organization's investment in an instrument where the value of 
such instrument is linked to the value of the banking organization's 
own capital instrument or a capital instrument of a financial 
institution. Examples of indirect and synthetic exposures include: (1) 
An investment in the capital of an investment fund that has an 
investment in the capital of an unconsolidated financial institution; 
(2) a total return swap on a capital instrument of the banking 
organization or another financial institution; (3) a guarantee or 
credit protection, provided to a third party, related to the third 
party's investment in the capital of another financial institution; (4) 
a purchased call option or a written put option on the capital 
instrument of another financial institution; (5) a forward purchase 
agreement on the capital of another financial institution; and (6) a 
trust preferred security collateralized debt obligation (TruPS CDO).
    Investments, including indirect and synthetic exposures, in the 
capital of unconsolidated financial institutions are subject to the 
corresponding deduction approach if they surpass certain thresholds 
described below. With the prior written approval of the primary Federal 
supervisor, for the period of time stipulated by the supervisor, a 
banking organization is not required to deduct investments in the 
capital of unconsolidated financial institutions described in this 
section if the investment is made in connection with the banking 
organization providing financial support to a financial institution in 
distress, as determined by the supervisor. Likewise, a banking 
organization that is an underwriter of a failed underwriting can 
request approval from its primary Federal supervisor to exclude 
underwriting positions related to such failed underwriting held for 
longer than five days.
    Some commenters requested clarification that a long position and 
short hedging position are considered ``maturity matched'' if (1) the 
maturity period of the short position extends beyond the maturity 
period of the long position or (2) both long and short positions mature 
or terminate within the same calendar quarter. The agencies note that 
they concur with these commenters' interpretation of the maturity 
matching of long and short hedging positions.
    For purposes of calculating the net long position in the capital of 
an unconsolidated financial institution, several commenters expressed 
concern that allowing banking organizations to net gross long positions 
with short positions only where the maturity of the short position 
either matches the maturity of the long position or has a maturity of 
at least one year is not practical, as some exposures, such as cash 
equities, have no maturity. These commenters expressed concern that 
such a maturity requirement could result in banking organizations 
deducting equities held as hedges for equity swap transactions with a 
client, making the latter transactions uneconomical and resulting in 
disruptions to market activity. Similarly, these commenters argued that 
providing customer accommodation equity swaps could become burdensome 
as a strict reading of the proposal could affect the ability of banking 
organizations to offset the equity swap with the long equity position 
because the maturity of the equity swap is typically less than one 
year. The agencies have considered the comments and have decided to 
retain the maturity requirement as proposed. The agencies believe that 
the proposed maturity requirements will reduce the possibility of 
``cliff effects'' resulting from the deduction of open equity positions 
when a banking organization is unable to replace the hedge or sell the 
long equity position.
i. Indirect Exposure Calculations
    The proposal provided that an indirect exposure would result from a 
banking organization's investment in an unconsolidated entity that has 
an exposure to a capital instrument of a financial institution, while a 
synthetic exposure would result from the banking organization's 
investment in an instrument where the value of such instrument is 
linked to the value of a capital instrument of a financial institution. 
With the exception of index securities, the proposal did not, however, 
provide a mechanism for calculating the amount of the indirect exposure 
that is subject to deduction. The final rule clarifies the 
methodologies for calculating the net long position related to an 
indirect exposure (which is subject to deduction under the final rule) 
by providing a methodology for calculating the gross long position of 
such indirect exposure.

[[Page 62066]]

The agencies believe that the options provided in the final rule will 
provide banking organizations with increased clarity regarding the 
treatment of indirect exposures, as well as increased risk-sensitivity 
to the banking organization's actual potential exposure.
    In order to limit the potential difficulties in determining whether 
an unconsolidated entity in fact holds the banking organization's own 
capital or the capital of unconsolidated financial institutions, the 
final rule also provides that the indirect exposure requirements only 
apply when the banking organization holds an investment in an 
investment fund, as defined in the rule. Accordingly, a banking 
organization invested in, for example, a commercial company is not 
required to determine whether the commercial company has any holdings 
of the banking organization's own capital or the capital instruments of 
financial institutions.
    The final rule provides that a banking organization may determine 
that its gross long position is equivalent to its carrying value of its 
investment in an investment fund that holds the banking organization's 
own capital or that holds an investment in the capital of an 
unconsolidated financial institution, which would be subject to 
deduction according to section 22(c). Recognizing, however, that the 
banking organization's exposure to those capital instruments may be 
less than its carrying value of its investment in the investment fund, 
the final rule provides two alternatives for calculating the gross long 
position of an indirect exposure. For an indirect exposure resulting 
from a position in an index, a banking organization may, with the prior 
approval of its primary Federal supervisor, use a conservative estimate 
of the amount of its investment in its own capital instruments or the 
capital instruments of other financial institutions. If the investment 
is held through an investment fund, a banking organization may use a 
look-through approach similar to the approach used for risk weighting 
equity exposures to investment funds. Under this approach, a banking 
organization may multiply the carrying value of its investment in an 
investment fund by either the exact percentage of the banking 
organization's own capital instrument or capital instruments of 
unconsolidated financial institutions held by the investment fund or by 
the highest stated prospectus limit for such investments held by the 
investment fund. Accordingly, if a banking organization with a carrying 
value of $10,000 for its investment in an investment fund knows that 
the investment fund has invested 30 percent of its assets in the 
capital of financial institutions, then the banking organization could 
subject $3,000 (the carrying value times the percentage invested in the 
capital of financial institutions) to deduction from regulatory 
capital. The agencies believe that the approach is flexible and 
benefits a banking organization that obtains and maintains information 
about its investments through investment funds. It also provides a 
simpler calculation method for a banking organization that either does 
not have information about the holdings of the investment fund or 
chooses not to do the more complex calculation.
j. Non-Significant Investments in the Capital of Unconsolidated 
Financial Institutions
    The proposal provided that non-significant investments in the 
capital of unconsolidated financial institutions would be the net long 
position in investments where a banking organization owns 10 percent or 
less of the issued and outstanding common stock of an unconsolidated 
financial institution.
    Under the proposal, if the aggregate amount of a banking 
organization's non-significant investments in the capital of 
unconsolidated financial institutions exceeds 10 percent of the sum of 
the banking organization's own common equity tier 1 capital, minus 
certain applicable deductions and other regulatory adjustments to 
common equity tier 1 capital (the 10 percent threshold for non-
significant investments), the banking organization would have been 
required to deduct the amount of the non-significant investments that 
are above the 10 percent threshold for non-significant investments, 
applying the corresponding deduction approach.\107\
---------------------------------------------------------------------------

    \107\ The regulatory adjustments and deductions applied in the 
calculation of the 10 percent threshold for non-significant 
investments are those required under sections 22(a) through 22(c)(3) 
of the proposal. That is, the required deductions and adjustments 
for goodwill and other intangibles (other than MSAs) net of 
associated DTLs (when the banking organization has elected to net 
DTLs in accordance with section 22(e)), DTAs that arise from net 
operating loss and tax credit carryforwards net of related valuation 
allowances and DTLs (in accordance with section 22(e)), cash-flow 
hedges associated with items that are not recognized at fair value 
on the balance sheet, excess ECLs (for advanced approaches banking 
organizations only), gains-on-sale on securitization exposures, 
gains and losses due to changes in own credit risk on financial 
liabilities measured at fair value, defined benefit pension fund net 
assets for banking organizations that are not insured by the FDIC 
(net of associated DTLs in accordance with section 22(e)), 
investments in own regulatory capital instruments (not deducted as 
treasury stock), and reciprocal crossholdings.
---------------------------------------------------------------------------

    Under the proposal, the amount to be deducted from a specific 
capital component would be equal to the amount of a banking 
organization's non-significant investments in the capital of 
unconsolidated financial institutions exceeding the 10 percent 
threshold for non-significant investments multiplied by the ratio of: 
(1) The amount of non-significant investments in the capital of 
unconsolidated financial institutions in the form of such capital 
component to (2) the amount of the banking organization's total non-
significant investments in the capital of unconsolidated financial 
institutions. The amount of a banking organization's non-significant 
investments in the capital of unconsolidated financial institutions 
that does not exceed the 10 percent threshold for non-significant 
investments would, under the proposal, generally be assigned the 
applicable risk weight under section 32 or section 131, as applicable 
(in the case of non-common stock instruments), section 52 or section 
152, as applicable (in the case of common stock instruments), or 
section 53, section 154, as applicable (in the case of indirect 
investments via an investment fund), or, in the case of a covered 
position, in accordance with subpart F, as applicable.
    One commenter requested clarification that a banking organization 
would not have to take a ``double deduction'' for an investment made in 
unconsolidated financial institutions held through another 
unconsolidated financial institution in which the banking organization 
has invested. The agencies note that, under the final rule, where a 
banking organization has an investment in an unconsolidated financial 
institution (Institution A) and Institution A has an investment in 
another unconsolidated financial institution (Institution B), the 
banking organization would not be deemed to have an indirect investment 
in Institution B for purposes of the final rule's capital thresholds 
and deductions because the banking organization's investment in 
Institution A is already subject to capital thresholds and deductions. 
However, if a banking organization has an investment in an investment 
fund that does not meet the definition of a financial institution, it 
must consider the assets of the investment fund to be indirect 
holdings.
    Some commenters requested clarification that the deductions for 
non-significant investments in the capital of unconsolidated financial 
institutions may be net of associated DTLs. The agencies have clarified 
in the final rule that a banking organization must deduct the net long 
position in non-significant investments in the capital of 
unconsolidated financial institutions,

[[Page 62067]]

net of associated DTLs in accordance with section 22(e) of the final 
rule, that exceeds the 10 percent threshold for non-significant 
investments. Under section 22(e) of the final rule, the netting of DTLs 
against assets that are subject to deduction or fully deducted under 
section 22 of the final rule is permitted but not required.
    Other commenters asked the agencies and the FDIC to confirm that 
the proposal would not require that investments in TruPS CDOs be 
treated as investments in the capital of unconsolidated financial 
institutions, but rather treat the investments as securitization 
exposures. The agencies believe that investments in TruPS CDOs are 
synthetic exposures to the capital of unconsolidated financial 
institutions and are thus subject to deduction. Under the final rule, 
any amounts of TruPS CDOs that are not deducted are subject to the 
securitization treatment.
k. Significant Investments in the Capital of Unconsolidated Financial 
Institutions That Are Not in the Form of Common Stock
    Under the proposal, a significant investment in the capital of an 
unconsolidated financial institution would be the net long position in 
an investment where a banking organization owns more than 10 percent of 
the issued and outstanding common stock of the unconsolidated financial 
institution. Significant investments in the capital of unconsolidated 
financial institutions that are not in the form of common stock are 
investments where the banking organization owns capital of an 
unconsolidated financial institution that is not in the form of common 
stock in addition to 10 percent of the issued and outstanding common 
stock of that financial institution. Such a non-common stock investment 
would be deducted by applying the corresponding deduction approach. 
Significant investments in the capital of unconsolidated financial 
institutions that are in the form of common stock would be subject to 
10 and 15 percent common equity tier 1 capital threshold deductions 
described below in this section.
    A number of commenters sought clarification as to whether under 
section 22(c) of the proposal, a banking organization may deduct any 
significant investments in the capital of unconsolidated financial 
institutions that are not in the form of common stock net of associated 
DTLs. The final rule clarifies that such deductions may be net of 
associated DTLs in accordance with paragraph 22(e) of the final rule. 
Other than this revision, the final rule adopts the proposed rule.
    More generally, commenters also sought clarification on the 
treatment of investments in the capital of unconsolidated financial 
institutions (for example, the distinction between significant and non-
significant investments). Thus, the chart below summarizes the 
treatment of investments in the capital of unconsolidated financial 
institutions.
BILLING CODE 4810-33-P

[[Page 62068]]

[GRAPHIC] [TIFF OMITTED] TR11OC13.000


[[Page 62069]]


l. Items Subject to the 10 and 15 Percent Common Equity Tier 1 Capital 
Threshold Deductions
    Under the proposal, a banking organization would have deducted from 
the sum of its common equity tier 1 capital elements the amount of each 
of the following items that individually exceeds the 10 percent common 
equity tier 1 capital deduction threshold described below: (1) DTAs 
arising from temporary differences that could not be realized through 
net operating loss carrybacks (net of any related valuation allowances 
and net of DTLs, as described in section 22(e) of the proposal); (2) 
MSAs, net of associated DTLs in accordance with section 22(e) of the 
proposal; and (3) significant investments in the capital of 
unconsolidated financial institutions in the form of common stock 
(referred to herein as items subject to the threshold deductions).
    Under the proposal, a banking organization would have calculated 
the 10 percent common equity tier 1 capital deduction threshold by 
taking 10 percent of the sum of a banking organization's common equity 
tier 1 elements, less adjustments to, and deductions from common equity 
tier 1 capital required under sections 22(a) through (c) of the 
proposal.
    As mentioned above in section V.B, under the proposal banking 
organizations would have been required to deduct from common equity 
tier 1 capital any goodwill embedded in the valuation of significant 
investments in the capital of unconsolidated financial institutions in 
the form of common stock. A banking organization would have been 
allowed to reduce the investment amount of such significant investment 
by the goodwill embedded in such investment. For example, if a banking 
organization has deducted $10 of goodwill embedded in a $100 
significant investment in the capital of an unconsolidated financial 
institution in the form of common stock, the banking organization would 
be allowed to reduce the investment amount of such significant 
investment by the amount of embedded goodwill (that is, the value of 
the investment would be $90 for purposes of the calculation of the 
amount that would be subject to deduction under this part of the 
proposal).
    In addition, under the proposal the aggregate amount of the items 
subject to the threshold deductions that are not deducted as a result 
of the 10 percent common equity tier 1 capital deduction threshold 
described above must not exceed 15 percent of a banking organization's 
common equity tier 1 capital, as calculated after applying all 
regulatory adjustments and deductions required under the proposal (the 
15 percent common equity tier 1 capital deduction threshold). That is, 
a banking organization would have been required to deduct in full the 
amounts of the items subject to the threshold deductions on a combined 
basis that exceed 17.65 percent (the proportion of 15 percent to 85 
percent) of common equity tier 1 capital elements, less all regulatory 
adjustments and deductions required for the calculation of the 10 
percent common equity tier 1 capital deduction threshold mentioned 
above, and less the items subject to the 10 and 15 percent deduction 
thresholds. As described below, the proposal required a banking 
organization to include the amounts of these three items that are not 
deducted from common equity tier 1 capital in its risk-weighted assets 
and assign a 250 percent risk weight to them.
    Some commenters asserted that subjecting DTAs resulting from net 
unrealized losses in an investment portfolio to the proposed 10 percent 
common equity tier 1 capital deduction threshold under section 22(d) of 
the proposal would result in a ``double deduction'' in that the net 
unrealized losses would have already been included in common equity 
tier 1 through the AOCI treatment. Under GAAP, net unrealized losses 
recognized in AOCI are reported net of tax effects (that is, taxes that 
give rise to DTAs). The tax effects related to net unrealized losses 
would reduce the amount of net unrealized losses reflected in common 
equity tier 1 capital. Given that the tax effects reduce the losses 
that would otherwise accrue to common equity tier 1 capital, the 
agencies are of the view that subjecting these DTAs to the 10 percent 
limitation would not result in a ``double deduction.''
    More generally, several commenters noted that the proposed 10 and 
15 percent common equity tier 1 capital deduction thresholds and the 
proposed 250 percent risk-weight are unduly punitive. Commenters 
recommended several alternatives including, for example, that the 
agencies and the FDIC should only retain the 10 percent limit on each 
threshold item but eliminate the 15 percent aggregate limit. The 
agencies believe that the proposed thresholds are appropriate as they 
increase the quality and loss-absorbency of regulatory capital, and are 
therefore adopting the proposed deduction thresholds as final. The 
agencies realize that these stricter limits on threshold items may 
require banking organizations to make appropriate changes in their 
capital structure or business model, and thus have provided a lengthy 
transition period to allow banking organizations to adequately plan for 
the new limits.
    Under section 475 of the Federal Deposit Insurance Corporation 
Improvement Act of 1991 (FDICIA) (12 U.S.C. 1828 note), the amount of 
readily marketable purchased mortgage servicing rights (PMSRs) that a 
banking organization may include in regulatory capital cannot be more 
than 90 percent of their fair value. In addition to this statutory 
requirement, the general risk-based capital rules require the same 
treatment for all MSAs, including PMSRs. Under the proposed rule, if 
the amount of MSAs a banking organization deducts after applying the 10 
percent and 15 percent common equity tier 1 deduction threshold is less 
than 10 percent of the fair value of its MSAs, then the banking 
organization would have deducted an additional amount of MSAs so that 
the total amount of MSAs deducted is at least 10 percent of the fair 
value of its MSAs.
    Some commenters requested removal of the 90 percent MSA fair value 
limitation, including for PMSRs under FDICIA. These commenters note 
that section 475(b) of FDICIA provides the agencies and the FDIC with 
authority to remove the 90 percent limitation on PMSRs, subject to a 
joint determination by the agencies and the FDIC that its removal would 
not have an adverse effect on the deposit insurance fund or the safety 
and soundness of insured depository institutions. The commenters 
asserted that removal of the 90 percent limitation would be appropriate 
because other provisions of the proposal pertaining to MSAs (including 
PMSRs) would require more capital to be retained even if the fair value 
limitation were removed.
    The agencies agree with these commenters and, pursuant to section 
475(b) of FDICIA, have determined that PMSRs may be valued at not more 
than 100 percent of their fair value, because the capital treatment of 
PMSRs in the final rule (specifically, the deduction approach for MSAs 
(including PMSRs) exceeding the 10 and 15 common equity deduction 
thresholds and the 250 percent risk weight applied to all MSAs not 
subject to deduction) is more conservative than the FDICIA fair value 
limitation and the 100 percent risk weight applied to MSAs under 
existing rules and such approach will not have an adverse effect on the 
deposit insurance fund or safety and soundness of insured depository 
institutions. For the same reasons, the agencies are also

[[Page 62070]]

removing the 90 percent fair value limitation for all other MSAs.
    Commenters also provided a variety of recommendations related to 
the proposed limitations on the inclusion of MSAs in regulatory 
capital. For instance, some commenters advocated removing the proposed 
deduction provision for hedged and commercial and multifamily-related 
MSAs, as well as requested an exemption from the proposed deduction 
requirement for community banking organizations with less than $10 
billion.
    Other commenters recommended increasing the amount of MSAs 
includable in regulatory capital. For example, one commenter 
recommended that MSAs should be limited to 100 percent of tier l 
capital if the underlying loans are prudently underwritten. Another 
commenter requested that the final rule permit thrifts and commercial 
banking organizations to include in regulatory capital MSAs equivalent 
to 50 and 25 percent of tier 1 capital, respectively.
    Several commenters also objected to the proposed risk weights for 
MSAs, asserting that a 250 percent risk weight for an asset that is 
marked-to-fair value quarterly is unreasonably punitive and that a 100 
percent risk weight should apply; that MSAs allowable in capital should 
be increased, at a minimum, to 30 percent of tier 1 capital, with a 
risk weight of no greater than 50 percent for existing MSAs; that 
commercial MSAs should continue to be subject to the risk weighting and 
deduction methodology under the general risk-based capital rules; and 
that originated MSAs should retain the same risk weight treatment under 
the general risk-based capital rules given that the ability to 
originate new servicing to replace servicing lost to prepayment in a 
falling-rate environment provides for a substantial hedge. Another 
commenter recommended that the agencies and the FDIC grandfather all 
existing MSAs that are being fair valued on banking organizations' 
balance sheets and exclude MSAs from the proposed 15 percent deduction 
threshold.
    After considering these comments, the agencies are adopting the 
proposed limitation on MSAs includable in common equity tier 1 capital 
without change in the final rule. MSAs, like other intangible assets, 
have long been either fully or partially excluded from regulatory 
capital in the United States because of the high level of uncertainty 
regarding the ability of banking organizations to realize value from 
these assets, especially under adverse financial conditions.
m. Netting of Deferred Tax Liabilities Against Deferred Tax Assets and 
Other Deductible Assets
    Under the proposal, banking organizations would have been permitted 
to net DTLs against assets (other than DTAs) subject to deduction under 
section 22 of the proposal, provided the DTL is associated with the 
asset and the DTL would be extinguished if the associated asset becomes 
impaired or is derecognized under GAAP. Likewise, banking organizations 
would be prohibited from using the same DTL more than once for netting 
purposes. This practice would be generally consistent with the approach 
that the agencies currently take with respect to the netting of DTLs 
against goodwill.
    With respect to the netting of DTLs against DTAs, under the 
proposal the amount of DTAs that arise from net operating loss and tax 
credit carryforwards, net of any related valuation allowances, and the 
amount of DTAs arising from temporary differences that the banking 
organization could not realize through net operating loss carrybacks, 
net of any related valuation allowances, could be netted against DTLs 
if certain conditions are met.
    The agencies and the FDIC received numerous comments recommending 
changes to and seeking clarification on various aspects of the proposed 
treatment of deferred taxes. Certain commenters asked whether 
deductions of significant and non-significant investments in the 
capital of unconsolidated financial institutions under section 22(c)(4) 
and 22(c)(5) of the proposed rule may be net of associated DTLs. A 
commenter also recommended that a banking organization be permitted to 
net a DTA against a fair value measurement or similar adjustment to an 
asset (for example, in the case of a certain cash-flow hedges) or a 
liability (for example, in the case of changes in the fair value of a 
banking organization's liabilities attributed to changes in the banking 
organization's own credit risk) that is associated with the adjusted 
value of the asset or liability that itself is subject to a capital 
adjustment or deduction under the Basel III NPR. These DTAs would be 
derecognized under GAAP if the adjustment were reversed. Accordingly, 
one commenter recommended that proposed text in section 22(e) be 
revised to apply to netting of DTAs as well as DTLs.
    The agencies agree that for regulatory capital purposes, a banking 
organization may exclude from the deduction thresholds DTAs and DTLs 
associated with fair value measurement or similar adjustments to an 
asset or liability that are excluded from common equity tier 1 capital 
under the final rule. The agencies note that GAAP requires net 
unrealized gains and losses \108\ recognized in AOCI to be recorded net 
of deferred tax effects. Moreover, under the agencies' general risk-
based capital rules and associated regulatory reporting instructions, 
banking organizations must deduct certain net unrealized gains, net of 
applicable taxes, and add back certain net unrealized losses, again, 
net of applicable taxes. Permitting banking organizations to exclude 
net unrealized gains and losses included in AOCI without netting of 
deferred tax effects would cause a banking organization to overstate 
the amount of net unrealized gains and losses excluded from regulatory 
capital and potentially overstate or understate deferred taxes included 
in regulatory capital.
---------------------------------------------------------------------------

    \108\ The word ``net'' in the term ``net unrealized gains and 
losses'' refers to the netting of gains and losses before tax.
---------------------------------------------------------------------------

    Accordingly, under the final rule, banking organizations must make 
all adjustments to common equity tier 1 capital under section 22(b) of 
the final rule net of any associated deferred tax effects. In addition, 
banking organizations may make all deductions from common equity tier 1 
capital elements under section 22(c) and (d) of the final rule net of 
associated DTLs, in accordance with section 22(e) of the final rule.
    Commenters also sought clarification as to whether banking 
organizations may change from reporting period to reporting period 
their decision to net DTLs against DTAs as opposed to netting DTLs 
against other assets subject to deduction. Consistent with the 
agencies' general risk-based capital rules, the final rule permits, but 
does not require, a banking organization to net DTLs associated with 
items subject to regulatory deductions from common equity tier 1 
capital under section 22(a). The agencies' general risk-based capital 
rules do not explicitly address whether or how often a banking 
organization may change its DTL netting approach for items subject to 
deduction, such as goodwill and other intangible assets.
    If a banking organization elects to either net DTLs against DTAs or 
to net DTLs against other assets subject to deduction, the final rule 
requires that it must do so consistently. For example, a banking 
organization that elects to deduct goodwill net of associated DTLs will 
be required to continue that

[[Page 62071]]

practice for all future reporting periods. Under the final rule, a 
banking organization must obtain approval from its primary Federal 
supervisor before changing its approach for netting DTLs against DTAs 
or assets subject to deduction under section 22(a), which would be 
permitted, for example, in situations where a banking organization 
merges with or acquires another banking organization, or upon a 
substantial change in a banking organization's business model.
    Commenters also asked whether banking organizations would be 
permitted or required to exclude (from the amount of DTAs subject to 
the threshold deductions under section 22(d) of the proposal) deferred 
tax assets and liabilities relating to net unrealized gains and losses 
reported in AOCI that are subject to: (1) Regulatory adjustments to 
common equity tier 1 capital (section 22(b) of the proposal), (2) 
deductions from regulatory capital related to investments in capital 
instruments (section 22(c) of the proposal), and (3) items subject to 
the 10 and 15 percent common equity tier 1 capital deduction thresholds 
(section 22(d) of the proposal).
    Under the agencies' general risk-based capital rules, before 
calculating the amount of DTAs subject to the DTA limitations for 
inclusion in tier 1 capital, a banking organization may eliminate the 
deferred tax effects of any net unrealized gains and losses on AFS debt 
securities. A banking organization that adopts a policy to eliminate 
such deferred tax effects must apply that approach consistently in all 
future calculations of the amount of disallowed DTAs.
    For purposes of the final rule, the agencies have decided to permit 
banking organizations to eliminate from the calculation of DTAs subject 
to threshold deductions under section 22(d) of the final rule the 
deferred tax effects associated with any items that are subject to 
regulatory adjustment to common equity tier 1 capital under section 
22(b). A banking organization that elects to eliminate such deferred 
tax effects must continue that practice consistently from period to 
period. A banking organization must obtain approval from its primary 
Federal supervisor before changing its election to exclude or not 
exclude these amounts from the calculation of DTAs. Additionally, the 
agencies have decided to require DTAs associated with any net 
unrealized losses or differences between the tax basis and the 
accounting basis of an asset pertaining to items (other than those 
items subject to adjustment under section 22(b)) that are: (1) Subject 
to deduction from common equity tier 1 capital under section 22(c) or 
(2) subject to the threshold deductions under section 22(d) to be 
subject to the threshold deductions under section 22(d) of the final 
rule.
    Commenters also sought clarification as to whether banking 
organizations would be required to compute DTAs and DTLs quarterly for 
regulatory capital purposes. In this regard, commenters stated that 
GAAP requires annual computation of DTAs and DTLs, and that more 
frequent computation requirements for regulatory capital purposes would 
be burdensome.
    Some DTA and DTL items must be adjusted at least quarterly, such as 
DTAs and DTLs associated with certain gains and losses included in 
AOCI. Therefore, the agencies expect banking organizations to use the 
DTA and DTL amounts reported in the regulatory reports for balance 
sheet purposes to be used for regulatory capital calculations. The 
final rule does not require banking organizations to perform these 
calculations more often than would otherwise be required in order to 
meet quarterly regulatory reporting requirements.
    A few commenters also asked whether the agencies and the FDIC would 
continue to allow banking organizations to use DTLs embedded in the 
carrying value of a leveraged lease to reduce the amount of DTAs 
subject to the 10 percent and 15 percent common equity tier 1 capital 
deduction thresholds contained in section 22(d) of the proposal. The 
valuation of a leveraged lease acquired in a business combination gives 
recognition to the estimated future tax effect of the remaining cash-
flows of the lease. Therefore, any future tax liabilities related to an 
acquired leveraged lease are included in the valuation of the leveraged 
lease, and are not separately reported under GAAP as DTLs. This can 
artificially increase the amount of net DTAs reported by banking 
organizations that acquire a leveraged lease portfolio under purchase 
accounting. Accordingly, the agencies' currently allow banking 
organizations to treat future taxes payable included in the valuation 
of a leveraged lease portfolio as a reversing taxable temporary 
difference available to support the recognition of DTAs.\109\ The final 
rule amends the proposal by explicitly permitting a banking 
organization to use the DTLs embedded in the carrying value of a 
leveraged lease to reduce the amount of DTAs consistent with section 
22(e).
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    \109\ Temporary differences arise when financial events or 
transactions are recognized in one period for financial reporting 
purposes and in another period, or periods, for tax purposes. A 
reversing taxable temporary difference is a temporary difference 
that produces additional taxable income future periods.
---------------------------------------------------------------------------

    In addition, commenters asked the agencies and the FDIC to clarify 
whether a banking organization is required to deduct from the sum of 
its common equity tier 1 capital elements net DTAs arising from timing 
differences that the banking organization could realize through net 
operating loss carrybacks. The agencies confirm that under the final 
rule, DTAs that arise from temporary differences that the banking 
organization may realize through net operating loss carrybacks are not 
subject to the 10 percent and 15 percent common equity tier 1 capital 
deduction thresholds (deduction thresholds). This is consistent with 
the agencies' general risk-based capital rules, which do not limit DTAs 
that can potentially be realized from taxes paid in prior carryback 
years. However, consistent with the proposal, the final rule requires 
that banking organizations deduct from common equity tier 1 capital 
elements the amount of DTAs arising from temporary differences that the 
banking organization could not realize through net operating loss 
carrybacks that exceed the deduction thresholds under section 22(d) of 
the final rule.
    Some commenters recommended that the agencies and the FDIC retain 
the provision in the agencies' and the FDIC's general risk-based 
capital rules that permits a banking organization to measure the amount 
of DTAs subject to inclusion in tier 1 capital by the amount of DTAs 
that the banking organization could reasonably be expected to realize 
within one year, based on its estimate of future taxable income.\110\ 
In addition, commenters argued that the full deduction of net operating 
loss and tax credit carryforwards from common equity tier 1 capital is 
an inappropriate reaction to concerns about DTAs as an element of 
capital, and that there are

[[Page 62072]]

appropriate circumstances where an institution should be allowed to 
include the value of its DTAs related to net operating loss 
carryforwards in regulatory capital.
---------------------------------------------------------------------------

    \110\ Under the agencies' general risk-based capital rules, a 
banking organization generally must deduct from tier 1 capital DTAs 
that are dependent upon future taxable income, which exceed the 
lesser of either: (1) The amount of DTAs that the bank could 
reasonably expect to realize within one year of the quarter-end 
regulatory report, based on its estimate of future taxable income 
for that year, or (2) 10 percent of tier 1 capital, net of goodwill 
and all intangible assets other than purchased credit card 
relationships, and servicing assets. See 12 CFR part 3, appendix A, 
section 2(c)(1)(iii) (national banks) and 12 CFR 167.12(h)(1)(i) 
(Federal savings associations (OCC); 12 CFR part 208, appendix A, 
section 2(b)(4), 12 CFR part 225, appendix A, section 2(b)(4) 
(Board); 12 CFR part 325, appendix A section I.A.1.iii(a) (state 
nonmember banks), and 12 CFR 390.465(a)(2)(vii) (state savings 
associations).
---------------------------------------------------------------------------

    The deduction thresholds for DTAs in the final rule are intended to 
address the concern that GAAP standards for DTAs could allow banking 
organizations to include in regulatory capital excessive amounts of 
DTAs that are dependent upon future taxable income. The concern is 
particularly acute when banking organizations begin to experience 
financial difficulty. In this regard, the agencies and the FDIC 
observed that as the recent financial crisis began, many banking 
organizations that had included DTAs in regulatory capital based on 
future taxable income were no longer able to do so because they 
projected more than one year of losses for tax purposes.
    The agencies note that under the proposal and final rule, DTAs that 
arise from temporary differences that the banking organization may 
realize through net operating loss carrybacks are not subject to the 
deduction thresholds and will be subject to a risk weight of 100 
percent. Further, banking organizations will continue to be permitted 
to include some or all of their DTAs that are associated with timing 
differences that are not realizable through net operating loss 
carrybacks in regulatory capital. In this regard, the final rule 
strikes an appropriate balance between prudential concerns and 
practical considerations about the ability of banking organizations to 
realize DTAs.
    The proposal stated: ``A [BANK] is not required to deduct from the 
sum of its common equity tier 1 capital elements net DTAs arising from 
timing differences that the [BANK] could realize through net operating 
loss carrybacks (emphasis added).'' \111\ Commenters requested that the 
agencies and the FDIC clarify that the word ``net'' in this sentence 
was intended to refer to DTAs ``net of valuation allowances.'' The 
agencies have amended section 22(e) of the final rule text to clarify 
that the word ``net'' in this instance was intended to refer to DTAs 
``net of any related valuation allowances and net of DTLs.''
---------------------------------------------------------------------------

    \111\ See footnote 14, 77 FR 52863 (August 30, 2012).
---------------------------------------------------------------------------

    In addition, a commenter requested that the agencies and the FDIC 
remove the condition in section 22(e) of the final rule providing that 
only DTAs and DTLs that relate to taxes levied by the same taxing 
authority may be offset for purposes of the deduction of DTAs. This 
commenter notes that under a GAAP, a company generally calculates its 
DTAs and DTLs relating to state income tax in the aggregate by applying 
a blended state rate. Thus, banking organizations do not typically 
track DTAs and DTLs on a state-by-state basis for financial reporting 
purposes.
    The agencies recognize that under GAAP, if the tax laws of the 
relevant state and local jurisdictions do not differ significantly from 
federal income tax laws, then the calculation of deferred tax expense 
can be made in the aggregate considering the combination of federal, 
state, and local income tax rates. The rate used should consider 
whether amounts paid in one jurisdiction are deductible in another 
jurisdiction. For example, since state and local taxes are deductible 
for federal purposes, the aggregate combined rate would generally be 
(1) the federal tax rate plus (2) the state and local tax rates, minus 
(3) the federal tax effect of the deductibility of the state and local 
taxes at the federal tax rate. Also, for financial reporting purposes, 
consistent with GAAP, the agencies allow banking organizations to 
offset DTAs (net of valuation allowance) and DTLs related to a 
particular tax jurisdiction. Moreover, for regulatory reporting 
purposes, consistent with GAAP, the agencies require separate 
calculations of income taxes, both current and deferred amounts, for 
each tax jurisdiction. Accordingly, banking organizations must 
calculate DTAs and DTLs on a state-by-state basis for financial 
reporting purposes under GAAP and for regulatory reporting purposes.
3. Investments in Hedge Funds and Private Equity Funds Pursuant to 
Section 13 of the Bank Holding Company Act
    Section 13 of the Bank Holding Company Act, which was added by 
section 619 of the Dodd-Frank Act, contains a number of restrictions 
and other prudential requirements applicable to any ``banking entity'' 
\112\ that engages in proprietary trading or has certain interests in, 
or relationships with, a hedge fund or a private equity fund.\113\
---------------------------------------------------------------------------

    \112\ See 12 U.S.C. 1851. The term ``banking entity'' is defined 
in section 13(h)(1) of the Bank Holding Company Act, as amended by 
section 619 of the Dodd-Frank Act. See 12 U.S.C. 1851(h)(1). The 
statutory definition includes any insured depository institution 
(other than certain limited purpose trust institutions), any company 
that controls an insured depository institution, any company that is 
treated as a bank holding company for purposes of section 8 of the 
International Banking Act of 1978 (12 U.S.C. 3106), and any 
affiliate or subsidiary of any of the foregoing.
    \113\ Section 13 of the Bank Holding Company Act defines the 
terms ``hedge fund'' and ``private equity fund'' as ``an issuer that 
would be an investment company, as defined in the Investment Company 
Act of 1940, but for section 3(c)(1) or 3(c)(7) of that Act, or such 
similar funds as the [relevant agencies] may, by rule . . . 
determine.'' See 12 U.S.C. 1851(h)(2).
---------------------------------------------------------------------------

    Section 13(d)(3) of the Bank Holding Company Act provides that the 
relevant agencies ``shall . . . adopt rules imposing additional capital 
requirements and quantitative limitations, including diversification 
requirements, regarding activities permitted under [Section 13] if the 
appropriate Federal banking agencies, the SEC, and the Commodity 
Futures Trading Commission (CFTC) determine that additional capital and 
quantitative limitations are appropriate to protect the safety and 
soundness of banking entities engaged in such activities.'' The Dodd-
Frank Act also added section 13(d)(4)(B)(iii) to the Bank Holding 
Company Act, which pertains to investments in a hedge fund or private 
equity fund organized and offered by a banking entity and provides for 
deductions from the assets and tangible equity of the banking entity 
for these investments in hedge funds or private equity funds.
    On November 7, 2011, the agencies, the FDIC, and the SEC issued a 
proposal to implement Section 13 of the Bank Holding Company Act.\114\ 
The proposal would require a ``banking entity'' to deduct from tier 1 
capital its investments in a hedge fund or a private equity fund that 
the banking entity organizes and offers.\115\ The agencies intend to 
address this capital requirement, as it applies to banking 
organizations, within the context of the agencies' entire regulatory 
capital framework, so that its potential interaction with all other 
regulatory capital requirements can be fully assessed.
---------------------------------------------------------------------------

    \114\ See 76 FR 68846 (November 7, 2011). On February 14, 2012, 
the CFTC published a substantively similar proposed rule 
implementing section 13 of the Bank Holding Company Act. See 77 FR 
8332 (February 14, 2012).
    \115\ See Id., Sec.  --.12(d).
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VI. Denominator Changes Related to the Regulatory Capital Changes

    Consistent with Basel III, the proposal provided a 250 percent risk 
weight for the portion of the following items that are not otherwise 
subject to deduction: (1) MSAs, (2) DTAs arising from temporary 
differences that a banking organization could not realize through net 
operating loss carrybacks (net of any related valuation allowances and 
net of

[[Page 62073]]

DTLs, as described in section 22(e) of the rule), and (3) significant 
investments in the capital of unconsolidated financial institutions in 
the form of common stock that are not deducted from tier 1 capital.
    Several commenters objected to the proposed 250 percent risk weight 
and stated that the agencies and the FDIC instead should apply a 100 
percent risk weight to the amount of these assets below the deduction 
thresholds. Commenters stated that the relatively high risk weight 
would drive business, particularly mortgage servicing, out of the 
banking sector and into unregulated shadow banking entities.
    After considering the comments, the agencies continue to believe 
that the 250 percent risk weight is appropriate in light of the 
relatively greater risks inherent in these assets, as described above. 
These risks are sufficiently significant that concentrations in these 
assets warrant deductions from capital, and any exposure to these 
assets merits a higher-than 100 percent risk weight. Therefore, the 
final rule adopts the proposed treatment without change.
    The final rule, consistent with the proposal, requires banking 
organizations to apply a 1,250 percent risk weight to certain exposures 
that were subject to deduction under the general risk-based capital 
rules. Therefore, for purposes of calculating total risk-weighted 
assets, the final rule requires a banking organization to apply a 1,250 
percent risk weight to the portion of a credit-enhancing interest-only 
strip (CEIO) that does not constitute an after-tax-gain-on-sale.

VII. Transition Provisions

    The proposal established transition provisions for: (i) Minimum 
regulatory capital ratios; (ii) capital conservation and 
countercyclical capital buffers; (iii) regulatory capital adjustments 
and deductions; (iv) non-qualifying capital instruments; and (v) the 
supplementary leverage ratio. Most of the transition periods in the 
proposal began on January 1, 2013, and would have provided banking 
organizations between three and six years to comply with the 
requirements in the proposed rule. Among other provisions, the proposal 
would have provided a transition period for the phase-out of non-
qualifying capital instruments from regulatory capital under either a 
three- or ten-year transition period based on the organization's 
consolidated total assets. The proposed transition provisions were 
designed to give banking organizations sufficient time to adjust to the 
revised capital framework while minimizing the potential impact that 
implementation could have on their ability to lend. The transition 
provisions also were designed to ensure compliance with the Dodd-Frank 
Act. As a result, they would have been, in certain circumstances, more 
stringent than the transition arrangements set forth in Basel III.
    The agencies and the FDIC received multiple comments on the 
proposed transition framework. Most of the commenters characterized the 
proposed transition schedule for the minimum capital ratios as overly 
aggressive and expressed concern that banking organizations would not 
be able to meet the increased capital requirements (in accordance with 
the transition schedule) in the current economic environment. 
Commenters representing community banking organizations argued that 
such organizations generally have less access to the capital markets 
relative to larger banking organizations and, therefore, usually 
increase capital primarily by accumulating retained earnings. 
Accordingly, these commenters requested additional time to satisfy the 
minimum capital requirements under the proposed rule, and specifically 
asked the agencies and the FDIC to provide banking organizations until 
January 1, 2019 to comply with the proposed minimum capital 
requirements. Other commenters commenting on behalf of community 
banking organizations, however, considered the transition period 
reasonable. One commenter requested a shorter implementation timeframe 
for the largest banking organizations, asserting that these 
organizations already comply with the proposed standards. Another 
commenter suggested removing the transition period and delaying the 
effective date until the industry more fully recovers from the recent 
crisis. According to this commenter, the effective date should be 
delayed to ensure that implementation of the rule would not result in a 
contraction in aggregate U.S. lending capacity.
    Several commenters representing SLHCs asked the agencies and the 
FDIC to delay implementation of the final rule for such organizations 
until July 21, 2015. Banking organizations not previously supervised by 
the Board, including SLHCs, become subject to the applicable 
requirements of section 171 on that date.\116\ Additionally, these 
commenters expressed concern that SLHCs would not be able to comply 
with the new minimum capital requirements before that date because they 
were not previously subject to the agencies' risk-based capital 
framework. The commenters asserted that SLHCs would therefore need 
additional time to change their capital structure, balance sheets, and 
internal systems to comply with the proposal. These commenters also 
noted that the Board provided a three-year implementation period for 
BHCs when the general risk-based capital rules were initially adopted. 
Commenters representing SLHCs with substantial insurance activity also 
requested additional time to comply with the proposal because some of 
these organizations currently operate under a different accounting 
framework and would require a longer period of time to adapt their 
systems to the proposed capital rules, which generally are based on 
GAAP.
---------------------------------------------------------------------------

    \116\ 12 U.S.C. 5371(b)(4)(D).
---------------------------------------------------------------------------

    A number of commenters suggested an effective date based on the 
publication date of the final rule in the Federal Register. According 
to the commenters, such an approach would provide banking organizations 
with certainty regarding the effective date of the final rule that 
would allow them to plan for and implement any required system and 
process changes. One commenter requested simultaneous implementation of 
all three proposals because some elements of the Standardized Approach 
NPR affect the implementation of the Basel III NPR. A number of 
commenters also requested additional time to comply with the proposed 
capital conservation buffer. According to these commenters, 
implementation of the capital conservation buffer would make the equity 
instruments of banking organizations less attractive to potential 
investors and could even encourage divestment among existing 
shareholders. Therefore, the commenters maintained, the proposed rule 
would require banking organizations to raise capital by accumulating 
retained earnings, and doing so could take considerable time in the 
current economic climate. For these reasons, the commenters asked the 
agencies and the FDIC to delay implementation of the capital 
conservation buffer for an additional five years to provide banking 
organizations sufficient time to increase retained earnings without 
curtailing lending activity. Other commenters requested that the 
agencies and the FDIC fully exempt banks with total consolidated assets 
of $50 billion or less from the capital conservation buffer, further 
recommending that if the agencies and the FDIC declined to make this 
accommodation then the phase-in period for the capital conservation 
buffer should be extended by at least

[[Page 62074]]

three years to January 1, 2022, to provide community banking 
organizations with enough time to meet the new regulatory minimums.
    A number of commenters noted that Basel III phases in the deduction 
of goodwill from 2014 to 2018, and requested that the agencies and the 
FDIC adopt this transition for goodwill in the United States to prevent 
U.S. institutions from being disadvantaged relative to their global 
competitors.
    Many commenters objected to the proposed schedule for the phase out 
of TruPS from tier 1 capital, particularly for banking organizations 
with less than $15 billion in total consolidated assets. As discussed 
in more detail in section V.A., the commenters requested that the 
agencies and the FDIC grandfather existing TruPS issued by depository 
institution holding companies with less than $15 billion and 2010 MHCs, 
as permitted by section 171 of the Dodd-Frank Act. In general, these 
commenters characterized TruPS as a relatively safe, low-cost form of 
capital issued in full compliance with regulatory requirements that 
would be difficult for smaller institutions to replace in the current 
economic environment. Some commenters requested that community banking 
organizations be exempt from the phase-out of TruPS and from the phase-
out of cumulative preferred stock for these reasons. Another commenter 
requested that the agencies and the FDIC propose that institutions with 
under $5 billion in total consolidated assets be allowed to continue to 
include TruPS in regulatory capital at full value until the call or 
maturity of the TruPS instrument.
    Some commenters encouraged the agencies and the FDIC to adopt the 
ten-year transition schedule under Basel III for TruPS of banking 
organizations with total consolidated assets of more than $15 billion. 
These commenters asserted that the proposed transition framework for 
TruPS would disadvantage U.S. banking organizations relative to foreign 
competitors. One commenter expressed concern that the transition 
framework under the proposed rule also would disrupt payment schedules 
for TruPS CDOs.
    Commenters proposed several additional alternative transition 
frameworks for TruPS. For example, one commenter recommended a 10 
percent annual reduction in the amount of TruPS banking organizations 
with $15 billion or more of total consolidated assets may recognize in 
tier 1 capital beginning in 2013, followed by a phase-out of the 
remaining amount in 2015. According to the commenter, such a framework 
would comply with the Dodd-Frank Act and allow banking organizations 
more time to replace TruPS. Another commenter suggested that the final 
rule allow banking organizations to progressively reduce the amount of 
TruPS eligible for inclusion in tier 1 capital by 1.25 to 2.5 percent 
per year. One commenter encouraged the agencies and the FDIC to avoid 
penalizing banking organizations that elect to redeem TruPS during the 
transition period. Specifically, the commenter asked the agencies and 
the FDIC to revise the proposed transition framework so that any TruPS 
redeemed during the transition period would not reduce the total amount 
of TruPS eligible for inclusion in tier 1 capital. Under such an 
approach, the amount of TruPS eligible for inclusion in tier 1 capital 
during the transition period would equal the lesser of: (a) The 
remaining outstanding balance or (b) the percentage decline factor 
times the balance outstanding at the time the final rule is published 
in the Federal Register.
    One commenter encouraged the agencies and the FDIC to allow a 
banking organization that grows to more than $15 billion in total 
assets as a result of merger and acquisition activity to remain subject 
to the proposed transition framework for non-qualifying capital 
instruments issued by organizations with less than $15 billion in total 
assets. According to the commenter, such an approach should apply to 
either the buyer or seller in the transaction. Other commenters asked 
the agencies and the FDIC to allow banking organizations whose total 
consolidated assets grew to over $15 billion just prior to May 19, 
2010, and whose asset base subsequently declined below that amount to 
include all TruPS in their tier 1 capital during 2013 and 2014 on the 
same basis as institutions with less than $15 billion in total 
consolidated assets and, thereafter, be subject to the deductions 
required by section 171 of the Dodd-Frank Act.
    Commenters representing advanced approaches banking organizations 
generally objected to the proposed transition framework for the 
supplementary leverage ratio, and requested a delay in its 
implementation. For example, one commenter recommended the agencies and 
the FDIC defer implementation of the supplementary leverage ratio until 
the agencies and the FDIC have had an opportunity to consider whether 
it is likely to result in regulatory arbitrage and international 
competitive inequality as a result of differences in national 
accounting frameworks and standards. Another commenter asked the 
agencies and the FDIC to delay implementation of the supplementary 
leverage ratio until no earlier than January 1, 2018, as provided in 
Basel III, or until the BCBS completes its assessment and reaches 
international agreement on any further adjustments. A few commenters, 
however, supported the proposed transition framework for the 
supplementary leverage ratio because it could be used as an important 
regulatory tool to ensure there is sufficient capital in the financial 
system.
    After considering the comments and the potential challenges some 
banking organizations may face in complying with the final rule, the 
agencies have agreed to delay the compliance date for banking 
organizations that are not advanced approaches banking organizations 
and for covered SLHCs until January 1, 2015. Therefore, such entities 
are not required to calculate their regulatory capital requirements 
under the final rule until January 1, 2015. Thereafter, these banking 
organizations must calculate their regulatory capital requirements in 
accordance with the final rule, subject to the transition provisions 
set forth in subpart G of the final rule.
    The final rule also establishes the effective date of the final 
rule for advanced approaches banking organizations that are not SLHCs 
as January 1, 2014. In accordance with Tables 5-17 below, the 
transition provisions for the regulatory capital adjustments and 
deductions in the final rule commence either one or two years later 
than in the proposal, depending on whether the banking organization is 
or is not an advanced approaches banking organization. The December 31, 
2018, end-date for the transition period for regulatory capital 
adjustments and deductions is the same under the final rule as under 
the proposal.

A. Transitions Provisions for Minimum Regulatory Capital Ratios

    In response to the commenters' concerns, the final rule modifies 
the proposed transition provisions for the minimum capital 
requirements. Banking organizations that are not advanced approaches 
banking organizations and covered SLHCs are not required to comply with 
the minimum capital requirements until January 1, 2015. This is a delay 
of two years from the beginning of the proposed transition period. 
Because the agencies are not requiring compliance with the final rule 
until January 1, 2015 for these entities, there is no additional 
transition period for the minimum regulatory capital ratios. This 
approach should give

[[Page 62075]]

banking organizations sufficient time to raise or accumulate any 
additional capital needed to satisfy the new minimum requirements and 
upgrade internal systems without adversely affecting their lending 
capacity.
    Under the final rule, an advanced approaches banking organization 
that is not an SLHC must comply with minimum common equity tier 1, tier 
1, and total capital ratio requirements of 4.0 percent, 5.5 percent, 
and 8.0 percent during calendar year 2014, and 4.5 percent, 6.0 
percent, 8.0 percent, respectively, beginning January 1, 2015. These 
transition provisions are consistent with those under Basel III for 
internationally-active banking organizations. During calendar year 
2014, advanced approaches banking organizations must calculate their 
minimum common equity tier 1, tier 1, and total capital ratios using 
the definitions for the respective capital components in section 20 of 
the final rule (adjusted in accordance with the transition provisions 
for regulatory adjustments and deductions and for the non-qualifying 
capital instruments for advanced approaches banking organizations 
described in this section).

B. Transition Provisions for Capital Conservation and Countercyclical 
Capital Buffers

    The agencies have finalized transitions for the capital 
conservation and countercyclical capital buffers as proposed. The 
capital conservation buffer transition period begins in 2016, a full 
year after banking organizations that are not advanced approaches 
banking organizations and banking organizations that are covered SLHCs 
are required to comply with the final rule, and two years after 
advanced approaches banking organizations that are not SLHCs are 
required to comply with the final rule. The agencies believe that this 
is an adequate time frame to meet the buffer level necessary to avoid 
restrictions on capital distributions. Table 5 shows the regulatory 
capital levels advanced approaches banking organizations that are not 
SLHCs generally must satisfy to avoid limitations on capital 
distributions and discretionary bonus payments during the applicable 
transition period, from January 1, 2016 until January 1, 2019.

                Table 5--Regulatory Capital Levels for Advanced Approaches Banking Organizations
----------------------------------------------------------------------------------------------------------------
                                      Jan. 1,      Jan. 1,      Jan. 1,      Jan. 1,      Jan. 1,      Jan. 1,
                                        2014         2015         2016         2017         2018         2019
                                     (percent)    (percent)    (percent)    (percent)    (percent)    (percent)
----------------------------------------------------------------------------------------------------------------
Capital conservation buffer.......  ...........  ...........        0.625         1.25        1.875          2.5
Minimum common equity tier 1                4.0          4.5        5.125         5.75        6.375          7.0
 capital ratio + capital
 conservation buffer..............
Minimum tier 1 capital ratio +              5.5          6.0        6.625         7.25        7.875          8.5
 capital conservation buffer......
Minimum total capital ratio +               8.0          8.0        8.625         9.25        9.875         10.5
 capital conservation buffer......
Maximum potential countercyclical   ...........  ...........        0.625         1.25        1.875          2.5
 capital buffer...................
----------------------------------------------------------------------------------------------------------------

    Table 6 shows the regulatory capital levels banking organizations 
that are not advanced approaches banking organizations and banking 
organizations that are covered SLHCs generally must satisfy to avoid 
limitations on capital distributions and discretionary bonus payments 
during the applicable transition period, from January 1, 2016 until 
January 1, 2019.

              Table 6--Regulatory Capital Levels for Non-Advanced Approaches Banking Organizations
----------------------------------------------------------------------------------------------------------------
                                                   Jan. 1,      Jan. 1,      Jan. 1,      Jan. 1,      Jan. 1,
                                                     2015         2016         2017         2018         2019
                                                  (percent)    (percent)    (percent)    (percent)    (percent)
----------------------------------------------------------------------------------------------------------------
Capital conservation buffer....................  ...........        0.625         1.25        1.875          2.5
Minimum common equity tier 1 capital ratio +             4.5        5.125         5.75        6.375          7.0
 capital conservation buffer...................
Minimum tier 1 capital ratio + capital                   6.0        6.625         7.25        7.875          8.5
 conservation buffer...........................
Minimum total capital ratio + capital                    8.0        8.625         9.25        9.875         10.5
 conservation buffer...........................
----------------------------------------------------------------------------------------------------------------

    As provided in Table 5 and Table 6, the transition period for the 
capital conservation and countercyclical capital buffers does not begin 
until January 1, 2016. During this transition period, from January 1, 
2016 through December 31, 2018, all banking organizations are subject 
to transition arrangements with respect to the capital conservation 
buffer as outlined in more detail in Table 7. For advanced approaches 
banking organizations, the countercyclical capital buffer will be 
phased in according to the transition schedule set forth in Table 7 by 
proportionately expanding each of the quartiles of the capital 
conservation buffer.

          Table 7--Transition Provision for the Capital Conservation and Countercyclical Capital Buffer
----------------------------------------------------------------------------------------------------------------
                                                                                      Maximum payout ratio (as a
            Transition period                     Capital conservation buffer           percentage of eligible
                                                                                           retained income)
----------------------------------------------------------------------------------------------------------------
Calendar year 2016......................  Greater than 0.625 percent (plus 25         No payout ratio limitation
                                           percent of any applicable countercyclical   applies.
                                           capital buffer amount).
                                          Less than or equal to 0.625 percent (plus   60.
                                           25 percent of any applicable
                                           countercyclical capital buffer amount),
                                           and greater than 0.469 percent (plus
                                           18.75 percent of any applicable
                                           countercyclical capital buffer amount).

[[Page 62076]]

 
                                          Less than or equal to 0.469 percent (plus   40.
                                           18.75 percent of any applicable
                                           countercyclical capital buffer amount),
                                           and greater than 0.313 percent (plus 12.5
                                           percent of any applicable countercyclical
                                           capital buffer amount).
                                          Less than or equal to 0.313 percent (plus   20.
                                           12.5 percent of any applicable
                                           countercyclical capital buffer amount),
                                           and greater than 0.156 percent (plus 6.25
                                           percent of any applicable countercyclical
                                           capital buffer amount).
                                          Less than or equal to 0.156 percent (plus   0.
                                           6.25 percent of any applicable
                                           countercyclical capital buffer amount).
Calendar year 2017......................  Greater than 1.25 percent (plus 50 percent  No payout ratio limitation
                                           of any applicable countercyclical capital   applies.
                                           buffer amount).
                                          Less than or equal to 1.25 percent (plus    60.
                                           50 percent of any applicable
                                           countercyclical capital buffer amount),
                                           and greater than 0.938 percent (plus 37.5
                                           percent of any applicable countercyclical
                                           capital buffer amount).
                                          Less than or equal to 0.938 percent (plus   40.
                                           37.5 percent of any applicable
                                           countercyclical capital buffer amount),
                                           and greater than 0.625 percent (plus 25
                                           percent of any applicable countercyclical
                                           capital buffer amount).
                                          Less than or equal to 0.625 percent (plus   20.
                                           25 percent of any applicable
                                           countercyclical capital buffer amount),
                                           and greater than 0.313 percent (plus 12.5
                                           percent of any applicable countercyclical
                                           capital buffer amount).
                                          Less than or equal to 0.313 percent (plus   0.
                                           12.5 percent of any applicable
                                           countercyclical capital buffer amount).
Calendar year 2018......................  Greater than 1.875 percent (plus 75         No payout ratio limitation
                                           percent of any applicable countercyclical   applies.
                                           capital buffer amount).
                                          Less than or equal to 1.875 percent (plus   60.
                                           75 percent of any applicable
                                           countercyclical capital buffer amount),
                                           and greater than 1.406 percent (plus
                                           56.25 percent of any applicable
                                           countercyclical capital buffer amount).
                                          Less than or equal to 1.406 percent (plus   40.
                                           56.25 percent of any applicable
                                           countercyclical capital buffer amount),
                                           and greater than 0.938 percent (plus 37.5
                                           percent of any applicable countercyclical
                                           capital buffer amount).
                                          Less than or equal to 0.938 percent (plus   20.
                                           37.5 percent of any applicable
                                           countercyclical capital buffer amount),
                                           and greater than 0.469 percent (plus
                                           18.75 percent of any applicable
                                           countercyclical capital buffer amount).
                                          Less than or equal to 0.469 percent (plus   0.
                                           18.75 percent of any applicable
                                           countercyclical capital buffer amount).
----------------------------------------------------------------------------------------------------------------

C. Transition Provisions for Regulatory Capital Adjustments and 
Deductions

    To give sufficient time to banking organizations to adapt to the 
new regulatory capital adjustments and deductions, the final rule 
incorporates transition provisions for such adjustments and deductions 
that commence at the time at which the banking organization becomes 
subject to the final rule. As explained above, the final rule maintains 
the proposed transition periods, except for non-qualifying capital 
instruments as described below.
    Banking organizations that are not advanced approaches banking 
organizations and banking organizations that are covered SLHCs will 
begin the transitions for regulatory capital adjustments and deductions 
on January 1, 2015. From January 1, 2015, through December 31, 2017, 
these banking organizations will be required to make the regulatory 
capital adjustments to and deductions from regulatory capital in 
section 22 of the final rule in accordance with the proposed transition 
provisions for such adjustments and deductions outlined below. Starting 
on January 1, 2018, these banking organizations will apply all 
regulatory capital adjustments and deductions as set forth in section 
22 of the final rule.
    For an advanced approaches banking organization that is not an 
SLHC, the first year of transition for adjustments and deductions 
begins on January 1, 2014. From January 1, 2014, through December 31, 
2017, such banking organizations will be required to make the 
regulatory capital adjustments to and deductions from regulatory 
capital in section 22 of the final rule in accordance with the proposed 
transition provisions for such adjustments and deductions outlined 
below. Starting on January 1, 2018, advanced approaches banking 
organizations will be subject to all regulatory capital adjustments and 
deductions as described in section 22 of the final rule.
1. Deductions for Certain Items Under Section 22(a) of the Final Rule
    The final rule provides that banking organizations will deduct from 
common equity tier 1 capital or tier 1 capital in accordance with Table 
8 below: (1) Goodwill (section 22(a)(1)); (2) DTAs that arise from 
operating loss and tax credit carryforwards (section 22(a)(3)); (3) 
gain-on-sale associated with a securitization exposure (section 
22(a)(4)): (4) defined benefit pension fund assets (section 22(a)(5)); 
(5) for an advanced approaches banking organization that has completed 
the parallel run process and that has received notification from its 
primary Federal supervisor pursuant to section 121(d) of subpart E of 
the final rule, expected credit loss that exceeds eligible credit 
reserves (section 22(a)(6)); and (6) financial subsidiaries (section 
22(a)(7)). During the transition period, the percentage of these items 
that is not deducted from common equity tier 1 capital must be deducted 
from tier 1 capital.

[[Page 62077]]



      Table 8--Transition Deductions Under Section 22(a)(1) and Sections 22(a)(3)-(a)(7) of the Final Rule
----------------------------------------------------------------------------------------------------------------
                                                             Transition     Transition deductions under sections
                                                          deductions under             22(a)(3)-(a)(6)
                                                          section 22(a)(1) -------------------------------------
                                                            and (7) \1\
                   Transition period                    ------------------- Percentage of the
                                                         Percentage of the   deductions from   Percentage of the
                                                          deductions from     common equity     deductions from
                                                           common equity      tier 1 capital     tier 1 capital
                                                           tier 1 capital
----------------------------------------------------------------------------------------------------------------
January 1, 2014 to December 31, 2014 (advanced                         100                 20                 80
 approaches banking organizations only)................
January 1, 2015 to December 31, 2015...................                100                 40                 60
January 1, 2016 to December 31, 2016...................                100                 60                 40
January 1, 2017 to December 31, 2017...................                100                 80                 20
January 1, 2018 and thereafter.........................                100                100                  0
----------------------------------------------------------------------------------------------------------------
\1\ In addition, a FSA should deduct from common equity tier 1 non-includable subsidiaries. See 12 CFR
  3.22(a)(8).

    Beginning on January 1, 2014, advanced approaches banking 
organizations that are not SLHCs will be required to deduct the full 
amount of goodwill (which may be net of any associated DTLs), including 
any goodwill embedded in the valuation of significant investments in 
the capital of unconsolidated financial institutions, from common 
equity tier 1 capital. All other banking organizations will begin 
deducting goodwill (which may be net of any associated DTLs), including 
any goodwill embedded in the valuation of significant investments in 
the capital of unconsolidated financial institutions from common equity 
tier 1 capital, on January 1, 2015. This approach is stricter than the 
Basel III approach, which transitions the goodwill deduction from 
common equity tier 1 capital through 2017. However, as discussed in 
section V.B of this preamble, under U.S. law, goodwill cannot be 
included in a banking organization's regulatory capital and has not 
been included in banking organizations' regulatory capital under the 
general risk-based capital rules.\117\ Additionally, the agencies 
believe that fully deducting goodwill from common equity tier 1 capital 
from the date a banking organization must comply with the final rule 
will result in a more appropriate measure of common equity tier 1 
capital.
---------------------------------------------------------------------------

    \117\ See 12 U.S.C. 1464(t)(9)(A) and 12 U.S.C. 1828(n).
---------------------------------------------------------------------------

    Beginning on January 1, 2014, a national bank or insured state bank 
subject to the advanced approaches rule will be required to deduct 100 
percent of the aggregate amount of its outstanding equity investment, 
including the retained earnings, in any financial subsidiary from 
common equity tier 1 capital. All other national and insured state 
banks will begin deducting 100 percent of the aggregate amount of their 
outstanding equity investment, including the retained earnings, in a 
financial subsidiary from common equity tier 1 capital on January 1, 
2015. The deduction from common equity tier 1 capital represents a 
change from the general risk-based capital rules, which require the 
deduction to be made from total capital. As explained in section V.B of 
this preamble, similar to goodwill, this deduction is required by 
statute and is consistent with the general risk-based capital rules. 
Accordingly, the deduction is not subject to a transition period.
    The final rule also retains the existing deduction for Federal 
associations' investments in, and extensions of credit to, non-
includable subsidiaries at 12 CFR 3.22(a)(8).\118\ This deduction is 
required by statute \119\ and is consistent with the general risk-based 
capital rules. Accordingly, the deduction is not subject to a 
transition period and must be fully deducted in the first year that the 
Federal or state savings association becomes subject to the final rule.
---------------------------------------------------------------------------

    \118\ For additional information on this deduction, see section 
V.B ``Activities by savings association subsidiaries that are 
impermissible for national banks'' of this preamble.
    \119\ See 12 U.S.C. 1464(t)(5).
---------------------------------------------------------------------------

2. Deductions for Intangibles Other Than Goodwill and Mortgage 
Servicing Assets
    For deductions of intangibles other than goodwill and MSAs, 
including purchased credit-card relationships (PCCRs) (see section 
22(a)(2) of the final rule), the applicable transition period in the 
final rule is set forth in Table 9. During the transition period, any 
of these items that are not deducted will be subject to a risk weight 
of 100 percent. Advanced approaches banking organizations that are not 
SLHCs will begin the transition on January 1, 2014, and other banking 
organizations will begin the transition on January 1, 2015.

                      Table 9--Transition Deductions Under Section 22(a)(2) of the Proposal
----------------------------------------------------------------------------------------------------------------
                                                                          Transition deductions under section
                          Transition period                             22(a)(2)--Percentage of the deductions
                                                                           from common equity tier 1 capital
----------------------------------------------------------------------------------------------------------------
January 1, 2014 to December 31, 2014 (advanced approaches banking                                            20
 organizations only)................................................
January 1, 2015 to December 31, 2015................................                                         40
January 1, 2016 to December 31, 2016................................                                         60
January 1, 2017 to December 31, 2017................................                                         80
January 1, 2018 and thereafter......................................                                        100
----------------------------------------------------------------------------------------------------------------


[[Page 62078]]

3. Regulatory Adjustments Under Section 22(b)(1) of the Final Rule
    During the transition period, any of the adjustments required under 
section 22(b)(1) that are not applied to common equity tier 1 capital 
must be applied to tier 1 capital instead, in accordance with Table 10. 
Advanced approaches banking organizations that are not SLHCs will begin 
the transition on January 1, 2014, and other banking organizations will 
begin the transition on January 1, 2015.

                             Table 10--Transition Adjustments Under Section 22(b)(1)
----------------------------------------------------------------------------------------------------------------
                                                      Transition adjustments under section 22(b)(1)
                                       -------------------------------------------------------------------------
           Transition period                Percentage of the adjustment
                                          applied to common equity tier 1        Percentage of the adjustment
                                                      capital                     applied to tier 1 capital
----------------------------------------------------------------------------------------------------------------
January 1, 2014, to December 31, 2014                                   20                                   80
 (advanced approaches banking
 organizations only)..................
January 1, 2015, to December 31, 2015.                                  40                                   60
January 1, 2016, to December 31, 2016.                                  60                                   40
January 1, 2017, to December 31, 2017.                                  80                                   20
January 1, 2018 and thereafter........                                 100                                    0
----------------------------------------------------------------------------------------------------------------

4. Phase-out of Current Accumulated Other Comprehensive Income 
Regulatory Capital Adjustments
    Under the final rule, the transition period for the inclusion of 
the aggregate amount of: (1) Unrealized gains on available-for-sale 
equity securities; (2) net unrealized gains or losses on available-for-
sale debt securities; (3) any amounts recorded in AOCI attributed to 
defined benefit postretirement plans resulting from the initial and 
subsequent application of the relevant GAAP standards that pertain to 
such plans (excluding, at the banking organization's option, the 
portion relating to pension assets deducted under section 22(a)(5)); 
(4) accumulated net gains or losses on cash-flow hedges related to 
items that are reported on the balance sheet at fair value included in 
AOCI; and (5) net unrealized gains or losses on held-to-maturity 
securities that are included in AOCI (transition AOCI adjustment 
amount) only applies to advanced approaches banking organizations and 
other banking organizations that have not made an AOCI opt-out election 
under section 22(b)(2) of the rule and described in section V.B of this 
preamble. Advanced approaches banking organizations that are not SLHCs 
will begin the phase out of the current AOCI regulatory capital 
adjustments on January 1, 2014; other banking organizations that have 
not made the AOCI opt-out election will begin making these adjustments 
on January 1, 2015. Specifically, if a banking organization's 
transition AOCI adjustment amount is positive, it will adjust its 
common equity tier 1 capital by deducting the appropriate percentage of 
such aggregate amount in accordance with Table 11 below. If such amount 
is negative, it will adjust its common equity tier 1 capital by adding 
back the appropriate percentage of such aggregate amount in accordance 
with Table 11 below. The agencies and the FDIC did not include net 
unrealized gains or losses on held-to-maturity securities that are 
included in AOCI as part of the transition AOCI adjustment amount in 
the proposal. However, the agencies have decided to add such an 
adjustment as it reflects the agencies' approach towards AOCI 
adjustments in the general risk: Based capital rules.

                          Table 11--Percentage of the Transition AOCI Adjustment Amount
----------------------------------------------------------------------------------------------------------------
                                                                           Percentage of the transition AOCI
                          Transition period                            adjustment amount to be applied to common
                                                                                 equity tier 1 capital
----------------------------------------------------------------------------------------------------------------
January 1, 2014, to December 31, 2014 (advanced approaches banking                                           80
 organizations only)................................................
January 1, 2015, to December 31, 2015 (advanced approaches banking                                           60
 organizations and banking organizations that have not made an opt-
 out election)......................................................
January 1, 2016, to December 31, 2016 (advanced approaches banking                                           40
 organizations and banking organizations that have not made an opt-
 out election)......................................................
January 1, 2017, to December 31, 2017 (advanced approaches banking                                           20
 organizations and banking organizations that have not made an opt-
 out election)......................................................
January 1, 2018 and thereafter (advanced approaches banking                                                   0
 organizations and banking organizations that have not made an opt-
 out election)......................................................
----------------------------------------------------------------------------------------------------------------

    Beginning on January 1, 2018, advanced approaches banking 
organizations and other banking organizations that have not made an 
AOCI opt-out election must include AOCI in common equity tier 1 
capital, with the exception of accumulated net gains and losses on 
cash-flow hedges related to items that are not measured at fair value 
on the balance sheet, which must be excluded from common equity tier 1 
capital.
5. Phase-Out of Unrealized Gains on Available for Sale Equity 
Securities in Tier 2 Capital
    Advanced approaches banking organizations and banking organizations 
not subject to the advanced approaches rule that have not made an AOCI 
opt-out election will decrease the amount of unrealized gains on AFS 
preferred stock classified as an equity security under GAAP and AFS 
equity exposures currently held in tier 2 capital during the transition 
period in accordance with Table 12. An advanced approaches banking 
organization that is not an SLHC will begin the adjustments on January 
1, 2014; all other banking organizations that have not made an

[[Page 62079]]

AOCI opt-out election will begin the adjustments on January 1, 2015.

 Table 12--Percentage of Unrealized Gains on AFS Preferred Stock Classified as an Equity Security Under GAAP and
                           AFS Equity Exposures That May Be Included in Tier 2 Capital
----------------------------------------------------------------------------------------------------------------
                                                                         Percentage of unrealized gains on AFS
                                                                        preferred stock classified as an equity
                          Transition period                               security under GAAP and AFS equity
                                                                       exposures that may be included in tier 2
                                                                                        capital
----------------------------------------------------------------------------------------------------------------
January 1, 2014, to December 31, 2014 (advanced approaches banking                                           36
 organizations only)................................................
January 1, 2015, to December 31, 2015 (advanced approaches banking                                           27
 organizations and banking organizations that have not made an opt-
 out election)......................................................
January 1, 2016, to December 31, 2016 (advanced approaches banking                                           18
 organizations and banking organizations that have not made an opt-
 out election)......................................................
January 1, 2017, to December 31, 2017 (advanced approaches banking                                            9
 organizations and banking organizations that have not made an opt-
 out election)......................................................
January 1, 2018 and thereafter (advanced approaches banking                                                   0
 organizations and banking organizations that have not made an opt-
 out election)......................................................
----------------------------------------------------------------------------------------------------------------

6. Phase-in of Deductions Related to Investments in Capital Instruments 
and to the Items Subject to the 10 and 15 Percent Common Equity Tier 1 
Capital Deduction Thresholds (Sections 22(c) and 22(d)) of the Final 
Rule
    Under the final rule, a banking organization must calculate the 
appropriate deductions under sections 22(c) and 22(d) of the rule 
related to investments in the capital of unconsolidated financial 
institutions and to the items subject to the 10 and 15 percent common 
equity tier 1 capital deduction thresholds (that is, MSAs, DTAs arising 
from temporary differences that the banking organization could not 
realize through net operating loss carrybacks, and significant 
investments in the capital of unconsolidated financial institutions in 
the form of common stock) as set forth in Table 13. Advanced approaches 
banking organizations that are not SLHCs will apply the transition 
framework beginning January 1, 2014. All other banking organizations 
will begin applying the transition framework on January 1, 2015. During 
the transition period, a banking organization will make the aggregate 
common equity tier 1 capital deductions related to these items in 
accordance with the percentages outlined in Table 13 and must apply a 
100 percent risk-weight to the aggregate amount of such items that is 
not deducted. On January 1, 2018, and thereafter, each banking 
organization will be required to apply a 250 percent risk weight to the 
aggregate amount of the items subject to the 10 and 15 percent common 
equity tier 1 capital deduction thresholds that are not deducted from 
common equity tier 1 capital.

                 Table 13--Transition Deductions Under Sections 22(c) and 22(d) of the Proposal
----------------------------------------------------------------------------------------------------------------
                                                                      Transition deductions under sections 22(c)
                          Transition period                             and 22(d)--Percentage of the deductions
                                                                           from common equity tier 1 capital
----------------------------------------------------------------------------------------------------------------
January 1, 2014, to December 31, 2014...............................                                         20
(advanced approaches banking organizations only)....................
January 1, 2015, to December 31, 2015...............................                                         40
January 1, 2016, to December 31, 2016...............................                                         60
January 1, 2017, to December 31, 2017...............................                                         80
January 1, 2018 and thereafter......................................                                        100
----------------------------------------------------------------------------------------------------------------

    During the transition period, banking organizations will phase in 
the deduction requirement for the amounts of DTAs arising from 
temporary differences that could not be realized through net operating 
loss carryback, MSAs, and significant investments in the capital of 
unconsolidated financial institutions in the form of common stock that 
exceed the 10 percent threshold in section 22(d) according to Table 13.
    During the transition period, banking organizations will not be 
subject to the methodology to calculate the 15 percent common equity 
deduction threshold for DTAs arising from temporary differences that 
could not be realized through net operating loss carrybacks, MSAs, and 
significant investments in the capital of unconsolidated financial 
institutions in the form of common stock described in section 22(d) of 
the final rule. During the transition period, a banking organization 
will be required to deduct from its common equity tier 1 capital the 
percentage as set forth in Table 13 of the amount by which the 
aggregate sum of the items subject to the 10 and 15 percent common 
equity tier 1 capital deduction thresholds exceeds 15 percent of the 
sum of the banking organization's common equity tier 1 capital after 
making the deductions and adjustments required under sections 22(a) 
through (c).

D. Transition Provisions for Non-Qualifying Capital Instruments

    Under the final rule, there are different transition provisions for 
non-qualifying capital instruments depending on the type and size of a 
banking organization as discussed below.

[[Page 62080]]

1. Depository Institution Holding Companies With Less than $15 Billion 
in Total Consolidated Assets as of December 31, 2009 and 2010 Mutual 
Holding Companies
    BHCs have historically included (subject to limits) in tier 1 
capital ``restricted core capital elements'' such as cumulative 
perpetual preferred stock and TruPS, which generally would not comply 
with the eligibility criteria for additional tier 1 capital instruments 
outlined in section 20 of the final rule. As discussed in section V.A 
of this preamble, section 171 of the Dodd-Frank Act would not require 
depository institution holding companies with less than $15 billion in 
total consolidated assets as of December 31, 2009, (depository 
institution holding companies under $15 billion) or 2010 MHCs to deduct 
these types of instruments from tier 1 capital. However, as discussed 
in section V.A of this preamble, above, because these instruments would 
no longer qualify as tier 1 capital under the proposed criteria and 
have been found to be less able to absorb losses, the agencies and the 
FDIC proposed to require depository institution holding companies under 
$15 billion and 2010 MHCs to phase these instruments out of capital 
over a 10-year period consistent with Basel III.
    For the reasons discussed in section V.A of this preamble, as 
permitted by section 171 of the Dodd-Frank Act, the agencies have 
decided not to adopt this proposal in the final rule. Depository 
institution holding companies under $15 billion and 2010 MHCs may 
continue to include non-qualifying instruments that were issued prior 
to May 19, 2010 in tier 1 or tier 2 capital in accordance with the 
general risk-based capital rules, subject to specific limitations. More 
specifically, these depository institution holding companies will be 
able to continue including outstanding tier 1 capital non-qualifying 
capital instruments in additional tier 1 capital (subject to the limit 
of 25 percent of tier 1 capital elements excluding any non-qualifying 
capital instruments and after all regulatory capital deductions and 
adjustments applied to tier 1 capital) until they redeem the 
instruments or until the instruments mature. Likewise, consistent with 
the general risk-based capital rules, any tier 1 capital instrument 
that is excluded from tier 1 because it exceeds the 25 percent limit 
referenced above can be included in tier 2 capital.\120\
---------------------------------------------------------------------------

    \120\ 12 CFR part 225, appendix A, 1(b)(3).
---------------------------------------------------------------------------

2. Depository Institutions
    Under the final rule, beginning on January 1, 2014, an advanced 
approaches depository institution and beginning on January 1, 2015, a 
depository institution that is not a depository institution subject to 
the advanced approaches rule may include in regulatory capital debt or 
equity instruments issued prior to September 12, 2010 that do not meet 
the criteria for additional tier 1 or tier 2 capital instruments in 
section 20 of the final rule, but that were included in tier 1 or tier 
2 capital, respectively, as of September 12, 2010 (non-qualifying 
capital instruments issued prior to September 12, 2010). These 
instruments may be included up to the percentage of the outstanding 
principal amount of such non-qualifying capital instruments as of the 
effective date of the final rule in accordance with the phase-out 
schedule in Table 14.
    As of January 1, 2014 for advanced approaches banking organizations 
that are not SLHCs, and January 1, 2015 for all other banking 
organizations and for covered SLHCs that are advanced approaches 
organizations, debt or equity instruments issued after September 12, 
2010, that do not meet the criteria for additional tier 1 or tier 2 
capital instruments in section 20 of the final rule may not be included 
in additional tier 1 or tier 2 capital.

   Table 14--Percentage of Non-Qualifying Capital Instruments Issued Prior to September 12, 2010 Includable in
                                       Additional Tier 1 or Tier 2 Capital
----------------------------------------------------------------------------------------------------------------
                                                                         Percentage of non-qualifying capital
                                                                      instruments issued prior to September 2010
                  Transition Period (calendar year)                    includable in additional tier 1 or tier 2
                                                                          capital for depository institutions
----------------------------------------------------------------------------------------------------------------
Calendar year 2014 (advanced approaches banking organizations only).                                         80
Calendar year 2015..................................................                                         70
Calendar year 2016..................................................                                         60
Calendar year 2017..................................................                                         50
Calendar year 2018..................................................                                         40
Calendar year 2019..................................................                                         30
Calendar year 2020..................................................                                         20
Calendar year 2021..................................................                                         10
Calendar year 2022 and thereafter...................................                                          0
----------------------------------------------------------------------------------------------------------------

3. Depository Institution Holding Companies With $15 Billion or More in 
Total Consolidated Assets as of December 31, 2009 That Are Not 2010 
Mutual Holding Companies
    Under the final rule, consistent with the proposal and with section 
171 of the Dodd-Frank Act, debt or equity instruments that do not meet 
the criteria for additional tier 1 or tier 2 capital instruments in 
section 20 of the final rule, but that were issued and included in tier 
1 or tier 2 capital, respectively, prior to May 19, 2010 (non-
qualifying capital instruments) and were issued by a depository 
institution holding company with total consolidated assets greater than 
or equal to $15 billion as of December 31, 2009 (depository institution 
holding company of $15 billion or more) that is not a 2010 MHC must be 
phased out as set forth in Table 15 below.\121\ More specifically, 
depository institution holding companies of $15 billion or more that 
are advanced approaches banking organizations and that are not SLHCs 
must begin to apply this phase-out on January 1, 2014; other depository 
institution holding companies of $15 billion or more, including covered 
SLHCs, must begin to apply the phase-out on January 1, 2015. 
Accordingly,

[[Page 62081]]

under the final rule, a depository institution holding company of $15 
billion or more that is an advanced approaches banking organization and 
that is not an SLHC will be allowed to include only 50 percent of non-
qualifying capital instruments in regulatory capital as of January 1, 
2014; all depository institution holding companies of $15 billion or 
more will be allowed to include only 25 percent as of January 1, 2015, 
and 0 percent as of January 1, 2016, and thereafter.
---------------------------------------------------------------------------

    \121\ Consistent with the language of the statute, this 
requirement also applies to those institutions that, for a brief 
period of time, exceeded the $15 billion threshold and then 
subsequently have fallen below it so long as their asset size was 
greater than or equal to $15 billion in total consolidated assets as 
of December 31, 2009.
---------------------------------------------------------------------------

    The agencies acknowledge that the majority of existing TruPS would 
not technically comply with the final rule's tier 2 capital eligibility 
criteria (given that existing TruPS allow for acceleration after 5 
years of interest deferral) even though these instruments are eligible 
for inclusion in tier 2 capital under the general risk-based capital 
rules. However, the agencies believe that: (1) The inclusion of 
existing TruPS in tier 2 capital (until they are redeemed or they 
mature) does not raise safety and soundness concerns, and (2) it may be 
less disruptive to the banking system to allow certain banking 
organizations to include TruPS in tier 2 capital until they are able to 
replace such instruments with new capital instruments that fully comply 
with the eligibility criteria of the final rule. Accordingly, the 
agencies have decided to permit non-advanced approaches depository 
institution holding companies with over $15 billion in total 
consolidated assets permanently to include non-qualifying capital 
instruments, including TruPS that are phased out of tier 1 capital in 
tier 2 capital and not phase-out those instruments.
    Under the final rule, advanced approaches depository institution 
holding companies will not be permitted to permanently include existing 
non-qualifying capital instruments in tier 2 capital if they do not 
meet tier 2 criteria under the final rule. Such banking organizations 
generally face fewer market obstacles in replacing non-qualifying 
capital instruments than smaller banking organizations. From January 1, 
2016, until December 31, 2021, these banking organizations will be 
required to phase out non-qualifying capital instruments from tier 2 
capital in accordance with the percentages in Table 14 above. 
Consequently, an advanced approaches depository institution holding 
company will be allowed to include in tier 2 capital in calendar year 
2016 up to 60 percent of the principal amount of TruPS that such 
banking organization had outstanding as of January 1, 2014, but will 
not be able to include any of these instruments in regulatory capital 
after year-end 2021.

  Table 15--Percentage of Non-Qualifying Capital Instruments Includable in Additional Tier 1 or Tier 2 Capital
----------------------------------------------------------------------------------------------------------------
                                                                         Percentage of non-qualifying capital
                                                                       instruments includable in additional tier
                  Transition period (calendar year)                       1 or tier 2 capital for depository
                                                                         institution holding companies of $15
                                                                                    billion or more
----------------------------------------------------------------------------------------------------------------
Calendar year 2014 (advanced approaches banking organizations only).                                         50
Calendar year 2015..................................................                                         25
Calendar year 2016 And thereafter...................................                                          0
----------------------------------------------------------------------------------------------------------------

4. Merger and Acquisition Transition Provisions
    Under the final rule, consistent with the proposal, if a depository 
institution holding company of $15 billion or more acquires a 
depository institution holding company with total consolidated assets 
of less than $15 billion as of December 31, 2009 or a 2010 MHC, the 
non-qualifying capital instruments of the resulting organization will 
be subject to the phase-out schedule outlined in Table 15, above. 
Likewise, if a depository institution holding company under $15 billion 
makes an acquisition and the resulting organization has total 
consolidated assets of $15 billion or more, its non-qualifying capital 
instruments also will be subject to the phase-out schedule outlined in 
Table 15, above. Some commenters argued that this provision could 
create disincentives for mergers and acquisitions, but the agencies 
continue to believe these provisions appropriately subject institutions 
that are larger (or that become larger) to the stricter phase-out 
requirements for non-qualifying capital instruments, consistent with 
the language and intent of section 171 of the Dodd-Frank Act. 
Depository institution holding companies under $15 billion and 2010 
MHCs that merge with or acquire other banking organizations that result 
in organizations that remain below $15 billion or remain MHCs would be 
able to continue to include non-qualifying capital instruments in 
regulatory capital.
5. Phase-Out Schedule for Surplus and Non-Qualifying Minority Interest
    Under the transition provisions in the final rule, a banking 
organization is allowed to include in regulatory capital a portion of 
the common equity tier 1, tier 1, or total capital minority interest 
that is disqualified from regulatory capital as a result of the 
requirements and limitations outlined in section 21 (surplus minority 
interest). If a banking organization has surplus minority interest 
outstanding when the final rule becomes effective, that surplus 
minority interest will be subject to the phase-out schedule outlined in 
Table 16. Advanced approaches banking organizations that are not SLHCs 
must begin to phase out surplus minority interest in accordance with 
Table 16 beginning on January 1, 2014. All other banking organizations 
will begin the phase out for surplus minority interest on January 1, 
2015.
    During the transition period, a banking organization will also be 
able to include in tier 1 or total capital a portion of the instruments 
issued by a consolidated subsidiary that qualified as tier 1 or total 
capital of the banking organization on the date the rule becomes 
effective, but that do not qualify as tier 1 or total capital under 
section 20 of the final rule (non-qualifying minority interest) in 
accordance with Table 16.

[[Page 62082]]



   Table 16 --Percentage of the Amount of Surplus or Non-qualifying Minority Interest Includable in Regulatory
                                        Capital During Transition Period
----------------------------------------------------------------------------------------------------------------
                                                                      Percentage of the amount of surplus or non-
                                                                       qualifying minority interest that can be
                          Transition period                            included in regulatory capital during the
                                                                                   transition period
----------------------------------------------------------------------------------------------------------------
January 1, 2014, to December 31, 2014 (advanced approaches banking                                           80
 organizations only)................................................
January 1, 2015, to December 31, 2015...............................                                         60
January 1, 2016, to December 31, 2016...............................                                         40
January 1, 2017, to December 31, 2017...............................                                         20
January 1, 2018 and thereafter......................................                                          0
----------------------------------------------------------------------------------------------------------------

VIII. Standardized Approach for Risk-Weighted Assets

    In the Standardized Approach NPR, the agencies and the FDIC 
proposed to revise methodologies for calculating risk-weighted assets. 
As discussed above and in the proposal, these revisions were intended 
to harmonize the agencies' and the FDIC's rules for calculating risk-
weighted assets and to enhance the risk sensitivity and remediate 
weaknesses identified over recent years.\122\ The proposed revisions 
incorporated elements of the Basel II standardized approach \123\ as 
modified by the 2009 Enhancements, certain aspects of Basel III, and 
other proposals in recent consultative papers published by the 
BCBS.\124\ Consistent with section 939A of the Dodd-Frank Act, the 
agencies and the FDIC also proposed alternatives to credit ratings for 
calculating risk weights for certain assets.
---------------------------------------------------------------------------

    \122\ 77 FR 52888 (August 30, 2012).
    \123\ See BCBS, ``International Convergence of Capital 
Measurement and Capital Standards: A Revised Framework,'' (June 
2006), available at https://www.bis.org/publ/bcbs128.htm.
    \124\ See, e.g., ``Basel III FAQs answered by the Basel 
Committee'' (July, October, December 2011), available at https://www.bis.org/list/press_releases/index.htm; ``Capitalization of 
Banking Organization Exposures to Central Counterparties'' (December 
2010, revised November 2011) (CCP consultative release), available 
at https://www.bis.org/publ/bcbs206.pdf.
---------------------------------------------------------------------------

    The proposal also included potential revisions for the recognition 
of credit risk mitigation that would allow for greater recognition of 
financial collateral and a wider range of eligible guarantors. In 
addition, the proposal set forth more risk-sensitive treatments for 
residential mortgages, equity exposures and past due loans, derivatives 
and repo-style transactions cleared through CCPs, and certain 
commercial real estate exposures that typically have higher credit 
risk, as well as operational requirements for securitization exposures. 
The agencies and the FDIC also proposed to apply disclosure 
requirements to top-tier banking organizations with $50 billion or more 
in total assets that are not subject to the advanced approaches rule.
    The agencies and the FDIC received a significant number of comments 
regarding the proposed standardized approach for risk-weighted assets. 
Although a few commenters observed that the proposals would provide a 
sound framework for determining risk-weighted assets for all banking 
organizations that would generally benefit U.S. banking organizations, 
a significant number of other commenters asserted that the proposals 
were too complex and burdensome, especially for smaller banking 
organizations, and some argued that it was inappropriate to apply the 
proposed requirements to such banking organizations because such 
institutions did not cause the recent financial crisis. Other 
commenters expressed concern that the new calculation for risk-weighted 
assets would adversely affect banking organizations' regulatory capital 
ratios and that smaller banking organizations would have difficulties 
obtaining the data and performing the calculations required by the 
proposals. A number of commenters also expressed concern about the 
burden of the proposals in the context of multiple new regulations, 
including new standards for mortgages and increased regulatory capital 
requirements generally. One commenter urged the agencies and the FDIC 
to maintain key aspects of the proposed risk-weighted asset treatment 
for community banking organizations, but generally requested that the 
agencies and the FDIC reduce the perceived complexity. The agencies 
have considered these comments and, where applicable, have focused on 
simplicity, comparability, and broad applicability of methodologies for 
U.S. banking organizations under the standardized approach.
    Some commenters asked that the proposed requirements be optional 
for community banking organizations until the effects of the proposals 
have been studied, or that the proposed standardized approach be 
withdrawn entirely. A number of the commenters requested specific 
modifications to the proposals. For example, some requested an 
exemption for community banking organizations from the proposed due 
diligence requirements for securitization exposures. Other commenters 
requested that the agencies and the FDIC grandfather the risk weighting 
of existing loans, arguing that doing so would lessen the proposed 
rule's implementation burden.
    To address commenters' concerns about the standardized approach's 
burden and the accessibility of credit, the agencies have revised 
elements of the proposed rule, as described in further detail below. In 
particular, the agencies have modified the proposed approach to risk 
weighting residential mortgage loans to reflect the approach in the 
agencies general risk-based capital rules. The agencies believe the 
standardized approach more accurately captures the risk of banking 
organizations' assets and, therefore, are applying this aspect of the 
final rule to all banking organizations subject to the rule.
    This section of the preamble describes in detail the specific 
proposals for the standardized treatment of risk-weighted assets, 
comments received on those proposals, and the provisions of the final 
rule in subpart D as adopted by the agencies. These sections of the 
preamble discuss how subpart D of the final rule differs from the 
general risk-based capital rules, and provides examples for how a 
banking organization must calculate risk-weighted asset amounts under 
the final rule.
    Beginning on January 1, 2015, all banking organizations will be 
required to calculate risk-weighted assets under subpart D of the final 
rule. Until then, banking organizations must calculate risk-weighted 
assets using the methodologies set forth in the general risk-based 
capital rules. Advanced approaches banking organizations are subject to 
additional requirements, as described in section III.D of this

[[Page 62083]]

preamble, regarding the timeframe for implementation.

A. Calculation of Standardized Total Risk-Weighted Assets

    Consistent with the Standardized Approach NPR, the final rule 
requires a banking organization to calculate its risk-weighted asset 
amounts for its on- and off-balance sheet exposures and, for market 
risk banks only, standardized market risk-weighted assets as determined 
under subpart F.\125\ Risk-weighted asset amounts generally are 
determined by assigning on-balance sheet assets to broad risk-weight 
categories according to the counterparty, or, if relevant, the 
guarantor or collateral. Similarly, risk-weighted asset amounts for 
off-balance sheet items are calculated using a two-step process: (1) 
Multiplying the amount of the off-balance sheet exposure by a credit 
conversion factor (CCF) to determine a credit equivalent amount, and 
(2) assigning the credit equivalent amount to a relevant risk-weight 
category.
---------------------------------------------------------------------------

    \125\ This final rule incorporates the market risk rule into the 
integrated regulatory framework as subpart F.
---------------------------------------------------------------------------

    A banking organization must determine its standardized total risk-
weighted assets by calculating the sum of (1) its risk-weighted assets 
for general credit risk, cleared transactions, default fund 
contributions, unsettled transactions, securitization exposures, and 
equity exposures, each as defined below, plus (2) market risk-weighted 
assets, if applicable, minus (3) the amount of the banking 
organization's ALLL that is not included in tier 2 capital, and any 
amounts of allocated transfer risk reserves.

B. Risk-Weighted Assets for General Credit Risk

    Consistent with the proposal, under the final rule total risk-
weighted assets for general credit risk equals the sum of the risk-
weighted asset amounts as calculated under section 31(a) of the final 
rule. General credit risk exposures include a banking organization's 
on-balance sheet exposures (other than cleared transactions, default 
fund contributions to CCPs, securitization exposures, and equity 
exposures, each as defined in section 2 of the final rule), exposures 
to over-the-counter (OTC) derivative contracts, off-balance sheet 
commitments, trade and transaction-related contingencies, guarantees, 
repo-style transactions, financial standby letters of credit, forward 
agreements, or other similar transactions.
    Under the final rule, the exposure amount for the on-balance sheet 
component of an exposure is generally the banking organization's 
carrying value for the exposure as determined under GAAP. The agencies 
believe that using GAAP to determine the amount and nature of an 
exposure provides a consistent framework that can be easily applied 
across all banking organizations. Generally, banking organizations 
already use GAAP to prepare their financial statements and regulatory 
reports, and this treatment reduces potential burden that could 
otherwise result from requiring banking organizations to comply with a 
separate set of accounting and measurement standards for risk-based 
capital calculation purposes under non-GAAP standards, such as 
regulatory accounting practices or legal classification standards.
    For purposes of the definition of exposure amount for AFS or held-
to-maturity debt securities and AFS preferred stock not classified as 
equity under GAAP that are held by a banking organization that has made 
an AOCI opt-out election, the exposure amount is the banking 
organization's carrying value (including net accrued but unpaid 
interest and fees) for the exposure, less any net unrealized gains, and 
plus any net unrealized losses. For purposes of the definition of 
exposure amount for AFS preferred stock classified as an equity 
security under GAAP that is held by a banking organization that has 
made an AOCI opt-out election, the exposure amount is the banking 
organization's carrying value (including net accrued but unpaid 
interest and fees) for the exposure, less any net unrealized gains that 
are reflected in such carrying value but excluded from the banking 
organization's regulatory capital.
    In most cases, the exposure amount for an off-balance sheet 
component of an exposure is determined by multiplying the notional 
amount of the off-balance sheet component by the appropriate CCF as 
determined under section 33 of the final rule. The exposure amount for 
an OTC derivative contract or cleared transaction is determined under 
sections 34 and 35, respectively, of the final rule, whereas exposure 
amounts for collateralized OTC derivative contracts, collateralized 
cleared transactions, repo-style transactions, and eligible margin 
loans are determined under section 37 of the final rule.
1. Exposures to Sovereigns
    Consistent with the proposal, the final rule defines a sovereign as 
a central government (including the U.S. government) or an agency, 
department, ministry, or central bank of a central government. In the 
Standardized Approach NPR, the agencies and the FDIC proposed to retain 
the general risk-based capital rules' risk weights for exposures to and 
claims directly and unconditionally guaranteed by the U.S. government 
or its agencies. The final rule adopts the proposed treatment and 
provides that exposures to the U.S. government, its central bank, or a 
U.S. government agency and the portion of an exposure that is directly 
and unconditionally guaranteed by the U.S. government, the U.S. central 
bank, or a U.S. government agency receive a zero percent risk 
weight.\126\ Consistent with the general risk-based capital rules, the 
portion of a deposit or other exposure insured or otherwise 
unconditionally guaranteed by the FDIC or the National Credit Union 
Administration also is assigned a zero percent risk weight. An exposure 
conditionally guaranteed by the U.S. government, its central bank, or a 
U.S. government agency receives a 20 percent risk weight.\127\ This 
includes an exposure that is conditionally guaranteed by the FDIC or 
the National Credit Union Administration.
---------------------------------------------------------------------------

    \126\ Similar to the general risk-based capital rules, a claim 
would not be considered unconditionally guaranteed by a central 
government if the validity of the guarantee is dependent upon some 
affirmative action by the holder or a third party, for example, 
asset servicing requirements. See 12 CFR part 3, appendix A, section 
1(c)(11) (national banks) and 12 CFR 167.6 (Federal savings 
associations) (OCC); 12 CFR parts 208 and 225, appendix A, section 
III.C.1 (Board).
    \127\ Loss-sharing agreements entered into by the FDIC with 
acquirers of assets from failed institutions are considered 
conditional guarantees for risk-based capital purposes due to 
contractual conditions that acquirers must meet. The guaranteed 
portion of assets subject to a loss-sharing agreement may be 
assigned a 20 percent risk weight. Because the structural 
arrangements for these agreements vary depending on the specific 
terms of each agreement, institutions should consult with their 
primary Federal regulator to determine the appropriate risk-based 
capital treatment for specific loss-sharing agreements.
---------------------------------------------------------------------------

    The agencies and the FDIC proposed in the Standardized Approach NPR 
to revise the risk weights for exposures to foreign sovereigns. The 
agencies' general risk-based capital rules generally assign risk 
weights to direct exposures to sovereigns and exposures directly 
guaranteed by sovereigns based on whether the sovereign is a member of 
the Organization for Economic Co-operation and Development (OECD) and, 
as applicable, whether the exposure is unconditionally or conditionally 
guaranteed by the sovereign.\128\
---------------------------------------------------------------------------

    \128\ 12 CFR part 3, appendix A, section 3 (national banks) and 
12 CFR 167.6 (Federal savings associations) (OCC); 12 CFR parts 208 
and 225, appendix A, section III.C.1 (Board).
---------------------------------------------------------------------------

    Under the proposed rule, the risk weight for a foreign sovereign 
exposure

[[Page 62084]]

would have been determined using OECD Country Risk Classifications 
(CRCs) (the CRC methodology).\129\ The CRCs reflect an assessment of 
country risk, used to set interest rate charges for transactions 
covered by the OECD arrangement on export credits. The CRC methodology 
classifies countries into one of eight risk categories (0-7), with 
countries assigned to the zero category having the lowest possible risk 
assessment and countries assigned to the 7 category having the highest 
possible risk assessment. Using CRCs to risk weight sovereign exposures 
is an option that is included in the Basel II standardized framework. 
The agencies and the FDIC proposed to map risk weights ranging from 0 
percent to 150 percent to CRCs in a manner consistent with the Basel II 
standardized approach, which provides risk weights for foreign 
sovereigns based on country risk scores.
---------------------------------------------------------------------------

    \129\ For more information on the OECD country risk 
classification methodology, see OECD, ``Country Risk 
Classification,'' available at https://www.oecd.org/document/49/0,3746,en_2649_34169_1901105_1_1_1_1,00.html.
---------------------------------------------------------------------------

    The agencies and the FDIC also proposed to assign a 150 percent 
risk weight to foreign sovereign exposures immediately upon determining 
that an event of sovereign default has occurred or if an event of 
sovereign default has occurred during the previous five years. The 
proposal defined sovereign default as noncompliance by a sovereign with 
its external debt service obligations or the inability or unwillingness 
of a sovereign government to service an existing loan according to its 
original terms, as evidenced by failure to pay principal or interest 
fully and on a timely basis, arrearages, or restructuring. 
Restructuring would include a voluntary or involuntary restructuring 
that results in a sovereign not servicing an existing obligation in 
accordance with the obligation's original terms.
    The agencies and the FDIC received several comments on the proposed 
risk weights for foreign sovereign exposures. Some commenters 
criticized the proposal, arguing that CRCs are not sufficiently risk 
sensitive and basing risk weights on CRCs unduly benefits certain 
jurisdictions with unstable fiscal positions. A few commenters asserted 
that the increased burden associated with tracking CRCs to determine 
risk weights outweighs any increased risk sensitivity gained by using 
CRCs relative to the general risk-based capital rules. Some commenters 
also requested that the CRC methodology be disclosed so that banking 
organizations could perform their own due diligence. One commenter also 
indicated that community banking organizations should be permitted to 
maintain the treatment under the general risk-based capital rules.
    Following the publication of the proposed rule, the OECD determined 
that certain high-income countries that received a CRC of 0 in 2012 
will no longer receive any CRC.\130\
---------------------------------------------------------------------------

    \130\ See https://www.oecd.or/tad/xcred/cat0.htm Participants to 
the Arrangement on Officially Supported Export Credits agreed that 
the automatic classification of High Income OECD and High Income 
Euro Area countries in Country Risk Category Zero should be 
terminated. In the future, these countries will no longer be 
classified but will remain subject to the same market credit risk 
pricing disciplines that are applied to all Category Zero countries. 
This means that the change will have no practical impact on the 
rules that apply to the provision of official export credits.
---------------------------------------------------------------------------

    Despite the limitations associated with risk weighting foreign 
sovereign exposures using CRCs, the agencies have decided to retain 
this methodology, modified as described below to take into account that 
some countries will no longer receive a CRC. Although the agencies 
recognize that the risk sensitivity provided by the CRCs is limited, 
they consider CRCs to be a reasonable alternative to credit ratings for 
sovereign exposures and the CRC methodology to be more granular and 
risk sensitive than the current risk-weighting methodology based solely 
on OECD membership. Furthermore, the OECD regularly updates CRCs and 
makes the assessments publicly available on its Web site.\131\ 
Accordingly, the agencies believe that risk weighting foreign sovereign 
exposures with reference to CRCs (as applicable) should not unduly 
burden banking organizations. Additionally, the 150 percent risk weight 
assigned to defaulted sovereign exposures should mitigate the concerns 
raised by some commenters that the use of CRCs assigns inappropriate 
risk weights to exposures to countries experiencing fiscal stress.
---------------------------------------------------------------------------

    \131\ For more information on the OECD country risk 
classification methodology, see OECD, ``Country Risk 
Classification,'' available at https://www.oecd.org/document/49/0,3746,en_2649_ 34169_1901105_1_1_1_1,00.html.
---------------------------------------------------------------------------

    The final rule assigns risk weights to foreign sovereign exposures 
as set forth in Table 17 below. The agencies modified the final rule to 
reflect a change in OECD practice for assigning CRCs for certain member 
countries so that those member countries that no longer receive a CRC 
are assigned a zero percent risk weight. Applying a zero percent risk 
weight to exposures to these countries is appropriate because they will 
remain subject to the same market credit risk pricing formulas of the 
OECD's rating methodologies that are applied to all OECD countries with 
a CRC of 0. In other words, OECD member countries that are no longer 
assigned a CRC exhibit a similar degree of country risk as that of a 
jurisdiction with a CRC of zero. The final rule, therefore, provides a 
zero percent risk weight in these cases. Additionally, a zero percent 
risk weight for these countries is generally consistent with the risk 
weight they would receive under the agencies' general risk-based 
capital rules.

             Table 17--Risk Weights for Sovereign Exposures
------------------------------------------------------------------------
                                                            Risk weight
                                                           (in percent)
------------------------------------------------------------------------
CRC:
  0-1...................................................               0
  2.....................................................              20
  3.....................................................              50
  4-6...................................................             100
  7.....................................................             150
------------------------------------------------------------------------
OECD Member with No CRC.................................               0
------------------------------------------------------------------------
Non-OECD Member with No CRC.............................             100
------------------------------------------------------------------------
Sovereign Default.......................................             150
------------------------------------------------------------------------

    Consistent with the proposal, the final rule provides that if a 
banking supervisor in a sovereign jurisdiction allows banking 
organizations in that jurisdiction to apply a lower risk weight to an 
exposure to the sovereign than Table 17 provides, a U.S. banking 
organization may assign the lower risk weight to an exposure to the 
sovereign, provided the exposure is denominated in the sovereign's 
currency and the U.S. banking organization has at least an equivalent 
amount of liabilities in that foreign currency.
2. Exposures to Certain Supranational Entities and Multilateral 
Development Banks
    Under the general risk-based capital rules, exposures to certain 
supranational entities and MDBs receive a 20 percent risk weight. 
Consistent with the Basel II standardized framework, the agencies and 
the FDIC proposed to apply a zero percent risk weight to exposures to 
the Bank for International Settlements, the European Central Bank, the 
European Commission, and the International Monetary Fund. The agencies 
and the FDIC also proposed to apply a zero percent risk weight to 
exposures to an MDB in accordance with the Basel framework. The 
proposal defined an MDB to include the International Bank for 
Reconstruction and Development, the Multilateral Investment Guarantee 
Agency, the International Finance Corporation, the Inter-American 
Development Bank, the Asian

[[Page 62085]]

Development Bank, the African Development Bank, the European Bank for 
Reconstruction and Development, the European Investment Bank, the 
European Investment Fund, the Nordic Investment Bank, the Caribbean 
Development Bank, the Islamic Development Bank, the Council of Europe 
Development Bank, and any other multilateral lending institution or 
regional development bank in which the U.S. government is a shareholder 
or contributing member or which the primary Federal supervisor 
determines poses comparable credit risk.
    As explained in the proposal, the agencies believe this treatment 
is appropriate in light of the generally high-credit quality of MDBs, 
their strong shareholder support, and a shareholder structure comprised 
of a significant proportion of sovereign entities with strong 
creditworthiness. The agencies have adopted this aspect of the proposal 
without change. Exposures to regional development banks and 
multilateral lending institutions that are not covered under the 
definition of MDB generally are treated as corporate exposures assigned 
to the 100 percent risk weight category.
3. Exposures to Government-Sponsored Enterprises
    The general risk-based capital rules assign a 20 percent risk 
weight to exposures to GSEs that are not equity exposures and a 100 
percent risk weight to GSE preferred stock in the case of the Board 
(the OCC has assigned a 20 percent risk weight to GSE preferred stock).
    The agencies and the FDIC proposed to continue to assign a 20 
percent risk weight to exposures to GSEs that are not equity exposures 
and to also assign a 100 percent risk weight to preferred stock issued 
by a GSE. As explained in the proposal, the agencies believe these risk 
weights remain appropriate for the GSEs under their current 
circumstances, including those in the conservatorship of the Federal 
Housing Finance Agency and receiving capital support from the U.S. 
Treasury. The agencies maintain that the obligations of the GSEs, as 
private corporations whose obligations are not explicitly guaranteed by 
the full faith and credit of the United States, should not receive the 
same treatment as obligations that have such an explicit guarantee.
4. Exposures to Depository Institutions, Foreign Banks, and Credit 
Unions
    The general risk-based capital rules assign a 20 percent risk 
weight to all exposures to U.S. depository institutions and foreign 
banks incorporated in an OECD country. Under the general risk-based 
capital rules, short-term exposures to foreign banks incorporated in a 
non-OECD country receive a 20 percent risk weight and long-term 
exposures to such entities receive a 100 percent risk weight.
    The proposed rule would assign a 20 percent risk weight to 
exposures to U.S. depository institutions and credit unions.\132\ 
Consistent with the Basel II standardized framework, under the proposed 
rule, an exposure to a foreign bank would receive a risk weight one 
category higher than the risk weight assigned to a direct exposure to 
the foreign bank's home country, based on the assignment of risk 
weights by CRC, as discussed above.\133\ A banking organization would 
be required to assign a 150 percent risk weight to an exposure to a 
foreign bank immediately upon determining that an event of sovereign 
default has occurred in the foreign bank's home country, or if an event 
of sovereign default has occurred in the foreign bank's home country 
during the previous five years.
---------------------------------------------------------------------------

    \132\ A depository institution is defined in section 3 of the 
Federal Deposit Insurance Act (12 U.S.C. 1813(c)(1)). Under this 
final rule, a credit union refers to an insured credit union as 
defined under the Federal Credit Union Act (12 U.S.C. 1752(7)).
    \133\ Foreign bank means a foreign bank as defined in Sec.  
211.2 of the Federal Reserve Board's Regulation K (12 CFR 211.2), 
that is not a depository institution. For purposes of the proposal, 
home country meant the country where an entity is incorporated, 
chartered, or similarly established.
---------------------------------------------------------------------------

    A few commenters asserted that the proposed 20 percent risk weight 
for exposures to U.S. banking organizations--when compared to corporate 
exposures that are assigned a 100 percent risk weight--would continue 
to encourage banking organizations to become overly concentrated in the 
financial sector. The agencies have concluded that the proposed 20 
percent risk weight is an appropriate reflection of risk for this 
exposure type when taking into consideration the extensive regulatory 
and supervisory frameworks under which these institutions operate. In 
addition, the agencies note that exposures to the capital of other 
financial institutions, including depository institutions and credit 
unions, are subject to deduction from capital if they exceed certain 
limits as set forth in section 22 of the final rule (discussed above in 
section V.B of this preamble). Therefore, the final rule retains, as 
proposed, the 20 percent risk weight for exposures to U.S. banking 
organizations.
    The agencies have adopted the proposal with modifications to take 
into account the OECD's decision to withdraw CRCs for certain OECD 
member countries. Accordingly, exposures to a foreign bank in a country 
that does not have a CRC, but that is a member of the OECD, are 
assigned a 20 percent risk weight and exposures to a foreign bank in a 
non-OECD member country that does not have a CRC continue to receive a 
100 percent risk weight.
    Additionally, the agencies have adopted the proposed requirement 
that exposures to a financial institution that are included in the 
regulatory capital of such financial institution receive a risk weight 
of 100 percent, unless the exposure is (1) An equity exposure, (2) a 
significant investment in the capital of an unconsolidated financial 
institution in the form of common stock under section 22 of the final 
rule, (3) an exposure that is deducted from regulatory capital under 
section 22 of the final rule, or (4) an exposure that is subject to the 
150 percent risk weight under Table 2 of section 32 of the final rule.
    As described in the Standardized Approach NPR, in 2011, the BCBS 
revised certain aspects of the Basel capital framework to address 
potential adverse effects of the framework on trade finance in low-
income countries.\134\ In particular, the framework was revised to 
remove the sovereign floor for trade finance-related claims on banking 
organizations under the Basel II standardized approach.\135\ The 
proposal incorporated this revision and would have permitted a banking 
organization to assign a 20 percent risk weight to self-liquidating 
trade-related contingent items that arise from the movement of goods 
and that have a maturity of three months or less.\136\ Consistent with 
the proposal, the final rule permits a banking organization to assign a 
20 percent risk weight to self-liquidating, trade-related contingent 
items that arise from the movement of

[[Page 62086]]

goods and that have a maturity of three months or less.
---------------------------------------------------------------------------

    \134\ See BCBS, ``Treatment of Trade Finance under the Basel 
Capital Framework,'' (October 2011), available at https://www.bis.org/publ/bcbs205.pdf. ``Low income country'' is a 
designation used by the World Bank to classify economies (see World 
Bank, ``How We Classify Countries,'' available at https://data.worldbank.org/about/country-classifications).
    \135\ The BCBS indicated that it removed the sovereign floor for 
such exposures to make access to trade finance instruments easier 
and less expensive for low income countries. Absent removal of the 
floor, the risk weight assigned to these exposures, where the 
issuing banking organization is incorporated in a low income 
country, typically would be 100 percent.
    \136\ One commenter requested that the agencies and the FDIC 
confirm whether short-term self-liquidating trade finance 
instruments are considered exempt from the one-year maturity floor 
in the advances approaches rule. Section 131(d)(7) of the final rule 
provides that a trade-related letter of credit is exempt from the 
one-year maturity floor.
---------------------------------------------------------------------------

    As discussed in the proposal, although the Basel capital framework 
permits exposures to securities firms that meet certain requirements to 
be assigned the same risk weight as exposures to depository 
institutions, the agencies do not believe that the risk profile of 
securities firms is sufficiently similar to depository institutions to 
justify assigning the same risk weight to both exposure types. 
Therefore, the agencies and the FDIC proposed that banking 
organizations assign a 100 percent risk weight to exposures to 
securities firms, which is the same risk weight applied to BHCs, SLHCs, 
and other financial institutions that are not insured depository 
institutions or credit unions, as described in section VIII.B of this 
preamble.
    Several commenters asserted that the final rule should be 
consistent with the Basel framework and permit lower risk weights for 
exposures to securities firms, particularly for securities firms in a 
sovereign jurisdiction with a CRC of 0 or 1. The agencies considered 
these comments and have concluded that that exposures to securities 
firms exhibit a similar degree of risk as exposures to other financial 
institutions that are assigned a 100 percent risk weight, because of 
the nature and risk profile of their activities, which are more 
expansive and exhibit more varied risk profiles than the activities 
permissible for depository institutions and credit unions. Accordingly, 
the agencies have adopted the 100 percent risk weight for securities 
firms without change.
5. Exposures to Public-Sector Entities
    The proposal defined a PSE as a state, local authority, or other 
governmental subdivision below the level of a sovereign, which includes 
U.S. states and municipalities. The proposed definition did not include 
government-owned commercial companies that engage in activities 
involving trade, commerce, or profit that are generally conducted or 
performed in the private sector. The agencies and the FDIC proposed to 
define a general obligation as a bond or similar obligation that is 
backed by the full faith and credit of a PSE, whereas a revenue 
obligation would be defined as a bond or similar obligation that is an 
obligation of a PSE, but which the PSE has committed to repay with 
revenues from a specific project rather than general tax funds. In the 
final rule, the agencies are adopting these definitions as proposed.
    The agencies and the FDIC proposed to assign a 20 percent risk 
weight to a general obligation exposure to a PSE that is organized 
under the laws of the United States or any state or political 
subdivision thereof, and a 50 percent risk weight to a revenue 
obligation exposure to such a PSE. These are the risk weights assigned 
to U.S. states and municipalities under the general risk-based capital 
rules.
    Some commenters asserted that available default data does not 
support a differentiated treatment between revenue obligations and 
general obligations. In addition, some commenters contended that higher 
risk weights for revenue obligation bonds would needlessly and 
adversely affect state and local agencies' ability to meet the needs of 
underprivileged constituents. One commenter specifically recommended 
assigning a 20 percent risk weight to investment-grade revenue 
obligations. Another commenter recommended that exposures to U.S. PSEs 
should receive the same treatment as exposures to the U.S. government.
    The agencies considered these comments, including with respect to 
burden on state and local programs, but concluded that the higher 
regulatory capital requirement for revenue obligations is appropriate 
because those obligations are dependent on revenue from specific 
projects and generally a PSE is not legally obligated to repay these 
obligations from other revenue sources. Although some evidence may 
suggest that there are not substantial differences in credit quality 
between general and revenue obligation exposures, the agencies believe 
that such dependence on project revenue presents more credit risk 
relative to a general repayment obligation of a state or political 
subdivision of a sovereign. Therefore, the proposed differentiation of 
risk weights between general obligation and revenue exposures is 
retained in the final rule. The agencies also continue to believe that 
PSEs collectively pose a greater credit risk than U.S. sovereign debt 
and, therefore, are appropriately assigned a higher risk weight under 
the final rule.
    Consistent with the Basel II standardized framework, the agencies 
and the FDIC proposed to require banking organizations to risk weight 
exposures to a non-U.S. PSE based on (1) the CRC assigned to the PSE's 
home country and (2) whether the exposure is a general obligation or a 
revenue obligation. The risk weights assigned to revenue obligations 
were proposed to be higher than the risk weights assigned to a general 
obligation issued by the same PSE.
    For purposes of the final rule, the agencies have adopted the 
proposed risk weights for non-U.S. PSEs with modifications to take into 
account the OECD's decision to withdraw CRCs for certain OECD member 
countries (discussed above), as set forth in Table 18 below. Under the 
final rule, exposures to a non-U.S. PSE in a country that does not have 
a CRC and is not an OECD member receive a 100 percent risk weight. 
Exposures to a non-U.S. PSE in a country that has defaulted on any 
outstanding sovereign exposure or that has defaulted on any sovereign 
exposure during the previous five years receive a 150 percent risk 
weight.

        Table 18--Risk Weights for Exposures to Non-U.S. PSE General Obligations and Revenue Obligations
                                                  [In percent]
----------------------------------------------------------------------------------------------------------------
                                         Risk weight for exposures to non-    Risk weight for exposures to non-
                                            U.S. PSE general obligations         U.S.PSE revenue obligations
----------------------------------------------------------------------------------------------------------------
CRC:
    0-1...............................                                  20                                   50
    2.................................                                  50                                  100
    3.................................                                 100                                  100
    4-7...............................                                 150                                  150
OECD Member with No CRC...............                                  20                                   50
Non-OECD member with No CRC...........                                 100                                  100
Sovereign Default.....................                                 150                                  150
----------------------------------------------------------------------------------------------------------------


[[Page 62087]]

    Consistent with the general risk-based capital rules as well as the 
proposed rule, a banking organization may apply a different risk weight 
to an exposure to a non-U.S. PSE if the banking organization supervisor 
in that PSE's home country allows supervised institutions to assign the 
alternative risk weight to exposures to that PSE. In no event, however, 
may the risk weight for an exposure to a non-U.S. PSE be lower than the 
risk weight assigned to direct exposures to the sovereign of that PSE's 
home country.
6. Corporate Exposures
    Generally consistent with the general risk-based capital rules, the 
agencies and the FDIC proposed to require banking organizations to 
assign a 100 percent risk weight to all corporate exposures, including 
bonds and loans. The proposal defined a corporate exposure as an 
exposure to a company that is not an exposure to a sovereign, the Bank 
for International Settlements, the European Central Bank, the European 
Commission, the International Monetary Fund, an MDB, a depository 
institution, a foreign bank, a credit union, a PSE, a GSE, a 
residential mortgage exposure, a pre-sold construction loan, a 
statutory multifamily mortgage, a high-volatility commercial real 
estate (HVCRE) exposure, a cleared transaction, a default fund 
contribution, a securitization exposure, an equity exposure, or an 
unsettled transaction. The definition also captured all exposures that 
are not otherwise included in another specific exposure category.
    Several commenters recommended differentiating the proposed risk 
weights for corporate bonds based on a bond's credit quality. Other 
commenters requested the agencies and the FDIC align the final rule 
with the Basel international standard that aligns risk weights with 
credit ratings. A few commenters asserted that a single 100 percent 
risk weight would disproportionately and adversely impact insurance 
companies that generally hold a higher share of corporate bonds in 
their investment portfolios. Another commenter contended that corporate 
bonds should receive a 50 percent risk weight, arguing that other 
exposures included in the corporate exposure category (such as 
commercial and industrial bank loans) are empirically of greater risk 
than corporate bonds.
    One commenter requested that the standardized approach provide a 
distinct capital treatment of a 75 percent risk weight for retail 
exposures, consistent with the international standard under Basel II. 
The agencies have concluded that the proposed 100 percent risk weight 
assigned to retail exposures is appropriate given their risk profile in 
the United States and have retained the proposed treatment in the final 
rule. Consistent with the proposal, the final rule neither defines nor 
provides a separate treatment for retail exposures in the standardized 
approach.
    As described in the proposal, the agencies removed the use of 
ratings from the regulatory capital framework, consistent with section 
939A of the Dodd-Frank Act. The agencies therefore evaluated a number 
of alternatives to credit ratings to provide a more granular risk 
weight treatment for corporate exposures.\137\ For example, the 
agencies considered market-based alternatives, such as the use of 
credit default and bond spreads, and use of particular indicators or 
parameters to differentiate between relative levels of credit risk. 
However, the agencies viewed each of the possible alternatives as 
having significant drawbacks, including their operational complexity, 
or insufficient development. For instance, the agencies were concerned 
that bond markets may sometimes misprice risk and bond spreads may 
reflect factors other than credit risk. The agencies also were 
concerned that such approaches could introduce undue volatility into 
the risk-based capital requirements.
---------------------------------------------------------------------------

    \137\ See, for example, 76 FR 73526 (Nov. 29, 2011) and 76 FR 
73777 (Nov. 29, 2011).
---------------------------------------------------------------------------

    The agencies considered suggestions offered by commenters and 
understand that a 100 percent risk weight may overstate the credit risk 
associated with some high-quality bonds. However, the agencies believe 
that a single risk weight of less than 100 percent would understate the 
risk of many corporate exposures and, as explained, have not yet 
identified an alternative methodology to credit ratings that would 
provide a sufficiently rigorous basis for differentiating the risk of 
various corporate exposures. In addition, the agencies believe that, on 
balance, a 100 percent risk weight is generally representative of a 
well-diversified corporate exposure portfolio. The final rule retains 
without change the 100 percent risk weight for all corporate exposures 
as well as the proposed definition of corporate exposure.
    A few commenters requested clarification on the treatment for 
general-account insurance products. Under the final rule, consistent 
with the proposal, if a general-account exposure is to an organization 
that is not a banking organization, such as an insurance company, the 
exposure must receive a risk weight of 100 percent. Exposures to 
securities firms are subject to the corporate exposure treatment under 
the final rule, as described in section VIII.B of this preamble.
7. Residential Mortgage Exposures
    Under the general risk-based capital requirements, first-lien 
residential mortgages made in accordance with prudent underwriting 
standards on properties that are owner-occupied or rented typically are 
assigned to the 50 percent risk-weight category. Otherwise, residential 
mortgage exposures are assigned to the 100 percent risk weight 
category.
    The proposal would have substantially modified the risk-weight 
framework applicable to residential mortgage exposures and differed 
materially from both the general risk-based capital rules and the Basel 
capital framework. The agencies and the FDIC proposed to divide 
residential mortgage exposures into two categories. The proposal 
applied relatively low risk weights to residential mortgage exposures 
that did not have product features associated with higher credit risk, 
or ``category 1'' residential mortgages as defined in the proposal. The 
proposal defined all other residential mortgage exposures as ``category 
2'' mortgages, which would receive relatively high risk weights. For 
both category 1 and category 2 mortgages, the proposed risk weight 
assigned also would have depended on the mortgage exposure's LTV ratio. 
Under the proposal, a banking organization would not be able to 
recognize private mortgage insurance (PMI) when calculating the LTV 
ratio of a residential mortgage exposure. Due to the varying degree of 
financial strength of mortgage insurance providers, the agencies stated 
that they did not believe that it would be prudent to consider PMI in 
the determination of LTV ratios under the proposal.
    The agencies and the FDIC received a significant number of comments 
in opposition to the proposed risk weights for residential mortgages 
and in favor of retaining the risk-weight framework for residential 
mortgages in the general risk-based capital rules. Many commenters 
asserted that the increased risk weights for certain mortgages would 
inhibit lending to creditworthy borrowers, particularly when combined 
with the other proposed statutory and regulatory requirements being 
implemented under the authority of the Dodd-Frank Act, and could 
ultimately jeopardize the recovery of a still-fragile residential real 
estate market. Various commenters

[[Page 62088]]

asserted that the agencies and the FDIC did not provide sufficient 
empirical support for the proposal and stated the proposal was overly 
complex and would not contribute meaningfully to the risk sensitivity 
of the regulatory capital requirements. They also asserted that the 
proposal would require some banking organizations to raise revenue 
through other, more risky activities to compensate for the potential 
increased costs.
    Commenters also indicated that the distinction between category 1 
and category 2 residential mortgages would adversely impact certain 
loan products that performed relatively well even during the recent 
crisis, such as balloon loans originated by community banking 
organizations. Other commenters criticized the proposed increased 
capital requirements for various loan products, including balloon and 
interest-only mortgages. Community banking organization commenters in 
particular asserted that such mortgage products are offered to hedge 
interest-rate risk and are frequently the only option for a significant 
segment of potential borrowers in their regions.
    A number of commenters argued that the proposal would place U.S. 
banking organizations at a competitive disadvantage relative to foreign 
banking organizations subject to the Basel II standardized framework, 
which generally assigns a 35 percent risk weight to residential 
mortgage exposures. Several commenters indicated that the proposed 
treatment would potentially undermine government programs encouraging 
residential mortgage lending to lower-income individuals and 
underserved regions. Commenters also asserted that PMI should receive 
explicit recognition in the final rule through a reduction in risk 
weights, given the potential negative impact on mortgage availability 
(particularly to first-time borrowers) of the proposed risk weights.
    In addition to comments on the specific elements of the proposal, a 
significant number of commenters alleged that the agencies and the FDIC 
did not sufficiently consider the potential impact of other regulatory 
actions on the mortgage industry. For instance, commenters expressed 
considerable concern regarding the new requirements associated with the 
Dodd-Frank Act's qualified mortgage definition under the Truth in 
Lending Act.\138\ Many of these commenters asserted that when combined 
with this proposal, the cumulative effect of the new regulatory 
requirements could adversely impact the residential mortgage industry.
---------------------------------------------------------------------------

    \138\ The proposal was issued prior to publication of the 
Consumer Financial Protection Bureau's final rule regarding 
qualified mortgage standards. See 78 FR 6407 (January 30, 2013).
---------------------------------------------------------------------------

    The agencies and the FDIC also received specific comments 
concerning potential logistical difficulties they would face 
implementing the proposal. Many commenters argued that tracking loans 
by LTV and category would be administratively burdensome, requiring the 
development or purchase of new systems. These commenters requested 
that, at a minimum, existing mortgages continue to be assigned the risk 
weights they would receive under the general risk-based capital rules 
and exempted from the proposed rules. Many commenters also requested 
clarification regarding the method for calculating the LTV for first 
and subordinate liens, as well as how and whether a loan could be 
reclassified between the two residential mortgage categories. For 
instance, commenters raised various technical questions on how to 
calculate the LTV of a restructured mortgage and under what conditions 
a restructured loan could qualify as a category 1 residential mortgage 
exposure.
    The agencies considered the comments pertaining to the residential 
mortgage proposal, particularly comments regarding the issuance of new 
regulations designed to improve the quality of mortgage underwriting 
and to generally reduce the associated credit risk, including the final 
definition of ``qualified mortgage'' as implemented by the Consumer 
Financial Protection Bureau (CFPB) pursuant to the Dodd-Frank Act.\139\ 
Additionally, the agencies are mindful of the uncertain implications 
that the proposal, along with other mortgage-related rulemakings, could 
have had on the residential mortgage market, particularly regarding 
underwriting and credit availability. The agencies also considered the 
commenters' observations about the burden of calculating the risk 
weights for banking organizations' existing mortgage portfolios, and 
have taken into account the commenters' concerns about the availability 
of different mortgage products across different types of markets.
---------------------------------------------------------------------------

    \139\ See id.
---------------------------------------------------------------------------

    In light of these considerations, the agencies have decided to 
retain in the final rule the treatment for residential mortgage 
exposures that is currently set forth in the general risk-based capital 
rules. The agencies may develop and propose changes in the treatment of 
residential mortgage exposures in the future, and in that process, the 
agencies intend to take into consideration structural and product 
market developments, other relevant regulations, and potential issues 
with implementation across various product types.
    Accordingly, as under the general risk-based capital rules, the 
final rule assigns exposures secured by one-to-four family residential 
properties to either the 50 percent or the 100 percent risk-weight 
category. Exposures secured by a first-lien on an owner-occupied or 
rented one-to-four family residential property that meet prudential 
underwriting standards, including standards relating to the loan amount 
as a percentage of the appraised value of the property, are not 90 days 
or more past due or carried on non-accrual status, and that are not 
restructured or modified receive a 50 percent risk weight. If a banking 
organization holds the first and junior lien(s) on a residential 
property and no other party holds an intervening lien, the banking 
organization must treat the combined exposure as a single loan secured 
by a first lien for purposes of determining the loan-to-value ratio and 
assigning a risk weight. A banking organization must assign a 100 
percent risk weight to all other residential mortgage exposures. Under 
the final rule, a residential mortgage guaranteed by the federal 
government through the Federal Housing Administration (FHA) or the 
Department of Veterans Affairs (VA) generally will be risk-weighted at 
20 percent.
    Consistent with the general risk-based capital rules, under the 
final rule, a residential mortgage exposure may be assigned to the 50 
percent risk-weight category only if it is not restructured or 
modified. Under the final rule, consistent with the proposal, a 
residential mortgage exposure modified or restructured on a permanent 
or trial basis solely pursuant to the U.S. Treasury's Home Affordable 
Mortgage Program (HAMP) is not considered to be restructured or 
modified. Several commenters from community banking organizations 
encouraged the agencies to broaden this exemption and not penalize 
banking organizations for participating in other successful loan 
modification programs. As described in greater detail in the proposal, 
the agencies believe that treating mortgage loans modified pursuant to 
HAMP in this manner is appropriate in light of the special and unique 
incentive features of HAMP, and the fact that the program is offered by 
the U.S. government to achieve the public policy objective of promoting 
sustainable loan

[[Page 62089]]

modifications for homeowners at risk of foreclosure in a way that 
balances the interests of borrowers, servicers, and lenders.
8. Pre-Sold Construction Loans and Statutory Multifamily Mortgages
    The general risk-based capital rules assign either a 50 percent or 
a 100 percent risk weight to certain one-to-four family residential 
pre-sold construction loans and to multifamily residential loans, 
consistent with provisions of the Resolution Trust Corporation 
Refinancing, Restructuring, and Improvement Act of 1991 (RTCRRI 
Act).\140\ The proposal maintained the same general treatment as the 
general risk-based capital rules and clarified and updated the manner 
in which the general risk-based capital rules define these exposures. 
Under the proposal, a pre-sold construction loan would be subject to a 
50 percent risk weight unless the purchase contract is cancelled.
---------------------------------------------------------------------------

    \140\ The RTCRRI Act mandates that each agency provide in its 
capital regulations (i) a 50 percent risk weight for certain one-to-
four-family residential pre-sold construction loans and multifamily 
residential loans that meet specific statutory criteria in the 
RTCRRI Act and any other underwriting criteria imposed by the 
agencies, and (ii) a 100 percent risk weight for one-to-four-family 
residential pre-sold construction loans for residences for which the 
purchase contract is cancelled. 12 U.S.C. 1831n, note.
---------------------------------------------------------------------------

    The agencies are adopting this aspect of the proposal without 
change. The final rule defines a pre-sold construction loan, in part, 
as any one-to-four family residential construction loan to a builder 
that meets the requirements of section 618(a)(1) or (2) of the RTCRRI 
Act, and also harmonizes the agencies' prior regulations. Under the 
final rule, a multifamily mortgage that does not meet the definition of 
a statutory multifamily mortgage is treated as a corporate exposure.
9. High-Volatility Commercial Real Estate
    Supervisory experience has demonstrated that certain acquisition, 
development, and construction loans (which are a subset of commercial 
real estate exposures) present particular risks for which the agencies 
believe banking organizations should hold additional capital. 
Accordingly, the agencies and the FDIC proposed to require banking 
organizations to assign a 150 percent risk weight to any HVCRE 
exposure, which is higher than the 100 percent risk weight applied to 
such loans under the general risk-based capital rules. The proposal 
defined an HVCRE exposure to include any credit facility that finances 
or has financed the acquisition, development, or construction of real 
property, unless the facility finances one- to four-family residential 
mortgage property, or commercial real estate projects that meet certain 
prudential criteria, including with respect to the LTV ratio and 
capital contributions or expense contributions of the borrower.
    Commenters criticized the proposed HVCRE definition as overly broad 
and suggested an exclusion for certain acquisition, development, or 
construction (ADC) loans, including: (1) ADC loans that are less than a 
specific dollar amount or have a debt service coverage ratio of 100 
percent (rather than 80 percent, under the agencies' and the FDIC's 
lending standards); (2) community development projects or projects 
financed by low-income housing tax credits; and (3) certain loans 
secured by agricultural property for the sole purpose of acquiring 
land. Several commenters asserted that the proposed 150 percent risk 
weight was too high for secured loans and would hamper local commercial 
development. Another commenter recommended the agencies and the FDIC 
increase the number of HVCRE risk-weight categories to reflect LTV 
ratios.
    The agencies have considered the comments and have decided to 
retain the 150 percent risk weight for HVCRE exposures (modified as 
described below), given the increased risk of these activities when 
compared to other commercial real estate loans.\141\ The agencies 
believe that segmenting HVCRE by LTV ratio would introduce undue 
complexity without providing a sufficient improvement in risk 
sensitivity. The agencies have also determined not to exclude from the 
HVCRE definition ADC loans that are characterized by a specified dollar 
amount or loans with a debt service coverage ratio greater than 80 
percent because an arbitrary threshold would likely not capture certain 
ADC loans with elevated risks. Consistent with the proposal, a 
commercial real estate loan that is not an HVCRE exposure is treated as 
a corporate exposure.
---------------------------------------------------------------------------

    \141\ See the definition of ``high-volatility commercial real 
estate exposure'' in section 2 of the final rule.
---------------------------------------------------------------------------

    Many commenters requested clarification as to whether all 
commercial real estate or ADC loans are considered HVCRE exposures. 
Consistent with the proposal, the final rule's HVCRE definition only 
applies to a specific subset of ADC loans and is, therefore, not 
applicable to all commercial real estate loans. Specifically, some 
commenters sought clarification on whether a facility would remain an 
HVCRE exposure for the life of the loan and whether owner-occupied 
commercial real estate loans are included in the HVCRE definition. The 
agencies note that when the life of the ADC project concludes and the 
credit facility is converted to permanent financing in accordance with 
the banking organization's normal lending terms, the permanent 
financing is not an HVCRE exposure. Thus, a loan permanently financing 
owner-occupied commercial real estate is not an HVCRE exposure. Given 
these clarifications, the agencies believe that many concerns regarding 
the potential adverse impact on commercial development were, in part, 
driven by a lack of clarity regarding the definition of the HVCRE, and 
believe that the treatment of HVCRE exposures in the final rule 
appropriately reflects their risk relative to other commercial real 
estate exposures.
    Commenters also sought clarification as to whether cash or 
securities used to purchase land counts as borrower-contributed 
capital. In addition, a few commenters requested further clarification 
on what constitutes contributed capital for purposes of the final rule. 
Consistent with existing guidance, cash used to purchase land is a form 
of borrower contributed capital under the HVCRE definition.
    In response to the comments, the final rule amends the proposed 
HVCRE definition to exclude loans that finance the acquisition, 
development, or construction of real property that would qualify as 
community development investments. The final rule does not require a 
banking organization to have an investment in the real property for it 
to qualify for the exemption: Rather, if the real property is such that 
an investment in that property would qualify as a community development 
investment, then a facility financing acquisition, development, or 
construction of that property would meet the terms of the exemption. 
The agencies have, however, determined not to give an automatic 
exemption from the HVCRE definition to all ADC loans to businesses or 
farms that have gross annual revenues of $1 million or less, although 
they could qualify for another exemption from the definition. For 
example, an ADC loan to a small business with annual revenues of under 
$1 million that meets the LTV ratio and contribution requirements set 
forth in paragraph (3) of the definition would qualify for that 
exemption from the definition as would a loan that finances real 
property that: Provides affordable housing (including multi-family 
rental housing) for low to moderate income

[[Page 62090]]

individuals; is used in the provision of community services for low to 
moderate income individuals; or revitalizes or stabilizes low to 
moderate income geographies, designated disaster areas, or underserved 
areas specifically determined by the federal banking agencies based on 
the needs of low- and moderate-income individuals in those areas. The 
final definition also exempts ADC loans for the purchase or development 
of agricultural land, which is defined as all land known to be used or 
usable for agricultural purposes (such as crop and livestock 
production), provided that the valuation of the agricultural land is 
based on its value for agricultural purposes and the valuation does not 
consider any potential use of the land for non-agricultural commercial 
development or residential development.
10. Past-Due Exposures
    Under the general risk-based capital rules, the risk weight of a 
loan does not change if the loan becomes past due, with the exception 
of certain residential mortgage loans. The Basel II standardized 
approach provides risk weights ranging from 50 to 150 percent for 
exposures, except sovereign exposures and residential mortgage 
exposures, that are more than 90 days past due to reflect the increased 
risk of loss. Accordingly, to reflect the impaired credit quality of 
such exposures, the agencies and the FDIC proposed to require a banking 
organization to assign a 150 percent risk weight to an exposure that is 
not guaranteed or not secured (and that is not a sovereign exposure or 
a residential mortgage exposure) if it is 90 days or more past due or 
on nonaccrual.
    A number of commenters maintained that the proposed 150 percent 
risk weight is too high for various reasons. Specifically, several 
commenters asserted that ALLL is already reflected in the risk-based 
capital numerator, and therefore an increased risk weight double-counts 
the risk of a past-due exposure. Other commenters characterized the 
increased risk weight as procyclical and burdensome (particularly for 
community banking organizations), and maintained that it would 
unnecessarily discourage lending and loan modifications or workouts.
    The agencies have considered the comments and have decided to 
retain the proposed 150 percent risk weight for past-due exposures in 
the final rule. The agencies note that the ALLL is intended to cover 
estimated, incurred losses as of the balance sheet date, rather than 
unexpected losses. The higher risk weight on past due exposures ensures 
sufficient regulatory capital for the increased probability of 
unexpected losses on these exposures. The agencies believe that any 
increased capital burden, potential rise in procyclicality, or impact 
on lending associated with the 150 percent risk weight is justified 
given the overall objective of better capturing the risk associated 
with the impaired credit quality of these exposures.
    One commenter requested clarification as to whether a banking 
organization could reduce the risk weight for past-due exposures from 
150 percent when the carrying value is charged down to the amount 
expected to be recovered. For the purposes of the final rule, a banking 
organization must apply a 150 percent risk weight to all past-due 
exposures, including any amount remaining on the balance sheet 
following a charge-off, to reflect the increased uncertainty as to the 
recovery of the remaining carrying value.
11. Other Assets
    Generally consistent with the general risk-based capital rules, the 
agencies have decided to adopt, as proposed, the risk weights described 
below for exposures not otherwise assigned to a specific risk weight 
category. Specifically, a banking organization must assign:
    (1) A zero percent risk weight to cash owned and held in all of a 
banking organization's offices or in transit; gold bullion held in the 
banking organization's own vaults, or held in another depository 
institution's vaults on an allocated basis to the extent gold bullion 
assets are offset by gold bullion liabilities; and to exposures that 
arise from the settlement of cash transactions (such as equities, fixed 
income, spot foreign exchange and spot commodities) with a CCP where 
there is no assumption of ongoing counterparty credit risk by the CCP 
after settlement of the trade and associated default fund 
contributions;
    (2) A 20 percent risk weight to cash items in the process of 
collection; and
    (3) A 100 percent risk weight to all assets not specifically 
assigned a different risk weight under the final rule (other than 
exposures that would be deducted from tier 1 or tier 2 capital), 
including deferred acquisition costs (DAC) and value of business 
acquired (VOBA).
    In addition, subject to the proposed transition arrangements under 
section 300 of the final rule, a banking organization must assign:
    (1) A 100 percent risk weight to DTAs arising from temporary 
differences that the banking organization could realize through net 
operating loss carrybacks; and
    (2) A 250 percent risk weight to the portion of MSAs and DTAs 
arising from temporary differences that the banking organization could 
not realize through net operating loss carrybacks that are not deducted 
from common equity tier 1 capital pursuant to section 22(d).
    The agencies and the FDIC received a few comments on the treatment 
of DAC and VOBA. DAC represents certain costs incurred in the 
acquisition of a new contract or renewal insurance contract that are 
capitalized pursuant to GAAP. VOBA refers to assets that reflect 
revenue streams from insurance policies purchased by an insurance 
company. One commenter asked for clarification on risk weights for 
other types of exposures that are not assigned a specific risk weight 
under the proposal. Consistent with the proposal, under the final rule 
these assets receive a 100 percent risk weight, together with other 
assets not specifically assigned a different risk weight under the NPR.
    Consistent with the general risk-based capital rules, the final 
rule retains the limited flexibility to address situations where 
exposures of a banking organization that are not exposures typically 
held by depository institutions do not fit wholly within the terms of 
another risk-weight category. Under the final rule, a banking 
organization may assign such exposures to the risk-weight category 
applicable under the capital rules for BHCs or covered SLHCs, provided 
that (1) the banking organization is not authorized to hold the asset 
under applicable law other than debt previously contracted or similar 
authority; and (2) the risks associated with the asset are 
substantially similar to the risks of assets that are otherwise 
assigned to a risk-weight category of less than 100 percent under 
subpart D of the final rule.

C. Off-Balance Sheet Items

1. Credit Conversion Factors
    Under the proposed rule, as under the general risk-based capital 
rules, a banking organization would calculate the exposure amount of an 
off-balance sheet item by multiplying the off-balance sheet component, 
which is usually the contractual amount, by the applicable credit 
conversion factors (CCF). This treatment would apply to all off-balance 
sheet items, such as commitments, contingent items, guarantees, certain 
repo-style transactions, financial standby letters of credit, and 
forward agreements. The proposed rule, however, introduced

[[Page 62091]]

new CCFs applicable to certain exposures, such as a higher CCF for 
commitments with an original maturity of one year or less that are not 
unconditionally cancelable.
    Commenters offered a number of suggestions for revising the 
proposed CCFs that would be applied to off-balance sheet exposures. 
Commenters generally asked for lower CCFs that, according to the 
commenters, are more directly aligned with a particular off-balance 
sheet exposure's loss history. In addition, some commenters asked the 
agencies and the FDIC to conduct a calibration study to show that the 
proposed CCFs were appropriate.
    The agencies have decided to retain the proposed CCFs for off-
balance sheet exposures without change for purposes of the final rule. 
The agencies believe that the proposed CCFs meet the agencies' goals of 
improving risk sensitivity and implementing higher capital requirements 
for certain exposures through a simple methodology. Furthermore, 
alternatives proposed by commenters, such as exposure measures tied 
directly to a particular exposure's loss history, would create 
significant operational burdens for many small- and mid-sized banking 
organizations, by requiring them to keep accurate historical records of 
losses and continuously adjust their capital requirements for certain 
exposures to account for new loss data. Such a system would be 
difficult for the agencies to monitor, as the agencies would need to 
verify the accuracy of historical loss data and ensure that capital 
requirements are properly applied across institutions. Incorporation of 
additional factors, such as loss history or increasing the number of 
CCF categories, would detract from the agencies' stated goal of 
simplicity in its capital treatment of off-balance sheet exposures. 
Additionally, the agencies believe that the CCFs, as proposed, were 
properly calibrated to reflect the risk profiles of the exposures to 
which they are applied and do not believe a calibration study is 
required.
    Accordingly, under the final rule, as proposed, a banking 
organization may apply a zero percent CCF to the unused portion of 
commitments that are unconditionally cancelable by the banking 
organization. For purposes of the final rule, a commitment means any 
legally binding arrangement that obligates a banking organization to 
extend credit or to purchase assets. Unconditionally cancelable means a 
commitment for which a banking organization may, at any time, with or 
without cause, refuse to extend credit (to the extent permitted under 
applicable law). In the case of a residential mortgage exposure that is 
a line of credit, a banking organization can unconditionally cancel the 
commitment if it, at its option, may prohibit additional extensions of 
credit, reduce the credit line, and terminate the commitment to the 
full extent permitted by applicable law. If a banking organization 
provides a commitment that is structured as a syndication, the banking 
organization is only required to calculate the exposure amount for its 
pro rata share of the commitment.
    The proposed rule provided a 20 percent CCF for commitments with an 
original maturity of one year or less that are not unconditionally 
cancelable by a banking organization, and for self-liquidating, trade-
related contingent items that arise from the movement of goods with an 
original maturity of one year or less.
    Some commenters argued that the proposed designation of a 20 
percent CCF for certain exposures was too high. For example, they 
requested that the final rule continue the current practice of applying 
a zero percent CCF to all unfunded lines of credit with less than one 
year maturity, regardless of the lender's ability to unconditionally 
cancel the line of credit. They also requested a CCF lower than 20 
percent for the unused portions of letters of credit extended to a 
small, mid-market, or trade finance company with durations of less than 
one year or less. These commenters asserted that current market 
practice for these lines have covenants based on financial ratios, and 
any increase in riskiness that violates the contractual minimum ratios 
would prevent the borrower from drawing down the unused portion.
    For purposes of the final rule, the agencies are retaining the 20 
percent CCF, as it accounts for the elevated level of risk banking 
organizations face when extending short-term commitments that are not 
unconditionally cancelable. Although the agencies understand certain 
contractual provisions are common in the market, these practices are 
not static, and it is more appropriate from a regulatory standpoint to 
base a CCF on whether a commitment is unconditionally cancellable. A 
banking organization must apply a 20 percent CCF to a commitment with 
an original maturity of one year or less that is not unconditionally 
cancellable by the banking organization. The final rule also maintains 
the 20 percent CCF for self-liquidating, trade-related contingent items 
that arise from the movement of goods with an original maturity of one 
year or less. The final rule also requires a banking organization to 
apply a 50 percent CCF to commitments with an original maturity of more 
than one year that are not unconditionally cancelable by the banking 
organization, and to transaction-related contingent items, including 
performance bonds, bid bonds, warranties, and performance standby 
letters of credit.
    Some commenters requested clarification regarding the treatment of 
commitments to extend letters of credit. They argued that these 
commitments are no more risky than commitments to extend loans and 
should receive similar treatment (20 percent or 50 percent CCF). For 
purposes of the final rule, the agencies note that section 33(a)(2) 
allows banking organizations to apply the lower of the two applicable 
CCFs to the exposures related to commitments to extend letters of 
credit. Banking organizations will need to make this determination 
based upon the individual characteristics of each letter of credit.
    Under the final rule, a banking organization must apply a 100 
percent CCF to off-balance sheet guarantees, repurchase agreements, 
credit-enhancing representations and warranties that are not 
securitization exposures, securities lending or borrowing transactions, 
financial standby letters of credit, and forward agreements, and other 
similar exposures. The off-balance sheet component of a repurchase 
agreement equals the sum of the current fair values of all positions 
the banking organization has sold subject to repurchase. The off-
balance sheet component of a securities lending transaction is the sum 
of the current fair values of all positions the banking organization 
has lent under the transaction. For securities borrowing transactions, 
the off-balance sheet component is the sum of the current fair values 
of all non-cash positions the banking organization has posted as 
collateral under the transaction. In certain circumstances, a banking 
organization may instead determine the exposure amount of the 
transaction as described in section 37 of the final rule.
    In contrast to the general risk-based capital rules, which require 
capital for securities lending and borrowing transactions and 
repurchase agreements that generate an on-balance sheet exposure, the 
final rule requires a banking organization to hold risk-based capital 
against all repo-style transactions, regardless of whether they 
generate on-balance sheet exposures, as described in section 37 of the 
final rule. One commenter disagreed with this treatment and requested 
an exemption from the capital treatment for off-balance sheet repo-
style exposures.

[[Page 62092]]

However, the agencies adopted this approach because banking 
organizations face counterparty credit risk when engaging in repo-style 
transactions, even if those transactions do not generate on-balance 
sheet exposures, and thus should not be exempt from risk-based capital 
requirements.
2. Credit-Enhancing Representations and Warranties
    Under the general risk-based capital rules, a banking organization 
is subject to a risk-based capital requirement when it provides credit-
enhancing representations and warranties on assets sold or otherwise 
transferred to third parties as such positions are considered recourse 
arrangements.\142\ However, the general risk-based capital rules do not 
impose a risk-based capital requirement on assets sold or transferred 
with representations and warranties that (1) Contain early default 
clauses or similar warranties that permit the return of, or premium 
refund clauses covering, one-to-four family first-lien residential 
mortgage loans for a period not to exceed 120 days from the date of 
transfer; and (2) contain premium refund clauses that cover assets 
guaranteed, in whole or in part, by the U.S. government, a U.S. 
government agency, or a U.S. GSE, provided the premium refund clauses 
are for a period not to exceed 120 days; or (3) permit the return of 
assets in instances of fraud, misrepresentation, or incomplete 
documentation.\143\
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    \142\ 12 CFR part 3, appendix A, section 4(a)(11) and 12 CFR 
167.6(b) (OCC); 12 CFR parts 208 and 225 appendix A, section 
III.B.3.a.xii (Board).
    \143\ 12 CFR part 3, appendix A, section 4(a)(8) and 12 CFR 
167.6(b) (OCC); 12 CFR part 208, appendix A, section II.B.3.a.ii.1 
and 12 CFR part 225, appendix A, section III.B.3.a.ii.(1) (Board).
---------------------------------------------------------------------------

    In contrast, under the proposal, if a banking organization provides 
a credit-enhancing representation or warranty on assets it sold or 
otherwise transferred to third parties, including early default clauses 
that permit the return of, or premium refund clauses covering, one-to-
four family residential first mortgage loans, the banking organization 
would treat such an arrangement as an off-balance sheet guarantee and 
apply a 100 percent CCF to determine the exposure amount, provided the 
exposure does not meet the definition of a securitization exposure. The 
agencies and the FDIC proposed a different treatment than the one under 
the general risk-based capital rules because of the risk to which 
banking organizations are exposed while credit-enhancing 
representations and warranties are in effect. Some commenters asked for 
clarification on what qualifies as a credit-enhancing representation 
and warranty, and commenters made numerous suggestions for revising the 
proposed definition. In particular, they disagreed with the agencies' 
and the FDIC's proposal to remove the exemptions related to early 
default clauses and premium refund clauses since these representations 
and warranties generally are considered to be low risk exposures and 
banking organizations are not currently required to hold capital 
against these representations and warranties.
    Some commenters encouraged the agencies and the FDIC to retain the 
120-day safe harbor from the general risk-based capital rules, which 
would not require holding capital against assets sold with certain 
early default clauses of 120 days or less. These commenters argued that 
the proposal to remove the 120-day safe harbor would impede the ability 
of banking organizations to make loans and would increase the cost of 
credit to borrowers. Furthermore, certain commenters asserted that 
removal of the 120-day safe harbor was not necessary for loan 
portfolios that are well underwritten, those for which put-backs are 
rare, and where the banking organization maintains robust buyback 
reserves.
    After reviewing the comments, the agencies decided to retain in the 
final rule the 120-day safe harbor in the definition of credit-
enhancing representations and warranties for early default and premium 
refund clauses on one-to-four family residential mortgages that qualify 
for the 50 percent risk weight as well as for premium refund clauses 
that cover assets guaranteed, in whole or in part, by the U.S. 
government, a U.S. government agency, or a U.S. GSE. The agencies 
determined that retaining the safe harbor would help to address 
commenters' confusion about what qualifies as a credit-enhancing 
representation and warranty. Therefore, consistent with the general 
risk-based capital rules, under the final rule, credit-enhancing 
representations and warranties will not include (1) Early default 
clauses and similar warranties that permit the return of, or premium 
refund clauses covering, one-to-four family first-lien residential 
mortgage loans that qualify for a 50 percent risk weight for a period 
not to exceed 120 days from the date of transfer; \144\ (2) premium 
refund clauses that cover assets guaranteed by the U.S. government, a 
U.S. Government agency, or a GSE, provided the premium refund clauses 
are for a period not to exceed 120 days from the date of transfer; or 
(3) warranties that permit the return of underlying exposures in 
instances of misrepresentation, fraud, or incomplete documentation.
---------------------------------------------------------------------------

    \144\ These warranties may cover only those loans that were 
originated within 1 year of the date of transfer.
---------------------------------------------------------------------------

    Some commenters requested clarification from the agencies and the 
FDIC regarding representations made about the value of the underlying 
collateral of a sold loan. For example, many purchasers of mortgage 
loans originated by banking organizations require that the banking 
organization repurchase the loan if the value of the collateral is 
other than as stated in the documentation provided to the purchaser or 
if there were any material misrepresentations in the appraisal process. 
The agencies confirm that such representations meets the 
``misrepresentation, fraud, or incomplete documentation'' exclusion in 
the definition of credit-enhancing representations and warranties and 
is not subject to capital treatment.
    A few commenters also requested clarification regarding how the 
definition of credit-enhancing representations and warranties in the 
proposal interacts with Federal Home Loan Mortgage Corporation (FHLMC), 
Federal National Mortgage Association (FNMA), and Government National 
Mortgage Association (GNMA) sales conventions. These same commenters 
also requested verification in the final rule that mortgages sold with 
representations and warranties would all receive a 100 percent risk 
weight, regardless of the characteristics of the mortgage exposure. 
First, the definition of credit-enhancing representations and 
warranties described in this final rule is separate from the sales 
conventions required by FLHMA, FNMA, and GNMA. Those entities will 
continue to set their own requirements for secondary sales, including 
representation and warranty requirements. Second, the risk weights 
applied to mortgage exposures themselves are not affected by the 
inclusion of representations and warranties. Mortgage exposures will 
continue to receive either a 50 or 100 percent risk weight, as outlined 
in section 32(g) of this final rule, regardless of the inclusion of 
representations and warranties when they are sold in the secondary 
market. If such representations and warranties meet the rule's 
definition of credit-enhancing representations and warranties, then the 
institution must maintain regulatory capital against the associated 
credit risk.
    Some commenters disagreed with the proposed methodology for 
determining the capital requirement for

[[Page 62093]]

representations and warranties, and offered alternatives that they 
argued would conform to existing market practices and better 
incentivize high-quality underwriting. Some commenters indicated that 
many originators already hold robust buyback reserves and argued that 
the agencies and the FDIC should require originators to hold adequate 
liquidity in their buyback reserves, instead of requiring a duplicative 
capital requirement. Other commenters asked that any capital 
requirement be directly aligned to that originator's history of 
honoring representation and warranty claims. These commenters stated 
that originators who underwrite high-quality loans should not be 
required to hold as much capital against their representations and 
warranties as originators who exhibit what the commenters referred to 
as ``poor underwriting standards.'' Finally, a few commenters requested 
that the agencies and the FDIC completely remove, or significantly 
reduce, capital requirements for representations and warranties. They 
argue that the market is able to regulate itself, as a banking 
organization will not be able to sell its loans in the secondary market 
if they are frequently put back by the buyers.
    The agencies considered these alternatives and have decided to 
finalize the proposed methodology for determining the capital 
requirement applied to representations and warranties without change. 
The agencies are concerned that buyback reserves could be inadequate, 
especially if the housing market enters another prolonged downturn. 
Robust and clear capital requirements, in addition to separate buyback 
reserves held by originators, better ensure that representation and 
warranty claims will be fulfilled in times of stress. Furthermore, 
capital requirements based upon originators' historical representation 
and warranty claims are not only operationally difficult to implement 
and monitor, but they can also be misleading. Underwriting standards at 
firms are not static and can change over time. The agencies believe 
that capital requirements based on past performance of a particular 
underwriter do not always adequately capture the current risks faced by 
that firm. The agencies believe that the incorporation of the 120-day 
safe harbor in the final rule as discussed above addresses many of the 
commenters' concerns.
    Some commenters requested clarification on the duration of the 
capital treatment for credit-enhancing representations and warranties. 
For instance, some commenters questioned whether capital is required 
for credit-enhancing representations and warranties after the 
contractual life of the representations and warranties has expired or 
whether capital has to be held for the life of the asset. Banking 
organizations are not required to hold capital for any credit-enhancing 
representation and warranty after the expiration of the representation 
or warranty, regardless of the maturity of the underlying loan.
    Additionally, commenters indicated that market practice for some 
representations and warranties for sold mortgages stipulates that 
originators only need to refund the buyer any servicing premiums and 
other earned fees in cases of early default, rather than requiring 
putback of the underlying loan to the seller. These commenters sought 
clarification as to whether the proposal would have required them to 
hold capital against the value of the underlying loan or only for the 
premium or fees that could be subject to a refund, as agreed upon in 
their contract with the buyer. For purposes of the final rule, a 
banking organization must hold capital only for the maximum contractual 
amount of the banking organization's exposure under the representations 
and warranties. In the case described by the commenters, the banking 
organization would hold capital against the value of the servicing 
premium and other earned fees, rather than the value of the underlying 
loan, for the duration specified in the representations and warranties 
agreement.
    Some commenters also requested exemptions from the proposed 
treatment of representations and warranties for particular originators, 
types of transactions, or asset categories. In particular, many 
commenters asked for an exemption for community banking organizations, 
claiming that the proposed treatment would lessen credit availability 
and increase the costs of lending. One commenter argued that bona fide 
mortgage sale agreements should be exempt from capital requirements. 
Other commenters requested an exemption for the portion of any off-
balance sheet asset that is subject to a risk retention requirement 
under section 941 of the Dodd-Frank Act and any regulations promulgated 
thereunder.\145\ Some commenters also requested that the agencies and 
the FDIC delay action on the proposal until the risk retention rule is 
finalized. Other commenters also requested exemptions for qualified 
mortgages (QM) and ``prime'' mortgage loans.
---------------------------------------------------------------------------

    \145\ See 15 U.S.C. 78o-11, et seq.
---------------------------------------------------------------------------

    The agencies have decided not to adopt any of the specific 
exemptions suggested by the commenters. Although community banking 
organizations are critical to ensure the flow of credit to small 
businesses and individual borrowers, providing them with an exemption 
from the proposed treatment of credit-enhancing representations and 
warranties would be inconsistent with safety and soundness because the 
risks from these exposures to community banking organizations are no 
different than those to other banking organizations. The agencies also 
have not provided exemptions in this rulemaking to portions of off-
balance sheet assets subject to risk retention, QM, and ``prime 
loans.'' The relevant agencies have not yet adopted a final rule 
implementing the risk retention provisions of section 941 of the Dodd-
Frank Act, and the agencies, therefore, do not believe it is 
appropriate to provide an exemption relating to risk retention in this 
final rule. In addition, while the QM rulemaking is now final,\146\ the 
agencies believe it is appropriate to first evaluate how the QM 
designation affects the mortgage market before requiring less capital 
to be held against off-balance sheet assets that cover these loans. As 
noted above, the incorporation in the final rule of the 120-day safe 
harbor addresses many of the concerns about burden.
---------------------------------------------------------------------------

    \146\ See 12 CFR part 1026.
---------------------------------------------------------------------------

    The risk-based capital treatment for off-balance sheet items in 
this final rule is consistent with section 165(k) of the Dodd-Frank Act 
which provides that, in the case of a BHC with $50 billion or more in 
total consolidated assets, the computation of capital, for purposes of 
meeting capital requirements, shall take into account any off-balance-
sheet activities of the company.\147\ The final rule complies with the 
requirements of section 165(k) of the Dodd-Frank Act by requiring a BHC 
to hold risk-based capital for its off-balance sheet exposures, as 
described in sections 31, 33, 34 and 35 of the final rule.
---------------------------------------------------------------------------

    \147\ Section 165(k) of the Dodd-Frank Act (12 U.S.C. 5365(k)). 
This section defines an off-balance sheet activity as an existing 
liability of a company that is not currently a balance sheet 
liability, but may become one upon the happening of some future 
event. Such transactions may include direct credit substitutes in 
which a banking organization substitutes its own credit for a third 
party; irrevocable letters of credit; risk participations in 
bankers' acceptances; sale and repurchase agreements; asset sales 
with recourse against the seller; interest rate swaps; credit swaps; 
commodities contracts; forward contracts; securities contracts; and 
such other activities or transactions as the Board may define 
through a rulemaking.

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[[Page 62094]]

D. Over-the-Counter Derivative Contracts

    In the Standardized Approach NPR, the agencies and the FDIC 
proposed generally to retain the treatment of OTC derivatives provided 
under the general risk-based capital rules, which is similar to the 
current exposure method (CEM) for determining the exposure amount for 
OTC derivative contracts contained in the Basel II standardized 
framework.\148\ Proposed revisions to the treatment of the OTC 
derivative contracts included an updated definition of an OTC 
derivative contract, a revised conversion factor matrix for calculating 
the PFE, a revision of the criteria for recognizing the netting 
benefits of qualifying master netting agreements and of financial 
collateral, and the removal of the 50 percent risk weight cap for OTC 
derivative contracts.
---------------------------------------------------------------------------

    \148\ The general risk-based capital rules for savings 
associations regarding the calculation of credit equivalent amounts 
for derivative contracts differ from the rules for other banking 
organizations. (See 12 CFR 167(a)(2) (Federal savings associations) 
and 12 CFR 390.466(a)(2) (state savings associations)). The savings 
association rules address only interest rate and foreign exchange 
rate contracts and include certain other differences. Accordingly, 
the description of the general risk-based capital rules in this 
preamble primarily reflects the rules applicable to state and 
national banks and BHCs.
---------------------------------------------------------------------------

    The agencies and the FDIC received a number of comments on the 
proposed CEM relating to OTC derivatives. These comments generally 
focused on the revised conversion factor matrix, the proposed removal 
of the 50 percent cap on risk weights for OTC derivative transactions 
in the general risk-based capital rules, and commenters' view that 
there is a lack of risk sensitivity in the calculation of the exposure 
amount of OTC derivatives and netting benefits. A specific discussion 
of the comments on particular aspects of the proposal follows.
    One commenter asserted that the proposed conversion factors for 
common interest rate and foreign exchange contracts, and risk 
participation agreements (a simplified form of credit default swaps) 
(set forth in Table 19 below), combined with the removal of the 50 
percent risk weight cap, would drive up banking organizations' capital 
requirements associated with these routine transactions and result in 
much higher transaction costs for small businesses. Another commenter 
asserted that the zero percent conversion factor assigned to interest 
rate derivatives with a remaining maturity of one year or less is not 
appropriate as the PFE incorrectly assumes all interest rate 
derivatives always can be covered by taking a position in a liquid 
market.
    The agencies acknowledge that the standardized matrix of conversion 
factors may be too simplified for some banking organizations. The 
agencies believe, however, that the matrix approach appropriately 
balances the policy goals of simplicity and risk-sensitivity, and that 
the conversion factors themselves have been appropriately calibrated 
for the products to which they relate.
    Some commenters supported retention of the 50 percent risk weight 
cap for derivative exposures under the general risk-based capital 
rules. Specifically, one commenter argued that the methodology for 
calculating the exposure amount without the 50 percent risk weight cap 
would result in inappropriately high capital charge unless the 
methodology were amended to recognize the use of netting and 
collateral. Accordingly, the commenter encouraged the agencies and the 
FDIC to retain the 50 percent risk weight cap until the BCBS enhances 
the CEM to improve risk-sensitivity.
    The agencies believe that as the market for derivatives has 
developed, the types of counterparties acceptable to participants have 
expanded to include counterparties that merit a risk weight greater 
than 50 percent. In addition, the agencies are aware of the ongoing 
work of the BCBS to improve the current exposure method and expect to 
consider any necessary changes to update the exposure amount 
calculation when the BCBS work is completed.
    Some commenters suggested that the agencies and the FDIC allow the 
use of internal models approved by the primary Federal supervisor as an 
alternative to the proposal, consistent with Basel III. The agencies 
chose not to incorporate all of the methodologies included in the Basel 
II standardized framework in the final rule. The agencies believe that, 
given the range of banking organizations that are subject to the final 
rule in the United States, it is more appropriate to permit only the 
proposed non-models based methodology for calculating OTC derivatives 
exposure amounts under the standardized approach. For larger and more 
complex banking organizations, the use of the internal model 
methodology and other models-based methodologies is permitted under the 
advanced approaches rule. One commenter asked the agencies and the FDIC 
to provide a definition for ``netting,'' as the meaning of this term 
differs widely under various master netting agreements used in industry 
practice. Another commenter asserted that net exposures are likely to 
understate actual exposures and the risk of early close-out posed to 
banking organizations facing financial difficulties, that the 
conversion factors for PFE are inappropriate, and that a better measure 
of risk tied to gross exposure is needed. With respect to the 
definition of netting, the agencies note that the definition of 
``qualifying master netting agreement'' provides a functional 
definition of netting. With respect to the use of net exposure for 
purposes of determining PFE, the agencies believe that, in light of the 
existing international framework to enforce netting arrangements 
together with the conditions for recognizing netting that are included 
in this final rule, the use of net exposure is appropriate in the 
context of a risk-based counterparty credit risk charge that is 
specifically intended to address default risk. The final rule also 
continues to limit full recognition of netting for purposes of 
calculating PFE for counterparty credit risk under the standardized 
approach.\149\
---------------------------------------------------------------------------

    \149\ See section 34(a)(2) of the final rule.
---------------------------------------------------------------------------

    Other commenters suggested adopting broader recognition of netting 
under the PFE calculation for netting sets, using a factor of 85 
percent rather than 60 percent in the formula for recognizing netting 
effects to be consistent with the BCBS CCP interim framework (which is 
defined and discussed in section VIII.E of this preamble, below). 
Another commenter suggested implementing a 15 percent haircut on the 
calculated exposure amount for failure to recognize risk mitigants and 
portfolio diversification. With respect to the commenters' request for 
greater recognition of netting in the calculation of PFE, the agencies 
note that the BCBS CCP interim framework's use of 85 percent 
recognition of netting was limited to the calculation of the 
hypothetical capital requirement of the QCCP for purposes of 
determining a clearing member banking organization's risk-weighted 
asset amount for its default fund contribution. As such, the final rule 
retains the proposed formula for recognizing netting effects for OTC 
derivative contracts that was set out in the proposal. The agencies 
expect to consider whether it would be necessary to propose any changes 
to the CEM once BCBS discussions on this topic are complete.
    The proposed rule placed a cap on the PFE of sold credit 
protection, equal to the net present value of the amount of unpaid 
premiums. One commenter questioned the appropriateness of the proposed 
cap, and suggested that a seller's exposure be measured as the gross 
exposure amount of the credit

[[Page 62095]]

protection provided on the name referenced in the credit derivative 
contract. The agencies believe that the proposed approach is 
appropriate for measuring counterparty credit risk because it reflects 
the amount a banking organization may lose on its exposure to the 
counterparty that purchased protection. The exposure amount on a sold 
credit derivative would be calculated separately under section 34(a).
    Another commenter asserted that current credit exposure (netted and 
unnetted) understates or ignores the risk that the mark is inaccurate. 
Generally, the agencies expect a banking organization to have in place 
policies and procedures regarding the valuation of positions, and that 
those processes would be reviewed in connection with routine and 
periodic supervisory examinations of a banking organization.
    The final rule generally adopts the proposed treatment for OTC 
derivatives without change. Under the final rule, as under the general 
risk-based capital rules, a banking organization is required to hold 
risk-based capital for counterparty credit risk for an OTC derivative 
contract. As defined in the rule, a derivative contract is a financial 
contract whose value is derived from the values of one or more 
underlying assets, reference rates, or indices of asset values or 
reference rates. A derivative contract includes an interest rate, 
exchange rate, equity, or a commodity derivative contract, a credit 
derivative, and any other instrument that poses similar counterparty 
credit risks. Derivative contracts also include unsettled securities, 
commodities, and foreign exchange transactions with a contractual 
settlement or delivery lag that is longer than the lesser of the market 
standard for the particular instrument or five business days. This 
applies, for example, to mortgage-backed securities (MBS) transactions 
that the GSEs conduct in the To-Be-Announced market.
    Under the final rule, an OTC derivative contract does not include a 
derivative contract that is a cleared transaction, which is subject to 
a specific treatment as described in section VIII.E of this preamble. 
However, an OTC derivative contract includes an exposure of a banking 
organization that is a clearing member banking organization to its 
clearing member client where the clearing member banking organization 
is either acting as a financial intermediary and enters into an 
offsetting transaction with a CCP or where the clearing member banking 
organization provides a guarantee to the CCP on the performance of the 
client. The rationale for this treatment is the banking organization's 
continued exposure directly to the risk of the clearing member client. 
In recognition of the shorter close-out period for these transactions, 
however, the final rule permits a banking organization to apply a 
scaling factor to recognize the shorter holding period as discussed in 
section VIII.E of this preamble.
    To determine the risk-weighted asset amount for an OTC derivative 
contract under the final rule, a banking organization must first 
determine its exposure amount for the contract and then apply to that 
amount a risk weight based on the counterparty, eligible guarantor, or 
recognized collateral.
    For a single OTC derivative contract that is not subject to a 
qualifying master netting agreement (as defined further below in this 
section), the rule requires the exposure amount to be the sum of (1) 
the banking organization's current credit exposure, which is the 
greater of the fair value or zero, and (2) PFE, which is calculated by 
multiplying the notional principal amount of the OTC derivative 
contract by the appropriate conversion factor, in accordance with Table 
19 below.
    Under the final rule, the conversion factor matrix includes the 
additional categories of OTC derivative contracts as illustrated in 
Table 19. For an OTC derivative contract that does not fall within one 
of the specified categories in Table 19, the final rule requires PFE to 
be calculated using the ``other'' conversion factor.

                                          Table 19--Conversion Factor Matrix for OTC Derivative Contracts \150\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                              Credit       Credit (non-
                                                              Foreign      (investment-     investment-                      Precious
        Remaining maturity \151\           Interest rate   exchange rate       grade           grade          Equity      metals (except       Other
                                                             and gold        reference       reference                         gold)
                                                                           asset) \152\       asset)
--------------------------------------------------------------------------------------------------------------------------------------------------------
One year or less........................            0.00            0.01            0.05            0.10            0.06            0.07            0.10
Greater than one year and less than or             0.005            0.05            0.05            0.10            0.08            0.07            0.12
 equal to five years....................
Greater than five years.................           0.015           0.075            0.05            0.10            0.10            0.08            0.15
--------------------------------------------------------------------------------------------------------------------------------------------------------

    For multiple OTC derivative contracts subject to a qualifying 
master netting agreement, a banking organization must calculate the 
exposure amount by adding the net current credit exposure and the 
adjusted sum of the PFE amounts for all OTC derivative contracts 
subject to the qualifying master netting agreement. Under the final 
rule, the net current credit exposure is the greater of zero and the 
net sum of all positive and negative fair values of the individual OTC 
derivative contracts subject to the qualifying master netting 
agreement. The adjusted sum of the PFE amounts must be calculated as 
described in section 34(a)(2)(ii) of the final rule.
    Under the final rule, to recognize the netting benefit of multiple 
OTC derivative contracts, the contracts must be subject to a qualifying 
master netting agreement; however, unlike under the general risk-based 
capital rules, under the final rule for most transactions, a banking 
organization may rely on sufficient legal review instead of an opinion 
on the enforceability of the netting agreement as described below.\153\ 
The final rule defines a

[[Page 62096]]

qualifying master netting agreement as any written, legally enforceable 
netting agreement that creates a single legal obligation for all 
individual transactions covered by the agreement upon an event of 
default (including receivership, insolvency, liquidation, or similar 
proceeding) provided that certain conditions set forth in section 3 of 
the final rule are met.\154\ These conditions include requirements with 
respect to the banking organization's right to terminate the contract 
and liquidate collateral and meeting certain standards with respect to 
legal review of the agreement to ensure its meets the criteria in the 
definition.
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    \150\ For a derivative contract with multiple exchanges of 
principal, the conversion factor is multiplied by the number of 
remaining payments in the derivative contract.
    \151\ For a derivative contract that is structured such that on 
specified dates any outstanding exposure is settled and the terms 
are reset so that the market value of the contract is zero, the 
remaining maturity equals the time until the next reset date. For an 
interest rate derivative contract with a remaining maturity of 
greater than one year that meets these criteria, the minimum 
conversion factor is 0.005.
    \152\ A banking organization must use the column labeled 
``Credit (investment-grade reference asset)'' for a credit 
derivative whose reference asset is an outstanding unsecured long-
term debt security without credit enhancement that is investment 
grade. A banking organization must use the column labeled ``Credit 
(non-investment-grade reference asset)'' for all other credit 
derivatives.
    \153\ Under the general risk-based capital rules, to recognize 
netting benefits a banking organization must enter into a bilateral 
master netting agreement with its counterparty and obtain a written 
and well-reasoned legal opinion of the enforceability of the netting 
agreement for each of its netting agreements that cover OTC 
derivative contracts.
    \154\ The final rule adds a new section 3: Operational 
requirements for counterparty credit risk. This section organizes 
substantive requirements related to cleared transactions, eligible 
margin loans, qualifying cross-product master netting agreements, 
qualifying master netting agreements, and repo-style transactions in 
a central place to assist banking organizations in determining their 
legal responsibilities. These substantive requirements are 
consistent with those included in the proposal.
---------------------------------------------------------------------------

    The legal review must be sufficient so that the banking 
organization may conclude with a well-founded basis that, among other 
things, the contract would be found legal, binding, and enforceable 
under the law of the relevant jurisdiction and that the contract meets 
the other requirements of the definition. In some cases, the legal 
review requirement could be met by reasoned reliance on a commissioned 
legal opinion or an in-house counsel analysis. In other cases, for 
example, those involving certain new derivative transactions or 
derivative counterparties in jurisdictions where a banking organization 
has little experience, the banking organization would be expected to 
obtain an explicit, written legal opinion from external or internal 
legal counsel addressing the particular situation.
    Under the final rule, if an OTC derivative contract is 
collateralized by financial collateral, a banking organization must 
first determine the exposure amount of the OTC derivative contract as 
described in this section of the preamble. Next, to recognize the 
credit risk mitigation benefits of the financial collateral, a banking 
organization could use the simple approach for collateralized 
transactions as described in section 37(b) of the final rule. 
Alternatively, if the financial collateral is marked-to-market on a 
daily basis and subject to a daily margin maintenance requirement, a 
banking organization could adjust the exposure amount of the contract 
using the collateral haircut approach described in section 37(c) of the 
final rule.
    Similarly, if a banking organization purchases a credit derivative 
that is recognized under section 36 of the final rule as a credit risk 
mitigant for an exposure that is not a covered position under subpart 
F, it is not required to compute a separate counterparty credit risk 
capital requirement for the credit derivative, provided it does so 
consistently for all such credit derivative contracts. Further, where 
these credit derivative contracts are subject to a qualifying master 
netting agreement, the banking organization must either include them 
all or exclude them all from any measure used to determine the 
counterparty credit risk exposure to all relevant counterparties for 
risk-based capital purposes.
    Under the final rule, a banking organization must treat an equity 
derivative contract as an equity exposure and compute its risk-weighted 
asset amount according to the simple risk-weight approach (SRWA) 
described in section 52 (unless the contract is a covered position 
under the market risk rule). If the banking organization risk weights a 
contract under the SRWA described in section 52, it may choose not to 
hold risk-based capital against the counterparty risk of the equity 
contract, so long as it does so for all such contracts. Where the OTC 
equity contracts are subject to a qualified master netting agreement, a 
banking organization either includes or excludes all of the contracts 
from any measure used to determine counterparty credit risk exposures. 
If the banking organization is treating an OTC equity derivative 
contract as a covered position under subpart F, it also must calculate 
a risk-based capital requirement for counterparty credit risk of the 
contract under this section.
    In addition, if a banking organization provides protection through 
a credit derivative that is not a covered position under subpart F of 
the final rule, it must treat the credit derivative as an exposure to 
the underlying reference asset and compute a risk-weighted asset amount 
for the credit derivative under section 32 of the final rule. The 
banking organization is not required to compute a counterparty credit 
risk capital requirement for the credit derivative, as long as it does 
so consistently for all such OTC credit derivative contracts. Further, 
where these credit derivative contracts are subject to a qualifying 
master netting agreement, the banking organization must either include 
all or exclude all such credit derivatives from any measure used to 
determine counterparty credit risk exposure to all relevant 
counterparties for risk-based capital purposes.
    Where the banking organization provides protection through a credit 
derivative treated as a covered position under subpart F, it must 
compute a supplemental counterparty credit risk capital requirement 
using an amount determined under section 34 for OTC credit derivative 
contracts or section 35 for credit derivatives that are cleared 
transactions. In either case, the PFE of the protection provider would 
be capped at the net present value of the amount of unpaid premiums.
    Under the final rule, the risk weight for OTC derivative 
transactions is not subject to any specific ceiling, consistent with 
the Basel capital framework.
    Although the agencies generally adopted the proposal without 
change, the final rule has been revised to add a provision regarding 
the treatment of a clearing member banking organization's exposure to a 
clearing member client (as described below under ``Cleared 
Transactions,'' a transaction between a clearing member banking 
organization and a client is treated as an OTC derivative exposure). 
However, the final rule recognizes the shorter close-out period for 
cleared transactions that are derivative contracts, such that a 
clearing member banking organization can reduce its exposure amount to 
its client by multiplying the exposure amount by a scaling factor of no 
less than 0.71. See section VIII.E of this preamble, below, for 
additional discussion.

E. Cleared Transactions

    The BCBS and the agencies support incentives designed to encourage 
clearing of derivative and repo-style transactions \155\ through a CCP 
wherever possible in order to promote transparency, multilateral 
netting, and robust risk-management practices.
---------------------------------------------------------------------------

    \155\ See section 2 of the final rule for the definition of a 
repo-style transaction.
---------------------------------------------------------------------------

    Although there are some risks associated with CCPs, as discussed 
below, the agencies believe that CCPs generally help improve the safety 
and soundness of the derivatives and repo-style transactions markets 
through the multilateral netting of exposures, establishment and 
enforcement of collateral requirements, and the promotion of market 
transparency.
    As discussed in the proposal, when developing Basel III, the BCBS 
recognized that as more transactions move to central clearing, the 
potential for risk concentration and systemic risk

[[Page 62097]]

increases. To address these concerns, in the period preceding the 
proposal, the BCBS sought comment on a more risk-sensitive approach for 
determining capital requirements for banking organizations' exposures 
to CCPs.\156\ In addition, to encourage CCPs to maintain strong risk-
management procedures, the BCBS sought comment on a proposal for lower 
risk-based capital requirements for derivative and repo-style 
transaction exposures to CCPs that meet the standards established by 
the Committee on Payment and Settlement Systems (CPSS) and 
International Organization of Securities Commissions (IOSCO).\157\ 
Exposures to such entities, termed QCCPs in the final rule, would be 
subject to lower risk weights than exposures to CCPs that did not meet 
those criteria.
---------------------------------------------------------------------------

    \156\ See ``Capitalisation of Banking Organization Exposures to 
Central Counterparties'' (November 2011) (CCP consultative release), 
available at https://www.bis.org/publ/bcbs206.pdf.
    \157\ See CPSS-IOSCO, ``Recommendations for Central 
Counterparties'' (November 2004), available at https://www.bis.org/publ/cpss64.pdf?noframes=1.
---------------------------------------------------------------------------

    Consistent with the BCBS proposals and the CPSS-IOSCO standards, 
the agencies and the FDIC sought comment on specific risk-based capital 
requirements for cleared derivative and repo-style transactions that 
are designed to incentivize the use of CCPs, help reduce counterparty 
credit risk, and promote strong risk management of CCPs to mitigate 
their potential for systemic risk. In contrast to the general risk-
based capital rules, which permit a banking organization to exclude 
certain derivative contracts traded on an exchange from the risk-based 
capital calculation, the proposal would have required a banking 
organization to hold risk-based capital for an outstanding derivative 
contract or a repo-style transaction that has been cleared through a 
CCP, including an exchange.
    The proposal also included a capital requirement for default fund 
contributions to CCPs. In the case of non-qualifying CCPs (that is, 
CCPs that do not meet the risk-management, supervision, and other 
standards for QCCPs outlined in the proposal), the risk-weighted asset 
amount for default fund contributions to such CCPs would be equal to 
the sum of the banking organization's default fund contributions to the 
CCPs multiplied by 1,250 percent. In the case of QCCPs, the risk-
weighted asset amount would be calculated according to a formula based 
on the hypothetical capital requirement for a QCCP, consistent with the 
Basel capital framework. The proposal included a formula with inputs 
including the exposure amount of transactions cleared through the QCCP, 
collateral amounts, the number of members of the QCCP, and default fund 
contributions.
    Following issuance of the proposal, the BCBS issued an interim 
framework for the capital treatment of bank exposures to CCPs (BCBS CCP 
interim framework).\158\ The BCBS CCP interim framework reflects 
several key changes from the CCP consultative release, including: (1) A 
provision to allow a clearing member banking organization to apply a 
scalar when using the CEM (as described below) in the calculation of 
its exposure amount to a client (or use a reduced margin period of risk 
when using the internal models methodology (IMM) to calculate exposure 
at default (EAD) under the advanced approaches rule); (2) revisions to 
the risk weights applicable to a clearing member banking organization's 
exposures when such clearing member banking organization guarantees 
QCCP performance; (3) a provision to permit clearing member banking 
organizations to choose from one of two formulaic methodologies for 
determining the capital requirement for default fund contributions; and 
(4) revisions to the CEM formula to recognize netting to a greater 
extent for purposes of calculating the capital requirement for default 
fund contributions.
---------------------------------------------------------------------------

    \158\ See ``Capital requirements for bank exposures to central 
counterparties'' (July 2012), available at https://www.bis.org/publ/bcbs227.pdf.
---------------------------------------------------------------------------

    The agencies and the FDIC received a number of comments on the 
proposal relating to cleared transactions. Commenters also encouraged 
the agencies and the FDIC to revise certain aspects of the proposal in 
a manner consistent with the BCBS CCP interim framework.
    Some commenters asserted that the definition of QCCP should be 
revised, specifically by including a definitive list of QCCPs rather 
than requiring each banking organization to demonstrate that a CCP 
meets certain qualifying criteria. The agencies believe that a static 
list of QCCPs would not reflect the potentially dynamic nature of a 
CCP, and that banking organizations are situated to make this 
determination on an ongoing basis.
    Some commenters recommended explicitly including derivatives 
clearing organizations (DCOs) and securities-based swap clearing 
agencies in the definition of a QCCP. Commenters also suggested 
including in the definition of QCCP any CCP that the CFTC or SEC 
exempts from registration because it is deemed by the CFTC or SEC to be 
subject to ``comparable, comprehensive supervision'' by another 
regulator. The agencies note that such registration (or exemption from 
registration based on being subject to ``comparable, comprehensive 
supervision'') does not necessarily mean that the CCP is subject to, or 
in compliance with, the standards established by the CPSS and IOSCO. In 
contrast, a designated FMU, which is included in the definition of 
QCCP, is subject to regulation that corresponds to such standards.
    Another commenter asserted that, consistent with the BCBS CCP 
interim framework, the final rule should provide for the designation of 
a QCCP by the agencies in the absence of a national regime for 
authorization and licensing of CCPs. The final rule has not been 
amended to include this aspect of the BCBS CCP interim framework 
because the agencies believe a national regime for authorizing and 
licensing CCPs is a critical mechanism to ensure the compliance and 
ongoing monitoring of a CCP's adherence to internationally recognized 
risk-management standards. Another commenter requested that a three-
month grace period apply for CCPs that cease to be QCCPs. The agencies 
note that such a grace period was included in the proposed rule, and 
the final rule retains the proposed definition without substantive 
change.\159\
---------------------------------------------------------------------------

    \159\ This provision is located in sections 35 and 133 of the 
final rule.
---------------------------------------------------------------------------

    With respect to the proposed definition of cleared transaction, 
some commenters asserted that the definition should recognize omnibus 
accounts because their collateral is bankruptcy-remote. The agencies 
agree with these commenters and have revised the operational 
requirements for cleared transactions to include an explicit reference 
to such accounts.
    The BCBS CCP interim framework requires trade portability to be 
``highly likely,'' as a condition of whether a trade satisfies the 
definition of cleared transaction. One commenter who encouraged the 
agencies and the FDIC to adopt the standards set forth in the BCBS CCP 
interim framework sought clarification of the meaning of ``highly 
likely'' in this context. The agencies clarify that, consistent with 
the BCBS CCP interim framework, if there is clear precedent for 
transactions to be transferred to a non-defaulting clearing member upon 
the default of another clearing member (commonly referred to as 
``portability'') and there are no indications that such practice will 
not continue, then these factors should be considered, when assessing 
whether client positions are portable. The

[[Page 62098]]

definition of ``cleared transaction'' in the final rule is discussed in 
further detail below.
    Another commenter sought clarification on whether reasonable 
reliance on a commissioned legal opinion for foreign financial 
jurisdictions could satisfy the ``sufficient legal review'' requirement 
for bankruptcy remoteness of client positions. The agencies believe 
that reasonable reliance on a commissioned legal opinion could satisfy 
this requirement. Another commenter expressed concern that the proposed 
framework for cleared transactions would capture securities 
clearinghouses, and encouraged the agencies to clarify their intent 
with respect to such entities for purposes of the final rule. The 
agencies note that the definition of ``cleared transaction'' refers 
only to OTC derivatives and repo-style transactions. As a result, 
securities clearinghouses are not within the scope of the cleared 
transactions framework.
    One commenter asserted that the agencies and the FDIC should 
recognize varying close-out period conventions for specific cleared 
products, specifically exchange-traded derivatives. This commenter also 
asserted that the agencies and the FDIC should adjust the holding 
period assumptions or allow CCPs to use alternative methods to compute 
the appropriate haircut for cleared transactions. For purposes of this 
final rule, the agencies retained a standard close-out period in the 
interest of avoiding unnecessary complexity, and note that cleared 
transactions with QCCPs attract extremely low risk weights (generally, 
2 or 4 percent), which, in part, is in recognition of the shorter 
close-out period involved in cleared transactions.
    Another commenter requested confirmation that the risk weight 
applicable to the trade exposure amount for a cleared credit default 
swap (CDS) could be substituted for the risk weight assigned to an 
exposure that was hedged by the cleared CDS, that is, the substitution 
treatment described in sections 36 and 134 would apply. The agencies 
confirm that under the final rule, a banking organization may apply the 
substitution treatment of sections 36 or 134 to recognize the credit 
risk mitigation benefits of a cleared CDS as long as the CDS is an 
eligible credit derivative and meets the other criteria for 
recognition. Thus, if a banking organization purchases an eligible 
credit derivative as a hedge of an exposure and the eligible credit 
derivative qualifies as a cleared transaction, the banking organization 
may substitute the risk weight applicable to the cleared transaction 
under sections 35 or 133 of the final rule (instead of using the risk 
weight associated with the protection provider).\160\ Furthermore, the 
agencies have modified the definition of eligible guarantor to include 
a QCCP.
---------------------------------------------------------------------------

    \160\ See ``Basel III counterparty credit risk and exposures to 
central counterparties--Frequently asked questions'' (December 2012 
(update of FAQs published in November 2012)), available at https://www.bis.org/publ/bcbs237.pdf.
---------------------------------------------------------------------------

    Another commenter asserted that the final rule should decouple the 
risk weights applied to collateral exposure and those assigned to other 
components of trade exposure to recognize the separate components of 
risk. The agencies note that, if collateral is bankruptcy remote, then 
it would not be included in the trade exposure amount calculation (see 
sections 35(b)(2) and 133(b)(2) of the final rule). The agencies also 
note that such collateral must be risk weighted in accordance with 
other sections of the final rule as appropriate, to the extent that the 
posted collateral remains an asset on a banking organization's balance 
sheet.
    A number of commenters addressed the use of the CEM for purposes of 
calculating a capital requirement for a default fund contribution to a 
CCP (Kccp).\161\ Some commenters asserted that the CEM is 
not appropriate for determining the hypothetical capital requirement 
for a QCCP (Kccp) under the proposed formula because it 
lacks risk sensitivity and sophistication, and was not developed for 
centrally-cleared transactions. Another commenter asserted that the use 
of CEM should be clarified in the clearing context, specifically, 
whether the modified CEM approach would permit the netting of 
offsetting positions booked under different ``desk IDs'' or ``hub 
accounts'' for a given clearing member banking organization. Another 
commenter encouraged the agencies and the FDIC to allow banking 
organizations to use the IMM to calculate Kccp. Another 
commenter encouraged the agencies and the FDIC to continue to work with 
the BCBS to harmonize international and domestic capital rules for 
cleared transactions.
---------------------------------------------------------------------------

    \161\ See section VIII.D of this preamble for a description of 
the CEM.
---------------------------------------------------------------------------

    Although the agencies recognize that the CEM has certain 
limitations, the agencies consider the CEM, as modified for cleared 
transactions, to be a reasonable approach that would produce consistent 
results across banking organizations. Regarding the commenter's request 
for clarification of netting positions across ``desk IDs'' or ``hub 
accounts,'' the CEM would recognize netting across such transactions if 
such netting is legally enforceable upon a CCP's default. Moreover, the 
agencies believe that the use of models either by the CCP, whose model 
would not be subject to review and approval by the agencies, or by the 
banking organizations, whose models may vary significantly, likely 
would produce inconsistent results that would not serve as a basis for 
comparison across banking organizations. The agencies recognize that 
additional work is being performed by the BCBS to revise the CCP 
capital framework and the CEM. The agencies expect to modify the final 
rule to incorporate the BCBS improvements to the CCP capital framework 
and CEM through the normal rulemaking process.
    Other commenters suggested that the agencies and the FDIC not allow 
preferential treatment for clearinghouses, which they asserted are 
systemically critical institutions. In addition, some of these 
commenters argued that the agency clearing model should receive a more 
favorable capital requirement because the agency relationship 
facilitates protection and portability of client positions in the event 
of a clearing member default, compared to the back-to-back principal 
model. As noted above, the agencies acknowledge that as more 
transactions move to central clearing, the potential for risk 
concentration and systemic risk increases. As noted in the proposal, 
the risk weights applicable to cleared transactions with QCCPs 
(generally 2 or 4 percent) represent an increase for many cleared 
transactions as compared to the general risk-based capital rules (which 
exclude from the risk-based ratio calculations exchange rate contracts 
with an original maturity of fourteen or fewer calendar days and 
derivative contracts traded on exchanges that require daily receipt and 
payment of cash variation margin),\162\ in part to reflect the 
increased concentration and systemic risk inherent in such 
transactions. In regards to the agency clearing model, the agencies 
note that a clearing member banking organization that acts as an agent 
for a client and that guarantees the client's performance to the QCCP 
would have no exposure to the QCCP to risk weight. The exposure arising 
from the guarantee would be treated as an OTC derivative with a reduced 
holding period, as discussed below.
---------------------------------------------------------------------------

    \162\ See 12 CFR part 3, appendix A, section 3(b)(7)(iv) 
(national banks) and 12 CFR 167.6(a)(2)(iv)(E) (Federal savings 
associations) (OCC); 12 CFR part 208, appendix A paragraph 
III.E.1.e; 12 CFR part 225, appendix A paragraph III.E.1.e (Board).

---------------------------------------------------------------------------

[[Page 62099]]

    Another commenter suggested that the final rule address the 
treatment of unfunded default fund contribution amounts and potential 
future contributions to QCCPs, noting that the treatment of these 
potential exposures is not addressed in the BCBS CCP interim framework. 
The agencies have clarified in the final rule that if a banking 
organization's unfunded default fund contribution to a CCP is 
unlimited, the banking organization's primary Federal supervisor will 
determine the risk-weighted asset amount for such default fund 
contribution based on factors such as the size, structure, and 
membership of the CCP and the riskiness of its transactions. The final 
rule does not contemplate unlimited default fund contributions to QCCPs 
because defined default fund contribution amounts are a prerequisite to 
being a QCCP.
    Another commenter asserted that it is unworkable to require 
securities lending transactions to be conducted through a CCP, and that 
it would be easier and more sensible to make the appropriate 
adjustments in the final rule to ensure a capital treatment for 
securities lending transactions that is proportional to their actual 
risks. The agencies note that the proposed rule would not have required 
securities lending transactions to be cleared. The agencies also 
acknowledge that clearing may not be widely available for securities 
lending transactions, and believe that the collateral haircut approach 
(sections 37(c) and 132(b) of the final rule) and for advanced 
approaches banking organizations, the simple value-at-risk (VaR) and 
internal models methodologies (sections 132(b)(3) and (d) of the final 
rule) are an appropriately risk-sensitive exposure measure for non-
cleared securities lending exposures.
    One commenter asserted that end users and client-cleared trades 
would be disadvantaged by the proposal. Although there may be increased 
transaction costs associated with the introduction of the CCP 
framework, the agencies believe that the overall risk mitigation that 
should result from the capital requirements generated by the framework 
will help promote financial stability, and that the measures the 
agencies have taken in the final rule to incentivize client clearing 
are aimed at addressing the commenters' concerns. Several commenters 
suggested that the proposed rule created a disincentive for client 
clearing because of the clearing member banking organization's exposure 
to the client. The agencies agree with the need to mitigate 
disincentives for client clearing in the methodology, and have amended 
the final rule to reflect a lower margin period of risk, or holding 
period, as applicable, as discussed further below.
    Commenters suggested delaying implementation of a cleared 
transactions framework in the final rule until the BCBS CCP interim 
framework is finalized, implementing the BCBS CCP interim framework in 
the final rule pending finalization of the BCBS interim framework, or 
providing a transition period for banking organizations to be able to 
comply with some of the requirements. A number of commenters urged the 
agencies and the FDIC to incorporate all substantive changes of the 
BCBS CCP interim framework, ranging from minor adjustments to more 
material modifications.
    After considering the comments and reviewing the standards in the 
BCBS CCP interim framework, the agencies believe that the modifications 
to capital standards for cleared transactions in the BCBS CCP interim 
framework are appropriate and believe that they would result in 
modifications that address many commenters' concerns. Furthermore, the 
agencies believe that it is prudent to implement the BCBS CCP interim 
framework, rather than wait for the final framework, because the 
changes in the BCBS CCP interim framework represent a sound approach to 
mitigating the risks associated with cleared transactions. Accordingly, 
the agencies have incorporated the material elements of the BCBS CCP 
interim framework into the final rule. In addition, given the delayed 
effective date of the final rule, the agencies believe that an 
additional transition period, as suggested by some commenters, is not 
necessary.
    The material changes to the proposed rule to incorporate the CCP 
interim rule are described below. Other than these changes, the final 
rule retains the capital requirements for cleared transaction exposures 
generally as proposed by the agencies and the FDIC. As noted in the 
proposal, the international discussions are ongoing on these issues, 
and the agencies will revisit this issue once the Basel capital 
framework is revised.
1. Definition of Cleared Transaction
    The final rule defines a cleared transaction as an exposure 
associated with an outstanding derivative contract or repo-style 
transaction that a banking organization or clearing member has entered 
into with a CCP (that is, a transaction that a CCP has accepted).\163\ 
Cleared transactions include the following: (1) A transaction between a 
CCP and a clearing member banking organization for the banking 
organization's own account; (2) a transaction between a CCP and a 
clearing member banking organization acting as a financial intermediary 
on behalf of its clearing member client; (3) a transaction between a 
client banking organization and a clearing member where the clearing 
member acts on behalf of the client banking organization and enters 
into an offsetting transaction with a CCP; and (4) a transaction 
between a clearing member client and a CCP where a clearing member 
banking organization guarantees the performance of the clearing member 
client to the CCP. Such transactions must also satisfy additional 
criteria provided in section 3 of the final rule, including bankruptcy 
remoteness of collateral, transferability criteria, and portability of 
the clearing member client's position. As explained above, the agencies 
have modified the definition in the final rule to specify that 
regulated omnibus accounts to meet the requirement for bankruptcy 
remoteness.
---------------------------------------------------------------------------

    \163\ For example, the agencies expect that a transaction with a 
derivatives clearing organization (DCO) would meet the criteria for 
a cleared transaction. A DCO is a clearinghouse, clearing 
association, clearing corporation, or similar entity that enables 
each party to an agreement, contract, or transaction to substitute, 
through novation or otherwise, the credit of the DCO for the credit 
of the parties; arranges or provides, on a multilateral basis, for 
the settlement or netting of obligations; or otherwise provides 
clearing services or arrangements that mutualize or transfer credit 
risk among participants. To qualify as a DCO, an entity must be 
registered with the U.S. Commodity Futures Trading Commission and 
comply with all relevant laws and procedures.
---------------------------------------------------------------------------

    A banking organization is required to calculate risk-weighted 
assets for all of its cleared transactions, whether the banking 
organization acts as a clearing member (defined as a member of, or 
direct participant in, a CCP that is entitled to enter into 
transactions with the CCP) or a clearing member client (defined as a 
party to a cleared transaction associated with a CCP in which a 
clearing member acts either as a financial intermediary with respect to 
the party or guarantees the performance of the party to the CCP).
    Derivative transactions that are not cleared transactions because 
they do not meet all the criteria, are OTC derivative transactions. For 
example, if a transaction submitted to the CCP is not accepted by the 
CCP because the terms of the transaction submitted by the clearing 
members do not match or because other operational issues are identified 
by the CCP, the transaction does not meet the definition of a cleared 
transaction and is an OTC derivative transaction. If the counterparties 
to the transaction resolve the issues and

[[Page 62100]]

resubmit the transaction and it is accepted, the transaction would then 
be a cleared transaction. A cleared transaction does not include an 
exposure of a banking organization that is a clearing member to its 
clearing member client where the banking organization is either acting 
as a financial intermediary and enters into an offsetting transaction 
with a CCP or where the banking organization provides a guarantee to 
the CCP on the performance of the client. Under the standardized 
approach, as discussed below, such a transaction is an OTC derivative 
transaction with the exposure amount calculated according to section 
34(e) of the final rule or a repo-style transaction with the exposure 
amount calculated according to section 37(c) of the final rule. Under 
the advanced approaches rule, such a transaction is treated as either 
an OTC derivative transaction with the exposure amount calculated 
according to sections 132(c)(8) or (d)(5)(iii)(C) of the final rule or 
a repo-style transaction with the exposure amount calculated according 
to sections 132(b) or (d) of the final rule.
2. Exposure Amount Scalar for Calculating for Client Exposures
    Under the proposal, a transaction between a clearing member banking 
organization and a client was treated as an OTC derivative exposure, 
with the exposure amount calculated according to sections 34 or 132 of 
the proposal. The agencies acknowledged in the proposal that this 
treatment could have created disincentives for banking organizations to 
facilitate client clearing. Commenters' feedback and the BCBS CCP 
interim framework's treatment on this subject provided alternatives to 
address the incentive concern.
    Consistent with comments and the BCBS CCP interim framework, under 
the final rule, a clearing member banking organization must treat its 
counterparty credit risk exposure to clients as an OTC derivative 
contract, irrespective of whether the clearing member banking 
organization guarantees the transaction or acts as an intermediary 
between the client and the QCCP. Consistent with the BCBS CCP interim 
framework, to recognize the shorter close-out period for cleared 
transactions, under the standardized approach a clearing member banking 
organization may calculate its exposure amount to a client by 
multiplying the exposure amount, calculated using the CEM, by a scaling 
factor of no less than 0.71, which represents a five-day holding 
period. A clearing member banking organization must use a longer 
holding period and apply a larger scaling factor to its exposure amount 
in accordance with Table 20 if it determines that a holding period 
longer than five days is appropriate. A banking organization's primary 
Federal supervisor may require a clearing member banking organization 
to set a longer holding period if the primary Federal supervisor 
determines that a longer period is commensurate with the risks 
associated with the transaction. The agencies believe that the 
recognition of a shorter close-out period appropriately captures the 
risk associated with such transactions while furthering the policy goal 
of promoting central clearing.

              Table 20--Holding Periods and Scaling Factors
------------------------------------------------------------------------
       Holding period (days)                    Scaling factor
------------------------------------------------------------------------
                       5                                 0.71
                       6                                 0.77
                       7                                 0.84
                       8                                 0.89
                       9                                 0.95
                      10                                 1.00
------------------------------------------------------------------------

3. Risk Weighting for Cleared Transactions
    Under the final rule, to determine the risk-weighted asset amount 
for a cleared transaction, a clearing member client banking 
organization or a clearing member banking organization must multiply 
the trade exposure amount for the cleared transaction by the 
appropriate risk weight, determined as described below. The trade 
exposure amount is calculated as follows:
    (1) For a cleared transaction that is a derivative contract or a 
netting set of derivatives contracts, the trade exposure amount is 
equal to the exposure amount for the derivative contract or netting set 
of derivative contracts, calculated using the CEM for OTC derivative 
contracts (described in sections 34 or 132(c) of the final rule) or for 
advanced approaches banking organizations that use the IMM, under 
section 132(d) of the final rule), plus the fair value of the 
collateral posted by the clearing member client banking organization 
and held by the CCP or clearing member in a manner that is not 
bankruptcy remote; and
    (2) For a cleared transaction that is a repo-style transaction or a 
netting set of repo-style transactions, the trade exposure amount is 
equal to the exposure amount calculated under the collateral haircut 
approach used for financial collateral (described in section 37(c) and 
132(b) of the final rule) (or for advanced approaches banking 
organizations the IMM under section 132(d) of the final rule) plus the 
fair value of the collateral posted by the clearing member client 
banking organization that is held by the CCP or clearing member in a 
manner that is not bankruptcy remote.
    The trade exposure amount does not include any collateral posted by 
a clearing member client banking organization or clearing member 
banking organization that is held by a custodian in a manner that is 
bankruptcy remote \164\ from the CCP, clearing member, other 
counterparties of the clearing member, and the custodian itself. In 
addition to the capital requirement for the cleared transaction, the 
banking organization remains subject to a capital requirement for any 
collateral provided to a CCP, a clearing member, or a custodian in 
connection with a cleared transaction in accordance with section 32 or 
131 of the final rule. Consistent with the BCBS CCP interim framework, 
the risk weight for a cleared transaction depends on whether the CCP is 
a QCCP. Central counterparties that are designated FMUs and foreign 
entities regulated and supervised in a manner equivalent to designated 
FMUs are QCCPs. In addition, a CCP could be a QCCP under the final rule 
if it is in sound financial condition and meets certain standards that 
are consistent with BCBS expectations for QCCPs, as set forth in the 
QCCP definition.
---------------------------------------------------------------------------

    \164\ Under the final rule, bankruptcy remote, with respect to 
an entity or asset, means that the entity or asset would be excluded 
from an insolvent entity's estate in a receivership, insolvency or 
similar proceeding.
---------------------------------------------------------------------------

    A clearing member banking organization must apply a 2 percent risk 
weight to its trade exposure amount to a QCCP. A banking organization 
that is a clearing member client may apply a 2 percent risk weight to 
the trade exposure amount only if:
    (1) The collateral posted by the clearing member client banking 
organization to the QCCP or clearing member is subject to an 
arrangement that prevents any losses to the clearing member client due 
to the joint default or a concurrent insolvency, liquidation, or 
receivership proceeding of the clearing member and any other clearing 
member clients of the clearing member, and
    (2) The clearing member client banking organization has conducted 
sufficient legal review to conclude with a well-founded basis (and 
maintains sufficient written documentation of that legal review) that 
in the event of a legal challenge (including one resulting from default 
or a liquidation, insolvency, or receivership proceeding) the relevant 
court and administrative authorities

[[Page 62101]]

would find the arrangements to be legal, valid, binding, and 
enforceable under the law of the relevant jurisdiction.
    If the criteria above are not met, a clearing member client banking 
organization must apply a risk weight of 4 percent to the trade 
exposure amount.
    Under the final rule, as under the proposal, for a cleared 
transaction with a CCP that is not a QCCP, a clearing member banking 
organization and a clearing member client banking organization must 
risk weight the trade exposure amount to the CCP according to the risk 
weight applicable to the CCP under section 32 of the final rule 
(generally, 100 percent). Collateral posted by a clearing member 
banking organization that is held by a custodian in a manner that is 
bankruptcy remote from the CCP is not subject to a capital requirement 
for counterparty credit risk. Similarly, collateral posted by a 
clearing member client that is held by a custodian in a manner that is 
bankruptcy remote from the CCP, clearing member, and other clearing 
member clients of the clearing member is not be subject to a capital 
requirement for counterparty credit risk.
    The proposed rule was silent on the risk weight that would apply 
where a clearing member banking organization acts for its own account 
or guarantees a QCCP's performance to a client. Consistent with the 
BCBS CCP interim framework, the final rule provides additional 
specificity regarding the risk-weighting methodologies for certain 
exposures of clearing member banking organizations. The final rule 
provides that a clearing member banking organization that (i) acts for 
its own account, (ii) is acting as a financial intermediary (with an 
offsetting transaction or a guarantee of the client's performance to a 
QCCP), or (iii) guarantees a QCCP's performance to a client would apply 
a two percent risk weight to the banking organization's exposure to the 
QCCP. The diagrams below demonstrate the various potential transactions 
and exposure treatment in the final rule. Table 21 sets out how the 
transactions illustrated in the diagrams below are risk-weighted under 
the final rule.
    In the diagram, ``T'' refers to a transaction, and the arrow 
indicates the direction of the exposure. The diagram describes the 
appropriate risk weight treatment for exposures from the perspective of 
a clearing member banking organization entering into cleared 
transactions for its own account (T1), a clearing member 
banking organization entering into cleared transactions on behalf of a 
client (T2 through T7), and a banking 
organization entering into cleared transactions as a client of a 
clearing member (T8 and T9). Table 21 shows for 
each trade whom the exposure is to, a description of the type of trade, 
and the risk weight that would apply based on the risk of the 
counterparty.
BILLING CODE 4810-33-P

[[Page 62102]]

[GRAPHIC] [TIFF OMITTED] TR11OC13.001

BILLING CODE 4810-33-C

[[Page 62103]]



                             Table 21--Risk Weights for Various Cleared Transactions
----------------------------------------------------------------------------------------------------------------
                                                                                        Risk-weighting treatment
                                        Exposure to                  Description          under the final rule
----------------------------------------------------------------------------------------------------------------
T1...........................  QCCP.........................  Own account.............  2% risk weight on trade
                                                                                         exposure amount.
T2...........................  Client.......................  Financial intermediary    OTC derivative with CEM
                                                               with offsetting trade     scalar.**
                                                               to QCCP.
T3...........................  QCCP.........................  Financial intermediary    2% risk weight on trade
                                                               with offsetting trade     exposure amount.
                                                               to QCCP.
T4...........................  Client.......................  Agent with guarantee of   OTC derivative with CEM
                                                               client performance.       scalar.**
T5...........................  QCCP.........................  Agent with guarantee of   No exposure.
                                                               client performance.
T6...........................  Client.......................  Guarantee of QCCP         OTC derivative with CEM
                                                               performance.              scalar.**
T7...........................  QCCP.........................  Guarantee of QCCP         2% risk weight on trade
                                                               performance.              exposure amount.
T8...........................  CM...........................  CM financial              2% or 4%* risk weight on
                                                               intermediary with         trade exposure amount.
                                                               offsetting trade to
                                                               QCCP.
T9...........................  QCCP.........................  CM agent with guarantee   2% or 4%* risk weight on
                                                               of client performance.    trade exposure amount.
----------------------------------------------------------------------------------------------------------------

4. Default Fund Contribution Exposures
    There are several risk mitigants available when a party clears a 
transaction through a CCP rather than on a bilateral basis: The 
protection provided to the CCP clearing members by the margin 
requirements imposed by the CCP; the CCP members' default fund 
contributions; and the CCP's own capital and contribution to the 
default fund, which are an important source of collateral in case of 
counterparty default.\165\ CCPs independently determine default fund 
contributions that are required from members. The BCBS therefore 
established, and the final rule adopts, a risk-sensitive approach for 
risk weighting a banking organization's exposure to a default fund.
---------------------------------------------------------------------------

    \165\ Default funds are also known as clearing deposits or 
guaranty funds.
---------------------------------------------------------------------------

    Under the proposed rule, there was only one method that a clearing 
member banking organization could use to calculate its risk-weighted 
asset amount for default fund contributions. The BCBS CCP interim 
framework added a second method to better reflect the lower risks 
associated with exposures to those clearinghouses that have relatively 
large default funds with a significant amount unfunded. Commenters 
requested that the final rule adopt both methods contained in the BCBS 
CCP interim framework.
    Accordingly, under the final rule, a banking organization that is a 
clearing member of a CCP must calculate the risk-weighted asset amount 
for its default fund contributions at least quarterly or more 
frequently if there is a material change, in the opinion of the banking 
organization or the primary Federal supervisor, in the financial 
condition of the CCP. A default fund contribution means the funds 
contributed or commitments made by a clearing member to a CCP's 
mutualized loss-sharing arrangement. If the CCP is not a QCCP, the 
banking organization's risk-weighted asset amount for its default fund 
contribution is either the sum of the default fund contributions 
multiplied by 1,250 percent, or in cases where the default fund 
contributions may be unlimited, an amount as determined by the banking 
organization's primary Federal supervisor based on factors described 
above.
    Consistent with the BCBS CCP interim framework, the final rule 
requires a banking organization to calculate a risk-weighted asset 
amount for its default fund contribution using one of two methods. 
Method one requires a clearing member banking organization to use a 
three-step process. The first step is for the clearing member banking 
organization to calculate the QCCP's hypothetical capital requirement 
(KCCP), unless the QCCP has already disclosed it, in which 
case the banking organization must rely on that disclosed figure, 
unless the banking organization determines that a higher figure is 
appropriate based on the nature, structure, or characteristics of the 
QCCP. KCCP is defined as the capital that a QCCP is required 
to hold if it were a banking organization, and is calculated using the 
CEM for OTC derivatives or the collateral haircut approach for repo-
style transactions, recognizing the risk-mitigating effects of 
collateral posted by and default fund contributions received from the 
QCCP clearing members.
    The final rule provides several modifications to the calculation of 
KCCP to adjust for certain features that are unique to 
QCCPs. Namely, the modifications permit: (1) A clearing member to 
offset its exposure to a QCCP with actual default fund contributions, 
and (2) greater recognition of netting when using the CEM to calculate 
KCCP described below. Additionally, the risk weight of all 
clearing members is set at 20 percent, except when a banking 
organization's primary Federal supervisor has determined that a higher 
risk weight is appropriate based on the specific characteristics of the 
QCCP and its clearing members. Finally, for derivative contracts that 
are options, the PFE amount calculation is adjusted by multiplying the 
notional principal amount of the derivative contract by the appropriate 
conversion factor and the absolute value of the option's delta (that 
is, the ratio of the change in the value of the derivative contract to 
the corresponding change in the price of the underlying asset).
    In the second step of method one, the final rule requires a banking 
organization to compare KCCP to the funded portion of the 
default fund of a QCCP, and to calculate the total of all the clearing 
members' capital requirements (K*cm). If the total funded 
default fund of a QCCP is less than KCCP, the final rule 
requires additional capital to be assessed against the shortfall 
because of the small size of the funded portion of the default fund 
relative to KCCP. If the total funded default fund of a QCCP 
is greater than KCCP, but the QCCP's own funded 
contributions to the default fund are less than KCCP (so 
that the clearing members' default fund contributions are required to 
achieve KCCP), the clearing members' default fund 
contributions up to KCCP are risk-weighted at 100 percent 
and a decreasing capital factor, between 1.6 percent and 0.16 percent, 
is applied to the clearing members' funded default fund contributions 
above KCCP. If the QCCP's own contribution to the default 
fund is greater than KCCP, then only the decreasing capital 
factor is applied to the clearing members' default fund contributions.
    In the third step of method one, the final rule requires 
(K*cm) to be allocated back to each individual clearing 
member. This allocation is proportional to each clearing member's 
contribution to the default fund but adjusted to reflect the impact of 
two average-size clearing members defaulting as well as to account for 
the concentration of exposures among clearing members. A clearing 
member banking organization multiplies its allocated capital

[[Page 62104]]

requirement by 12.5 to determine its risk-weighted asset amount for its 
default fund contribution to the QCCP.
    As the alternative, a banking organization is permitted to use 
method two, which is a simplified method under which the risk-weighted 
asset amount for its default fund contribution to a QCCP equals 1,250 
percent multiplied by the default fund contribution, subject to an 
overall cap. The cap is based on a banking organization's trade 
exposure amount for all of its transactions with a QCCP. A banking 
organization's risk-weighted asset amount for its default fund 
contribution to a QCCP is either a 1,250 percent risk weight applied to 
its default fund contribution to that QCCP or 18 percent of its trade 
exposure amount to that QCCP. Method two subjects a banking 
organization to an overall cap on the risk-weighted assets from all its 
exposures to the CCP equal to 20 percent times the trade exposures to 
the CCP. This 20 percent cap is arrived at as the sum of the 2 percent 
capital requirement for trade exposure plus 18 percent for the default 
fund portion of a banking organization's exposure to a QCCP.
    To address commenter concerns that the CEM underestimates the 
multilateral netting benefits arising from a QCCP, the final rule 
recognizes the larger diversification benefits inherent in a 
multilateral netting arrangement for purposes of measuring the QCCP's 
potential future exposure associated with derivative contracts. 
Consistent with the BCBS CCP interim framework, and as mentioned above, 
the final rule replaces the proposed factors (0.3 and 0.7) in the 
formula to calculate Anet with 0.15 and 0.85, in sections 
35(d)(3)(i)(A)(1) and 133(d)(3)(i)(A)(1) of the final rule, 
respectively.

F. Credit Risk Mitigation

    Banking organizations use a number of techniques to mitigate credit 
risks. For example, a banking organization may collateralize exposures 
with cash or securities; a third party may guarantee an exposure; a 
banking organization may buy a credit derivative to offset an 
exposure's credit risk; or a banking organization may net exposures 
with a counterparty under a netting agreement. The general risk-based 
capital rules recognize these techniques to some extent. This section 
of the preamble describes how the final rule allows banking 
organizations to recognize the risk-mitigation effects of guarantees, 
credit derivatives, and collateral for risk-based capital purposes. In 
general, the final rule provides for a greater variety of credit risk 
mitigation techniques than the general risk-based capital rules.
    Similar to the general risk-based capital rules, under the final 
rule a banking organization generally may use a substitution approach 
to recognize the credit risk mitigation effect of an eligible guarantee 
from an eligible guarantor and the simple approach to recognize the 
effect of collateral. To recognize credit risk mitigants, all banking 
organizations must have operational procedures and risk-management 
processes that ensure that all documentation used in collateralizing or 
guaranteeing a transaction is legal, valid, binding, and enforceable 
under applicable law in the relevant jurisdictions. A banking 
organization should conduct sufficient legal review to reach a well-
founded conclusion that the documentation meets this standard as well 
as conduct additional reviews as necessary to ensure continuing 
enforceability.
    Although the use of credit risk mitigants may reduce or transfer 
credit risk, it simultaneously may increase other risks, including 
operational, liquidity, or market risk. Accordingly, a banking 
organization should employ robust procedures and processes to control 
risks, including roll-off and concentration risks, and monitor and 
manage the implications of using credit risk mitigants for the banking 
organization's overall credit risk profile.
1. Guarantees and Credit Derivatives
a. Eligibility Requirements
    Consistent with the Basel capital framework, the agencies and the 
FDIC proposed to recognize a wider range of eligible guarantors than 
permitted under the general risk-based capital rules, including 
sovereigns, the Bank for International Settlements, the International 
Monetary Fund, the European Central Bank, the European Commission, 
Federal Home Loan Banks (FHLB), Federal Agricultural Mortgage 
Corporation (Farmer Mac), MDBs, depository institutions, BHCs, SLHCs, 
credit unions, and foreign banks. Eligible guarantors would also 
include entities that are not special purpose entities that have issued 
and outstanding unsecured debt securities without credit enhancement 
that are investment grade and that meet certain other 
requirements.\166\
---------------------------------------------------------------------------

    \166\ Under the proposed and final rule, an exposure is 
``investment grade'' if the entity to which the banking organization 
is exposed through a loan or security, or the reference entity with 
respect to a credit derivative, has adequate capacity to meet 
financial commitments for the projected life of the asset or 
exposure. Such an entity or reference entity has adequate capacity 
to meet financial commitments if the risk of its default is low and 
the full and timely repayment of principal and interest is expected.
---------------------------------------------------------------------------

    Some commenters suggested modifying the proposed definition of 
eligible guarantor to remove the investment-grade requirement. 
Commenters also suggested that the agencies and the FDIC potentially 
include as eligible guarantors other entities, such as financial 
guaranty and private mortgage insurers. The agencies believe that 
guarantees issued by these types of entities can exhibit significant 
wrong-way risk and modifying the definition of eligible guarantor to 
accommodate these entities or entities that are not investment grade 
would be contrary to one of the key objectives of the capital 
framework, which is to mitigate interconnectedness and systemic 
vulnerabilities within the financial system. Therefore, the agencies 
have not included the recommended entities in the final rule's 
definition of ``eligible guarantor.'' The agencies have, however, 
amended the definition of eligible guarantor in the final rule to 
include QCCPs to accommodate use of the substitution approach for 
credit derivatives that are cleared transactions. The agencies believe 
that QCCPs, as supervised entities subject to specific risk-management 
standards, are appropriately included as eligible guarantors under the 
final rule.\167\ In addition, the agencies clarify one commenter's 
concern and confirm that re-insurers that are engaged predominantly in 
the business of providing credit protection do not qualify as an 
eligible guarantor under the final rule.
---------------------------------------------------------------------------

    \167\ See the definition of ``eligible guarantor'' in section 2 
of the final rule.
---------------------------------------------------------------------------

    Under the final rule, guarantees and credit derivatives are 
required to meet specific eligibility requirements to be recognized for 
credit risk mitigation purposes. Consistent with the proposal, under 
the final rule, an eligible guarantee is defined as a guarantee from an 
eligible guarantor that is written and meets certain standards and 
conditions, including with respect to its enforceability. An eligible 
credit derivative is defined as a credit derivative in the form of a 
CDS, n^th-to-default swap, total return swap, or any other 
form of credit derivative approved by the primary Federal supervisor, 
provided that the instrument meets the standards and conditions set 
forth in the definition. See the definitions of ``eligible guarantee'' 
and ``eligible credit derivative'' in section 2 of the final rule.
    Under the proposal, a banking organization would have been 
permitted to recognize the credit risk mitigation

[[Page 62105]]

benefits of an eligible credit derivative that hedges an exposure that 
is different from the credit derivative's reference exposure used for 
determining the derivative's cash settlement value, deliverable 
obligation, or occurrence of a credit event if (1) the reference 
exposure ranks pari passu with or is subordinated to the hedged 
exposure; (2) the reference exposure and the hedged exposure are to the 
same legal entity; and (3) legally-enforceable cross-default or cross-
acceleration clauses are in place to assure payments under the credit 
derivative are triggered when the issuer fails to pay under the terms 
of the hedged exposure.
    In addition to these two exceptions, one commenter encouraged the 
agencies and the FDIC to revise the final rule to recognize a proxy 
hedge as an eligible credit derivative even though such a transaction 
hedges an exposure that differs from the credit derivative's reference 
exposure. A proxy hedge was characterized by the commenter as a hedge 
of an exposure supported by a sovereign using a credit derivative on 
that sovereign. The agencies do not believe there is sufficient 
justification to include proxy hedges in the definition of eligible 
credit derivative because they have concerns regarding the ability of 
the hedge to sufficiently mitigate the risk of the underlying exposure. 
The agencies have, therefore, adopted the definition of eligible credit 
derivative as proposed.
    In addition, under the final rule, consistent with the proposal, 
when a banking organization has a group of hedged exposures with 
different residual maturities that are covered by a single eligible 
guarantee or eligible credit derivative, it must treat each hedged 
exposure as if it were fully covered by a separate eligible guarantee 
or eligible credit derivative.
b. Substitution Approach
    The agencies are adopting the substitution approach for eligible 
guarantees and eligible credit derivatives in the final rule without 
change. Under the substitution approach, if the protection amount (as 
defined below) of an eligible guarantee or eligible credit derivative 
is greater than or equal to the exposure amount of the hedged exposure, 
a banking organization substitutes the risk weight applicable to the 
guarantor or credit derivative protection provider for the risk weight 
applicable to the hedged exposure.
    If the protection amount of the eligible guarantee or eligible 
credit derivative is less than the exposure amount of the hedged 
exposure, a banking organization must treat the hedged exposure as two 
separate exposures (protected and unprotected) to recognize the credit 
risk mitigation benefit of the guarantee or credit derivative. In such 
cases, a banking organization calculates the risk-weighted asset amount 
for the protected exposure under section 36 of the final rule (using a 
risk weight applicable to the guarantor or credit derivative protection 
provider and an exposure amount equal to the protection amount of the 
guarantee or credit derivative). The banking organization calculates 
its risk-weighted asset amount for the unprotected exposure under 
section 32 of the final rule (using the risk weight assigned to the 
exposure and an exposure amount equal to the exposure amount of the 
original hedged exposure minus the protection amount of the guarantee 
or credit derivative).
    Under the final rule, the protection amount of an eligible 
guarantee or eligible credit derivative means the effective notional 
amount of the guarantee or credit derivative reduced to reflect any, 
maturity mismatch, lack of restructuring coverage, or currency mismatch 
as described below. The effective notional amount for an eligible 
guarantee or eligible credit derivative is the lesser of the 
contractual notional amount of the credit risk mitigant and the 
exposure amount of the hedged exposure, multiplied by the percentage 
coverage of the credit risk mitigant. For example, the effective 
notional amount of a guarantee that covers, on a pro rata basis, 40 
percent of any losses on a $100 bond is $40.
c. Maturity Mismatch Haircut
    The agencies are adopting the proposed haircut for maturity 
mismatch in the final rule without change. Under the final rule, the 
agencies have adopted the requirement that a banking organization that 
recognizes an eligible guarantee or eligible credit derivative must 
adjust the effective notional amount of the credit risk mitigant to 
reflect any maturity mismatch between the hedged exposure and the 
credit risk mitigant. A maturity mismatch occurs when the residual 
maturity of a credit risk mitigant is less than that of the hedged 
exposure(s).\168\
---------------------------------------------------------------------------

    \168\ As noted above, when a banking organization has a group of 
hedged exposures with different residual maturities that are covered 
by a single eligible guarantee or eligible credit derivative, a 
banking organization treats each hedged exposure as if it were fully 
covered by a separate eligible guarantee or eligible credit 
derivative. To determine whether any of the hedged exposures has a 
maturity mismatch with the eligible guarantee or credit derivative, 
the banking organization assesses whether the residual maturity of 
the eligible guarantee or eligible credit derivative is less than 
that of the hedged exposure.
---------------------------------------------------------------------------

    The residual maturity of a hedged exposure is the longest possible 
remaining time before the obligated party of the hedged exposure is 
scheduled to fulfil its obligation on the hedged exposure. A banking 
organization is required to take into account any embedded options that 
may reduce the term of the credit risk mitigant so that the shortest 
possible residual maturity for the credit risk mitigant is used to 
determine the potential maturity mismatch. If a call is at the 
discretion of the protection provider, the residual maturity of the 
credit risk mitigant is at the first call date. If the call is at the 
discretion of the banking organization purchasing the protection, but 
the terms of the arrangement at origination of the credit risk mitigant 
contain a positive incentive for the banking organization to call the 
transaction before contractual maturity, the remaining time to the 
first call date is the residual maturity of the credit risk mitigant. A 
banking organization is permitted, under the final rule, to recognize a 
credit risk mitigant with a maturity mismatch only if its original 
maturity is greater than or equal to one year and the residual maturity 
is greater than three months.
    Assuming that the credit risk mitigant may be recognized, a banking 
organization is required to apply the following adjustment to reduce 
the effective notional amount of the credit risk mitigant to recognize 
the maturity mismatch:

Pm = E x [(t-0.25)/(T-0.25)],

where:

(1) Pm = effective notional amount of the credit risk mitigant, 
adjusted for maturity mismatch;
(2) E = effective notional amount of the credit risk mitigant;
(3) t = the lesser of T or residual maturity of the credit risk 
mitigant, expressed in years; and
(4) T = the lesser of five or the residual maturity of the hedged 
exposure, expressed in years.

d. Adjustment for Credit Derivatives Without Restructuring as a Credit 
Event
    The agencies are adopting in the final rule the proposed adjustment 
for credit derivatives without restructuring as a credit event. 
Consistent with the proposal, under the final rule, a banking 
organization that seeks to recognize an eligible credit derivative that 
does not include a restructuring of the hedged exposure as a credit 
event under the derivative must reduce the effective notional amount of 
the credit derivative

[[Page 62106]]

recognized for credit risk mitigation purposes by 40 percent. For 
purposes of the credit risk mitigation framework, a restructuring may 
involve forgiveness or postponement of principal, interest, or fees 
that result in a credit loss event (that is, a charge-off, specific 
provision, or other similar debit to the profit and loss account). In 
these instances, the banking organization is required to apply the 
following adjustment to reduce the effective notional amount of the 
credit derivative:

Pr = Pm x 0.60,

where:

(1) Pr = effective notional amount of the credit risk mitigant, 
adjusted for lack of a restructuring event (and maturity mismatch, 
if applicable); and
(2) Pm = effective notional amount of the credit risk mitigant 
(adjusted for maturity mismatch, if applicable).
e. Currency Mismatch Adjustment
    Consistent with the proposal, under the final rule, if a banking 
organization recognizes an eligible guarantee or eligible credit 
derivative that is denominated in a currency different from that in 
which the hedged exposure is denominated, the banking organization must 
apply the following formula to the effective notional amount of the 
guarantee or credit derivative:

PC = Pr x (1-HFX),

where:

(1) Pc = effective notional amount of the credit risk mitigant, 
adjusted for currency mismatch (and maturity mismatch and lack of 
restructuring event, if applicable);
(2) Pr = effective notional amount of the credit risk mitigant 
(adjusted for maturity mismatch and lack of restructuring event, if 
applicable); and
(3) HFX = haircut appropriate for the currency mismatch 
between the credit risk mitigant and the hedged exposure.

    A banking organization is required to use a standard supervisory 
haircut of 8 percent for HFX (based on a ten-business-day 
holding period and daily marking-to-market and remargining). 
Alternatively, a banking organization has the option to use internally 
estimated haircuts of HFX based on a ten-business-day 
holding period and daily marking-to-market if the banking organization 
qualifies to use the own-estimates of haircuts in section 37(c)(4) of 
the final rule. In either case, the banking organization is required to 
scale the haircuts up using the square root of time formula if the 
banking organization revalues the guarantee or credit derivative less 
frequently than once every 10 business days. The applicable haircut 
(HM) is calculated using the following square root of time 
formula:
[GRAPHIC] [TIFF OMITTED] TR11OC13.002


where:

TM = equals the greater of 10 or the number of days 
between revaluation.
f. Multiple Credit Risk Mitigants
    Consistent with the proposal, under the final rule, if multiple 
credit risk mitigants cover a single exposure, a banking organization 
may disaggregate the exposure into portions covered by each credit risk 
mitigant (for example, the portion covered by each guarantee) and 
calculate separately a risk-based capital requirement for each portion, 
consistent with the Basel capital framework. In addition, when a single 
credit risk mitigant covers multiple exposures, a banking organization 
must treat each hedged exposure as covered by a single credit risk 
mitigant and must calculate separate risk-weighted asset amounts for 
each exposure using the substitution approach described in section 
36(c) of the final rule.
2. Collateralized Transactions
a. Eligible Collateral
    Under the proposal, the agencies and the FDIC would recognize an 
expanded range of financial collateral as credit risk mitigants that 
may reduce the risk-based capital requirements associated with a 
collateralized transaction, consistent with the Basel capital 
framework. The agencies and the FDIC proposed that a banking 
organization could recognize the risk-mitigating effects of financial 
collateral using the ``simple approach'' for any exposure provided that 
the collateral meets certain requirements. For repo-style transactions, 
eligible margin loans, collateralized derivative contracts, and single-
product netting sets of such transactions, a banking organization could 
alternatively use the collateral haircut approach. The proposal 
required a banking organization to use the same approach for similar 
exposures or transactions.
    The commenters generally agreed with this aspect of the proposal; 
however, a few commenters encouraged the agencies and the FDIC to 
expand the definition of financial collateral to include precious 
metals and certain residential mortgages that collateralize warehouse 
lines of credit. Several commenters asserted that the final rule should 
recognize as financial collateral conforming residential mortgages (or 
at least those collateralizing warehouse lines of credit) and/or those 
insured by the FHA or VA. They noted that by not including conforming 
residential mortgages in the definition of financial collateral, the 
proposed rule would require banking organizations providing warehouse 
lines to treat warehouse facilities as commercial loan exposures, thus 
preventing such entities from looking through to the underlying 
collateral in calculating the appropriate risk weighting. Others argued 
that a ``look through'' approach for a repo-style structure to the 
financial collateral held therein should be allowed. Another commenter 
argued that the final rule should allow recognition of intangible 
assets as financial collateral because they have real value. The 
agencies believe that the collateral types suggested by the commenters 
are not appropriate forms of financial collateral because they exhibit 
increased variation and credit risk, and are relatively more 
speculative than the recognized forms of financial collateral under the 
proposal. For example, residential mortgages can be highly 
idiosyncratic in regards to payment features, interest rate provisions, 
lien seniority, and maturities. The agencies believe that the proposed 
definition of financial collateral, which is broader than the 
collateral recognized under the general risk-based capital rules, 
included those collateral types of sufficient liquidity and asset 
quality to recognize as credit risk mitigants for risk-based capital 
purposes. As a result, the agencies have retained the definition of 
financial collateral as proposed. Therefore, consistent with the 
proposal, the final rule defines financial collateral as collateral in 
the form of: (1) Cash on deposit with the banking organization 
(including cash held for the banking organization by a third-party 
custodian or trustee); (2) gold bullion; (3) short- and long-term debt 
securities that are not resecuritization exposures and that are 
investment grade; (4) equity securities that are publicly-traded; (5) 
convertible bonds that are publicly-traded; or (6) money market fund 
shares and other mutual fund shares if a price for the shares is 
publicly quoted daily. With the exception of cash on deposit, the 
banking organization is also required to have a perfected, first-
priority security interest or, outside of the United States, the legal 
equivalent thereof, notwithstanding the prior security interest of any 
custodial agent. Even if a banking organization has the legal right, it 
still must ensure it monitors or has a freeze on the account to prevent 
a customer from withdrawing cash on deposit prior to defaulting. A 
banking organization is permitted to recognize partial 
collateralization of an exposure.

[[Page 62107]]

    Under the final rule, the agencies require that a banking 
organization could recognize the risk-mitigating effects of financial 
collateral using the simple approach described below, where: The 
collateral is subject to a collateral agreement for at least the life 
of the exposure; the collateral is revalued at least every six months; 
and the collateral (other than gold) and the exposure is denominated in 
the same currency. For repo-style transactions, eligible margin loans, 
collateralized derivative contracts, and single-product netting sets of 
such transactions, a banking organization could alternatively use the 
collateral haircut approach described below. The final rule, like the 
proposal, requires a banking organization to use the same approach for 
similar exposures or transactions.
b. Risk-Management Guidance for Recognizing Collateral
    Before a banking organization recognizes collateral for credit risk 
mitigation purposes, it should: (1) Conduct sufficient legal review to 
ensure, at the inception of the collateralized transaction and on an 
ongoing basis, that all documentation used in the transaction is 
binding on all parties and legally enforceable in all relevant 
jurisdictions; (2) consider the correlation between risk of the 
underlying direct exposure and collateral in the transaction; and (3) 
fully take into account the time and cost needed to realize the 
liquidation proceeds and the potential for a decline in collateral 
value over this time period.
    A banking organization also should ensure that the legal mechanism 
under which the collateral is pledged or transferred ensures that the 
banking organization has the right to liquidate or take legal 
possession of the collateral in a timely manner in the event of the 
default, insolvency, or bankruptcy (or other defined credit event) of 
the counterparty and, where applicable, the custodian holding the 
collateral.
    In addition, a banking organization should ensure that it (1) has 
taken all steps necessary to fulfill any legal requirements to secure 
its interest in the collateral so that it has and maintains an 
enforceable security interest; (2) has set up clear and robust 
procedures to ensure satisfaction of any legal conditions required for 
declaring the default of the borrower and prompt liquidation of the 
collateral in the event of default; (3) has established procedures and 
practices for conservatively estimating, on a regular ongoing basis, 
the fair value of the collateral, taking into account factors that 
could affect that value (for example, the liquidity of the market for 
the collateral and obsolescence or deterioration of the collateral); 
and (4) has in place systems for promptly requesting and receiving 
additional collateral for transactions whose terms require maintenance 
of collateral values at specified thresholds.
c. Simple Approach
    The agencies are adopting the simple approach without change for 
purposes of the final rule. Under the final rule, the collateralized 
portion of the exposure receives the risk weight applicable to the 
collateral. The collateral is required to meet the definition of 
financial collateral. For repurchase agreements, reverse repurchase 
agreements, and securities lending and borrowing transactions, the 
collateral would be the instruments, gold, and cash that a banking 
organization has borrowed, purchased subject to resale, or taken as 
collateral from the counterparty under the transaction. As noted above, 
in all cases, (1) the collateral must be subject to a collateral 
agreement for at least the life of the exposure; (2) the banking 
organization must revalue the collateral at least every six months; and 
(3) the collateral (other than gold) and the exposure must be 
denominated in the same currency.
    Generally, the risk weight assigned to the collateralized portion 
of the exposure must be no less than 20 percent. However, the 
collateralized portion of an exposure may be assigned a risk weight of 
less than 20 percent for the following exposures. OTC derivative 
contracts that are marked to fair value on a daily basis and subject to 
a daily margin maintenance agreement, may receive (1) a zero percent 
risk weight to the extent that contracts are collateralized by cash on 
deposit, or (2) a 10 percent risk weight to the extent that the 
contracts are collateralized by an exposure to a sovereign that 
qualifies for a zero percent risk weight under section 32 of the final 
rule. In addition, a banking organization may assign a zero percent 
risk weight to the collateralized portion of an exposure where the 
financial collateral is cash on deposit; or the financial collateral is 
an exposure to a sovereign that qualifies for a zero percent risk 
weight under section 32 of the final rule, and the banking organization 
has discounted the fair value of the collateral by 20 percent.
d. Collateral Haircut Approach
    Consistent with the proposal, in the final rule, a banking 
organization may use the collateral haircut approach to recognize the 
credit risk mitigation benefits of financial collateral that secures an 
eligible margin loan, repo-style transaction, collateralized derivative 
contract, or single-product netting set of such transactions. In 
addition, the banking organization may use the collateral haircut 
approach with respect to any collateral that secures a repo-style 
transaction that is included in the banking organization's VaR-based 
measure under subpart F of the final rule, even if the collateral does 
not meet the definition of financial collateral.
    To apply the collateral haircut approach, a banking organization 
must determine the exposure amount and the relevant risk weight for the 
counterparty or guarantor.
    The exposure amount for an eligible margin loan, repo-style 
transaction, collateralized derivative contract, or a netting set of 
such transactions is equal to the greater of zero and the sum of the 
following three quantities:
    (1) The value of the exposure less the value of the collateral. For 
eligible margin loans, repo-style transactions and netting sets 
thereof, the value of the exposure is the sum of the current market 
values of all instruments, gold, and cash the banking organization has 
lent, sold subject to repurchase, or posted as collateral to the 
counterparty under the transaction or netting set. For collateralized 
OTC derivative contracts and netting sets thereof, the value of the 
exposure is the exposure amount that is calculated under section 34 of 
the final rule. The value of the collateral equals the sum of the 
current market values of all instruments, gold and cash the banking 
organization has borrowed, purchased subject to resale, or taken as 
collateral from the counterparty under the transaction or netting set;
    (2) The absolute value of the net position in a given instrument or 
in gold (where the net position in a given instrument or in gold equals 
the sum of the current market values of the instrument or gold the 
banking organization has lent, sold subject to repurchase, or posted as 
collateral to the counterparty minus the sum of the current market 
values of that same instrument or gold that the banking organization 
has borrowed, purchased subject to resale, or taken as collateral from 
the counterparty) multiplied by the market price volatility haircut 
appropriate to the instrument or gold; and
    (3) The absolute value of the net position of instruments and cash 
in a currency that is different from the settlement currency (where the 
net position in a given currency equals the sum of the current market 
values of any instruments or cash in the currency the

[[Page 62108]]

banking organization has lent, sold subject to repurchase, or posted as 
collateral to the counterparty minus the sum of the current market 
values of any instruments or cash in the currency the banking 
organization has borrowed, purchased subject to resale, or taken as 
collateral from the counterparty) multiplied by the haircut appropriate 
to the currency mismatch.
    For purposes of the collateral haircut approach, a given instrument 
includes, for example, all securities with a single Committee on 
Uniform Securities Identification Procedures (CUSIP) number and would 
not include securities with different CUSIP numbers, even if issued by 
the same issuer with the same maturity date.
e. Standard Supervisory Haircuts
    When determining the exposure amount, the banking organization must 
apply a haircut for price market volatility and foreign exchange rates, 
determined either using standard supervisory market price volatility 
haircuts and a standard haircut for exchange rates or, with prior 
approval of the agency, a banking organization's own estimates of 
volatilities of market prices and foreign exchange rates.
    The standard supervisory market price volatility haircuts set a 
specified market price volatility haircut for various categories of 
financial collateral. These standard haircuts are based on the ten-
business-day holding period for eligible margin loans and derivative 
contracts. For repo-style transactions, a banking organization may 
multiply the standard supervisory haircuts by the square root of \1/2\ 
to scale them for a holding period of five business days. Several 
commenters argued that the proposed haircuts were too conservative and 
insufficiently risk-sensitive, and that banking organizations should be 
allowed to compute their own haircuts. Some commenters proposed 
limiting the maximum haircut for non-sovereign issuers that receive a 
100 percent risk weight to 12 percent and, more specifically, assigning 
a lower haircut than 25 percent for financial collateral in the form of 
an investment-grade corporate debt security that has a shorter residual 
maturity. The commenters asserted that these haircuts conservatively 
correspond to the existing rating categories and result in greater 
alignment with the Basel framework.
    In the final rule, the agencies have revised from 25.0 percent the 
standard supervisory market price volatility haircuts for financial 
collateral issued by non-sovereign issuers with a risk weight of 100 
percent to 4.0 percent for maturities of less than one year, 8.0 
percent for maturities greater than one year but less than or equal to 
five years, and 16.0 percent for maturities greater than five years, 
consistent with Table 22 below. The agencies believe that the revised 
haircuts better reflect the collateral's credit quality and an 
appropriate differentiation based on the collateral's residual 
maturity.
    A banking organization using the standard currency mismatch haircut 
is required to use an 8 percent haircut for each currency mismatch for 
transactions subject to a 10 day holding period, as adjusted for 
different required holding periods. One commenter asserted that the 
proposed adjustment for currency mismatch was unwarranted because in 
securities lending transactions, the parties typically require a higher 
collateral margin than in transactions where there is no mismatch. In 
the alternative, the commenter argued that the agencies and the FDIC 
should align the currency mismatch haircut more closely with a given 
currency combination and suggested those currencies of countries with a 
more favorable CRC from the OECD should receive a smaller haircut. The 
agencies have decided to adopt this aspect of the proposal without 
change in the final rule. The agencies believe that the own internal 
estimates for haircuts methodology described below allows banking 
organizations appropriate flexibility to more granularly reflect 
individual currency combinations, provided they meet certain criteria.

                                           Table 22--Standard Supervisory Market Price Volatility Haircuts \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                               Haircut (in percent) assigned based on:
                                                              ------------------------------------------------------------------------  Investment-grade
                                                                  Sovereign issuers risk weight     Non-sovereign issuers risk weight    securitization
                      Residual maturity                              under Sec.   --.32 \2\                under Sec.   --.32            exposures  (in
                                                              ------------------------------------------------------------------------      percent)
                                                                  Zero      20 or 50       100         20          50          100
--------------------------------------------------------------------------------------------------------------------------------------------------------
Less than or equal to 1 year.................................         0.5         1.0        15.0         1.0         2.0         4.0                4.0
Greater than 1 year and less than or equal to 5 years........         2.0         3.0        15.0         4.0         6.0         8.0               12.0
Greater than 5 years.........................................         4.0         6.0        15.0         8.0        12.0        16.0               24.0
--------------------------------------------------------------------------------------------------------------------------------------------------------
Main index equities (including convertible bonds) and gold..........................15.0.........
--------------------------------------------------------------------------------------------------------------------------------------------------------
Other publicly-traded equities (including convertible bonds)........................25.0.........
--------------------------------------------------------------------------------------------------------------------------------------------------------
Mutual funds....................................................Highest haircut applicable to any security in
                                                                         which the fund can invest.
--------------------------------------------------------------------------------------------------------------------------------------------------------
Cash collateral held................................................................Zero.........
--------------------------------------------------------------------------------------------------------------------------------------------------------
Other exposure types................................................................25.0.........
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ The market price volatility haircuts in Table 22 are based on a 10 business-day holding period.
\2\ Includes a foreign PSE that receives a zero percent risk weight.

    The final rule requires that a banking organization increase the 
standard supervisory haircut for transactions involving large netting 
sets. As noted in the proposed rule, during the recent financial 
crisis, many financial institutions experienced significant delays in 
settling or closing-out collateralized transactions, such as repo-style 
transactions and collateralized OTC derivatives. The assumed holding 
period for collateral in the collateral haircut approach under Basel II 
proved to be inadequate for certain transactions and netting sets and 
did not reflect the difficulties and delays that institutions had when 
settling or liquidating

[[Page 62109]]

collateral during a period of financial stress.
    Thus, consistent with the proposed rule, for netting sets where: 
(1) The number of trades exceeds 5,000 at any time during the quarter; 
(2) one or more trades involves illiquid collateral posted by the 
counterparty; or (3) the netting set includes any OTC derivatives that 
cannot be easily replaced, the final rule requires a banking 
organization to assume a holding period of 20 business days for the 
collateral under the collateral haircut approach. The formula and 
methodology for increasing the haircut to reflect the longer holding 
period is described in section 37(c) of the final rule. Consistent with 
the Basel capital framework, a banking organization is not required to 
adjust the holding period upward for cleared transactions. When 
determining whether collateral is illiquid or whether an OTC derivative 
cannot be easily replaced for these purposes, a banking organization 
should assess whether, during a period of stressed market conditions, 
it could obtain multiple price quotes within two days or less for the 
collateral or OTC derivative that would not move the market or 
represent a market discount (in the case of collateral) or a premium 
(in the case of an OTC derivative).
    One commenter requested the agencies and the FDIC clarify whether 
the 5,000-trade threshold applies on a counterparty-by-counterparty 
(rather than aggregate) basis, and only will be triggered in the event 
there are 5,000 open trades with a single counterparty within a single 
netting set in a given quarter. Commenters also asked whether the 
threshold would be calculated on an average basis or whether a de 
minimis number of breaches could be permitted without triggering the 
increased holding period or margin period of risk. One commenter 
suggested eliminating the threshold because it is ineffective as a 
measure of risk, and combined with other features of the proposals (for 
example, collateral haircuts, margin disputes), could create a 
disincentive for banking organizations to apply sound practices such as 
risk diversification.
    The agencies note that the 5,000-trade threshold applies to a 
netting set, which by definition means a group of transactions with a 
single counterparty that are subject to a qualifying master netting 
agreement. The 5,000 trade calculation threshold was proposed as an 
indicator that a set of transactions may be more complex, or require a 
lengthy period, to close out in the event of a default of a 
counterparty. The agencies continue to believe that the threshold of 
5,000 is a reasonable indicator of the complexity of a close-out. 
Therefore, the final rule retains the 5,000 trade threshold as 
proposed, without any de minimis exception.
    One commenter asked the agencies to clarify how trades would be 
counted in the context of an indemnified agency securities lending 
relationship. In such transactions, an agent banking organization acts 
as an intermediary for, potentially, multiple borrowers and lenders. 
The banking organization is acting as an agent with no exposure to 
either the securities lenders or borrowers except for an 
indemnification to the securities lenders in the event of a borrower 
default. The indemnification creates an exposure to the securities 
borrower, as the agent banking organization could suffer a loss upon 
the default of a borrower. In these cases, each transaction between the 
agent and a borrower would count as a trade. The agencies note that a 
trade in this instance consists of an order by the borrower, and not 
the number of securities lenders providing shares to fulfil the order 
or the number of shares underlying such order.\169\
---------------------------------------------------------------------------

    \169\ In the event that the agent banking organization reinvests 
the cash collateral proceeds on behalf of the lender and provides an 
explicit or implicit guarantee of the value of the collateral in 
such pool, the banking organization should hold capital, as 
appropriate, against the risk of loss of value of the collateral 
pool.
---------------------------------------------------------------------------

    The commenters also addressed the longer holding period for trades 
involving illiquid collateral posted by the counterparty. Some 
commenters asserted that one illiquid exposure or one illiquid piece of 
collateral should not taint the entire netting set. Other commenters 
recommended applying a materiality threshold (for example, 1 percent) 
below which one or more illiquid exposures would not trigger the longer 
holding period, or allowing banking organizations to define 
``materiality'' based on experience.
    Regarding the potential for an illiquid exposure to ``taint'' an 
entire netting set, the final rule does not require a banking 
organization to recognize any piece of collateral as a risk mitigant. 
Accordingly, if a banking organization elects to exclude the illiquid 
collateral from the netting set for purposes of calculating risk-
weighted assets, then such illiquid collateral does not result in an 
increased holding period for the netting set. With respect to a 
derivative that may not be easily replaced, a banking organization 
could create a separate netting set that would preserve the holding 
period for the original netting set of easily replaced transactions. 
Accordingly, the final rule adopts this aspect of the proposal without 
change.
    One commenter asserted that the final rule should not require a 
banking organization to determine whether an instrument is liquid on a 
daily basis, but rather should base the timing of such determination by 
product category and on long-term liquidity data. According to the 
commenter, such an approach would avoid potential confusion, volatility 
and destabilization of the funding markets. For purposes of determining 
whether collateral is illiquid or an OTC derivative contract is easily 
replaceable under the final rule, a banking organization may assess 
whether, during a period of stressed market conditions, it could obtain 
multiple price quotes within two days or less for the collateral or OTC 
derivative that would not move the market or represent a market 
discount (in the case of collateral) or a premium (in the case of an 
OTC derivative). A banking organization is not required to make a daily 
determination of liquidity under the final rule; rather, banking 
organizations should have policies and procedures in place to evaluate 
the liquidity of their collateral as frequently as warranted.
    Under the proposed rule, a banking organization would increase the 
holding period for a netting set if over the two previous quarters more 
than two margin disputes on a netting set have occurred that lasted 
longer than the holding period. However, consistent with the Basel 
capital framework, a banking organization would not be required to 
adjust the holding period upward for cleared transactions. Several 
commenters requested further clarification on the meaning of ``margin 
disputes.'' Some of these commenters suggested restricting ``margin 
disputes'' to formal legal action. Commenters also suggested 
restricting ``margin disputes'' to disputes resulting in the creation 
of an exposure that exceeded any available overcollateralization, or 
establishing a materiality threshold. One commenter suggested that 
margin disputes were not an indicator of an increased risk and, 
therefore, should not trigger a longer holding period.
    The agencies continue to believe that an increased holding period 
is appropriate regardless of whether the dispute exceeds applicable 
collateral requirements and regardless of whether the disputes exceed a 
materiality threshold. The agencies expect that the determination as to 
whether a dispute constitutes a margin dispute for purposes of the 
final rule will depend solely on the timing of the resolution. That is 
to say, if collateral is not

[[Page 62110]]

delivered within the time period required under an agreement, and such 
failure to deliver is not resolved in a timely manner, then such 
failure would count toward the two-margin-dispute limit. For the 
purpose of the final rule, where a dispute is subject to a recognized 
industry dispute resolution protocol, the agencies expect to consider 
the dispute period to begin after a third-party dispute resolution 
mechanism has failed.
    For comments and concerns that are specific to the parallel 
provisions in the advanced approaches rule, reference section XII.A of 
this preamble.
f. Own Estimates of Haircuts
    Under the final rule, consistent with the proposal, banking 
organizations may calculate market price volatility and foreign 
exchange volatility using own internal estimates with prior written 
approval of the banking organization's primary Federal supervisor. To 
receive approval to calculate haircuts using its own internal 
estimates, a banking organization must meet certain minimum qualitative 
and quantitative standards set forth in the final rule, including the 
requirements that a banking organization: (1) Uses a 99th percentile 
one-tailed confidence interval and a minimum five-business-day holding 
period for repo-style transactions and a minimum ten-business-day 
holding period for all other transactions; (2) adjusts holding periods 
upward where and as appropriate to take into account the illiquidity of 
an instrument; (3) selects a historical observation period that 
reflects a continuous 12-month period of significant financial stress 
appropriate to the banking organization's current portfolio; and (4) 
updates its data sets and compute haircuts no less frequently than 
quarterly, as well as any time market prices change materially. A 
banking organization estimates the volatilities of exposures, the 
collateral, and foreign exchange rates and should not take into account 
the correlations between them.
    The final rule provides a formula for converting own-estimates of 
haircuts based on a holding period different from the minimum holding 
period under the rule to haircuts consistent with the rule's minimum 
holding periods. The minimum holding periods for netting sets with more 
than 5,000 trades, netting sets involving illiquid collateral or an OTC 
derivative that cannot easily be replaced, and netting sets involving 
more than two margin disputes over the previous two quarters described 
above also apply for own-estimates of haircuts.
    Under the final rule, a banking organization is required to have 
policies and procedures that describe how it determines the period of 
significant financial stress used to calculate the banking 
organization's own internal estimates, and to be able to provide 
empirical support for the period used. These policies and procedures 
must address (1) how the banking organization links the period of 
significant financial stress used to calculate the own internal 
estimates to the composition and directional bias of the banking 
organization's current portfolio; and (2) the banking organization's 
process for selecting, reviewing, and updating the period of 
significant financial stress used to calculate the own internal 
estimates and for monitoring the appropriateness of the 12-month period 
in light of the banking organization's current portfolio. The banking 
organization is required to obtain the prior approval of its primary 
Federal supervisor for these policies and procedures and notify its 
primary Federal supervisor if the banking organization makes any 
material changes to them. A banking organization's primary Federal 
supervisor may require it to use a different period of significant 
financial stress in the calculation of the banking organization's own 
internal estimates.
    Under the final rule, a banking organization is allowed to 
calculate internally estimated haircuts for categories of debt 
securities that are investment-grade exposures. The haircut for a 
category of securities must be representative of the internal 
volatility estimates for securities in that category that the banking 
organization has lent, sold subject to repurchase, posted as 
collateral, borrowed, purchased subject to resale, or taken as 
collateral. In determining relevant categories, the banking 
organization must, at a minimum, take into account (1) the type of 
issuer of the security; (2) the credit quality of the security; (3) the 
maturity of the security; and (4) the interest rate sensitivity of the 
security.
    A banking organization must calculate a separate internally 
estimated haircut for each individual non-investment-grade debt 
security and for each individual equity security. In addition, a 
banking organization must estimate a separate currency mismatch haircut 
for its net position in each mismatched currency based on estimated 
volatilities for foreign exchange rates between the mismatched currency 
and the settlement currency where an exposure or collateral (whether in 
the form of cash or securities) is denominated in a currency that 
differs from the settlement currency.
g. Simple Value-at-Risk and Internal Models Methodology
    In the NPR, the agencies and the FDIC did not propose a simple VaR 
approach to calculate exposure amounts for eligible margin loans and 
repo-style transactions or IMM to calculate the exposure amount for the 
counterparty credit exposure for OTC derivatives, eligible margin 
loans, and repo-style transactions. These methodologies are included in 
the advanced approaches rule. The agencies and the FDIC sought comment 
on whether to implement the simple VaR approach and IMM in the 
standardized approach. Several commenters asserted that the IMM and 
simple VaR approach should be implemented in the final rule to better 
capture the risk of counterparty credit exposures. The agencies have 
considered these comments and, have concluded that the increased 
complexity and limited applicability of these models-based approaches 
is inconsistent with the agencies' overall focus in the standardized 
approach on simplicity, comparability, and broad applicability of 
methodologies for U.S. banking organizations. Therefore, consistent 
with the proposal, the final rule does not include the simple VaR 
approach or the IMM in the standardized approach.

G. Unsettled Transactions

    Under the proposed rule, a banking organization would be required 
to hold capital against the risk of certain unsettled transactions. One 
commenter expressed opposition to assigning a risk weight to unsettled 
transactions where previously none existed, because it would require a 
significant and burdensome tracking process without commensurate 
benefit. The agencies believe that it is important for a banking 
organization to have procedures to identify and track a delayed or 
unsettled transaction of the types specified in the rule. Such 
procedures capture the resulting risks associated with such delay. As a 
result, the agencies are adopting the risk-weighting requirements as 
proposed.
    Consistent with the proposal, the final rule provides for a 
separate risk-based capital requirement for transactions involving 
securities, foreign exchange instruments, and commodities that have a 
risk of delayed settlement or delivery. Under the final rule, the 
capital requirement does not, however, apply to certain types of 
transactions, including: (1) Cleared transactions that are marked-to-
market daily and subject to daily

[[Page 62111]]

receipt and payment of variation margin; (2) repo-style transactions, 
including unsettled repo-style transactions; (3) one-way cash payments 
on OTC derivative contracts; or (4) transactions with a contractual 
settlement period that is longer than the normal settlement period 
(which the proposal defined as the lesser of the market standard for 
the particular instrument or five business days).\170\ In the case of a 
system-wide failure of a settlement, clearing system, or central 
counterparty, the banking organization's primary Federal supervisor may 
waive risk-based capital requirements for unsettled and failed 
transactions until the situation is rectified.
---------------------------------------------------------------------------

    \170\ Such transactions are treated as derivative contracts as 
provided in section 34 or section 35 of the final rule.
---------------------------------------------------------------------------

    The final rule provides separate treatments for delivery-versus-
payment (DvP) and payment-versus-payment (PvP) transactions with a 
normal settlement period, and non-DvP/non-PvP transactions with a 
normal settlement period. A DvP transaction refers to a securities or 
commodities transaction in which the buyer is obligated to make payment 
only if the seller has made delivery of the securities or commodities 
and the seller is obligated to deliver the securities or commodities 
only if the buyer has made payment. A PvP transaction means a foreign 
exchange transaction in which each counterparty is obligated to make a 
final transfer of one or more currencies only if the other counterparty 
has made a final transfer of one or more currencies. A transaction is 
considered to have a normal settlement period if the contractual 
settlement period for the transaction is equal to or less than the 
market standard for the instrument underlying the transaction and equal 
to or less than five business days.
    Consistent with the proposal, under the final rule, a banking 
organization is required to hold risk-based capital against a DvP or 
PvP transaction with a normal settlement period if the banking 
organization's counterparty has not made delivery or payment within 
five business days after the settlement date. The banking organization 
determines its risk-weighted asset amount for such a transaction by 
multiplying the positive current exposure of the transaction for the 
banking organization by the appropriate risk weight in Table 23. The 
positive current exposure from an unsettled transaction of a banking 
organization is the difference between the transaction value at the 
agreed settlement price and the current market price of the 
transaction, if the difference results in a credit exposure of the 
banking organization to the counterparty.

      Table 23--Risk Weights for Unsettled DvP and PvP Transactions
------------------------------------------------------------------------
                                                         Risk weight to
                                                          be applied to
 Number of business days after contractual settlement   positive current
                         date                              exposure (in
                                                            percent)
------------------------------------------------------------------------
From 5 to 15..........................................             100.0
From 16 to 30.........................................             625.0
From 31 to 45.........................................             937.5
46 or more............................................           1,250.0
------------------------------------------------------------------------

    A banking organization must hold risk-based capital against any 
non-DvP/non-PvP transaction with a normal settlement period if the 
banking organization delivered cash, securities, commodities, or 
currencies to its counterparty but has not received its corresponding 
deliverables by the end of the same business day. The banking 
organization must continue to hold risk-based capital against the 
transaction until it has received the corresponding deliverables. From 
the business day after the banking organization has made its delivery 
until five business days after the counterparty delivery is due, the 
banking organization must calculate the risk-weighted asset amount for 
the transaction by risk weighting the current fair value of the 
deliverables owed to the banking organization, using the risk weight 
appropriate for an exposure to the counterparty in accordance with 
section 32. If a banking organization has not received its deliverables 
by the fifth business day after the counterparty delivery due date, the 
banking organization must assign a 1,250 percent risk weight to the 
current market value of the deliverables owed.

H. Risk-Weighted Assets for Securitization Exposures

    In the proposal, the agencies and the FDIC proposed to 
significantly revise the risk-based capital framework for 
securitization exposures. These proposed revisions included removing 
references to and reliance on credit ratings to determine risk weights 
for these exposures and using alternative standards of 
creditworthiness, as required by section 939A of the Dodd-Frank Act. 
These alternative standards were designed to produce capital 
requirements that generally would be consistent with those under the 
BCBS securitization framework and were consistent with those 
incorporated into the agencies' and the FDIC's market risk rule.\171\ 
They would have replaced both the ratings-based approach and an 
approach that permits banking organizations to use supervisor-approved 
internal systems to replicate external ratings processes for certain 
unrated exposures in the general risk-based capital rules.
---------------------------------------------------------------------------

    \171\ 77 FR 53060 (August 30, 2012).
---------------------------------------------------------------------------

    In addition, the agencies and the FDIC proposed to update the 
terminology for the securitization framework, include a definition of 
securitization exposure that encompasses a wider range of exposures 
with similar risk characteristics, and implement new due diligence 
requirements for securitization exposures.
1. Overview of the Securitization Framework and Definitions
    The proposed securitization framework was designed to address the 
credit risk of exposures that involve the tranching of credit risk of 
one or more underlying financial exposures. Consistent with the 
proposal, the final rule defines a securitization exposure as an on- or 
off-balance sheet credit exposure (including credit-enhancing 
representations and warranties) that arises from a traditional or 
synthetic securitization (including a resecuritization), or an exposure 
that directly or indirectly references a securitization exposure. 
Commenters expressed concerns that the proposed scope of the 
securitization framework was overly broad and requested that the 
definition of securitizations be narrowed to exposures that tranche the 
credit risk associated with a pool of assets. However, the agencies 
believe that limiting the securitization framework to exposures backed 
by a pool of assets would exclude tranched credit risk exposures that 
are appropriately captured under the securitization framework, such as 
certain first loss or other tranched guarantees provided to a single 
underlying exposure.
    In the proposal a traditional securitization was defined, in part, 
as a transaction in which credit risk of one or more underlying 
exposures has been transferred to one or more third parties (other than 
through the use of credit derivatives or guarantees), where the credit 
risk associated with the underlying exposures has been separated into 
at least two tranches reflecting different levels of seniority. The 
definition included certain other conditions, such as requiring all or 
substantially all of the underlying exposures to be financial 
exposures. The agencies have decided to finalize the

[[Page 62112]]

definition of traditional securitization largely as proposed, with some 
revisions (as discussed below), that reflect certain comments regarding 
exclusions under the framework and other modifications to the final 
rule.
    Both the designation of exposures as securitization exposures (or 
resecuritization exposures, as described below) and the calculation of 
risk-based capital requirements for securitization exposures under the 
final rule are guided by the economic substance of a transaction rather 
than its legal form. Provided there is tranching of credit risk, 
securitization exposures could include, among other things, ABS and 
MBS, loans, lines of credit, liquidity facilities, financial standby 
letters of credit, credit derivatives and guarantees, loan servicing 
assets, servicer cash advance facilities, reserve accounts, credit-
enhancing representations and warranties, and CEIOs. Securitization 
exposures also include assets sold with retained tranches.
    The agencies believe that requiring all or substantially all of the 
underlying exposures of a securitization to be financial exposures 
creates an important boundary between the general credit risk framework 
and the securitization framework. Examples of financial exposures 
include loans, commitments, credit derivatives, guarantees, 
receivables, asset-backed securities, mortgage-backed securities, other 
debt securities, or equity securities. Based on their cash flow 
characteristics, the agencies also consider asset classes such as lease 
residuals and entertainment royalties to be financial assets. The 
securitization framework is not designed, however, to apply to tranched 
credit exposures to commercial or industrial companies or nonfinancial 
assets or to amounts deducted from capital under section 22 of the 
final rule. Accordingly, a specialized loan to finance the construction 
or acquisition of large-scale projects (for example, airports or power 
plants), objects (for example, ships, aircraft, or satellites), or 
commodities (for example, reserves, inventories, precious metals, oil, 
or natural gas) generally would not be a securitization exposure 
because the assets backing the loan typically are nonfinancial assets 
(the facility, object, or commodity being financed).
    Consistent with the proposal, under the final rule, an operating 
company does not fall under the definition of a traditional 
securitization (even if substantially all of its assets are financial 
exposures). Operating companies generally refer to companies that are 
established to conduct business with clients with the intention of 
earning a profit in their own right and generally produce goods or 
provide services beyond the business of investing, reinvesting, 
holding, or trading in financial assets. Accordingly, an equity 
investment in an operating company generally would be an equity 
exposure. Under the final rule, banking organizations are operating 
companies and do not fall under the definition of a traditional 
securitization. However, investment firms that generally do not produce 
goods or provide services beyond the business of investing, 
reinvesting, holding, or trading in financial assets, would not be 
operating companies under the final rule and would not qualify for this 
general exclusion from the definition of traditional securitization.
    Under the proposed rule, paragraph (10) of the definition of 
traditional securitization specifically excluded exposures to 
investment funds (as defined in the proposal) and collective investment 
and pension funds (as defined in relevant regulations and set forth in 
the proposed definition of ``traditional securitization''). These 
specific exemptions served to narrow the potential scope of the 
securitization framework. Investment funds, collective investment 
funds, pension funds regulated under ERISA and their foreign 
equivalents, and transactions registered with the SEC under the 
Investment Company Act of 1940 and their foreign equivalents would be 
exempted from the definition because these entities and transactions 
are regulated and subject to strict leverage requirements. The proposal 
defined an investment fund as a company (1) where all or substantially 
all of the assets of the fund are financial assets; and (2) that has no 
material liabilities. In addition, the agencies explained in the 
proposal that the capital requirements for an extension of credit to, 
or an equity holding in, these transactions are more appropriately 
calculated under the rules for corporate and equity exposures, and that 
the securitization framework was not intended to apply to such 
transactions.
    Commenters generally agreed with the proposed exemptions from the 
definition of traditional securitization and requested that the 
agencies and the FDIC provide exemptions for exposures to a broader set 
of investment firms, such as pension funds operated by state and local 
governments. In view of the comments regarding pension funds, the final 
rule provides an additional exclusion from the definition of 
traditional securitization for a ``governmental plan'' (as defined in 
29 U.S.C. 1002(32)) that complies with the tax deferral qualification 
requirements provided in the Internal Revenue Code. The agencies 
believe that an exemption for such government plans is appropriate 
because they are subject to substantial regulation. Commenters also 
requested that the agencies and the FDIC provide exclusions for certain 
products provided to investment firms, such as extensions of short-term 
credit that support day-to-day investment-related activities. The 
agencies believe that exposures that meet the definition of traditional 
securitization, regardless of product type or maturity, would fall 
under the securitization framework. Accordingly, the agencies have not 
provided for any such exemptions under the final rule.\172\
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    \172\ The final rule also clarifies that the portion of a 
synthetic exposure to the capital of a financial institution that is 
deducted from capital is not a traditional securitization.
---------------------------------------------------------------------------

    To address the treatment of investment firms that are not 
specifically excluded from the securitization framework, the proposed 
rule provided discretion to the primary Federal supervisor of a banking 
organization to exclude from the definition of a traditional 
securitization those transactions in which the underlying exposures are 
owned by an investment firm that exercises substantially unfettered 
control over the size and composition of its assets, liabilities, and 
off-balance sheet exposures. While the commenters supported the 
agencies' and the FDIC's recognition that certain investment firms may 
warrant an exemption from the securitization framework, some expressed 
concern that the process for making such a determination may present 
significant implementation burden.
    To maintain sufficient flexibility to provide an exclusion for 
certain investment firms from the securitization framework, the 
agencies have retained this discretionary provision in the final rule 
without change. In determining whether to exclude an investment firm 
from the securitization framework, the agencies will consider a number 
of factors, including the assessment of the transaction's leverage, 
risk profile, and economic substance. This supervisory exclusion gives 
the primary Federal supervisor discretion to distinguish structured 
finance transactions, to which the securitization framework is designed 
to apply, from those of flexible investment firms, such as certain 
hedge funds and private equity funds. Only investment firms that can 
easily change the size and composition of their capital structure, as 
well as the size and composition of their assets and off-

[[Page 62113]]

balance sheet exposures, are eligible for the exclusion from the 
definition of traditional securitization under this provision. The 
agencies do not consider managed collateralized debt obligation 
vehicles, structured investment vehicles, and similar structures, which 
allow considerable management discretion regarding asset composition 
but are subject to substantial restrictions regarding capital 
structure, to have substantially unfettered control. Thus, such 
transactions meet the definition of traditional securitization under 
the final rule.
    The line between securitization exposures and non-securitization 
exposures may be difficult to identify in some circumstances. In 
addition to the supervisory exclusion from the definition of 
traditional securitization described above, the primary Federal 
supervisor may expand the scope of the securitization framework to 
include other transactions if doing so is justified by the economics of 
the transaction. Similar to the analysis for excluding an investment 
firm from treatment as a traditional securitization, the agencies will 
consider the economic substance, leverage, and risk profile of a 
transaction to ensure that an appropriate risk-based capital treatment 
is applied. The agencies will consider a number of factors when 
assessing the economic substance of a transaction including, for 
example, the amount of equity in the structure, overall leverage 
(whether on- or off-balance sheet), whether redemption rights attach to 
the equity investor, and the ability of the junior tranches to absorb 
losses without interrupting contractual payments to more senior 
tranches.
    Under the proposal, a synthetic securitization was defined as a 
transaction in which: (1) All or a portion of the credit risk of one or 
more underlying exposures is transferred to one or more third parties 
through the use of one or more credit derivatives or guarantees (other 
than a guarantee that transfers only the credit risk of an individual 
retail exposure); (2) the credit risk associated with the underlying 
exposures has been separated into at least two tranches reflecting 
different levels of seniority; (3) performance of the securitization 
exposures depends upon the performance of the underlying exposures; and 
(4) all or substantially all of the underlying exposures are financial 
exposures (such as loans, commitments, credit derivatives, guarantees, 
receivables, asset-backed securities, mortgage-backed securities, other 
debt securities, or equity securities). The agencies have decided to 
finalize the definition of synthetic securitization largely as 
proposed, but have also clarified in the final rule that transactions 
in which a portion of credit risk has been retained, not just 
transferred, through the use of credit derivatives is subject to the 
securitization framework.
    In response to the proposal, commenters requested that the agencies 
and the FDIC provide an exemption for guarantees that tranche credit 
risk under certain mortgage partnership finance programs, such as 
certain programs provided by the FHLBs, whereby participating member 
banking organizations provide credit enhancement to a pool of 
residential mortgage loans that have been delivered to the FHLB. The 
agencies believe that these exposures that tranche credit risk meet the 
definition of a synthetic securitization and that the risk of such 
exposures would be appropriately captured under the securitization 
framework. In contrast, mortgage-backed pass-through securities (for 
example, those guaranteed by FHLMC or FNMA) that feature various 
maturities but do not involve tranching of credit risk do not meet the 
definition of a securitization exposure. Only those MBS that involve 
tranching of credit risk are considered to be securitization exposures.
    Consistent with the 2009 Enhancements, the proposed rule defined a 
resecuritization exposure as an on- or off-balance sheet exposure to a 
resecuritization; or an exposure that directly or indirectly references 
a resecuritization exposure. A resecuritization would have meant a 
securitization in which one or more of the underlying exposures is a 
securitization exposure. An exposure to an asset-backed commercial 
paper (ABCP) program would not have been a resecuritization exposure if 
either: (1) The program-wide credit enhancement does not meet the 
definition of a resecuritization exposure; or (2) the entity sponsoring 
the program fully supports the commercial paper through the provision 
of liquidity so that the commercial paper holders effectively are 
exposed to the default risk of the sponsor instead of the underlying 
exposures.
    Commenters asked the agencies and the FDIC to narrow the definition 
of resecuritization by exempting resecuritizations in which a minimal 
amount of underlying assets are securitization exposures. According to 
commenters, the proposed definition would have a detrimental effect on 
certain collateralized loan obligation exposures, which typically 
include a small amount of securitization exposures as part of the 
underlying pool of assets in a securitization. Specifically, the 
commenters requested that resecuritizations be defined as a 
securitization in which five percent or more of the underlying 
exposures are securitizations. Commenters also asked the agencies and 
the FDIC to consider employing a pro rata treatment by only applying a 
higher capital surcharge to the portion of a securitization exposure 
that is backed by underlying securitization exposures. The agencies 
believe that the introduction of securitization exposures into a pool 
of securitized exposures significantly increases the complexity and 
correlation risk of the exposures backing the securities issued in the 
transaction, and that the resecuritization framework is appropriate for 
applying risk-based capital requirements to exposures to pools that 
contain securitization exposures.
    Commenters sought clarification as to whether the proposed 
definition of resecuritization would include a single exposure that has 
been retranched, such as a resecuritization of a real estate mortgage 
investment conduit (Re-REMIC). The agencies believe that the increased 
capital surcharge, or p factor, for resecuritizations was meant to 
address the increased correlation risk and complexity resulting from 
retranching of multiple underlying exposures and was not intended to 
apply to the retranching of a single underlying exposure. As a result, 
the definition of resecuritization in the final rule has been refined 
to clarify that resecuritizations do not include exposures comprised of 
a single asset that has been retranched. The agencies note that for 
purposes of the final rule, a resecuritization does not include pass-
through securities that have been pooled together and effectively re-
issued as tranched securities. This is because the pass-through 
securities do not tranche credit protection and, as a result, are not 
considered securitization exposures under the final rule.
    Under the final rule, if a transaction involves a traditional 
multi-seller ABCP conduit, a banking organization must determine 
whether the transaction should be considered a resecuritization 
exposure. For example, assume that an ABCP conduit acquires 
securitization exposures where the underlying assets consist of 
wholesale loans and no securitization exposures. As is typically the 
case in multi-seller ABCP conduits, each seller provides first-loss 
protection by over-collateralizing the conduit to which it sells loans. 
To ensure that the commercial paper issued by each

[[Page 62114]]

conduit is highly-rated, a banking organization sponsor provides either 
a pool-specific liquidity facility or a program-wide credit enhancement 
such as a guarantee to cover a portion of the losses above the seller-
provided protection.
    The pool-specific liquidity facility generally is not a 
resecuritization exposure under the final rule because the pool-
specific liquidity facility represents a tranche of a single asset pool 
(that is, the applicable pool of wholesale exposures), which contains 
no securitization exposures. However, a sponsor's program-wide credit 
enhancement that does not cover all losses above the seller-provided 
credit enhancement across the various pools generally constitutes 
tranching of risk of a pool of multiple assets containing at least one 
securitization exposure, and, therefore, is a resecuritization 
exposure.
    In addition, if the conduit in this example funds itself entirely 
with a single class of commercial paper, then the commercial paper 
generally is not a resecuritization exposure if, as noted above, either 
(1) the program-wide credit enhancement does not meet the definition of 
a resecuritization exposure or (2) the commercial paper is fully 
supported by the sponsoring banking organization. When the sponsoring 
banking organization fully supports the commercial paper, the 
commercial paper holders effectively are exposed to default risk of the 
sponsor instead of the underlying exposures, and the external rating of 
the commercial paper is expected to be based primarily on the credit 
quality of the banking organization sponsor, thus ensuring that the 
commercial paper does not represent a tranched risk position.
2. Operational Requirements
a. Due Diligence Requirements
    During the recent financial crisis, it became apparent that many 
banking organizations relied exclusively on ratings issued by 
Nationally Recognized Statistical Rating Organizations (NRSROs) and did 
not perform internal credit analysis of their securitization exposures. 
Consistent with the Basel capital framework and the agencies' general 
expectations for investment analysis, the proposal required banking 
organizations to satisfy specific due diligence requirements for 
securitization exposures. Specifically, under the proposal a banking 
organization would be required to demonstrate, to the satisfaction of 
its primary Federal supervisor, a comprehensive understanding of the 
features of a securitization exposure that would materially affect its 
performance. The banking organization's analysis would have to be 
commensurate with the complexity of the exposure and the materiality of 
the exposure in relation to capital of the banking organization. On an 
ongoing basis (no less frequently than quarterly), the banking 
organization must evaluate, review, and update as appropriate the 
analysis required under section 41(c)(1) of the proposed rule for each 
securitization exposure. The analysis of the risk characteristics of 
the exposure prior to acquisition, and periodically thereafter, would 
have to consider:
    (1) Structural features of the securitization that materially 
impact the performance of the exposure, for example, the contractual 
cash-flow waterfall, waterfall-related triggers, credit enhancements, 
liquidity enhancements, market value triggers, the performance of 
organizations that service the position, and deal-specific definitions 
of default;
    (2) Relevant information regarding the performance of the 
underlying credit exposure(s), for example, the percentage of loans 30, 
60, and 90 days past due; default rates; prepayment rates; loans in 
foreclosure; property types; occupancy; average credit score or other 
measures of creditworthiness; average LTV ratio; and industry and 
geographic diversification data on the underlying exposure(s);
    (3) Relevant market data of the securitization, for example, bid-
ask spread, most recent sales price and historical price volatility, 
trading volume, implied market rating, and size, depth and 
concentration level of the market for the securitization; and
    (4) For resecuritization exposures, performance information on the 
underlying securitization exposures, for example, the issuer name and 
credit quality, and the characteristics and performance of the 
exposures underlying the securitization exposures.
    Commenters expressed concern that many banking organizations would 
be unable to perform the due diligence necessary to meet the 
requirements and, as a result, would no longer purchase privately-
issued securitization exposures and would increase their holdings of 
GSE-guaranteed securities, thereby increasing the size of the GSEs. 
Commenters also expressed concerns regarding banking organizations' 
ability to obtain relevant market data for certain exposures, such as 
foreign exposures and exposures that are traded in markets that are 
typically illiquid, as well as their ability to obtain market data 
during periods of general market illiquidity. Commenters also stated 
concerns that uneven application of the requirements by supervisors may 
result in disparate treatment for the same exposure held at different 
banking organizations due to perceived management deficiencies. For 
these reasons, many commenters requested that the agencies and the FDIC 
consider removing the market data requirement from the due diligence 
requirements. In addition, some commenters suggested that the due 
diligence requirements be waived provided that all of the underlying 
loans meet certain underwriting standards.
    The agencies note that the proposed due diligence requirements are 
generally consistent with the goal of the agencies' investment 
permissibility requirements, which provide that banking organizations 
must be able to determine the risk of loss is low, even under adverse 
economic conditions. The agencies acknowledge potential restrictions on 
data availability and believe that the standards provide sufficient 
flexibility so that the due diligence requirements, such as relevant 
market data requirements, would be implemented as applicable. In 
addition, the agencies note that, where appropriate, pool-level data 
could be used to meet certain of the due diligence requirements. As a 
result, the agencies are adopting the due diligence requirements as 
proposed.
    Under the proposal, if a banking organization is not able to meet 
these due diligence requirements and demonstrate a comprehensive 
understanding of a securitization exposure to the satisfaction of its 
primary Federal supervisor, the banking organization would be required 
to assign a risk weight of 1,250 percent to the exposure. Commenters 
requested that the agencies and the FDIC adopt a more flexible approach 
to due diligence requirements rather than requiring a banking 
organization to assign a risk weight of 1,250 percent for violation of 
those requirements. For example, some commenters recommended that the 
agencies and the FDIC assign progressively increasing risk weights 
based on the severity and duration of infringements of due diligence 
requirements, to allow the agencies and the FDIC to differentiate 
between minor gaps in due diligence requirements and more serious 
violations.
    The agencies believe that the requirement to assign a 1,250 percent 
risk weight, rather than applying a lower risk weight, to exposures for 
violation of these requirements is appropriate given that such 
information is required to monitor appropriately the risk of the 
underlying assets. The agencies recognize the importance of

[[Page 62115]]

consistent and uniform application of the standards across banking 
organizations and will endeavor to ensure that supervisors consistently 
review banking organizations' due diligence on securitization 
exposures. The agencies believe that these efforts will mitigate 
concerns that the 1,250 percent risk weight will be applied 
inappropriately to banking organizations' failure to meet the due 
diligence requirements. At the same time, the agencies believe that the 
requirement that a banking organization's analysis be commensurate with 
the complexity and materiality of the securitization exposure provides 
the banking organization with sufficient flexibility to mitigate the 
potential for undue burden. As a result, the agencies are adopting the 
risk weight requirements related to due diligence requirements as 
proposed.
b. Operational Requirements for Traditional Securitizations
    The proposal outlined certain operational requirements for 
traditional securitizations that had to be met in order to apply the 
securitization framework. The agencies are adopting these operational 
requirements as proposed.
    In a traditional securitization, an originating banking 
organization typically transfers a portion of the credit risk of 
exposures to third parties by selling them to a securitization special 
purpose entity (SPE).\173\ Consistent with the proposal, the final rule 
defines a banking organization to be an originating banking 
organization with respect to a securitization if it (1) directly or 
indirectly originated or securitized the underlying exposures included 
in the securitization; or (2) serves as an ABCP program sponsor to the 
securitization.
---------------------------------------------------------------------------

    \173\ The final rule defines a securitization SPE as a 
corporation, trust, or other entity organized for the specific 
purpose of holding underlying exposures of a securitization, the 
activities of which are limited to those appropriate to accomplish 
this purpose, and the structure of which is intended to isolate the 
underlying exposures held by the entity from the credit risk of the 
seller of the underlying exposures to the entity.
---------------------------------------------------------------------------

    Under the final rule, consistent with the proposal, a banking 
organization that transfers exposures it has originated or purchased to 
a securitization SPE or other third party in connection with a 
traditional securitization can exclude the underlying exposures from 
the calculation of risk-weighted assets only if each of the following 
conditions are met: (1) The exposures are not reported on the banking 
organization's consolidated balance sheet under GAAP; (2) the banking 
organization has transferred to one or more third parties credit risk 
associated with the underlying exposures; and (3) any clean-up calls 
relating to the securitization are eligible clean-up calls (as 
discussed below).\174\
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    \174\ Commenters asked the agencies and the FDIC to consider the 
interaction between the proposed non-consolidation condition and the 
agencies' and the FDIC's proposed rules implementing section 941 of 
the Dodd-Frank Act regarding risk retention, given concerns that 
satisfaction of certain of the proposed risk retention requirements 
would affect the accounting treatment for certain transactions. The 
agencies acknowledge these concerns and will take into consideration 
any effects on the securitization framework as they continue to 
develop the risk retention rules.
---------------------------------------------------------------------------

    An originating banking organization that meets these conditions 
must hold risk-based capital against any credit risk it retains or 
acquires in connection with the securitization. An originating banking 
organization that fails to meet these conditions is required to hold 
risk-based capital against the transferred exposures as if they had not 
been securitized and must deduct from common equity tier 1 capital any 
after-tax gain-on-sale resulting from the transaction.
    In addition, if a securitization (1) includes one or more 
underlying exposures in which the borrower is permitted to vary the 
drawn amount within an agreed limit under a line of credit, and (2) 
contains an early amortization provision, the originating banking 
organization is required to hold risk-based capital against the 
transferred exposures as if they had not been securitized and deduct 
from common equity tier 1 capital any after-tax gain-on-sale resulting 
from the transaction.\175\ The agencies believe that this treatment is 
appropriate given the lack of risk transference in securitizations of 
revolving underlying exposures with early amortization provisions.
---------------------------------------------------------------------------

    \175\ Many securitizations of revolving credit facilities (for 
example, credit card receivables) contain provisions that require 
the securitization to be wound down and investors to be repaid if 
the excess spread falls below a certain threshold. This decrease in 
excess spread may, in some cases, be caused by deterioration in the 
credit quality of the underlying exposures. An early amortization 
event can increase a banking organization's capital needs if new 
draws on the revolving credit facilities need to be financed by the 
banking organization using on-balance sheet sources of funding. The 
payment allocations used to distribute principal and finance charge 
collections during the amortization phase of these transactions also 
can expose a banking organization to a greater risk of loss than in 
other securitization transactions. The final rule defines an early 
amortization provision as a provision in a securitization's 
governing documentation that, when triggered, causes investors in 
the securitization exposures to be repaid before the original stated 
maturity of the securitization exposure, unless the provision (1) is 
solely triggered by events not related to the performance of the 
underlying exposures or the originating banking organization (such 
as material changes in tax laws or regulations), or (2) leaves 
investors fully exposed to future draws by borrowers on the 
underlying exposures even after the provision is triggered.
---------------------------------------------------------------------------

c. Operational Requirements for Synthetic Securitizations
    In general, the proposed operational requirements for synthetic 
securitizations were similar to those proposed for traditional 
securitizations. The operational requirements for synthetic 
securitizations, however, were more detailed to ensure that the 
originating banking organization has truly transferred credit risk of 
the underlying exposures to one or more third parties. Under the 
proposal, an originating banking organization would have been able to 
recognize for risk-based capital purposes the use of a credit risk 
mitigant to hedge underlying exposures only if each of the conditions 
in the proposed definition of ``synthetic securitization'' was 
satisfied. The agencies are adopting the operational requirements 
largely as proposed. However, to ensure that synthetic securitizations 
created through tranched guarantees and credit derivatives are properly 
included in the framework, in the final rule the agencies have amended 
the operational requirements to recognize guarantees that meet all of 
the criteria set forth in the definition of eligible guarantee except 
the criterion under paragraph (3) of the definition. Additionally, the 
operational criteria recognize a credit derivative provided that the 
credit derivative meets all of the criteria set forth in the definition 
of eligible credit derivative except for paragraph 3 of the definition 
of eligible guarantee. As a result, a guarantee or credit derivative 
that provides a tranched guarantee would not be excluded by the 
operational requirements for synthetic securitizations.
    Failure to meet these operational requirements for a synthetic 
securitization prevents a banking organization that has purchased 
tranched credit protection referencing one or more of its exposures 
from using the securitization framework with respect to the reference 
exposures and requires the banking organization to hold risk-based 
capital against the underlying exposures as if they had not been 
synthetically securitized. A banking organization that holds a 
synthetic securitization as a result of purchasing credit protection 
may use the securitization framework to determine the risk-based 
capital requirement for its exposure. Alternatively, it may instead 
choose to disregard the credit protection and use

[[Page 62116]]

the general credit risk framework. A banking organization that provides 
tranched credit protection in the form of a synthetic securitization or 
credit protection to a synthetic securitization must use the 
securitization framework to compute risk-based capital requirements for 
its exposures to the synthetic securitization even if the originating 
banking organization fails to meet one or more of the operational 
requirements for a synthetic securitization.
d. Clean-Up Calls
    Under the proposal, to satisfy the operational requirements for 
securitizations and enable an originating banking organization to 
exclude the underlying exposures from the calculation of its risk-based 
capital requirements, any clean-up call associated with a 
securitization would need to be an eligible clean-up call. The proposed 
rule defined a clean-up call as a contractual provision that permits an 
originating banking organization or servicer to call securitization 
exposures before their stated maturity or call date. In the case of a 
traditional securitization, a clean-up call generally is accomplished 
by repurchasing the remaining securitization exposures once the amount 
of underlying exposures or outstanding securitization exposures falls 
below a specified level. In the case of a synthetic securitization, the 
clean-up call may take the form of a clause that extinguishes the 
credit protection once the amount of underlying exposures has fallen 
below a specified level.
    The final rule retains the proposed treatment for clean-up calls, 
and defines an eligible clean-up call as a clean-up call that (1) is 
exercisable solely at the discretion of the originating banking 
organization or servicer; (2) is not structured to avoid allocating 
losses to securitization exposures held by investors or otherwise 
structured to provide credit enhancement to the securitization (for 
example, to purchase non-performing underlying exposures); and (3) for 
a traditional securitization, is only exercisable when 10 percent or 
less of the principal amount of the underlying exposures or 
securitization exposures (determined as of the inception of the 
securitization) is outstanding; or, for a synthetic securitization, is 
only exercisable when 10 percent or less of the principal amount of the 
reference portfolio of underlying exposures (determined as of the 
inception of the securitization) is outstanding. Where a securitization 
SPE is structured as a master trust, a clean-up call with respect to a 
particular series or tranche issued by the master trust meets criteria 
(3) of the definition of ``eligible clean-up call'' as long as the 
outstanding principal amount in that series or tranche was 10 percent 
or less of its original amount at the inception of the series.
3. Risk-Weighted Asset Amounts for Securitization Exposures
    The proposed framework for assigning risk-based capital 
requirements to securitization exposures required banking organizations 
generally to calculate a risk-weighted asset amount for a 
securitization exposure by applying either (i) the simplified 
supervisory formula approach (SSFA), described in section VIII.H of the 
preamble, or (ii) if the banking organization is not subject to the 
market risk rule, a gross-up approach similar to an approach provided 
under the general risk-based capital rules. A banking organization 
would be required to apply either the SSFA or the gross-up approach 
consistently across all of its securitization exposures. However, a 
banking organization could choose to assign a 1,250 percent risk weight 
to any securitization exposure.
    Commenters expressed concerns regarding the potential differences 
in risk weights for similar exposures when using the gross-up approach 
compared to the SSFA, and the potential for capital arbitrage depending 
on the outcome of capital treatment under the framework. The agencies 
acknowledge these concerns and, to reduce arbitrage opportunities, have 
required that a banking organization apply either the gross-up approach 
or the SSFA consistently across all of its securitization exposures. 
Commenters also asked the agencies and the FDIC to clarify how often 
and under what circumstances a banking organization is allowed to 
switch between the SSFA and the gross-up approach. While the agencies 
are not placing restrictions on the ability of banking organizations to 
switch from the SSFA to the gross-up approach, the agencies do not 
anticipate there should be a need for frequent changes in methodology 
by a banking organization absent significant change in the nature of 
the banking organization's securitization activities, and expect 
banking organizations to be able to provide a rationale for changing 
methodologies to their primary Federal supervisors if requested.
    Citing potential disadvantages of the proposed securitization 
framework as compared to standards to be applied to international 
competitors that rely on the use of credit ratings, some commenters 
requested that banking organizations be able to continue to implement a 
ratings-based approach to allow the agencies and the FDIC more time to 
calibrate the SSFA in accordance with international standards that rely 
on ratings. The agencies again observe that in accordance with section 
939A of the Dodd-Frank Act, they are required to remove any references 
to, or reliance on, ratings in regulations. Accordingly, the final rule 
does not include any references to, or reliance on, credit ratings. The 
agencies have determined that the SSFA is an appropriate substitute 
standard to credit ratings that can be used to measure risk-based 
capital requirements and may be implemented uniformly across 
institutions. Under the proposed securitization framework, banking 
organizations would have been required or could choose to assign a risk 
weight of 1,250 percent to certain securitization exposures. Commenters 
stated that the 1,250 percent risk weight required under certain 
circumstances in the securitization framework would penalize banking 
organizations that hold capital above the total risk-based capital 
minimum and could require a banking organization to hold more capital 
against the exposure than the actual exposure amount at risk. As a 
result, commenters requested that the amount of risk-based capital 
required to be held against a banking organization's exposure be capped 
at the exposure amount. The agencies have decided to retain the 
proposed 1,250 percent risk weight in the final rule, consistent with 
their overall goals of simplicity and comparability, to provide for 
comparability in risk-weighted asset amounts for the same exposure 
across institutions.
    Consistent with the proposal, the final rule provides for 
alternative treatment of securitization exposures to ABCP programs and 
certain gains-on-sale and CEIO exposures. Specifically, similar to the 
general risk-based capital rules, the final rule includes a minimum 100 
percent risk weight for interest-only mortgage-backed securities and 
exceptions to the securitization framework for certain small-business 
loans and certain derivatives as described below. A banking 
organization may use the securitization credit risk mitigation rules to 
adjust the capital requirement under the securitization framework for 
an exposure to reflect certain collateral, credit derivatives, and 
guarantees, as described in more detail below.

[[Page 62117]]

a. Exposure Amount of a Securitization Exposure
    Under the final rule, the exposure amount of an on-balance sheet 
securitization exposure that is not a repo-style transaction, eligible 
margin loan, OTC derivative contract or derivative that is a cleared 
transaction is generally the banking organization's carrying value of 
the exposure. The final rule modifies the proposed treatment for 
determining exposure amounts under the securitization framework to 
reflect the ability of a banking organization not subject to the 
advanced approaches rule to make an AOCI opt-out election. As a result, 
the exposure amount of an on-balance sheet securitization exposure that 
is an available-for-sale debt security or an available-for-sale debt 
security transferred to held-to-maturity held by a banking organization 
that has made an AOCI opt-out election is the banking organization's 
carrying value (including net accrued but unpaid interest and fees), 
less any net unrealized gains on the exposure and plus any net 
unrealized losses on the exposure.
    The exposure amount of an off-balance sheet securitization exposure 
that is not an eligible ABCP liquidity facility, a repo-style 
transaction, eligible margin loan, an OTC derivative contract (other 
than a credit derivative), or a derivative that is a cleared 
transaction (other than a credit derivative) is the notional amount of 
the exposure. The treatment for OTC credit derivatives is described in 
more detail below.
    For purposes of calculating the exposure amount of an off-balance 
sheet exposure to an ABCP securitization exposure, such as a liquidity 
facility, consistent with the proposed rule, the notional amount may be 
reduced to the maximum potential amount that the banking organization 
could be required to fund given the ABCP program's current underlying 
assets (calculated without regard to the current credit quality of 
those assets). Thus, if $100 is the maximum amount that could be drawn 
given the current volume and current credit quality of the program's 
assets, but the maximum potential draw against these same assets could 
increase to as much as $200 under some scenarios if their credit 
quality were to improve, then the exposure amount is $200. An ABCP 
program is defined as a program established primarily for the purpose 
of issuing commercial paper that is investment grade and backed by 
underlying exposures held in a securitization SPE. An eligible ABCP 
liquidity facility is defined as a liquidity facility supporting ABCP, 
in form or in substance, which is subject to an asset quality test at 
the time of draw that precludes funding against assets that are 90 days 
or more past due or in default. Notwithstanding these eligibility 
requirements, a liquidity facility is an eligible ABCP liquidity 
facility if the assets or exposures funded under the liquidity facility 
that do not meet the eligibility requirements are guaranteed by a 
sovereign that qualifies for a 20 percent risk weight or lower.
    Commenters, citing accounting changes that require certain ABCP 
securitization exposures to be consolidated on banking organizations 
balance sheets, asked the agencies and the FDIC to consider capping the 
amount of an off-balance sheet securitization exposure to the maximum 
potential amount that the banking organization could be required to 
fund given the securitization SPE's current underlying assets. These 
commenters stated that the downward adjustment of the notional amount 
of a banking organization's off-balance sheet securitization exposure 
to the amount of the available asset pool generally should be permitted 
regardless of whether the exposure to a customer SPE is made directly 
through a credit commitment by the banking organization to the SPE or 
indirectly through a funding commitment that the banking organization 
makes to an ABCP conduit. The agencies believe that the requirement to 
hold risk-based capital against the full amount that may be drawn more 
accurately reflects the risks of potential draws under these exposures 
and have decided not to provide a separate provision for off-balance 
sheet exposures to customer-sponsored SPEs that are not ABCP conduits.
    Under the final rule, consistent with the proposal, the exposure 
amount of an eligible ABCP liquidity facility that is subject to the 
SSFA equals the notional amount of the exposure multiplied by a 100 
percent CCF. The exposure amount of an eligible ABCP liquidity facility 
that is not subject to the SSFA is the notional amount of the exposure 
multiplied by a 50 percent CCF. The exposure amount of a securitization 
exposure that is a repo-style transaction, eligible margin loan, an OTC 
derivative contract (other than a purchased credit derivative), or 
derivative that is a cleared transaction (other than a purchased credit 
derivative) is the exposure amount of the transaction as calculated 
under section 34 or section 37 of the final rule, as applicable.
b. Gains-On-Sale and Credit-Enhancing Interest-Only Strips
    Consistent with the proposal, under the final rule a banking 
organization must deduct from common equity tier 1 capital any after-
tax gain-on-sale resulting from a securitization and must apply a 1,250 
percent risk weight to the portion of a CEIO that does not constitute 
an after-tax gain-on-sale. The agencies believe this treatment is 
appropriate given historical supervisory concerns with the subjectivity 
involved in valuations of gains-on-sale and CEIOs. Furthermore, 
although the treatments for gains-on-sale and CEIOs can increase an 
originating banking organization's risk-based capital requirement 
following a securitization, the agencies believe that such anomalies 
are rare where a securitization transfers significant credit risk from 
the originating banking organization to third parties.
c. Exceptions Under the Securitization Framework
    Commenters stated concerns that the proposal would inhibit demand 
for private label securitization by making it more difficult for 
banking organizations, especially community banking organizations, to 
purchase private label mortgage-backed securities. Instead of 
implementing the SSFA and the gross-up approach, commenters suggested 
allowing banking organizations to assign a 20 percent risk weight to 
securitization exposures that are backed by mortgage exposures that 
would be ``qualified mortgages'' under the Truth in Lending Act and 
implementing regulations issued by the CFPB.\176\ The agencies believe 
that the proposed securitization approaches would be more appropriate 
in capturing the risks provided by structured transactions, including 
those backed by QM. The final rule does not provide an exclusion for 
such exposures.
---------------------------------------------------------------------------

    \176\ 78 FR 6408 (Jan. 30, 2013).
---------------------------------------------------------------------------

    Under the final rule, consistent with the proposal, there are 
several exceptions to the general provisions in the securitization 
framework that parallel the general risk-based capital rules. First, a 
banking organization is required to assign a risk weight of at least 
100 percent to an interest-only MBS. The agencies believe that a 
minimum risk weight of 100 percent is prudent in light of the 
uncertainty implied by the substantial price volatility of these 
securities. Second, as required by federal statute, a special set of 
rules continues to apply to securitizations of small-business loans

[[Page 62118]]

and leases on personal property transferred with retained contractual 
exposure by well-capitalized depository institutions.\177\ Finally, if 
a securitization exposure is an OTC derivative contract or derivative 
contract that is a cleared transaction (other than a credit derivative) 
that has a first priority claim on the cash flows from the underlying 
exposures (notwithstanding amounts due under interest rate or currency 
derivative contracts, fees due, or other similar payments), a banking 
organization may choose to set the risk-weighted asset amount of the 
exposure equal to the amount of the exposure.
---------------------------------------------------------------------------

    \177\ See 12 U.S.C. 1835. This provision places a cap on the 
risk-based capital requirement applicable to a well-capitalized 
depository institution that transfers small-business loans with 
recourse. The final rule does not expressly provide that the 
agencies may permit adequately-capitalized banking organizations to 
use the small business recourse rule on a case-by-case basis because 
the agencies may make such a determination under the general 
reservation of authority in section 1 of the final rule.
---------------------------------------------------------------------------

d. Overlapping Exposures
    Consistent with the proposal, the final rule includes provisions to 
limit the double counting of risks in situations involving overlapping 
securitization exposures. If a banking organization has multiple 
securitization exposures that provide duplicative coverage to the 
underlying exposures of a securitization (such as when a banking 
organization provides a program-wide credit enhancement and multiple 
pool-specific liquidity facilities to an ABCP program), the banking 
organization is not required to hold duplicative risk-based capital 
against the overlapping position. Instead, the banking organization 
must apply to the overlapping position the applicable risk-based 
capital treatment under the securitization framework that results in 
the highest risk-based capital requirement.
e. Servicer Cash Advances
    A traditional securitization typically employs a servicing banking 
organization that, on a day-to-day basis, collects principal, interest, 
and other payments from the underlying exposures of the securitization 
and forwards such payments to the securitization SPE or to investors in 
the securitization. Servicing banking organizations often provide a 
facility to the securitization under which the servicing banking 
organization may advance cash to ensure an uninterrupted flow of 
payments to investors in the securitization, including advances made to 
cover foreclosure costs or other expenses to facilitate the timely 
collection of the underlying exposures. These servicer cash advance 
facilities are securitization exposures.
    Consistent with the proposal, under the final rule a banking 
organization must apply the SSFA or the gross-up approach, as described 
below, or a 1,250 percent risk weight to a servicer cash advance 
facility. The treatment of the undrawn portion of the facility depends 
on whether the facility is an eligible servicer cash advance facility. 
An eligible servicer cash advance facility is a servicer cash advance 
facility in which: (1) The servicer is entitled to full reimbursement 
of advances, except that a servicer may be obligated to make non-
reimbursable advances for a particular underlying exposure if any such 
advance is contractually limited to an insignificant amount of the 
outstanding principal balance of that exposure; (2) the servicer's 
right to reimbursement is senior in right of payment to all other 
claims on the cash flows from the underlying exposures of the 
securitization; and (3) the servicer has no legal obligation to, and 
does not make, advances to the securitization if the servicer concludes 
the advances are unlikely to be repaid.
    Under the proposal, a banking organization that is a servicer under 
an eligible servicer cash advance facility is not required to hold 
risk-based capital against potential future cash advanced payments that 
it may be required to provide under the contract governing the 
facility. A banking organization that provides a non-eligible servicer 
cash advance facility would determine its risk-based capital 
requirement for the notional amount of the undrawn portion of the 
facility in the same manner as the banking organization would determine 
its risk-based capital requirement for other off-balance sheet 
securitization exposures. The agencies are clarifying the terminology 
in the final rule to specify that a banking organization that is a 
servicer under a non-eligible servicer cash advance facility must hold 
risk-based capital against the amount of all potential future cash 
advance payments that it may be contractually required to provide 
during the subsequent 12-month period under the contract governing the 
facility.
f. Implicit Support
    Consistent with the proposed rule, the final rule requires a 
banking organization that provides support to a securitization in 
excess of its predetermined contractual obligation (implicit support) 
to include in risk-weighted assets all of the underlying exposures 
associated with the securitization as if the exposures had not been 
securitized, and deduct from common equity tier 1 capital any after-tax 
gain-on-sale resulting from the securitization.\178\ In addition, the 
banking organization must disclose publicly (i) that it has provided 
implicit support to the securitization, and (ii) the risk-based capital 
impact to the banking organization of providing such implicit support. 
The agencies note that under the reservations of authority set forth in 
the final rule, the banking organization's primary Federal supervisor 
also could require the banking organization to hold risk-based capital 
against all the underlying exposures associated with some or all the 
banking organization's other securitizations as if the underlying 
exposures had not been securitized, and to deduct from common equity 
tier 1 capital any after-tax gain-on-sale resulting from such 
securitizations.
---------------------------------------------------------------------------

    \178\ The final rule is consistent with longstanding guidance on 
the treatment of implicit support, entitled, ``Interagency Guidance 
on Implicit Recourse in Asset Securitizations,'' (May 23, 2002). See 
OCC Bulletin 2002-20 (national banks) (OCC); and SR letter 02-15 
(Board).
---------------------------------------------------------------------------

4. Simplified Supervisory Formula Approach
    The proposed rule incorporated the SSFA, a simplified version of 
the supervisory formula approach (SFA) in the advanced approaches rule, 
to assign risk weights to securitization exposures. Many of the 
commenters focused on the burden of implementing the SSFA given the 
complexity of the approach in relation to the proposed treatment of 
mortgages exposures. Commenters also stated concerns that 
implementation of the SSFA would generally restrict credit growth and 
create competitive equity concerns with other jurisdictions 
implementing ratings-based approaches. The agencies acknowledge that 
there may be differences in capital requirements under the SSFA and the 
ratings-based approach in the Basel capital framework. As explained 
previously, section 939A of the Dodd-Frank Act requires the agencies to 
use alternative standards of creditworthiness and prohibits the 
agencies from including references to, or reliance upon, credit ratings 
in their regulations. Any alternative standard developed by the 
agencies may not generate the same result as a ratings-based capital 
framework under every circumstance. However, the agencies have designed 
the SSFA to result in generally comparable capital requirements to 
those that would be required under the Basel ratings-based approach 
without undue complexity. The agencies will monitor implementation of 
the SSFA and, based

[[Page 62119]]

on supervisory experience, consider what modifications, if any, may be 
necessary to improve the SSFA in the future.
    The agencies have adopted the proposed SSFA largely as proposed, 
with a revision to the delinquency parameter (parameter W) that will 
increase the risk sensitivity of the approach and clarify the operation 
of the formula when the contractual terms of the exposures underlying a 
securitization permit borrowers to defer payments of principal and 
interest, as described below. To limit potential burden of implementing 
the SSFA, banking organizations that are not subject to the market risk 
rule may also choose to use as an alternative the gross-up approach 
described in section VIII.H.5 below, provided that they apply the 
gross-up approach to all of their securitization exposures.
    Similar to the SFA under the advanced approaches rule, the SSFA is 
a formula that starts with a baseline derived from the capital 
requirements that apply to all exposures underlying the securitization 
and then assigns risk weights based on the subordination level of an 
exposure. The agencies designed the SSFA to apply relatively higher 
capital requirements to the more risky junior tranches of a 
securitization that are the first to absorb losses, and relatively 
lower requirements to the most senior exposures.
    The SSFA applies a 1,250 percent risk weight to securitization 
exposures that absorb losses up to the amount of capital that is 
required for the underlying exposures under subpart D of the final rule 
had those exposures been held directly by a banking organization. In 
addition, the agencies are implementing a supervisory risk-weight floor 
or minimum risk weight for a given securitization of 20 percent. While 
some commenters requested that the floor be lowered for certain low-
risk securitization exposures, the agencies believe that a 20 percent 
floor is prudent given the performance of many securitization exposures 
during the recent crisis.
    At the inception of a securitization, the SSFA requires more 
capital on a transaction-wide basis than would be required if the 
underlying assets had not been securitized. That is, if the banking 
organization held every tranche of a securitization, its overall 
capital requirement would be greater than if the banking organization 
held the underlying assets in portfolio. The agencies believe this 
overall outcome is important in reducing the likelihood of regulatory 
capital arbitrage through securitizations.
    The proposed rule required banking organizations to use data to 
assign the SSFA parameters that are not more than 91 days old. 
Commenters requested that the data requirement be amended to account 
for securitizations of underlying assets with longer payment periods, 
such as transactions featuring annual or biannual payments. In 
response, the agencies amended this requirement in the final rule so 
that data used to determine SSFA parameters must be the most currently 
available data. However, for exposures that feature payments on a 
monthly or quarterly basis, the final rule requires the data to be no 
more than 91 calendar days old.
    Under the final rule, to use the SSFA, a banking organization must 
obtain or determine the weighted-average risk weight of the underlying 
exposures (KG), as well as the attachment and detachment 
points for the banking organization's position within the 
securitization structure. ``KG,'' is calculated using the 
risk-weighted asset amounts in the standardized approach and is 
expressed as a decimal value between zero and 1 (that is, an average 
risk weight of 100 percent means that KG would equal 0.08). 
The banking organization may recognize the relative seniority of the 
exposure, as well as all cash funded enhancements, in determining 
attachment and detachment points. In addition, a banking organization 
must be able to determine the credit performance of the underlying 
exposures.
    The commenters expressed concerns that certain types of data that 
would be required to calculate KG may not be readily 
available, particularly data necessary to calculate the weighted-
average capital requirement of residential mortgages according to the 
proposed rule's standardized approach for residential mortgages. Some 
commenters therefore asked to be able to use the risk weights under the 
general risk-based capital rules for residential mortgages in the 
calculation of KG. Commenters also requested the use of 
alternative estimates or conservative proxy data to implement the SSFA 
when a parameter is not readily available, especially for 
securitizations of mortgage exposures. As previously discussed, the 
agencies are retaining in the final rule the existing mortgage 
treatment under the general risk-based capital rules. Accordingly, the 
agencies believe that banking organizations should generally have 
access to the data necessary to calculate the SSFA parameters for 
mortgage exposures.
    Commenters characterized the KG parameter as not 
sufficiently risk sensitive and asked the agencies and the FDIC to 
provide more recognition under the SSFA with respect to the credit 
quality of the underlying assets. Some commenters observed that the 
SSFA did not take into account sequential pay structures. As a result, 
some commenters requested that banking organizations be allowed to 
implement cash-flow models to increase risk sensitivity, especially 
given that the SSFA does not recognize the various types of cash-flow 
waterfalls for different transactions.
    In developing the final rule, the agencies considered the trade-
offs between added risk sensitivity, increased complexity that would 
result from reliance on cash-flow models, and consistency with 
standardized approach risk weights. The agencies believe it is 
important to calibrate capital requirements under the securitization 
framework in a manner that is consistent with the calibration used for 
the underlying assets of the securitization to reduce complexity and 
best align capital requirements under the securitization framework with 
requirements for credit exposures under the standardized approach. As a 
result, the agencies have decided to finalize the KG 
parameter as proposed.
    To make the SSFA more risk-sensitive and forward-looking, the 
parameter KG is modified based on delinquencies among the 
underlying assets of the securitization. The resulting adjusted 
parameter is labeled KA. KA is set equal to the 
weighted average of the KG value and a fixed parameter equal 
to 0.5.

KA = (1 - W) [middot] KG + (0.5 [middot] W)

    Under the proposal, the W parameter equaled the ratio of the sum of 
the dollar amounts of any underlying exposures of the securitization 
that are 90 days or more past due, subject to a bankruptcy or 
insolvency proceeding, in the process of foreclosure, held as real 
estate owned, in default, or have contractually deferred interest for 
90 days or more divided by the ending balance, measured in dollars, of 
the underlying exposures. Commenters expressed concern that the 
proposal would require additional capital for payment deferrals that 
are unrelated to the creditworthiness of the borrower, and encouraged 
the agencies and the FDIC to amend the proposal so that the numerator 
of the W parameter would not include deferrals of interest that are 
unrelated to the performance of the loan or the borrower, as is the 
case for certain federally-guaranteed student loans or certain consumer 
credit facilities that allow the borrower to defer principal and 
interest payments for the first 12 months following the purchase of a

[[Page 62120]]

product or service. Some commenters also asserted that the proposed 
SSFA would not accurately calibrate capital requirements for those 
student loans with a partial government guarantee. Another commenter 
also asked for clarification on which exposures are in the securitized 
pool.
    In response to these concerns, the agencies have decided to 
explicitly exclude from the numerator of parameter W loans with 
deferral of principal or interest for (1) federally-guaranteed student 
loans, in accordance with the terms of those programs, or (2) for 
consumer loans, including non-federally-guaranteed student loans, 
provided that such payments are deferred pursuant to provisions 
included in the contract at the time funds are disbursed that provide 
for period(s) of deferral that are not initiated based on changes in 
the creditworthiness of the borrower. The agencies believe that the 
SSFA appropriately reflects partial government guarantees because such 
guarantees are reflected in KG in the same manner that they 
are reflected in capital requirements for loans held on balance sheet. 
For clarity, the agencies have eliminated the term ``securitized pool'' 
from the final rule. The calculation of parameter W includes all 
underlying exposures of a securitization transaction.
    The agencies believe that, with the parameter W calibration set 
equal to 0.5, the overall capital requirement produced by the SSFA is 
sufficiently responsive and prudent to ensure sufficient capital for 
pools that demonstrate credit weakness. The entire specification of the 
SSFA in the final rule is as follows:
[GRAPHIC] [TIFF OMITTED] TR11OC13.003

    KSSFA is the risk-based capital requirement for the 
securitization exposure and is a function of three variables, labeled 
a, u, and l. The constant e is the base of the natural logarithms 
(which equals 2.71828). The variables a, u, and l have the following 
definitions:
[GRAPHIC] [TIFF OMITTED] TR11OC13.004

    The values A of and D denote the attachment and detachment points, 
respectively, for the tranche. Specifically, A is the attachment point 
for the tranche that contains the securitization exposure and 
represents the threshold at which credit losses will first be allocated 
to the exposure. This input is the ratio, as expressed as a decimal 
value between zero and one, of the dollar amount of the securitization 
exposures that are subordinated to the tranche that contains the 
securitization exposure held by the banking organization to the current 
dollar amount of all underlying exposures.
    Commenters requested that the agencies and the FDIC recognize 
unfunded forms of credit support, such as excess spread, in the 
calculation of A. Commenters also stated that where the carrying value 
of an exposure is less than its par value, the discount to par for a 
particular exposure should be recognized as additional credit 
protection. However, the agencies believe it is prudent to recognize 
only funded credit enhancements, such as overcollateralization or 
reserve accounts funded by accumulated cash flows, in the calculation 
of parameter A. Discounts and write-downs can be related to credit risk 
or due to other factors such as interest rate movements or liquidity. 
As a result, the agencies do not believe that discounts or write-downs 
should be factored into the SSFA as credit enhancement.
    Parameter D is the detachment point for the tranche that contains 
the securitization exposure and represents the threshold at which 
credit losses allocated to the securitization exposure would result in 
a total loss of principal. This input, which is a decimal value between 
zero and one, equals the value of parameter A plus the ratio of the 
current dollar amount of the securitization exposures that are pari 
passu with the banking organization's securitization exposure (that is, 
have equal seniority with respect to credit risk) to the current dollar 
amount of all underlying exposures. The SSFA specification is completed 
by the constant term p, which is set equal to 0.5 for securitization 
exposures that are not resecuritizations, or 1.5 for resecuritization 
exposures, and the variable KA, which is described above.
    When parameter D for a securitization exposure is less than or 
equal to KA, the exposure must be assigned a risk weight of 
1,250 percent. When A for a securitization exposure is greater than or 
equal to KA, the risk weight of the exposure, expressed as a 
percent, would equal KSSFA times 1,250. When A is less than 
KA and D is greater than KA, the applicable risk 
weight is a weighted average of 1,250 percent and 1,250 percent times 
KSSFA. As suggested by commenters, in order to make the 
description of the SSFA formula clearer, the term ``l'' has been 
redefined to be the maximum of 0 and A-KA, instead of the 
proposed A-KA. The risk weight would be determined according 
to the following formula:
[GRAPHIC] [TIFF OMITTED] TR11OC13.005


[[Page 62121]]


    For resecuritizations, banking organizations must use the SSFA to 
measure the underlying securitization exposure's contribution to 
KG. For example, consider a hypothetical securitization 
tranche that has an attachment point at 0.06 and a detachment point at 
0.07. Then assume that 90 percent of the underlying pool of assets were 
mortgage loans that qualified for a 50 percent risk weight and that the 
remaining 10 percent of the pool was a tranche of a separate 
securitization (where the underlying exposures consisted of mortgages 
that also qualified for a 50 percent weight). An exposure to this 
hypothetical tranche would meet the definition of a resecuritization 
exposure. Next, assume that the attachment point A of the underlying 
securitization that is the 10 percent share of the pool is 0.06 and the 
detachment point is 0.08. Finally, assume that none of the underlying 
mortgage exposures of either the hypothetical tranche or the underlying 
securitization exposure meet the final rule definition of 
``delinquent.''
    The value of KG for the resecuritization exposure equals 
the weighted average of the two distinct KG values. For the 
mortgages that qualify for the 50 percent risk weight and represent 90 
percent of the resecuritization, KG equals 0.04 (that is, 50 
percent of the 8 percent risk-based capital standard).

KG,re-securitization = (0.9 [middot] 0.04) + (0.1 [middot] 
KG,securitizaiton)
    To calculate the value of KG,securitization a banking organization 
would use the attachment and detachment points of 0.06 and 0.08, 
respectively. Applying those input parameters to the SSFA (together 
with p = 0.5 and KG = 0.04) results in a KG,securitization 
equal to 0.2325.
    Substituting this value into the equation yields:
KG,re-securitization = (0.9 [middot] 0.04) + (0.1 [middot] 0.2325) = 
0.05925

    This value of 0.05925 for KG,re-securitization, would then be used 
in the calculation of the risk-based capital requirement for the 
tranche of the resecuritization (where A = 0.06, B = 0.07, and p = 
1.5). The result is a risk weight of 1,172 percent for the tranche that 
runs from 0.06 to 0.07. Given that the attachment point is very close 
to the value of KG,re-securitization, the capital charge is nearly 
equal to the maximum risk weight of 1,250 percent.
    To apply the securitization framework to a single tranched exposure 
that has been re-tranched, such as some Re-REMICs, a banking 
organization must apply the SSFA or gross-up approach to the retranched 
exposure as if it were still part of the structure of the original 
securitization transaction. Therefore, a banking organization 
implementing the SSFA or the gross-up approach would calculate 
parameters for those approaches that would treat the retranched 
exposure as if it were still embedded in the original structure of the 
transaction while still recognizing any added credit enhancement 
provided by retranching. For example, under the SSFA a banking 
organization would calculate the approach using hypothetical attachment 
and detachment points that reflect the seniority of the retranched 
exposure within the original deal structure, as well as any additional 
credit enhancement provided by retranching of the exposure. Parameters 
that depend on pool-level characteristics, such as the W parameter 
under the SSFA, would be calculated based on the characteristics of the 
total underlying exposures of the initial securitization transaction, 
not just the retranched exposure.
5. Gross-Up Approach
    Under the final rule, consistent with the proposal, banking 
organizations that are not subject to the market risk rule may assign 
risk-weighted asset amounts to securitization exposures by implementing 
the gross-up approach described in section 43 of the final rule, which 
is similar to an existing approach provided under the general risk-
based capital rules. If the banking organization chooses to apply the 
gross-up approach, it is required to apply this approach to all of its 
securitization exposures, except as otherwise provided for certain 
securitization exposures under sections 44 and 45 of the final rule.
    The gross-up approach assigns risk-weighted asset amounts based on 
the full amount of the credit-enhanced assets for which the banking 
organization directly or indirectly assumes credit risk. To calculate 
risk-weighted assets under the gross-up approach, a banking 
organization determines four inputs: The pro rata share, the exposure 
amount, the enhanced amount, and the applicable risk weight. The pro 
rata share is the par value of the banking organization's exposure as a 
percentage of the par value of the tranche in which the securitization 
exposure resides. The enhanced amount is the par value of all the 
tranches that are more senior to the tranche in which the exposure 
resides. The applicable risk weight is the weighted-average risk weight 
of the underlying exposures in the securitization as calculated under 
the standardized approach.
    Under the gross-up approach, a banking organization is required to 
calculate the credit equivalent amount, which equals the sum of (1) the 
exposure of the banking organization's securitization exposure and (2) 
the pro rata share multiplied by the enhanced amount. To calculate 
risk-weighted assets for a securitization exposure under the gross-up 
approach, a banking organization is required to assign the applicable 
risk weight to the gross-up credit equivalent amount. As noted above, 
in all cases, the minimum risk weight for securitization exposures is 
20 percent.
    As discussed above, the agencies recognize that different capital 
requirements are likely to result from the application of the gross-up 
approach as compared to the SSFA. However, the agencies believe 
allowing smaller, less complex banking organizations not subject to the 
market risk rule to use the gross up approach (consistent with past 
practice under the existing general risk-based capital rules) is 
appropriate and should reduce operational burden for many banking 
organizations.
6. Alternative Treatments for Certain Types of Securitization Exposures
    Under the proposal, a banking organization generally would assign a 
1,250 percent risk weight to any securitization exposure to which the 
banking organization does not apply the SSFA or the gross-up approach. 
However, the proposal provided alternative treatments for certain types 
of securitization exposures described below, provided that the banking 
organization knows the composition of the underlying exposures at all 
times.
a. Eligible Asset-Backed Commercial Paper Liquidity Facilities
    Under the final rule, consistent with the proposal and the Basel 
capital framework, a banking organization is permitted to determine the 
risk-weighted asset amount of an eligible ABCP liquidity facility by 
multiplying the exposure amount by the highest risk weight applicable 
to any of the individual underlying exposures covered by the facility.
b. A Securitization Exposure in a Second-Loss Position or Better to an 
Asset-Backed Commercial Paper Program
    Under the final rule and consistent with the proposal, a banking 
organization may determine the risk-weighted asset amount of a 
securitization exposure that is in a second-loss position or better to 
an ABCP program by multiplying the

[[Page 62122]]

exposure amount by the higher of 100 percent and the highest risk 
weight applicable to any of the individual underlying exposures of the 
ABCP program, provided the exposure meets the following criteria:
    (1) The exposure is not an eligible ABCP liquidity facility;
    (2) The exposure is economically in a second-loss position or 
better, and the first-loss position provides significant credit 
protection to the second-loss position;
    (3) The exposure qualifies as investment grade; and
    (4) The banking organization holding the exposure does not retain 
or provide protection for the first-loss position.
    The agencies believe that this approach, which is consistent with 
the Basel capital framework, appropriately and conservatively assesses 
the credit risk of non-first-loss exposures to ABCP programs. The 
agencies are adopting this aspect of the proposal, without change, for 
purposes of the final rule.
7. Credit Risk Mitigation for Securitization Exposures
    Under the final rule, and consistent with the proposal, the 
treatment of credit risk mitigation for securitization exposures would 
differ slightly from the treatment for other exposures. To recognize 
the risk mitigating effects of financial collateral or an eligible 
guarantee or an eligible credit derivative from an eligible guarantor, 
a banking organization that purchases credit protection uses the 
approaches for collateralized transactions under section 37 of the 
final rule or the substitution treatment for guarantees and credit 
derivatives described in section 36 of the final rule. In cases of 
maturity or currency mismatches, or, if applicable, lack of a 
restructuring event trigger, the banking organization must make any 
applicable adjustments to the protection amount of an eligible 
guarantee or credit derivative as required by section 36 for any hedged 
securitization exposure. In addition, for synthetic securitizations, 
when an eligible guarantee or eligible credit derivative covers 
multiple hedged exposures that have different residual maturities, the 
banking organization is required to use the longest residual maturity 
of any of the hedged exposures as the residual maturity of all the 
hedged exposures. In the final rule, the agencies are clarifying that a 
banking organization is not required to compute a counterparty credit 
risk capital requirement for the credit derivative provided that this 
treatment is applied consistently for all of its OTC credit 
derivatives. However, a banking organization must calculate 
counterparty credit risk if the OTC credit derivative is a covered 
position under the market risk rule.
    Consistent with the proposal, a banking organization that purchases 
an OTC credit derivative (other than an n^th-to-default 
credit derivative) that is recognized as a credit risk mitigant for a 
securitization exposure that is not a covered position under the market 
risk rule is not required to compute a separate counterparty credit 
risk capital requirement provided that the banking organization does so 
consistently for all such credit derivatives. The banking organization 
must either include all or exclude all such credit derivatives that are 
subject to a qualifying master netting agreement from any measure used 
to determine counterparty credit risk exposure to all relevant 
counterparties for risk-based capital purposes. If a banking 
organization cannot, or chooses not to, recognize a credit derivative 
that is a securitization exposure as a credit risk mitigant, the 
banking organization must determine the exposure amount of the credit 
derivative under the treatment for OTC derivatives in section 34. In 
the final rule, the agencies are clarifying that if the banking 
organization purchases the credit protection from a counterparty that 
is a securitization, the banking organization must determine the risk 
weight for counterparty credit risk according to the securitization 
framework. If the banking organization purchases credit protection from 
a counterparty that is not a securitization, the banking organization 
must determine the risk weight for counterparty credit risk according 
to general risk weights under section 32. A banking organization that 
provides protection in the form of a guarantee or credit derivative 
(other than an n^th-to-default credit derivative) that covers 
the full amount or a pro rata share of a securitization exposure's 
principal and interest must risk weight the guarantee or credit 
derivative as if it holds the portion of the reference exposure covered 
by the guarantee or credit derivative.
8. Nth-to-Default Credit Derivatives
    Under the final rule and consistent with the proposal, the capital 
requirement for credit protection provided through an n^th-
to-default credit derivative is determined either by using the SSFA, or 
applying a 1,250 percent risk weight.
    A banking organization providing credit protection must determine 
its exposure to an n^th-to-default credit derivative as the 
largest notional amount of all the underlying exposures. When applying 
the SSFA, the attachment point (parameter A) is the ratio of the sum of 
the notional amounts of all underlying exposures that are subordinated 
to the banking organization's exposure to the total notional amount of 
all underlying exposures. In the case of a first-to-default credit 
derivative, there are no underlying exposures that are subordinated to 
the banking organization's exposure. In the case of a second-or-
subsequent-to default credit derivative, the smallest (n-1) underlying 
exposure(s) are subordinated to the banking organization's exposure.
    Under the SSFA, the detachment point (parameter D) is the sum of 
the attachment point and the ratio of the notional amount of the 
banking organization's exposure to the total notional amount of the 
underlying exposures. A banking organization that does not use the SSFA 
to calculate a risk weight for an n\th\-to-default credit derivative 
would assign a risk weight of 1,250 percent to the exposure.
    For protection purchased through a first-to-default derivative, a 
banking organization that obtains credit protection on a group of 
underlying exposures through a first-to-default credit derivative that 
meets the rules of recognition for guarantees and credit derivatives 
under section 36(b) of the final rule must determine its risk-based 
capital requirement for the underlying exposures as if the banking 
organization synthetically securitized the underlying exposure with the 
smallest risk-weighted asset amount and had obtained no credit risk 
mitigant on the other underlying exposures. A banking organization must 
calculate a risk-based capital requirement for counterparty credit risk 
according to section 34 of the final rule for a first-to-default credit 
derivative that does not meet the rules of recognition of section 
36(b).
    For second-or-subsequent-to-default credit derivatives, a banking 
organization that obtains credit protection on a group of underlying 
exposures through a n\th\-to-default credit derivative that meets the 
rules of recognition of section 36(b) of the final rule (other than a 
first-to-default credit derivative) may recognize the credit risk 
mitigation benefits of the derivative only if the banking organization 
also has obtained credit protection on the same underlying exposures in 
the form of first-through-(n-1)-to-default credit derivatives; or if n-
1 of the underlying exposures have already defaulted. If a banking 
organization satisfies these requirements, the banking organization 
determines its risk-based capital requirement for the underlying 
exposures as if the banking organization

[[Page 62123]]

had only synthetically securitized the underlying exposure with the 
n\th\ smallest risk-weighted asset amount and had obtained no credit 
risk mitigant on the other underlying exposures. For a n\th\-to-default 
credit derivative that does not meet the rules of recognition of 
section 36(b), a banking organization must calculate a risk-based 
capital requirement for counterparty credit risk according to the 
treatment of OTC derivatives under section 34 of the final rule. The 
agencies are adopting this aspect of the proposal without change for 
purposes of the final rule.

IX. Equity Exposures

    The proposal significantly revised the general risk-based capital 
rules' treatment for equity exposures. To improve risk sensitivity, the 
final rule generally follows the same approach to equity exposures as 
the proposal, while providing clarification on investments in a 
separate account as detailed below. In particular, the final rule 
requires a banking organization to apply the SRWA for equity exposures 
that are not exposures to an investment fund and apply certain look-
through approaches to assign risk-weighted asset amounts to equity 
exposures to an investment fund. These approaches are discussed in 
greater detail below.

A. Definition of Equity Exposure and Exposure Measurement

    The agencies are adopting the proposed definition of equity 
exposures, without change, for purposes of the final rule.\179\ Under 
the final rule, a banking organization is required to determine the 
adjusted carrying value for each equity exposure based on the 
approaches described below. For the on-balance sheet component of an 
equity exposure, other than an equity exposure that is classified as 
AFS where the banking organization has made an AOCI opt-out election 
under section 22(b)(2) of the final rule, the adjusted carrying value 
is a banking organization's carrying value of the exposure. For the on-
balance sheet component of an equity exposure that is classified as AFS 
where the banking organization has made an AOCI opt-out election under 
section 22(b)(2) of the final rule, the adjusted carrying value of the 
exposure is the banking organization's carrying value of the exposure 
less any net gains on the exposure that are reflected in the carrying 
value but excluded from the banking organization's regulatory capital 
components. For a commitment to acquire an equity exposure that is 
unconditional, the adjusted carrying value is the effective notional 
principal amount of the exposure multiplied by a 100 percent conversion 
factor. For a commitment to acquire an equity exposure that is 
conditional, the adjusted carrying value is the effective notional 
principal amount of the commitment multiplied by (1) a 20 percent 
conversion factor, for a commitment with an original maturity of one 
year or less or (2) a 50 percent conversion factor, for a commitment 
with an original maturity of over one year. For the off-balance sheet 
component of an equity exposure that is not an equity commitment, the 
adjusted carrying value is the effective notional principal amount of 
the exposure, the size of which is equivalent to a hypothetical on-
balance sheet position in the underlying equity instrument that would 
evidence the same change in fair value (measured in dollars) for a 
given small change in the price of the underlying equity instrument, 
minus the adjusted carrying value of the on-balance sheet component of 
the exposure.
---------------------------------------------------------------------------

    \179\ See the definition of ``equity exposure'' in section 2 of 
the final rule. However, as described above in section VIII.A of 
this preamble, the agencies have adjusted the definition of 
``exposure amount'' in line with certain requirements necessary for 
banking organizations that make an AOCI opt-out election.
---------------------------------------------------------------------------

    The agencies included the concept of the effective notional 
principal amount of the off-balance sheet portion of an equity exposure 
to provide a uniform method for banking organizations to measure the 
on-balance sheet equivalent of an off-balance sheet exposure. For 
example, if the value of a derivative contract referencing the common 
stock of company X changes the same amount as the value of 150 shares 
of common stock of company X, for a small change (for example, 1.0 
percent) in the value of the common stock of company X, the effective 
notional principal amount of the derivative contract is the current 
value of 150 shares of common stock of company X, regardless of the 
number of shares the derivative contract references. The adjusted 
carrying value of the off-balance sheet component of the derivative is 
the current value of 150 shares of common stock of company X minus the 
adjusted carrying value of any on-balance sheet amount associated with 
the derivative.

B. Equity Exposure Risk Weights

    The proposal set forth a SRWA for equity exposures, which the 
agencies have adopted without change in the final rule. Therefore, 
under the final rule, a banking organization determines the risk-
weighted asset amount for each equity exposure, other than an equity 
exposure to an investment fund, by multiplying the adjusted carrying 
value of the equity exposure, or the effective portion and ineffective 
portion of a hedge pair as described below, by the lowest applicable 
risk weight in section 52 of the final rule. A banking organization 
determines the risk-weighted asset amount for an equity exposure to an 
investment fund under section 53 of the final rule. A banking 
organization sums risk-weighted asset amounts for all of its equity 
exposures to calculate its aggregate risk-weighted asset amount for its 
equity exposures.
    Some commenters asserted that mutual banking organizations, which 
are more highly exposed to equity exposures than traditional depository 
institutions, should be permitted to assign a 100 percent risk weight 
to their equity exposures rather than the proposed 300 percent risk 
weight for publicly-traded equity exposures or 400 percent risk weight 
for non-publicly traded equity exposures. Some commenters also argued 
that a banking organization's equity investment in a banker's bank 
should get special treatment, for instance, exemption from the 400 
percent risk weight or deduction as an investment in the capital of an 
unconsolidated financial institution.
    The agencies have decided to retain the proposed risk weights in 
the final rule because they do not believe there is sufficient 
justification for a lower risk weight solely based on the nature of the 
institution (for example, mutual banking organization) holding the 
exposure. In addition, the agencies believe that a 100 percent risk 
weight does not reflect the inherent risk for equity exposures that 
fall under the proposed 300 percent and 400 percent risk-weight 
categories or that are subject to deduction as investments in 
unconsolidated financial institutions. The agencies have agreed to 
finalize the SRWA risk weights as proposed, which are summarized below 
in Table 24.

[[Page 62124]]



                  Table 24--Simple Risk-weight Approach
------------------------------------------------------------------------
Risk weight (in percent)                  Equity exposure
------------------------------------------------------------------------
0.......................  An equity exposure to a sovereign, the Bank
                           for International Settlements, the European
                           Central Bank, the European Commission, the
                           International Monetary Fund, an MDB, and any
                           other entity whose credit exposures receive a
                           zero percent risk weight under section 32 of
                           the final rule.
20......................  An equity exposure to a PSE, Federal Home Loan
                           Bank or Farmer Mac.
                           Community development equity
                           exposures.\180\
                           The effective portion of a hedge
                           pair.
100.....................   Non-significant equity exposures to
                           the extent that the aggregate adjusted
                           carrying value of the exposures does not
                           exceed 10 percent of tier 1 capital plus tier
                           2 capital
250.....................  A significant investment in the capital of an
                           unconsolidated financial institution in the
                           form of common stock that is not deducted
                           under section 22 of the final rule.
300.....................  A publicly-traded equity exposure (other than
                           an equity exposure that receives a 600
                           percent risk weight and including the
                           ineffective portion of a hedge pair).
400.....................  An equity exposure that is not publicly-traded
                           (other than an equity exposure that receives
                           a 600 percent risk weight).
600.....................  An equity exposure to an investment firm that
                           (i) would meet the definition of a
                           traditional securitization were it not for
                           the primary Federal supervisor's application
                           of paragraph (8) of that definition and (ii)
                           has greater than immaterial leverage.
------------------------------------------------------------------------

    Consistent with the proposal, the final rule defines publicly 
traded as traded on: (1) Any exchange registered with the SEC as a 
national securities exchange under section 6 of the Securities Exchange 
Act of 1934 (15 U.S.C. 78f); or (2) any non-U.S.-based securities 
exchange that is registered with, or approved by, a national securities 
regulatory authority and that provides a liquid, two-way market for the 
instrument in question. A two-way market refers to a market where there 
are independent bona fide offers to buy and sell so that a price 
reasonably related to the last sales price or current bona fide 
competitive bid and offer quotations can be determined within one day 
and settled at that price within a relatively short time frame 
conforming to trade custom.
---------------------------------------------------------------------------

    \180\ The final rule generally defines these exposures as 
exposures that qualify as community development investments under 12 
U.S.C. 24 (Eleventh), excluding equity exposures to an 
unconsolidated small business investment company and equity 
exposures held through a consolidated small business investment 
company described in section 302 of the Small Business Investment 
Act of 1958 (15 U.S.C. 682). Under the proposal, a savings 
association's community development equity exposure investments was 
defined to mean an equity exposure that are designed primarily to 
promote community welfare, including the welfare of low- and 
moderate-income communities or families, such as by providing 
services or jobs, and excluding equity exposures to an 
unconsolidated small business investment company and equity 
exposures held through a consolidated small business investment 
company described in section 302 of the Small Business Investment 
Act of 1958 (15 U.S.C. 682). The agencies have determined that a 
separate definition for a savings association's community 
development equity exposure is not necessary and, therefore, the 
final rule applies one definition of community development equity 
exposure to all types of covered banking organizations.
---------------------------------------------------------------------------

C. Non-significant Equity Exposures

    Under the final rule, and as proposed, a banking organization may 
apply a 100 percent risk weight to certain equity exposures deemed non-
significant. Non-significant equity exposures means an equity exposure 
to the extent that the aggregate adjusted carrying value of the 
exposures does not exceed 10 percent of the banking organization's 
total capital.\181\ To compute the aggregate adjusted carrying value of 
a banking organization's equity exposures for determining their non-
significance, the banking organization may exclude (1) equity exposures 
that receive less than a 300 percent risk weight under the SRWA (other 
than equity exposures determined to be non-significant); (2) the equity 
exposure in a hedge pair with the smaller adjusted carrying value; and 
(3) a proportion of each equity exposure to an investment fund equal to 
the proportion of the assets of the investment fund that are not equity 
exposures. If a banking organization does not know the actual holdings 
of the investment fund, the banking organization may calculate the 
proportion of the assets of the fund that are not equity exposures 
based on the terms of the prospectus, partnership agreement, or similar 
contract that defines the fund's permissible investments. If the sum of 
the investment limits for all exposure classes within the fund exceeds 
100 percent, the banking organization must assume that the investment 
fund invests to the maximum extent possible in equity exposures.
---------------------------------------------------------------------------

    \181\ The definition excludes exposures to an investment firm 
that (1) meet the definition of traditional securitization were it 
not for the primary Federal regulator's application of paragraph (8) 
of the definition of a traditional securitization and (2) has 
greater than immaterial leverage.
---------------------------------------------------------------------------

    To determine which of a banking organization's equity exposures 
qualify for a 100 percent risk weight based on non-significance, the 
banking organization first must include equity exposures to 
unconsolidated small-business investment companies, or those held 
through consolidated small-business investment companies described in 
section 302 of the Small Business Investment Act of 1958. Next, it must 
include publicly-traded equity exposures (including those held 
indirectly through investment funds), and then it must include non-
publicly-traded equity exposures (including those held indirectly 
through investment funds).\182\
---------------------------------------------------------------------------

    \182\ See 15 U.S.C. 682.
---------------------------------------------------------------------------

    One commenter proposed that certain exposures, including those to 
small-business investment companies, should not be subject to the 10 
percent capital limitation for non-significant equity exposures and 
should receive a 100 percent risk weight, consistent with the treatment 
of community development investments. The agencies reflected upon this 
comment and determined to retain the proposed 10 percent limit on a 
banking organization's total capital in the final rule given the 
inherent credit and concentration risks associated with these 
exposures.

D. Hedged Transactions

    Under the proposal, to determine risk-weighted assets under the 
SRWA, a banking organization could identify hedge pairs, which would be 
defined as two equity exposures that form an effective hedge, as long 
as each equity exposure is publicly traded or has a return that is 
primarily based on a publicly traded equity exposure. A banking 
organization would risk-weight only the effective and ineffective 
portions of a hedge pair rather than the entire adjusted carrying value 
of each exposure that makes up the pair. A few commenters requested 
that non-publicly traded equities be recognized in a

[[Page 62125]]

hedged transaction under the rule. Equities that are not publicly 
traded are subject to considerable valuation uncertainty due to a lack 
of transparency and are generally far less liquid than publicly traded 
equities. The agencies have therefore determined that given the 
potential increased risk associated with equities that are not publicly 
traded, recognition of these instruments as hedges under the rule is 
not appropriate. One commenter indicated that the test of hedge 
effectiveness used in the calculation of publicly traded equities 
should be more risk sensitive in evaluating all components of the 
transaction to better determine the appropriate risk weight. The 
examples the commenter highlighted indicated dissatisfaction with the 
assignment of a 100 percent risk weight to the effective portion of all 
hedge pairs. As described further below, the proposed rule contained 
three methodologies for identifying the measure of effectiveness of an 
equity hedge relationship, methodologies which recognize less-than-
perfect hedges. The proposal assigns a 100 percent risk weight to the 
effective portion of a hedge pair because some hedge pairs involve 
residual risks. In developing the standardized approach, the agencies 
and the FDIC sought to balance complexity and risk sensitivity, which 
limits the degree of granularity in hedge recognition. On balance, the 
agencies believe that it is more reflective of a banking organization's 
risk profile to recognize a broader range of hedge pairs and assign all 
hedge pairs a 100 percent risk weight than to recognize only perfect 
hedges and assign a lower risk weight. Accordingly, the agencies are 
adopting the proposed treatment without change.
    Under the final rule, two equity exposures form an effective hedge 
if: The exposures either have the same remaining maturity or each has a 
remaining maturity of at least three months; the hedge relationship is 
formally documented in a prospective manner (that is, before the 
banking organization acquires at least one of the equity exposures); 
the documentation specifies the measure of effectiveness (E) the 
banking organization uses for the hedge relationship throughout the 
life of the transaction; and the hedge relationship has an E greater 
than or equal to 0.8. A banking organization measures E at least 
quarterly and uses one of three measures of E described in the next 
section: The dollar-offset method, the variability-reduction method, or 
the regression method.
    It is possible that only part of a banking organization's exposure 
to a particular equity instrument is part of a hedge pair. For example, 
assume a banking organization has equity exposure A with a $300 
adjusted carrying value and chooses to hedge a portion of that exposure 
with equity exposure B with an adjusted carrying value of $100. Also 
assume that the combination of equity exposure B and $100 of the 
adjusted carrying value of equity exposure A form an effective hedge 
with an E of 0.8. In this situation, the banking organization treats 
$100 of equity exposure A and $100 of equity exposure B as a hedge 
pair, and the remaining $200 of its equity exposure A as a separate, 
stand-alone equity position. The effective portion of a hedge pair is 
calculated as E multiplied by the greater of the adjusted carrying 
values of the equity exposures forming the hedge pair. The ineffective 
portion of a hedge pair is calculated as (1-E) multiplied by the 
greater of the adjusted carrying values of the equity exposures forming 
the hedge pair. In the above example, the effective portion of the 
hedge pair is 0.8 x $100 = $80, and the ineffective portion of the 
hedge pair is (1 - 0.8) x $100 = $20.

E. Measures of Hedge Effectiveness

    As stated above, a banking organization could determine 
effectiveness using any one of three methods: The dollar-offset method, 
the variability-reduction method, or the regression method. Under the 
dollar-offset method, a banking organization determines the ratio of 
the cumulative sum of the changes in value of one equity exposure to 
the cumulative sum of the changes in value of the other equity 
exposure, termed the ratio of value change (RVC). If the changes in the 
values of the two exposures perfectly offset each other, the RVC is -1. 
If RVC is positive, implying that the values of the two equity 
exposures move in the same direction, the hedge is not effective and E 
equals 0. If RVC is negative and greater than or equal to -1 (that is, 
between zero and -1), then E equals the absolute value of RVC. If RVC 
is negative and less than -1, then E equals 2 plus RVC.
    The variability-reduction method of measuring effectiveness 
compares changes in the value of the combined position of the two 
equity exposures in the hedge pair (labeled X in the equation below) to 
changes in the value of one exposure as though that one exposure were 
not hedged (labeled A). This measure of E expresses the time-series 
variability in X as a proportion of the variability of A. As the 
variability described by the numerator becomes small relative to the 
variability described by the denominator, the measure of effectiveness 
improves, but is bounded from above by a value of one. E is computed 
as:
[GRAPHIC] [TIFF OMITTED] TR11OC13.007

    The value of t ranges from zero to T, where T is the length of the 
observation period for the values of A and B, and is comprised of 
shorter values each labeled t.
    The regression method of measuring effectiveness is based on a 
regression in which the change in value of one

[[Page 62126]]

exposure in a hedge pair is the dependent variable and the change in 
value of the other exposure in the hedge pair is the independent 
variable. E equals the coefficient of determination of this regression, 
which is the proportion of the variation in the dependent variable 
explained by variation in the independent variable. However, if the 
estimated regression coefficient is positive, then the value of E is 
zero. Accordingly, E is higher when the relationship between the values 
of the two exposures is closer.

F. Equity Exposures to Investment Funds

    Under the general risk-based capital rules, exposures to 
investments funds are captured through one of two methods. These 
methods are similar to the alternative modified look-through approach 
and the simple modified look-through approach described below. The 
proposal included an additional option, referred to in the NPR as the 
full look-through approach. The agencies and the FDIC proposed this 
separate treatment for equity exposures to an investment fund to ensure 
that the regulatory capital treatment for these exposures is 
commensurate with the risk. Thus, the risk-based capital requirement 
for equity exposures to investment funds that hold only low-risk assets 
would be relatively low, whereas high-risk exposures held through 
investment funds would be subject to a higher capital requirement. The 
final rule implements these three approaches as proposed and clarifies 
that the risk-weight for any equity exposure to an investment fund must 
be no less than 20 percent.
    In addition, the final rule clarifies, generally consistent with 
prior agency guidance, that a banking organization must treat an 
investment in a separate account, such as bank-owned life insurance, as 
if it were an equity exposure to an investment fund.\183\ A banking 
organization must use one of the look-through approaches provided in 
section 53 and, if applicable, section 154 of the final rule to 
determine the risk-weighted asset amount for such investments. A 
banking organization that purchases stable value protection on its 
investment in a separate account must treat the portion of the carrying 
value of its investment in the separate account attributable to the 
stable value protection as an exposure to the provider of the 
protection and the remaining portion as an equity exposure to an 
investment fund. Stable value protection means a contract where the 
provider of the contract pays to the policy owner of the separate 
account an amount equal to the shortfall between the fair value and 
cost basis of the separate account when the policy owner of the 
separate account surrenders the policy. It also includes a contract 
where the provider of the contract pays to the beneficiary an amount 
equal to the shortfall between the fair value and book value of a 
specified portfolio of assets.
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    \183\ Interagency Statement on the Purchase and Risk Management 
of Life Insurance, pp. 19-20, https://www.federalreserve.gov/boarddocs/srletters/2004/SR0419a1.pdf.
---------------------------------------------------------------------------

    A banking organization that provides stable value protection, such 
as through a stable value wrap that has provisions and conditions that 
minimize the wrap's exposure to credit risk of the underlying assets in 
the fund, must treat the exposure as if it were an equity derivative on 
an investment fund and determine the adjusted carrying value of the 
exposure as the sum of the adjusted carrying values of any on-balance 
sheet asset component determined according to section 51(b)(1) and the 
off-balance sheet component determined according to section 51(b)(3). 
That is, the adjusted carrying value is the effective notional 
principal amount of the exposure, the size of which is equivalent to a 
hypothetical on-balance sheet position in the underlying equity 
instrument that would evidence the same change in fair value (measured 
in dollars) given a small change in the price of the underlying equity 
instrument without subtracting the adjusted carrying value of the on-
balance sheet component of the exposure as calculated under the same 
paragraph. Risk-weighted assets for such an exposure is determined by 
applying one of the three look-through approaches as provided in 
section 53 and, if applicable, section 154 of the final rule.
    As discussed further below, under the final rule, a banking 
organization determines the risk-weighted asset amount for equity 
exposures to investment funds using one of three approaches: The full 
look-through approach, the simple modified look-through approach, or 
the alternative modified look-through approach, unless the equity 
exposure to an investment fund is a community development equity 
exposure. The risk-weighted asset amount for such community development 
equity exposures is the exposure's adjusted carrying value. If a 
banking organization does not use the full look-through approach, and 
an equity exposure to an investment fund is part of a hedge pair, a 
banking organization must use the ineffective portion of the hedge pair 
as the adjusted carrying value for the equity exposure to the 
investment fund. The risk-weighted asset amount of the effective 
portion of the hedge pair is equal to its adjusted carrying value. A 
banking organization could choose which approach to apply for each 
equity exposure to an investment fund.
1. Full Look-Through Approach
    A banking organization may use the full look-through approach only 
if the banking organization is able to calculate a risk-weighted asset 
amount for each of the exposures held by the investment fund. Under the 
final rule, a banking organization using the full look-through approach 
is required to calculate the risk-weighted asset amount for its 
proportionate ownership share of each of the exposures held by the 
investment fund (as calculated under subpart D of the final rule) as if 
the proportionate ownership share of the adjusted carrying value of 
each exposures were held directly by the banking organization. The 
banking organization's risk-weighted asset amount for the exposure to 
the fund is equal to (1) the aggregate risk-weighted asset amount of 
the exposures held by the fund as if they were held directly by the 
banking organization multiplied by (2) the banking organization's 
proportional ownership share of the fund.
2. Simple Modified Look-Through Approach
    Under the simple modified look-through approach, a banking 
organization sets the risk-weighted asset amount for its equity 
exposure to an investment fund equal to the adjusted carrying value of 
the equity exposure multiplied by the highest applicable risk weight 
under subpart D of the final rule to any exposure the fund is permitted 
to hold under the prospectus, partnership agreement, or similar 
agreement that defines the fund's permissible investments. The banking 
organization may exclude derivative contracts held by the fund that are 
used for hedging, rather than for speculative purposes, and do not 
constitute a material portion of the fund's exposures.
3. Alternative Modified Look-Through Approach
    Under the alternative modified look-through approach, a banking 
organization may assign the adjusted carrying value of an equity 
exposure to an investment fund on a pro rata basis to different risk 
weight categories under subpart D of the final rule based on the 
investment limits in the fund's prospectus, partnership agreement, or

[[Page 62127]]

similar contract that defines the fund's permissible investments.
    The risk-weighted asset amount for the banking organization's 
equity exposure to the investment fund is equal to the sum of each 
portion of the adjusted carrying value assigned to an exposure type 
multiplied by the applicable risk weight. If the sum of the investment 
limits for all permissible investments within the fund exceeds 100 
percent, the banking organization must assume that the fund invests to 
the maximum extent permitted under its investment limits in the 
exposure type with the highest applicable risk weight under subpart D 
and continues to make investments in the order of the exposure category 
with the next highest risk weight until the maximum total investment 
level is reached. If more than one exposure category applies to an 
exposure, the banking organization must use the highest applicable risk 
weight. A banking organization may exclude derivative contracts held by 
the fund that are used for hedging, rather than for speculative 
purposes, and do not constitute a material portion of the fund's 
exposures.
    Commenters expressed concerns regarding the application of the 
look-through approaches where an investment fund holds securitization 
exposures. Specifically, the commenters indicated a banking 
organization would be forced to apply a 1,250 percent risk weight to 
investment funds that hold securitization exposures if the banking 
organization does not have the information required to use one of the 
two applicable methods under subpart D to calculate the risk weight 
applicable to a securitization exposure: Gross-up treatment or the 
SSFA. According to the commenters, such an outcome would be overly 
punitive and inconsistent with the generally diversified composition of 
investment funds. The agencies acknowledge that a banking organization 
may have some difficulty obtaining all the information needed to use 
the gross-up treatment or SSFA, but believe that the proposed approach 
provides strong incentives for banking organizations to obtain such 
information. As a result, the agencies are adopting the treatment as 
proposed.

X. Insurance-Related Activities

    The Board proposed to apply consolidated regulatory capital 
requirements to SLHCs, consistent with the transfer of supervisory 
responsibilities to the Board under Title III of the Dodd-Frank Act, as 
well as the requirements in section 171 of the Dodd-Frank Act.
    Under the proposal, the consolidated regulatory capital 
requirements for SLHCs would be generally the same as those proposed 
for BHCs.\184\ In addition, the proposed regulatory capital 
requirements would be based on GAAP consolidated financial statements. 
Through this approach, the Board sought to take into consideration the 
unique characteristics, risks, and activities of SLHCs, while ensuring 
compliance with the requirements of the Dodd-Frank Act. Further, as 
explained in the proposal, a uniform approach for all holding companies 
was intended to help mitigate potential competitive equity issues, 
limit opportunities for regulatory arbitrage, and facilitate comparable 
treatment of similar risks across depository institution holding 
companies.
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    \184\ See also the Notice of Intent published by the Board in 
April, 2011, 76 FR 22662 (April 22, 2011), in which the Board 
discussed the possibility of applying the same consolidated 
regulatory capital requirements to savings and holding companies as 
those proposed for bank holding companies.
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    The proposal included special provisions related to the 
determination of risk-weighted assets for nonbanking exposures unique 
to insurance underwriting activities. The NPR extended the approach the 
agencies and the FDIC implemented in 2011 in the general risk-based 
capital rules for depository institutions, whereby certain low-risk 
exposures that are generally not held by depository institutions may 
receive the capital treatment applicable under the capital guidelines 
for BHCs under limited circumstances.\185\ This approach is consistent 
with section 171 of the Dodd-Frank Act, which requires that BHCs be 
subject to capital requirements that are no less stringent than those 
applied to insured depository institutions. The agencies and the FDIC 
solicited comments on all aspects of the proposed rule, including the 
treatment of insurance underwriting activities.
---------------------------------------------------------------------------

    \185\ See 76 FR 37620 (June 28, 2011).
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    As described above, the final rule does not apply to SLHCs that are 
not covered SLHCs because the Board will give further consideration to 
a framework for consolidated regulatory capital requirements for SLHCs 
that are not covered SLHCs due to the scope of their insurance 
underwriting and commercial activities. Some BHCs and covered SLHCs 
currently conduct insurance underwriting activities, however, and the 
final rule for depository institution holding companies provides a more 
risk-sensitive approach to policy loans, non-guaranteed separate 
accounts, and insurance underwriting risk than that explicitly provided 
in the standardized approach for depository institutions. The 
insurance-specific provisions of the proposed and final rules and 
related comments are discussed below.

A. Policy Loans

    The proposal defined a policy loan as a loan to policyholders under 
the provisions of an insurance contract that is secured by the cash 
surrender value or collateral assignment of the related policy or 
contract. Under the proposal, a policy loan would include: (1) A cash 
loan, including a loan resulting from early payment or accelerated 
payment benefits, on an insurance contract when the terms of contract 
specify that the payment is a policy loan secured by the policy; and 
(2) an automatic premium loan, which is a loan made in accordance with 
policy provisions that provide that delinquent premium payments are 
automatically paid from the cash value at the end of the established 
grace period for premium payments. The proposal assigned a risk weight 
of 20 percent to policy loans.
    Several commenters suggested that a policy loan should be assigned 
a zero percent risk weight because an insurance company that provides a 
loan generally retains a right of setoff for the value of the principal 
and interest payments of the policy loan against the related policy 
benefits. The Board does not believe that a zero percent risk weight is 
appropriate for policy loans and continues to believe they should be 
treated in a similar manner to a loan secured by cash collateral, which 
is assigned a 20 percent risk weight. The Board believes assigning a 
preferential but non-zero risk weight to a policy loan is appropriate 
in light of the fact that should a borrower default, the resulting loss 
to the insurance company is mitigated by the right to access the cash 
surrender value or collateral assignment of the related policy. 
Therefore, the final rule adopts the proposed treatment without change.

B. Separate Accounts

    The proposal provided a specific treatment for non-guaranteed 
separate accounts. Separate accounts are legally segregated pools of 
assets owned and held by an insurance company and maintained separately 
from its general account assets for the benefit of an individual 
contract holder, subject to certain conditions. Under the proposal, to 
qualify as a separate account, the following conditions would have to 
be met: (1) The account must be legally recognized under applicable 
law; (2) the assets in the account must be insulated from general 
liabilities of the insurance company under applicable law and

[[Page 62128]]

protected from the insurance company's general creditors in the event 
of the insurer's insolvency; (3) the insurance company must invest the 
funds within the account as directed by the contract holder in 
designated investment alternatives or in accordance with specific 
investment objectives or policies; and (4) all investment performance, 
net of contract fees and assessments, must be passed through to the 
contract holder, provided that contracts may specify conditions under 
which there may be a minimum guarantee, but not a ceiling.
    The proposal distinguished between guaranteed and non-guaranteed 
separate accounts. Under the proposal, to qualify as a non-guaranteed 
separate account, the insurance company could not contractually 
guarantee a minimum return or account value to the contract holder, and 
the insurance company must not be required to hold reserves for these 
separate account assets pursuant to its contractual obligations on an 
associated policy. The proposal provided for a zero percent risk weight 
for assets held in non-guaranteed separate accounts where all the 
losses are passed on to the contract holders and the insurance company 
does not bear the risk of the assets. The proposal provided that assets 
held in a separate account that does not qualify as a non-guaranteed 
separate account (that is, a guaranteed separate account) would be 
assigned risk weights in the same manner as other on-balance sheet 
assets.
    The NPR requested comments on this proposal, including the 
interaction of the proposed definition of a separate account with the 
state laws and the nature of the implications of any differences.
    A number of commenters stated that the proposed definition of a 
non-guaranteed separate account, including the proposed criterion that 
an insurance company would not be required to hold reserves for 
separate account assets pursuant to its contractual obligations on an 
associated policy, is too broad because, as commenters asserted, state 
laws require insurance companies to hold general account reserves for 
all contractual commitments. Accordingly, the commenters suggested that 
the capital requirement for guaranteed separate accounts should be 
based on the value of the guarantee, and not on the value of the 
underlying assets, because of what they characterized as an inverse 
relationship between the value of the underlying assets and the 
potential risk of a guarantee being realized.
    The Board continues to believe that it is appropriate to provide a 
preferential risk-based capital treatment to assets held in non-
guaranteed separate accounts and is adopting the treatment of these 
accounts as proposed. The criteria for non-guaranteed separate accounts 
ensure that a zero percent risk weight is applied only to those assets 
for which contract holders, and not the consolidated banking 
organization, would bear all the losses. Consistent with the proposal 
and with the general risk-based capital rules, the Board is not at this 
time providing a preferential treatment to assets held in guaranteed 
separate accounts. The Board believes that it is consistent with safety 
and soundness and with the risk profiles of banking organizations 
subject to the final rule to provide preferential capital treatment to 
non-guaranteed separate accounts while it considers whether and how to 
provide a unique treatment to guaranteed separate accounts. The Board 
notes that SLHCs that are not subject to the final rule because they 
meet the exclusion criteria in the definition of ``covered SLHC'' 
typically have the most material concentrations of guaranteed separate 
accounts of all depository institution holding companies.

C. Additional Deductions--Insurance Underwriting Subsidiaries

    Consistent with the treatment under the advanced approaches rule, 
the Basel III NPR provided that bank holding companies and SLHCs would 
consolidate and deduct the minimum regulatory capital requirement of 
insurance underwriting subsidiaries (generally 200 percent of the 
subsidiary's authorized control level as established by the appropriate 
state insurance regulator) from total capital to reflect the capital 
needed to cover insurance risks. The proposed deduction would be 50 
percent from tier 1 capital and 50 percent from tier 2 capital.
    A number of commenters stated that the proposed deduction is not 
appropriate for holding companies that are predominantly engaged in 
insurance activities where insurance underwriting companies contribute 
the predominant amount of regulatory capital and assets. In addition, 
the commenters asserted that the insurance risk-based capital 
requirements are designed to measure several specific categories of 
risk and that the proposed deduction should not include asset-specific 
risks to avoid double-counting of regulatory capital. Accordingly, 
commenters suggested that the proposed deduction be eliminated or 
modified to include only insurance regulatory capital for non-asset 
risks, such as insurance risk and business risk for life insurers and 
underwriting risk for casualty and property insurers. Further, the 
commenters stated that the proposal did not impose a similar deduction 
for other wholly-owned subsidiaries that are subject to capital 
requirements by functional regulators, such as insured depository 
institutions or broker-dealers.
    In response to these comments, the Board has modified the deduction 
required for insurance activities to more closely address insurance 
underwriting risk. Specifically, the final rule requires a banking 
organization to deduct an amount equal to the regulatory capital 
requirement for insurance underwriting risks established by the 
regulator of any insurance underwriting activities of the company 50 
percent from tier 1 capital and 50 percent from tier 2 capital. 
Accordingly, banking organizations that calculate their regulatory 
capital for insurance underwriting activities using the National 
Association of Insurance Commissioners' risk-based capital formulas are 
required to deduct regulatory capital attributable to the categories of 
the insurance risk-based capital that do not measure asset-specific 
risks. For example, for companies using the life risk-based capital 
formula, banking organizations must deduct the regulatory capital 
requirement related to insurance risk and business risk. For companies 
using the property and casualty risk-based formula, banking 
organizations must deduct the regulatory capital requirement related to 
underwriting risk--reserves and underwriting risk--net written 
premiums. For companies using the health risk-based formula, banking 
organizations must deduct the regulatory capital requirement related to 
underwriting risk and business risk. In no case may a banking 
organization reduce the capital requirement for underwriting risk to 
reflect any diversification with other risks.

XI. Market Discipline and Disclosure Requirements

A. Proposed Disclosure Requirements

    The agencies have long supported meaningful public disclosure by 
banking organizations with the objective of improving market discipline 
and encouraging sound risk-management practices. The BCBS introduced 
public disclosure requirements under Pillar 3 of Basel II, which is 
designed to complement the minimum capital requirements and the 
supervisory review process by encouraging market discipline through 
enhanced and

[[Page 62129]]

meaningful public disclosure.\186\ The BCBS introduced additional 
disclosure requirements in Basel III, which, under the final rule, 
apply to banking organizations as discussed herein.\187\
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    \186\ The agencies and the FDIC incorporated the BCBS disclosure 
requirements into the advanced approaches rule in 2007. See 72 FR 
69288, 69432 (December 7, 2007).
    \187\ In June 2012, the BCBS adopted Pillar 3 disclosure 
requirements in a paper titled ``Composition of Capital Disclosure 
Requirements,'' available at https://www.bis.org/publ/bcbs221.pdf. 
The agencies anticipate incorporating these disclosure requirements 
through a separate notice and comment period.
---------------------------------------------------------------------------

    The agencies and the FDIC received a limited number of comments on 
the proposed disclosure requirements. The commenters expressed some 
concern that the proposed requirements would be extended to apply to 
smaller banking organizations. As discussed further below, the agencies 
and the FDIC proposed the disclosure requirements for banking 
organizations with $50 billion or more in assets and believe they are 
most appropriate for these companies. The agencies believe that the 
proposed disclosure requirements strike the appropriate balance between 
the market benefits of disclosure and the additional burden to a 
banking organization that provides the disclosures, and therefore have 
adopted the requirements as proposed, with minor clarification with 
regard to timing of disclosures as discussed further below.
    The public disclosure requirements under section 62 of the final 
rule apply only to banking organizations with total consolidated assets 
of $50 billion or more that are not a consolidated subsidiary of a BHC, 
covered SLHC, or depository institution that is subject to these 
disclosure requirements or a subsidiary of a non-U.S. banking 
organization that is subject to comparable public disclosure 
requirements in its home jurisdiction or an advanced approaches banking 
organization making public disclosures pursuant to section 172 of the 
final rule. An advanced approaches banking organization that meets the 
$50 billion asset threshold, but that has not received approval from 
its primary Federal supervisor to exit parallel run, must make the 
disclosures described in sections 62 and 63 of the final rule. The 
agencies note that the asset threshold of $50 billion is consistent 
with the threshold established by section 165 of the Dodd-Frank Act 
relating to enhanced supervision and prudential standards for certain 
banking organizations.\188\ A banking organization may be able to 
fulfill some of the disclosure requirements by relying on similar 
disclosures made in accordance with federal securities law 
requirements. In addition, a banking organization may use information 
provided in regulatory reports to fulfill certain disclosure 
requirements. In these situations, a banking organization is required 
to explain any material differences between the accounting or other 
disclosures and the disclosures required under the final rule.
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    \188\ See section 165(a) of the Dodd-Frank Act (12 U.S.C. 
5365(a)). The Dodd-Frank Act provides that the Board may, upon the 
recommendation of the Financial Stability Oversight Council, 
increase the $50 billion asset threshold for the application of the 
resolution plan, concentration limit, and credit exposure report 
requirements. See 12 U.S.C. 5365(a)(2)(B).
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    A banking organization's exposure to risks and the techniques that 
it uses to identify, measure, monitor, and control those risks are 
important factors that market participants consider in their assessment 
of the banking organization. Accordingly, a banking organization must 
have a formal disclosure policy approved by its board of directors that 
addresses the banking organization's approach for determining the 
disclosures it should make. The policy should address the associated 
internal controls, disclosure controls, and procedures. The board of 
directors and senior management should ensure the appropriate review of 
the disclosures and that effective internal controls, disclosure 
controls, and procedures are maintained. One or more senior officers of 
the banking organization must attest that the disclosures meet the 
requirements of this final rule.
    A banking organization must decide the relevant disclosures based 
on a materiality concept. Information is regarded as material for 
purposes of the disclosure requirements in the final rule if the 
information's omission or misstatement could change or influence the 
assessment or decision of a user relying on that information for the 
purpose of making investment decisions.

B. Frequency of Disclosures

    Consistent with the agencies' longstanding requirements for robust 
quarterly disclosures in regulatory reports, and considering the 
potential for rapid changes in risk profiles, the final rule requires 
that a banking organization provide timely public disclosures after 
each calendar quarter. However, qualitative disclosures that provide a 
general summary of a banking organization's risk-management objectives 
and policies, reporting system, and definitions may be disclosed 
annually after the end of the fourth calendar quarter, provided any 
significant changes are disclosed in the interim. The agencies 
acknowledge that the timing of disclosures under the federal banking 
laws may not always coincide with the timing of disclosures required 
under other federal laws, including disclosures required under the 
federal securities laws and their implementing regulations by the SEC. 
For calendar quarters that do not correspond to fiscal year end, the 
agencies consider those disclosures that are made within 45 days of the 
end of the calendar quarter (or within 60 days for the limited purpose 
of the banking organization's first reporting period in which it is 
subject to the rule's disclosure requirements) as timely. In general, 
where a banking organization's fiscal year-end coincides with the end 
of a calendar quarter, the agencies consider qualitative and 
quantitative disclosures to be timely if they are made no later than 
the applicable SEC disclosure deadline for the corresponding Form 10-K 
annual report. In cases where an institution's fiscal year end does not 
coincide with the end of a calendar quarter, the primary Federal 
supervisor would consider the timeliness of disclosures on a case-by-
case basis. In some cases, management may determine that a significant 
change has occurred, such that the most recent reported amounts do not 
reflect the banking organization's capital adequacy and risk profile. 
In those cases, a banking organization needs to disclose the general 
nature of these changes and briefly describe how they are likely to 
affect public disclosures going forward. A banking organization should 
make these interim disclosures as soon as practicable after the 
determination that a significant change has occurred.

C. Location of Disclosures and Audit Requirements

    The disclosures required under the final rule must be publicly 
available (for example, included on a public Web site) for each of the 
last three years or such shorter time period beginning when the banking 
organization became subject to the disclosure requirements. For 
example, a banking organization that begins to make public disclosures 
in the first quarter of 2015 must make all of its required disclosures 
publicly available until the first quarter of 2018, after which it must 
make its required disclosures for the previous three years publicly 
available. Except as discussed below, management has some discretion to 
determine the appropriate medium and location of the disclosure. 
Furthermore, a banking organization has

[[Page 62130]]

flexibility in formatting its public disclosures.
    The agencies encourage management to provide all of the required 
disclosures in one place on the entity's public Web site and the 
agencies anticipate that the public Web site address would be reported 
in a banking organization's regulatory report. However, a banking 
organization may provide the disclosures in more than one public 
financial report or other regulatory reports (for example, in 
Management's Discussion and Analysis included in SEC filings), provided 
that the banking organization publicly provides a summary table 
specifically indicating the location(s) of all such disclosures (for 
example, regulatory report schedules, page numbers in annual reports). 
The agencies expect that disclosures of common equity tier 1, tier 1, 
and total capital ratios would be tested by external auditors as part 
of the financial statement audit.

D. Proprietary and Confidential Information

    The agencies believe that the disclosure requirements strike an 
appropriate balance between the need for meaningful disclosure and the 
protection of proprietary and confidential information.\189\ 
Accordingly, the agencies believe that banking organizations would be 
able to provide all of these disclosures without revealing proprietary 
and confidential information. Only in rare circumstances might 
disclosure of certain items of information required by the final rule 
compel a banking organization to reveal confidential and proprietary 
information. In these unusual situations, if a banking organization 
believes that disclosure of specific commercial or financial 
information would compromise its position by making public information 
that is either proprietary or confidential in nature, the banking 
organization will not be required to disclose those specific items 
under the rule's periodic disclosure requirement. Instead, the banking 
organization must disclose more general information about the subject 
matter of the requirement, together with the fact that, and the reason 
why, the specific items of information have not been disclosed. This 
provision applies only to those disclosures included in this final rule 
and does not apply to disclosure requirements imposed by accounting 
standards, other regulatory agencies, or under other requirements of 
the agencies.
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    \189\ Proprietary information encompasses information that, if 
shared with competitors, would render a banking organization's 
investment in these products/systems less valuable, and, hence, 
could undermine its competitive position. Information about 
customers is often confidential, in that it is provided under the 
terms of a legal agreement or counterparty relationship.
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E. Specific Public Disclosure Requirements

    The public disclosure requirements are designed to provide 
important information to market participants on the scope of 
application, capital, risk exposures, risk assessment processes, and, 
thus, the capital adequacy of the institution. The agencies note that 
the substantive content of the tables is the focus of the disclosure 
requirements, not the tables themselves. The table numbers below refer 
to the table numbers in section 63 of the final rule. A banking 
organization must make the disclosures described in Tables 1 through 
10.\190\
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    \190\ Other public disclosure requirements would continue to 
apply, such as federal securities law, and regulatory reporting 
requirements for banking organizations.
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    Table 1 disclosures, ``Scope of Application,'' name the top 
corporate entity in the group to which subpart D of the final rule 
applies and include a brief description of the differences in the basis 
for consolidating entities for accounting and regulatory purposes, as 
well as a description of any restrictions, or other major impediments, 
on transfer of funds or total capital within the group. These 
disclosures provide the basic context underlying regulatory capital 
calculations.
    Table 2 disclosures, ``Capital Structure,'' provide summary 
information on the terms and conditions of the main features of 
regulatory capital instruments, which allow for an evaluation of the 
quality of the capital available to absorb losses within a banking 
organization. A banking organization also must disclose the total 
amount of common equity tier 1, tier 1 and total capital, with separate 
disclosures for deductions and adjustments to capital. The agencies 
expect that many of these disclosure requirements would be captured in 
revised regulatory reports.
    Table 3 disclosures, ``Capital Adequacy,'' provide information on a 
banking organization's approach for categorizing and risk weighting its 
exposures, as well as the amount of total risk-weighted assets. The 
Table also includes common equity tier 1, and tier 1 and total risk-
based capital ratios for the top consolidated group, and for each 
depository institution subsidiary.
    Table 4 disclosures, ``Capital Conservation Buffer,'' require a 
banking organization to disclose the capital conservation buffer, the 
eligible retained income and any limitations on capital distributions 
and certain discretionary bonus payments, as applicable.
    Disclosures in Tables 5, ``Credit Risk: General Disclosures,'' 6, 
``General Disclosure for Counterparty Credit Risk-Related Exposures,'' 
and 7, ``Credit Risk Mitigation,'' relate to credit risk, counterparty 
credit risk and credit risk mitigation, respectively, and provide 
market participants with insight into different types and 
concentrations of credit risk to which a banking organization is 
exposed and the techniques it uses to measure, monitor, and mitigate 
those risks. These disclosures are intended to enable market 
participants to assess the credit risk exposures of the banking 
organization without revealing proprietary information.
    Table 8 disclosures, ``Securitization,'' provide information to 
market participants on the amount of credit risk transferred and 
retained by a banking organization through securitization transactions, 
the types of products securitized by the organization, the risks 
inherent in the organization's securitized assets, the organization's 
policies regarding credit risk mitigation, and the names of any 
entities that provide external credit assessments of a securitization. 
These disclosures provide a better understanding of how securitization 
transactions impact the credit risk of a banking organization. For 
purposes of these disclosures, ``exposures securitized'' include 
underlying exposures transferred into a securitization by a banking 
organization, whether originated by the banking organization or 
purchased from third parties, and third-party exposures included in 
sponsored programs. Securitization transactions in which the 
originating banking organization does not retain any securitization 
exposure are shown separately and are only reported for the year of 
inception of the transaction.
    Table 9 disclosures, ``Equities Not Subject to Subpart F of this 
Part,'' provide market participants with an understanding of the types 
of equity securities held by the banking organization and how they are 
valued. These disclosures also provide information on the capital 
allocated to different equity products and the amount of unrealized 
gains and losses.
    Table 10 disclosures, ``Interest Rate Risk for Non-trading 
Activities,'' require a banking organization to provide certain 
quantitative and qualitative disclosures regarding the banking

[[Page 62131]]

organization's management of interest rate risks.

XII. Risk-weighted Assets--Modifications to the Advanced Approaches

    In the Advanced Approaches NPR, the agencies and the FDIC proposed 
revisions to the advanced approaches rule to incorporate certain 
aspects of Basel III, as well as the requirements introduced by the 
BCBS in the 2009 Enhancements \191\ and subsequent consultative papers. 
In accordance with Basel III, the proposal sought to require advanced 
approaches banking organizations to hold more appropriate levels of 
capital for counterparty credit risk, CVA, and wrong-way risk. 
Consistent with the 2009 Enhancements, the agencies and the FDIC 
proposed to strengthen the risk-based capital requirements for certain 
securitization exposures by requiring banking organizations that are 
subject to the advanced approaches rule to conduct more rigorous credit 
analysis of securitization exposures and to enhance the disclosure 
requirements related to those exposures.
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    \191\ See ``Enhancements to the Basel II framework'' (July 
2009), available at https://www.bis.org/publ/bcbs157.htm.
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    The agencies and the FDIC also proposed revisions to the advanced 
approaches rule that are consistent with the requirements of section 
939A of the Dodd-Frank Act.\192\ The agencies and the FDIC proposed to 
remove references to ratings from certain defined terms under the 
advanced approaches rule, as well as the ratings-based approach for 
securitization exposures, and replace these provisions with alternative 
standards of creditworthiness. The proposed rule also contained a 
number of proposed technical amendments to clarify or adjust existing 
requirements under the advanced approaches rule. The Board also 
proposed to apply the advanced approaches rule and the market risk rule 
to SLHCs, and the FDIC and OCC proposed to apply the market risk rule 
to state and Federal savings associations, respectively.
---------------------------------------------------------------------------

    \192\ See section 939A of Dodd-Frank Act (15 U.S.C. 78o-7 note).
---------------------------------------------------------------------------

    This section of the preamble describes the proposals in the 
Advanced Approaches NPR, comments received on those proposals, and the 
revisions to the advanced approaches rule reflected in the final rule.
    In many cases, the comments received on the Standardized Approach 
NPR were also relevant to the proposed changes to the advanced 
approaches framework. The agencies generally took a consistent approach 
towards addressing the comments with respect to the standardized 
approach and the advanced approaches rule. Banking organizations that 
are or would be subject to the advanced approaches rule should refer to 
the relevant sections of the discussion of the standardized approach 
for further discussion of these comments.
    One commenter raised concerns about the use of models in 
determining regulatory capital requirements and encouraged the agencies 
and the FDIC to conduct periodic validation of banking organizations' 
models for capital adequacy and require modification if necessary. 
Consistent with the current advanced approaches rule, the final rule 
requires a banking organization to validate its models used to 
determine regulatory capital requirements on an ongoing basis. This 
validation must include an evaluation of conceptual soundness; an 
ongoing monitoring process that includes verification of processes and 
benchmarking; and an outcomes analysis process that includes 
backtesting. Under section 123 of the final rule, a banking 
organization's primary Federal supervisor may require the banking 
organization to calculate its advanced approaches risk-weighted assets 
according to modifications provided by the supervisor if the supervisor 
determines that the banking organization's advanced approaches total 
risk-weighted assets are not commensurate with its credit, market, 
operational or other risks.
    Other commenters suggested that the agencies and the FDIC interpret 
section 171 of the Dodd-Frank Act narrowly with regard to the advanced 
approaches framework. The agencies have adopted the approach taken in 
the proposed rule because they believe that the approach provides 
clear, consistent minimum requirements across institutions that comply 
with the requirements of section 171.

A. Counterparty Credit Risk

    The recent financial crisis highlighted certain aspects of the 
treatment of counterparty credit risk under the Basel II framework that 
were inadequate, and of banking organizations' risk management of 
counterparty credit risk that were insufficient. The Basel III 
revisions were intended to address both areas of weakness by ensuring 
that all material on- and off-balance sheet counterparty risks, 
including those associated with derivative-related exposures, are 
appropriately incorporated into banking organizations' risk-based 
capital ratios. In addition, new risk-management requirements in Basel 
III strengthen the oversight of counterparty credit risk exposures. The 
proposed rule included counterparty credit risk revisions in a manner 
generally consistent with the Basel III revisions to international 
standards, modified to incorporate alternative standards to the use of 
credit ratings. The discussion below highlights the proposed revisions, 
industry comments, and outcome of the final rule.
1. Recognition of Financial Collateral
a. Financial Collateral
    The EAD adjustment approach under section 132 of the proposed rules 
permitted a banking organization to recognize the credit risk 
mitigation benefits of financial collateral by adjusting the EAD rather 
than the loss given default (LGD) of the exposure for repo-style 
transactions, eligible margin loans and OTC derivative contracts. The 
permitted methodologies for recognizing such benefits included the 
collateral haircut approach, simple VaR approach and the IMM.
    Consistent with Basel III, the Advanced Approaches NPR proposed 
certain modifications to the definition of financial collateral. For 
example, the definition of financial collateral was modified so that 
resecuritizations would no longer qualify as financial collateral.\193\ 
Thus, resecuritization collateral could not be used to adjust the EAD 
of an exposure. The agencies believe that this treatment is appropriate 
because resecuritizations have been shown to have more market value 
volatility than other types of financial collateral.
---------------------------------------------------------------------------

    \193\ Under the proposed rule, a securitization in which one or 
more of the underlying exposures is a securitization position would 
be a resecuritization. A resecuritization position under the 
proposal meant an on- or off-balance sheet exposure to a 
resecuritization, or an exposure that directly or indirectly 
references a securitization exposure.
---------------------------------------------------------------------------

    The proposed rule also removed conforming residential mortgages 
from the definition of financial collateral. As a result, a banking 
organization would no longer be able to recognize the credit risk 
mitigation benefit of such instruments through an adjustment to EAD. 
Consistent with the Basel III framework, the agencies and the FDIC 
proposed to exclude all debt securities that are not investment grade 
from the definition of financial collateral. As discussed in section 
VII.F of this preamble, the proposed rule revised the definition of 
``investment grade'' for the advanced approaches rule and proposed 
conforming changes to the market risk rule.
    As discussed in section VIII.F of the preamble, the agencies 
believe that the

[[Page 62132]]

additional collateral types suggested by commenters are not appropriate 
forms of financial collateral because they exhibit increased variation 
and credit risk, and are relatively more speculative than the 
recognized forms of financial collateral under the proposal. In some 
cases, the assets suggested by commenters for eligibility as financial 
collateral were precisely the types of assets that became illiquid 
during the recent financial crisis. As a result, the agencies have 
retained the definition of financial collateral as proposed.
    b. Revised Supervisory Haircuts
    Securitization exposures have increased levels of volatility 
relative to other types of financial collateral. To address this issue, 
consistent with Basel III, the proposal incorporated new standardized 
supervisory haircuts for securitization exposures in the EAD adjustment 
approach based on the credit quality of the exposure. Consistent with 
section 939A of the Dodd-Frank Act, the proposed rule set out an 
alternative approach to assigning standard supervisory haircuts for 
securitization exposures, and amended the standard supervisory haircuts 
for other types of financial collateral to remove the references to 
credit ratings.
    Some commenters proposed limiting the maximum haircut for non-
sovereign issuers that receive a 100 percent risk weight to 12 percent, 
and more specifically assigning a lower haircut than 25 percent for 
financial collateral in the form of an investment-grade corporate debt 
security that has a shorter residual maturity. The commenters asserted 
that these haircuts conservatively correspond to the existing rating 
categories and result in greater alignment with the Basel framework. As 
discussed in section VIII.F of the preamble, in the final rule, the 
agencies have revised the standard supervisory market price volatility 
haircuts for financial collateral issued by non-sovereign issuers with 
a risk weight of 100 percent from 25.0 percent to 4.0 percent for 
maturities of less than one year, 8.0 percent for maturities greater 
than one year but less than or equal to five years, and 16.0 percent 
for maturities greater than five years, consistent with Table 25 below. 
The agencies believe that the revised haircuts better reflect the 
collateral's credit quality and an appropriate differentiation based on 
the collateral's residual maturity.
    Consistent with the proposal, under the final rule, supervisory 
haircuts for exposures to sovereigns, GSEs, public sector entities, 
depository institutions, foreign banks, credit unions, and corporate 
issuers are calculated based upon the risk weights for such exposures 
described under section 32 of the final rule. The final rule also 
clarifies that if a banking organization lends instruments that do not 
meet the definition of financial collateral, such as non-investment-
grade corporate debt securities or resecuritization exposures, the 
haircut applied to the exposure must be 25 percent.

                                           Table 25--Standard Supervisory Market Price Volatility Haircuts \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                Haircut (in percent) assigned based on:
                                                               ------------------------------------------------------------------------ Investment-grade
                                                                   Sovereign issuers risk weight     Non-sovereign issuers risk weight   securitization
                       Residual maturity                         under section 32 \2\ (in percent)     under section 32 (in percent)      exposures (in
                                                               ------------------------------------------------------------------------     percent)
                                                                   Zero      20 or 50       100         20          50          100
--------------------------------------------------------------------------------------------------------------------------------------------------------
Less than or equal to 1 year..................................         0.5         1.0        15.0         1.0         2.0         4.0               4.0
Greater than 1 year and less than or equal to 5 years.........         2.0         3.0        15.0         4.0         6.0         8.0              12.0
Greater than 5 years..........................................         4.0         6.0        15.0         8.0        12.0        16.0              24.0
--------------------------------------------------------------------------------------------------------------------------------------------------------
Main index equities (including convertible bonds) and gold...........................15.0.........
--------------------------------------------------------------------------------------------------------------------------------------------------------
Other publicly traded equities (including convertible bonds).........................25.0.........
--------------------------------------------------------------------------------------------------------------------------------------------------------
Mutual funds.....................................................Highest haircut applicable to any security in
                                                                          which the fund can invest.
--------------------------------------------------------------------------------------------------------------------------------------------------------
Cash collateral held.................................................................Zero.........
--------------------------------------------------------------------------------------------------------------------------------------------------------
Other exposure types.................................................................25.0.........
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ The market price volatility haircuts in Table 25 are based on a 10 business-day holding period.
\2\ Includes a foreign PSE that receives a zero percent risk weight.

2. Holding Periods and the Margin Period of Risk
    As noted in the proposal, during the recent financial crisis, many 
financial institutions experienced significant delays in settling or 
closing out collateralized transactions, such as repo-style 
transactions and collateralized OTC derivative contracts. The assumed 
holding period for collateral in the collateral haircut and simple VaR 
approaches and the margin period of risk in the IMM proved to be 
inadequate for certain transactions and netting sets.\194\ It also did 
not reflect the difficulties and delays experienced by institutions 
when settling or liquidating collateral during a period of financial 
stress.
---------------------------------------------------------------------------

    \194\ Under the advanced approaches rule, the margin period of 
risk means, with respect to a netting set subject to a collateral 
agreement, the time period from the most recent exchange of 
collateral with a counterparty until the next required exchange of 
collateral plus the period of time required to sell and realize the 
proceeds of the least liquid collateral that can be delivered under 
the terms of the collateral agreement and, where applicable, the 
period of time required to re-hedge the resulting market risk, upon 
the default of the counterparty.
---------------------------------------------------------------------------

    Consistent with Basel III, the proposed rule would have amended the 
advanced approaches rule to incorporate adjustments to the holding 
period in the collateral haircut and simple VaR approaches, and to the 
margin period of risk in the IMM that a banking organization may use to 
determine its capital requirement for repo-style transactions, OTC 
derivative transactions, and eligible margin loans, with respect to 
large netting sets, netting sets involving illiquid collateral or

[[Page 62133]]

including OTC derivatives that could not easily be replaced, or two 
margin disputes within a netting set over the previous two quarters 
that last for a certain length of time. For cleared transactions, which 
are discussed below, the agencies and the FDIC proposed not to require 
a banking organization to adjust the holding period or margin period of 
risk upward when determining the capital requirement for its 
counterparty credit risk exposures to the CCP, which is also consistent 
with Basel III.
    One commenter asserted that the proposed triggers for the increased 
margin period of risk were not in the spirit of the advanced approaches 
rule, which is intended to be more risk sensitive than the general 
risk-based capital rules. Another commenter asserted that banking 
organizations should be permitted to increase the holding period or 
margin period of risk by one or more business days, but not be required 
to increase it to the full period required under the proposal (20 
business days or at least double the margin period of risk).
    The agencies believe the triggers set forth in the proposed rule, 
as well as the increased holding period or margin period of risk are 
empirical indicators of increased risk of delay or failure of close-out 
on the default of a counterparty. The goal of risk sensitivity would 
suggest that modifying these indicators is not warranted and could lead 
to increased risks to the banking system. Accordingly, the final rule 
adopts these features as proposed.
3. Internal Models Methodology
    Consistent with Basel III, the proposed rule would have amended the 
advanced approaches rule so that the capital requirement for IMM 
exposures is equal to the larger of the capital requirement for those 
exposures calculated using data from the most recent three-year period 
and data from a three-year period that contains a period of stress 
reflected in the credit default spreads of the banking organization's 
counterparties. The proposed rule defined an IMM exposure as a repo-
style transaction, eligible margin loan, or OTC derivative contract for 
which a banking organization calculates EAD using the IMM.
    The proposed rule would have required a banking organization to 
demonstrate to the satisfaction of the banking organization's primary 
Federal supervisor at least quarterly that the stress period it uses 
for the IMM coincides with increased CDS or other credit spreads of its 
counterparties and to have procedures in place to evaluate the 
effectiveness of its stress calibration. These procedures would have 
been required to include a process for using benchmark portfolios that 
are vulnerable to the same risk factors as the banking organization's 
portfolio. In addition, under the proposal, the primary Federal 
supervisor could require a banking organization to modify its stress 
calibration if the primary Federal supervisor believes that another 
calibration better reflects the actual historic losses of the 
portfolio.
    Consistent with Basel III and the current advanced approaches rule, 
the proposed rule would have required a banking organization to 
establish a process for initial validation and annual review of its 
internal models. As part of the process, the proposed rule would have 
required a banking organization to have a backtesting program for its 
model that includes a process by which unacceptable model performance 
is identified and remedied. In addition, a banking organization would 
have been required to multiply the expected positive exposure (EPE) of 
a netting set by the default scaling factor alpha (set equal to 1.4) in 
calculating EAD. The primary Federal supervisor could require the 
banking organization to set a higher default scaling factor based on 
the past performance of the banking organization's internal model.
    The proposed rule would have required a banking organization to 
have policies for the measurement, management, and control of 
collateral, including the reuse of collateral and margin amounts, as a 
condition of using the IMM. Under the proposal, a banking organization 
would have been required to have a comprehensive stress testing program 
for the IMM that captures all credit exposures to counterparties and 
incorporates stress testing of principal market risk factors and the 
creditworthiness of its counterparties.
    Basel III provided that a banking organization could capture within 
its internal model the effect on EAD of a collateral agreement that 
requires receipt of collateral when the exposure to the counterparty 
increases. Basel II also contained a ``shortcut'' method to provide a 
banking organization whose internal model did not capture the effects 
of collateral agreements with a method to recognize some benefit from 
the collateral agreement. Basel III modifies the ``shortcut'' method 
for capturing the effects of collateral agreements by setting effective 
EPE to a counterparty as the lesser of the following two exposure 
calculations: (1) The exposure without any held or posted margining 
collateral, plus any collateral posted to the counterparty independent 
of the daily valuation and margining process or current exposure, or 
(2) an add-on that reflects the potential increase of exposure over the 
margin period of risk plus the larger of (i) the current exposure of 
the netting set reflecting all collateral received or posted by the 
banking organization excluding any collateral called or in dispute; or 
(ii) the largest net exposure (including all collateral held or posted 
under the margin agreement) that would not trigger a collateral call. 
The add-on would be computed as the largest expected increase in the 
netting set's exposure over any margin period of risk in the next year. 
The proposed rule included the Basel III modification of the 
``shortcut'' method.
    The final rule adopts all the proposed requirements discussed above 
with two modifications. With respect to the proposed requirement that a 
banking organization must demonstrate on a quarterly basis to its 
primary Federal supervisor the appropriateness of its stress period, 
under the final rule, the banking organization must instead demonstrate 
at least quarterly that the stress period coincides with increased CDS 
or other credit spreads of the banking organization's counterparties, 
and must maintain documentation of such demonstration. In addition, the 
formula for the ``shortcut'' method has been modified to clarify that 
the add-on is computed as the expected increase in the netting set's 
exposure over the margin period of risk.
a. Recognition of Wrong-Way Risk
    The recent financial crisis highlighted the interconnectedness of 
large financial institutions through an array of complex transactions. 
In recognition of this interconnectedness and to mitigate the risk of 
contagion from the banking sector to the broader financial system and 
the general economy, Basel III includes enhanced requirements for the 
recognition and treatment of wrong-way risk in the IMM. The proposed 
rule defined wrong-way risk as the risk that arises when an exposure to 
a particular counterparty is positively correlated with the probability 
of default of that counterparty.
    The proposed rule provided enhancements to the advanced approaches 
rule that require banking organizations' risk-management procedures to 
identify, monitor, and control wrong-way risk throughout the life of an 
exposure. The proposed rule required these risk-management procedures 
to include the use of stress testing and scenario analysis. In 
addition, where a banking organization has identified an IMM exposure 
with

[[Page 62134]]

specific wrong-way risk, the banking organization would be required to 
treat that transaction as its own netting set. The proposed rule 
defined specific wrong-way risk as a type of wrong-way risk that arises 
when either the counterparty and issuer of the collateral supporting 
the transaction, or the counterparty and the reference asset of the 
transaction, are affiliates or are the same entity.
    In addition, under the proposal, where a banking organization has 
identified an OTC derivative transaction, repo-style transaction, or 
eligible margin loan with specific wrong-way risk for which the banking 
organization otherwise applies the IMM, the banking organization would 
set the probability of default (PD) of the counterparty and a LGD equal 
to 100 percent. The banking organization would then enter these 
parameters into the appropriate risk-based capital formula specified in 
Table 1 of section 131 of the proposed rule, and multiply the output of 
the formula (K) by an alternative EAD based on the transaction type, as 
follows:
    (1) For a purchased credit derivative, EAD would be the fair value 
of the underlying reference asset of the credit derivative contract;
    (2) For an OTC equity derivative,\195\ EAD would be the maximum 
amount that the banking organization could lose if the fair value of 
the underlying reference asset decreased to zero;
---------------------------------------------------------------------------

    \195\ Under the final rule, equity derivatives that are call 
options are not be subject to a counterparty credit risk capital 
requirement for specific wrong-way risk.
---------------------------------------------------------------------------

    (3) For an OTC bond derivative (that is, a bond option, bond 
future, or any other instrument linked to a bond that gives rise to 
similar counterparty credit risks), EAD would be the smaller of the 
notional amount of the underlying reference asset and the maximum 
amount that the banking organization could lose if the fair value of 
the underlying reference asset decreased to zero; and
    (4) For repo-style transactions and eligible margin loans, EAD 
would be calculated using the formula in the collateral haircut 
approach of section 132 of the final rule and with the estimated value 
of the collateral substituted for the parameter C in the equation.
    The final rule adopts the proposed requirements regarding wrong-way 
risk discussed above.
b. Increased Asset Value Correlation Factor
    To recognize the correlation of financial institutions' 
creditworthiness attributable to similar sensitivities to common risk 
factors, the agencies and the FDIC proposed to incorporate the Basel 
III increase in the correlation factor used in the formulas provided in 
Table 1 of section 131 of the proposed rule for certain wholesale 
exposures. Under the proposed rule, banking organizations would apply a 
multiplier of 1.25 to the correlation factor for wholesale exposures to 
unregulated financial institutions that generate a majority of their 
revenue from financial activities, regardless of asset size. This 
category would include highly leveraged entities, such as hedge funds 
and financial guarantors. The proposal also included a definition of 
``regulated financial institution,'' meaning a financial institution 
subject to consolidated supervision and regulation comparable to that 
imposed on certain U.S. financial institutions, namely depository 
institutions, depository institution holding companies, nonbank 
financial companies supervised by the Board, designated FMUs, 
securities broker-dealers, credit unions, or insurance companies. 
Banking organizations would apply a multiplier of 1.25 to the 
correlation factor for wholesale exposures to regulated financial 
institutions with consolidated assets of greater than or equal to $100 
billion.
    Several commenters pointed out that in the proposed formulas for 
wholesale exposures to unregulated and regulated financial 
institutions, the 0.18 multiplier should be revised to 0.12 in order to 
be consistent with Basel III. The agencies have corrected this aspect 
of both formulas in the final rule.
    Another comment asserted that the 1.25 multiplier for the 
correlation factor for wholesale exposures to unregulated financial 
institutions or regulated financial institutions with more than $100 
billion in assets is an overly blunt tool and is not necessary as 
single counterparty credit limits already address interconnectivity 
risk. Consistent with the concerns about systemic risk and 
interconnectedness surrounding these classes of institutions, the 
agencies continue to believe that the 1.25 multiplier appropriately 
reflects the associated additional risk. Therefore, the final rule 
retains the 1.25 multiplier. In addition, the final rule also adopts 
the definition of ``regulated financial institution'' without change 
from the proposal. As discussed in section V.B, above, the agencies and 
the FDIC received significant comment on the definition of ``financial 
institution'' in the context of deductions of investments in the 
capital of unconsolidated financial institutions. That definition also, 
under the proposal, defined the universe of ``unregulated'' financial 
institutions as companies meeting the definition of ``financial 
institution'' that were not regulated financial institutions. For the 
reasons discussed in section V.B of the preamble, the agencies have 
modified the definition of ``financial institution,'' including by 
introducing an ownership interest threshold to the ``predominantly 
engaged'' test to determine if a banking organization must subject a 
particular unconsolidated investment in a company that may be a 
financial institution to the relevant deduction thresholds under 
subpart C of the final rule. While commenters stated that it would be 
burdensome to determine whether an entity falls within the definition 
of financial institution using the predominantly engaged test, the 
agencies believe that advanced approaches banking organizations should 
have the systems and resources to identify the activities of their 
wholesale counterparties. Accordingly, under the final rule, the 
agencies have adopted a definition of ``unregulated financial 
institution'' that does not include the ownership interest threshold 
test but otherwise incorporates revisions to the definition of 
``financial institution.'' Under the final rule, an ``unregulated 
financial institution'' is a financial institution that is not a 
regulated financial institution and that meets the definition of 
``financial institution'' under the final rule without regard to the 
ownership interest thresholds set forth in paragraph (4)(i) of that 
definition. The agencies believe the ``unregulated financial 
institution'' definition is necessary to maintain an appropriate scope 
for the 1.25 multiplier consistent with the proposal and Basel III.
4. Credit Valuation Adjustments
    After the recent financial crisis, the BCBS reviewed the treatment 
of counterparty credit risk and found that roughly two-thirds of 
counterparty credit risk losses during the crisis were due to fair 
value losses from CVA (that is, the fair value adjustment to reflect 
counterparty credit risk in the valuation of an OTC derivative 
contract), whereas one-third of counterparty credit risk losses 
resulted from actual defaults. The internal ratings-based approach in 
Basel II addressed counterparty credit risk as a combination of default 
risk and credit migration risk. Credit migration risk accounts for fair 
value losses resulting from deterioration of counterparties' credit 
quality short of default and is addressed in Basel II via the maturity 
adjustment multiplier. However, the

[[Page 62135]]

maturity adjustment multiplier in Basel II was calibrated for loan 
portfolios and may not be suitable for addressing CVA risk. Basel III 
therefore includes an explicit capital requirement for CVA risk. 
Accordingly, consistent with Basel III and the proposal, the final rule 
requires banking organizations to calculate risk-weighted assets for 
CVA risk.
    Consistent with the Basel III CVA capital requirement and the 
proposal, the final rule reflects in risk-weighted assets a potential 
increase of the firm-wide CVA due to changes in counterparties' credit 
spreads, assuming fixed expected exposure (EE) profiles. The proposed 
and final rules provide two approaches for calculating the CVA capital 
requirement: The simple approach and the advanced CVA approach. 
However, unlike Basel III, they do not include references to credit 
ratings.
    Consistent with the proposal and Basel III, the simple CVA approach 
in the final rule permits calculation of the CVA capital requirement 
(KCVA) based on a formula described in more detail below, 
with a modification consistent with section 939A of the Dodd-Frank Act. 
Under the advanced CVA approach in the final rule, consistent with the 
proposal, a banking organization would use the VaR model that it uses 
to calculate specific risk under section 207(b) of subpart F or another 
model that meets the quantitative requirements of sections 205(b) and 
207(b)(1) of subpart F to calculate its CVA capital requirement for its 
entire portfolio of OTC derivatives that are subject to the CVA capital 
requirement \196\ by modeling the impact of changes in the 
counterparties' credit spreads, together with any recognized CVA hedges 
on the CVA for the counterparties. To convert the CVA capital 
requirement to a risk-weighted asset amount, a banking organization 
must multiply its CVA capital requirement by 12.5. The CVA risk-
weighted asset amount is not a component of credit risk-weighted assets 
and therefore is not subject to the 1.06 multiplier for credit risk-
weighted assets under the final rule. Consistent with the proposal, the 
final rule provides that only a banking organization that is subject to 
the market risk rule and had obtained prior approval from its primary 
Federal supervisor to calculate (1) the EAD for OTC derivative 
contracts using the IMM described in section 132, and (2) the specific 
risk add-on for debt positions using a specific risk model described in 
section 207(b) of subpart F is eligible to use the advanced CVA 
approach. A banking organization that receives such approval would be 
able to continue to use the advanced CVA approach until it notifies its 
primary Federal supervisor in writing that it expects to begin 
calculating its CVA capital requirement using the simple CVA approach. 
Such notice must include an explanation from the banking organization 
as to why it is choosing to use the simple CVA approach and the date 
when the banking organization would begin to calculate its CVA capital 
requirement using the simple CVA approach.
---------------------------------------------------------------------------

    \196\ Certain CDS may be exempt from inclusion in the portfolio 
of OTC derivatives that are subject to the CVA capital requirement. 
For example, a CDS on a loan that is recognized as a credit risk 
mitigant and receives substitution treatment under section 134 would 
not be included in the portfolio of OTC derivatives that are subject 
to the CVA capital requirement.
---------------------------------------------------------------------------

    Consistent with the proposal, under the final rule, when 
calculating a CVA capital requirement, a banking organization may 
recognize the hedging benefits of single name CDS, single name 
contingent CDS, any other equivalent hedging instrument that references 
the counterparty directly, and index CDS (CDSind), provided 
that the equivalent hedging instrument is managed as a CVA hedge in 
accordance with the banking organization's hedging policies. A tranched 
or n^th-to-default CDS would not qualify as a CVA hedge. In 
addition, any position that is recognized as a CVA hedge would not be a 
covered position under the market risk rule, except in the case where 
the banking organization is using the advanced CVA approach, the hedge 
is a CDSind, and the VaR model does not capture the basis 
between the spreads of the index that is used as the hedging instrument 
and the hedged counterparty exposure over various time periods, as 
discussed in further detail below. The agencies and the FDIC received 
several comments on the proposed CVA capital requirement. One commenter 
asserted that there was ambiguity in the ``total CVA risk-weighted 
assets'' definition which could be read as indicating that 
KCVA is calculated for each counterparty and then summed. 
The agencies agree that KCVA relates to a banking 
organization's entire portfolio of OTC derivatives contracts, and the 
final rule reflects this clarification.
    A commenter asserted that the proposed CVA treatment should not 
apply to central banks, MDBs and other similar counterparties that have 
very low credit risk, such as the Bank for International Settlements 
and the European Central Bank, as well as U.S. PSEs. Another commenter 
pointed out that the proposal in the European Union to implement Basel 
III excludes sovereign, pension fund, and corporate counterparties from 
the proposed CVA treatment. Another commenter argued that the proposed 
CVA treatment should not apply to transactions executed with end-users 
when hedging business risk because the resulting increase in pricing 
will disproportionately impact small- and medium-sized businesses.
    The final rule does not exempt the entities suggested by 
commenters. However, the agencies anticipate that a counterparty that 
is exempt from the 0.03 percent PD floor under Sec.  --.131(d)(2) and 
receives a zero percent risk weight under Sec.  --.32 (that is, central 
banks, MDBs, the Bank for International Settlements and European 
Central Bank) likely would attract a minimal CVA requirement because 
the credit spreads associated with these counterparties have very 
little variability. Regarding the other entities mentioned by 
commenters (U.S. public sector entities, pension funds and corporate 
end-users), the agencies believe it is appropriate for CVA to apply as 
these counterparty types exhibit varying degrees of credit risk.
    Some commenters asked that the agencies and the FDIC clarify that 
interest rate hedges of CVA are not covered positions as defined in 
subpart F and, therefore, not subject to a market risk capital 
requirement. In addition, some commenters asserted that the overall 
capital requirements for CVA are more appropriately addressed as a 
trading book issue in the context of the BCBS Fundamental Review of the 
Trading Book.\197\ Another commenter asserted that CVA rates hedges (to 
the extent they might be covered positions) should be excluded from the 
market-risk rule capital requirements until supervisors are ready to 
approve allowing CVA rates sensitivities to be incorporated into a 
banking organization's general market risk VaR.
---------------------------------------------------------------------------

    \197\ See ``Fundamental review of the trading book'' (May 2012) 
available at https://www.bis.org/publ/bcbs219.pdf.
---------------------------------------------------------------------------

    The agencies recognize that CVA is not a covered position under the 
market risk rule. Hence, as elaborated in the market risk rule, hedges 
of non-covered positions that are not themselves trading positions also 
are not eligible to be a covered position under the market risk rule. 
Therefore, the agencies clarify that non-credit risk hedges (market 
risk hedges or exposure hedges) of CVA generally are not covered 
positions under the market risk rule, but rather are assigned risk-
weighted asset amounts under subparts D and E of the

[[Page 62136]]

final rule.\198\ Once the BCBS Fundamental Review of the Trading Book 
is complete, the agencies will review the BCBS findings and consider 
whether they are appropriate for U.S. banking organizations.
---------------------------------------------------------------------------

    \198\ The agencies believe that a banking organization needs to 
demonstrate rigorous risk management and the efficacy of its CVA 
hedges and should follow the risk management principles of the 
Interagency Supervisory Guidance on Counterparty Credit Risk 
Management (2011) and identification of covered positions as in the 
agencies' market risk rule, see 77 FR 53060 (August 30, 2012).
---------------------------------------------------------------------------

    One commenter asserted that observable LGDs for credit derivatives 
do not represent the best estimation of LGD for calculating CVA under 
the advanced CVA approach, and that the final rule should instead 
consider a number of parameters, including market observable recovery 
rates on unsecured bonds and structural components of the derivative. 
Another commenter argued that banking organizations should be permitted 
greater flexibility in determining market-implied loss given default 
(LGDMKT) and credit spread factors for VaR.
    Consistent with the BCBS's frequently asked question (BCBS FAQ) on 
this topic,\199\ the agencies recognize that while there is often 
limited market information of LGDMKT (or equivalently the 
market implied recovery rate), the agencies consider the use of 
LGDMKT to be the most appropriate approach to quantify CVA. 
It is also the market convention to use a fixed recovery rate for CDS 
pricing purposes; banking organizations may use that information for 
purposes of the CVA capital requirement in the absence of other 
information. In cases where a netting set of OTC derivative contracts 
has a different seniority than those derivative contracts that trade in 
the market from which LGDMKT is inferred, a banking 
organization may adjust LGDMKT to reflect this difference in 
seniority. Where no market information is available to determine 
LGDMKT, a banking organization may propose a method for 
determining LGDMKT based upon data collected by the banking 
organization that would be subject to approval by its primary Federal 
supervisor. The final rule has been amended to include this 
alternative.
---------------------------------------------------------------------------

    \199\ See ``Basel III counterparty credit risk and exposures to 
central counterparties--Frequently asked questions (December 2012 
(update of FAQs published November 2012)) at https://www.bis.org/publ/bcbs237.pdf.
---------------------------------------------------------------------------

    Regarding the proposed CVA EAD calculation assumptions in the 
advanced CVA approach, one commenter asserted that EE constant 
treatment is inappropriate, and that it is more appropriate to use the 
weighted average maturity of the portfolio rather than the netting set. 
Another commenter asserted that maturity should equal the weighted 
average maturity of all transactions in the netting set, rather than 
the greater of the notional weighted average maturity and the maximum 
of half of the longest maturity occurring in the netting set. The 
agencies note that this issue is relevant only where a banking 
organization utilized the current exposure method or the ``shortcut'' 
method, rather than IMM, for any immaterial portfolios of OTC 
derivatives contracts. As a result, the final rule retains the 
requirement to use the greater of the notional weighted average 
maturity (WAM) and the maximum of half of the longest maturity in the 
netting set when calculating EE constant treatment in the advanced CVA 
approach.
    One commenter asked the agencies and the FDIC to clarify that 
section 132(c)(3) would exempt the purchased CDS from the proposed CVA 
capital requirements in section 132(e) of the final rule. Consistent 
with the BCBS FAQ on this topic, the agencies agree that purchased 
credit derivative protection against a wholesale exposure that is 
subject to the double default framework or the PD substitution approach 
and where the wholesale exposure itself is not subject to the CVA 
capital requirement, will not be subject to the CVA capital requirement 
in the final rule. Also consistent with the BCBS FAQ, the purchased 
credit derivative protection may not be recognized as a hedge for any 
other exposure under the final rule.
    Another commenter asserted that single-name proxy CDS trades should 
be allowed as hedges in the advanced CVA approach CVA VaR calculation. 
Under the final rule, a banking organization is permitted to recognize 
the hedging benefits of single name CDS, single name contingent CDS, 
any other equivalent hedging instrument that references the 
counterparty directly, and CDSind, provided that the hedging 
instrument is managed as a CVA hedge in accordance with the banking 
organization's hedging policies. The final rule does not permit the use 
of single-name proxy CDS. The agencies believe this is an important 
limitation because of the significant basis risk that could arise from 
the use of a single-name proxy.
    Additionally, the final rule reflects several clarifying amendments 
to the proposed rule. First, the final rule divides the Advanced CVA 
formulas in the proposed rule into two parts: Formula 3 and Formula 3a. 
The agencies believe that this clarification is important to reflect 
the different purposes of the two formulas: The first formula (Formula 
3) is for the CVA VaR calculation, whereas the second formula (Formula 
3a) is for calculating CVA for each credit spread simulation scenario. 
The final rule includes a description that clarifies each formula's 
purpose. In addition, the notations in proposed Formula 3 have been 
changed from CVAstressedVaR and CVAunstressedVaR 
to VaR\CVA\stressed and VaR\CVA\unstressed. The 
definitions of these terms have not changed in the final rule. Finally, 
the subscript ``j'' in Formula 3a has been defined as 
referring either to stressed or unstressed calibrations. These formulas 
are discussed in the final rule description below.
a. Simple Credit Valuation Adjustment Approach
    Under the final rule, a banking organization without approval to 
use the advanced CVA approach must use formula 1 to calculate its CVA 
capital requirement for its entire portfolio of OTC derivative 
contracts. The simple CVA approach is based on an analytical 
approximation derived from a general CVA VaR formulation under a set of 
simplifying assumptions:
    (1) All credit spreads have a flat term structure;
    (2) All credit spreads at the time horizon have a lognormal 
distribution;
    (3) Each single name credit spread is driven by the combination of 
a single systematic factor and an idiosyncratic factor;
    (4) The correlation between any single name credit spread and the 
systematic factor is equal to 0.5;
    (5) All credit indices are driven by the single systematic factor; 
and
    (6) The time horizon is short (the square root of time scaling to 1 
year is applied). The approximation is based on the linearization of 
the dependence of both CVA and CDS hedges on credit spreads. Given the 
assumptions listed above, a measure of CVA VaR has a closed-form 
analytical solution. The formula of the simple CVA approach is obtained 
by applying certain standardizations, conservative adjustments, and 
scaling to the analytical CVA VaR result.
    A banking organization calculates KCVA, where:

[[Page 62137]]

[GRAPHIC] [TIFF OMITTED] TR11OC13.008

    In Formula 1, wi refers to the weight applicable to counterparty i 
assigned according to Table 26 below.\200\ In Basel III, the BCBS 
assigned wi based on the external rating of the counterparty. However, 
consistent with the proposal and section 939A of the Dodd-Frank Act, 
the final rule assigns wi based on the relevant PD of the counterparty, 
as assigned by the banking organization. Quantity wind in Formula 1 
refers to the weight applicable to the CDSind based on the average 
weight under Table 26 of the underlying reference names that comprise 
the index.
---------------------------------------------------------------------------

    \200\ These weights represent the assumed values of the product 
of a counterparties' current credit spread and the volatility of 
that credit spread.

    Table 26--Assignment of Counterparty Weight Under the Simple CVA
------------------------------------------------------------------------
                                                          Weight wi (in
               Internal PD  (in percent)                    percent)
------------------------------------------------------------------------
0.00-0.07.............................................              0.70
>0.07-0.15............................................              0.80
>0.15-0.40............................................              1.00
>0.4-2.00.............................................              2.00
>2.0-6.00.............................................              3.00
>6.0..................................................             10.00
------------------------------------------------------------------------

    EADitotal in Formula 1 refers to the sum of the EAD for all netting 
sets of OTC derivative contracts with counterparty i calculated using 
the current exposure methodology described in section 132(c) of the 
final rule, as adjusted by Formula 2 or the IMM described in section 
132(d) of the final rule. When the banking organization calculates EAD 
using the IMM, EADi^total equals 
EADunstressed.
[GRAPHIC] [TIFF OMITTED] TR11OC13.009

    The term ``exp'' is the exponential function. Quantity Mi in 
Formulas 1 and 2 refers to the EAD-weighted average of the effective 
maturity of each netting set with counterparty i (where each netting 
set's M cannot be smaller than one). Quantity Mihedge in 
Formula 1 refers to the notional weighted average maturity of the hedge 
instrument. Quantity Mind in Formula 1 equals the maturity of the 
CDSind or the notional weighted average maturity of any 
CDSind purchased to hedge CVA risk of counterparty i.
    Quantity Bi in Formula 1 refers to the sum of the notional amounts 
of any purchased single name CDS referencing counterparty i that is 
used to hedge CVA risk to counterparty i multiplied by (1-exp(-0.05 x 
Mi hedge))/(0.05 x Mihedge). Quantity B ind in Formula 1 
refers to the notional amount of one or more CDSind 
purchased as protection to hedge CVA risk for counterparty i multiplied 
by (1-exp(-0.05 x Mind))/(0.05 x Mind). If counterparty i is part of an 
index used for hedging, a banking organization is allowed to treat the 
notional amount in an index attributable to that counterparty as a 
single name hedge of counterparty i (Bi,) when calculating 
KCVA and subtract the notional amount of Bi from the 
notional amount of the CDSind. The CDSind hedge 
with the notional amount reduced by Bi can still be treated as a CVA 
index hedge.
b. Advanced Credit Valuation Adjustment Approach
    The final rule requires that the VaR model incorporate only changes 
in the counterparties' credit spreads, not changes in other risk 
factors; it does not require a banking organization to capture jump-to-
default risk in its VaR model.
    In order for a banking organization to receive approval to use the 
advanced CVA approach under the final rule, the banking organization 
needs to have the systems capability to calculate the CVA capital 
requirement on a daily basis but is not expected or required to 
calculate the CVA capital requirement on a daily basis.
    The CVA capital requirement under the advanced CVA approach is 
equal to the general market risk capital requirement of the CVA 
exposure using the ten-business-day time horizon of the market risk 
rule. The capital requirement does not include the incremental risk 
requirement of subpart F. If a banking organization uses the current 
exposure methodology to calculate the EAD of any immaterial OTC 
derivative portfolio, under the final rule the banking organization 
must use this EAD as a constant EE in the formula for the calculation 
of CVA. Also, the banking organization must set the maturity equal to 
the greater of half of the longest maturity occurring in the netting 
set and the notional weighted average maturity of all transactions in 
the netting set.

[[Page 62138]]

    The final rule requires a banking organization to use the formula 
for the advanced CVA approach to calculate KCVA as follows:
[GRAPHIC] [TIFF OMITTED] TR11OC13.010

VaRJ is the 99 percent VaR reflecting changes of CVAj and fair value of 
eligible hedges (aggregated across all counterparties and eligible 
hedges) resulting from simulated changes of credit spreads over a ten-
day time horizon.\201\ CVAj for a given counterparty must be calculated 
according to
---------------------------------------------------------------------------

    \201\ For purposes of this formula, the subscript 
``j'' refers either to a stressed or unstressed 
calibration as described in section 133(e)(6)(iv) and (v) of the 
final rule.
[GRAPHIC] [TIFF OMITTED] TR11OC13.011

---------------------------------------------------------------------------
In Formula 3a:

    (A) ti = the time of the i-th revaluation time bucket 
starting from t0 = 0.
    (B) tT = the longest contractual maturity across the 
OTC derivative contracts with the counterparty.
    (C) si = the CDS spread for the counterparty at tenor 
ti used to calculate the CVA for the counterparty. If a 
CDS spread is not available, the banking organization must use a 
proxy spread based on the credit quality, industry and region of the 
counterparty.
    (D) LGDMKT = the loss given default of the counterparty based on 
the spread of a publicly traded debt instrument of the counterparty, 
or, where a publicly traded debt instrument spread is not available, 
a proxy spread based on the credit quality, industry and region of 
the counterparty.
    (E) EEi = the sum of the expected exposures for all netting sets 
with the counterparty at revaluation time ti calculated 
using the IMM.
    (F) Di = the risk-free discount factor at time ti, 
where D0 = 1.
    (G) The function exp is the exponential function.
    (H) The subscript j refers either to a stressed or an unstressed 
calibration as described in section 132(e)(6)(iv) and (v) of the 
final rule.

    Under the final rule, if a banking organization's VaR model is not 
based on full repricing, the banking organization must use either 
Formula 4 or Formula 5 to calculate credit spread sensitivities. If the 
VaR model is based on credit spread sensitivities for specific tenors, 
the banking organization must calculate each credit spread sensitivity 
according to Formula 4:

[[Page 62139]]

[GRAPHIC] [TIFF OMITTED] TR11OC13.012

    Under the final rule, a banking organization must calculate 
VaR^CVAunstressed using CVAUnstressed and 
VaR^CVAstressed using CVAStressed. To calculate 
the CVAUnstressed measure in Formula 3a, a banking organization must 
use the EE for a counterparty calculated using current market data to 
compute current exposures and estimate model parameters using the 
historical observation period required under section 205(b)(2) of 
subpart F. However, if a banking organization uses the ``shortcut'' 
method described in section 132(d)(5) of the final rule to capture the 
effect of a collateral agreement when estimating EAD using the IMM, the 
banking organization must calculate the EE for the counterparty using 
that method and keep that EE constant with the maturity equal to the 
maximum of half of the longest maturity occurring in the netting set, 
and the notional weighted average maturity of all transactions in the 
netting set.
    To calculate the CVAStressed measure in Formula 3a, the final rule 
requires a banking organization to use the EE for a counterparty 
calculated using the stress calibration of the IMM. However, if a 
banking organization uses the ``shortcut'' method described in section 
132(d)(5) of the final rule to capture the effect of a collateral 
agreement when estimating EAD using the IMM, the banking organization 
must calculate the EE for the counterparty using that method and keep 
that EE constant with the maturity equal to the greater of half of the 
longest maturity occurring in the netting set with the notional amount 
equal to the weighted average maturity of all transactions in the 
netting set. Consistent with Basel III, the final rule requires a 
banking organization to calibrate the VaR model inputs to historical 
data from the most severe twelve-month stress period contained within 
the three-year stress period used to calculate EE. However, the 
agencies retain the flexibility to require a banking organization to 
use a different period of significant financial stress in the 
calculation of the CVAStressed measure that better reflects actual 
historic losses of the portfolio.
    Under the final rule, a banking organization's VaR model is 
required to capture the basis between the spreads of the index that is 
used as the hedging instrument and the hedged counterparty exposure 
over various time periods, including benign and stressed environments. 
If the VaR model does not capture that basis, the banking organization 
is permitted to reflect only 50 percent of the notional amount of the 
CDSind hedge in the VaR model.
5. Cleared Transactions (Central Counterparties)
    As discussed more fully in section VIII.E of this preamble on 
cleared transactions under the standardized approach, CCPs help improve 
the safety and soundness of the derivatives and repo-style transaction 
markets through the multilateral netting of exposures, establishment 
and enforcement of collateral requirements, and market transparency. 
Similar to the changes to the cleared transaction treatment in the 
subpart D of the final rule, the requirements regarding the cleared 
transaction framework in the subpart E has been revised to reflect the 
material changes from the BCBS CCP interim framework. Key changes from 
the CCP interim framework, include: (1) Allowing a clearing member 
banking organization to use a reduced margin period of risk when using 
the IMM or a scaling factor of no less than 0.71 \202\ when using the 
CEM in the calculation of its EAD for client-facing derivative trades; 
(2) updating the risk weights applicable to a clearing member banking 
organization's exposures when the

[[Page 62140]]

clearing member banking organization guarantees QCCP performance; (3) 
permitting clearing member banking organizations to choose from one of 
two approaches for determining the capital requirement for exposures to 
default fund contributions; and (4) updating the CEM formula to 
recognize netting to a greater extent for purposes of calculating its 
risk-weighted asset amount for default fund contributions.
---------------------------------------------------------------------------

    \202\ See Table 20 in section VIII.E of this preamble. 
Consistent with the scaling factor for the CEM in Table 20, an 
advanced approaches banking organization may reduce the margin 
period of risk when using the IMM to no shorter than 5 days.
---------------------------------------------------------------------------

    Additionally, changes in response to comments received on the 
proposal, as discussed in detail in section VIII.E of this preamble 
with respect to cleared transactions in the standardized approach, are 
also reflected in the final rule for advanced approaches. Banking 
organizations seeking more information on the changes relating to the 
material elements of the BCBS CCP interim framework and the comments 
received should refer to section VIII.E of this preamble.
6. Stress Period for Own Estimates
    During the recent financial crisis, increased volatility in the 
value of collateral led to higher counterparty exposures than estimated 
by banking organizations. Under the collateral haircut approach in the 
advanced approaches final rule, consistent with the proposal, a banking 
organization that receives prior approval from its primary Federal 
supervisor may calculate market price and foreign exchange volatility 
using own internal estimates. In response to the increased volatility 
experienced during the crisis, however, the final rule modifies the 
quantitative standards for approval by requiring banking organizations 
to base own internal estimates of haircuts on a historical observation 
period that reflects a continuous 12-month period of significant 
financial stress appropriate to the security or category of securities. 
As described in section VIII.F of this preamble with respect to the 
standardized approach, a banking organization is also required to have 
policies and procedures that describe how it determines the period of 
significant financial stress used to calculate the banking 
organization's own internal estimates, and must be able to provide 
empirical support for the period used. To ensure an appropriate level 
of conservativeness, in certain circumstances a primary Federal 
supervisor may require a banking organization to use a different period 
of significant financial stress in the calculation of own internal 
estimates for haircuts. The agencies are adopting this aspect of the 
proposal without change.

B. Removal of Credit Ratings

    Consistent with the proposed rule and section 939A of the Dodd-
Frank Act, the final rule includes a number of changes to definitions 
in the advanced approaches rule that currently reference credit 
ratings.\203\ These changes are consistent with the alternative 
standards included in the Standardized Approach and alternative 
standards that already have been implemented in the agencies' market 
risk rule. In addition, the final rule includes necessary changes to 
the hierarchy for risk weighting securitization exposures necessitated 
by the removal of the ratings-based approach, as described further 
below.
---------------------------------------------------------------------------

    \203\ See 76 FR 79380 (Dec. 21, 2011).
---------------------------------------------------------------------------

    In certain instances, the final rule uses an ``investment grade'' 
standard that does not rely on credit ratings. Under the final rule and 
consistent with the market risk rule, investment grade means that the 
entity to which the banking organization is exposed through a loan or 
security, or the reference entity with respect to a credit derivative, 
has adequate capacity to meet financial commitments for the projected 
life of the asset or exposure. Such an entity or reference entity has 
adequate capacity to meet financial commitments if the risk of its 
default is low and the full and timely repayment of principal and 
interest is expected.
    The agencies are largely adopting the proposed alternatives to 
ratings as proposed. Consistent with the proposal, the agencies are 
retaining the standards used to calculate the PFE for derivative 
contracts (as set forth in Table 2 of the final rule), which are based 
in part on whether the counterparty satisfies the definition of 
investment grade under the final rule. The agencies are also adopting 
as proposed the term ``eligible double default guarantor,'' which is 
used for purposes of determining whether a banking organization may 
recognize a guarantee or credit derivative under the credit risk 
mitigation framework. In addition, the agencies are adopting the 
proposed requirements for qualifying operational risk mitigants, which 
among other criteria, must be provided by an unaffiliated company that 
the banking organization deems to have strong capacity to meet its 
claims payment obligations and the obligor rating category to which the 
banking organization assigns the company is assigned a PD equal to or 
less than 10 basis points.
1. Eligible Guarantor
    Previously, to be an eligible securitization guarantor under the 
advanced approaches rule, a guarantor was required to meet a number of 
criteria. For example, the guarantor must have issued and outstanding 
an unsecured long-term debt security without credit enhancement that 
has a long-term applicable external rating in one of the three highest 
investment-grade rating categories. The final rule replaces the term 
``eligible securitization guarantor'' with the term ``eligible 
guarantor,'' which includes certain entities that have issued and 
outstanding unsecured debt securities without credit enhancement that 
are investment grade. Comments and modifications to the definition of 
eligible guarantor are discussed below and in section VIII.F of this 
preamble.
2. Money Market Fund Approach
    Previously, under the money market fund approach in the advanced 
approaches rule, banking organizations were permitted to assign a 7 
percent risk weight to exposures to money market funds that were 
subject to SEC rule 2a-7 and that had an applicable external rating in 
the highest investment grade rating category. The proposed rule 
eliminated the money market fund approach. Commenters stated that the 
elimination of the existing 7 percent risk weight for equity exposures 
to money market funds would result in an overly stringent treatment for 
those exposures under the remaining look-through approaches. However, 
during the recent financial crisis, several money market funds 
demonstrated elevated credit risk that is not consistent with a low 7 
percent risk weight. Accordingly, the agencies believe it is 
appropriate to eliminate the preferential risk weight for money market 
fund investments. As a result of the changes, a banking organization 
must use one of the three alternative approaches under section 154 of 
the final rule to determine the risk weight for its exposures to a 
money market fund.
3. Modified Look-Through Approaches for Equity Exposures to Investment 
Funds
    Under the proposal, risk weights for equity exposures under the 
simple modified look-through approach would have been based on the 
highest risk weight assigned to the exposure under the standardized 
approach (subpart D) based on the investment limits in the fund's 
prospectus, partnership agreement, or similar contract that defines the 
fund's permissible

[[Page 62141]]

investments. As discussed in the preamble regarding the standardized 
approach, commenters expressed concerns regarding their ability to 
implement the look-through approaches for investment funds that hold 
securitization exposures. However, the agencies believe that banking 
organizations should be aware of the nature of the investments in a 
fund in which the organization invests. To the extent that information 
is not available, the treatment in the final rule will create 
incentives for banking organizations to obtain the information 
necessary to compute risk-based capital requirements under the 
approach. These incentives are consistent with the agencies' 
supervisory aim that banking organizations have sufficient 
understanding of the characteristics and risks of their investments.

C. Revisions to the Treatment of Securitization Exposures

1. Definitions
    As discussed in section VIII.H of this preamble with respect to the 
standardized approach, the proposal introduced a new definition for 
resecuritization exposures consistent with the 2009 Enhancements and 
broadened the definition of a securitization exposure. In addition, the 
agencies and the FDIC proposed to amend the existing definition of 
traditional securitization in order to exclude certain types of 
investment firms from treatment under the securitization framework. 
Consistent with the approach taken with respect to the standardized 
approach, the proposed definitions under the securitization framework 
in the advanced approach are largely finalized as proposed, except for 
changes described below. Banking organizations should refer to part 
VIII.H of this preamble for further discussion of these comments.
    In response to the proposed definition of traditional 
securitization, commenters generally agreed with the proposed 
exemptions from the definition and requested that the agencies and the 
FDIC provide exemptions for exposures to a broader set of investment 
firms, such as pension funds operated by state and local governments. 
In view of the comments regarding pension funds, the final rule, as 
described in part VIII.H of this preamble, excludes from the definition 
of traditional securitization a ``governmental plan'' (as defined in 29 
U.S.C. 1002(32)) that complies with the tax deferral qualification 
requirements provided in the Internal Revenue Code. In response to the 
proposed definition of resecuritization, commenters requested 
clarification regarding its potential scope of application to exposures 
that they believed should not be considered resecuritizations. In 
response, the agencies have amended the definition of resecuritization 
by excluding securitizations that feature re-tranching of a single 
exposure. In addition, the agencies note that for purposes of the final 
rule, a resecuritization does not include pass-through securities that 
have been pooled together and effectively re-issued as tranched 
securities. This is because the pass-through securities do not tranche 
credit protection and, as a result, are not considered securitization 
exposures under the final rule.
    Previously, under the advanced approaches rule issued in 2007, the 
definition of eligible securitization guarantor included, among other 
entities, any entity (other than a securitization SPE) that has issued 
and has outstanding an unsecured long-term debt security without credit 
enhancement that has a long-term applicable external rating in one of 
the three highest investment-grade rating categories, or has a PD 
assigned by the banking organization that is lower than or equal to the 
PD associated with a long-term external rating in the third highest 
investment-grade category. The final rule removes the existing 
references to ratings from the definition of an eligible guarantor (the 
new term for an eligible securitization guarantor) and finalizes the 
requirements as proposed, as described in section VIII.F of this 
preamble.
    During the recent financial crisis, certain guarantors of 
securitization exposures had difficulty honoring those guarantees as 
the financial condition of the guarantors deteriorated at the same time 
as the guaranteed exposures experienced losses. Consistent with the 
proposal, a guarantor is not an eligible guarantor under the final rule 
if the guarantor's creditworthiness is positively correlated with the 
credit risk of the exposures for which it has provided guarantees. In 
addition, insurance companies engaged predominately in the business of 
providing credit protection are not eligible guarantors. Further 
discussion can be found in section VIII.F of this preamble.
2. Operational Criteria for Recognizing Risk Transference in 
Traditional Securitizations
    The proposal outlined certain operational requirements for 
traditional securitizations that had to be met in order to apply the 
securitization framework. Consistent with the standardized approach as 
discussed in section VIII.H of this preamble, the agencies are adopting 
the operational criteria for recognizing risk transference in 
traditional securitizations largely as proposed.
3. The Hierarchy of Approaches
    Consistent with section 939A of the Dodd-Frank Act, the proposed 
rule removed the ratings-based approach (RBA) and internal assessment 
approach for securitization exposures. The agencies are adopting the 
hierarchy largely as proposed. Under the final rule, the hierarchy for 
securitization exposures is as follows:
    (1) A banking organization is required to deduct from common equity 
tier 1 capital any after-tax gain-on-sale resulting from a 
securitization and apply a 1,250 percent risk weight to the portion of 
a CEIO that does not constitute after-tax gain-on-sale.
    (2) If a securitization exposure does not require deduction, a 
banking organization is required to assign a risk weight to the 
securitization exposure using the SFA. The agencies expect banking 
organizations to use the SFA rather than the SSFA in all instances 
where data to calculate the SFA is available.
    (3) If the banking organization cannot apply the SFA because not 
all the relevant qualification criteria are met, it is allowed to apply 
the SSFA. A banking organization should be able to explain and justify 
(for example, based on data availability) to its primary Federal 
supervisor any instances in which the banking organization uses the 
SSFA rather than the SFA for its securitization exposures.
    The SSFA, described in detail in part VIII.H of this preamble, is 
similar in construct and function to the SFA. A banking organization 
needs several inputs to calculate the SSFA. The first input is the 
weighted-average capital requirement calculated under the standardized 
approach that applies to the underlying exposures as if they are held 
directly by the banking organization. The second and third inputs 
indicate the position's level of subordination and relative size within 
the securitization. The fourth input is the level of delinquencies 
experienced on the underlying exposures. A banking organization must 
apply the hierarchy of approaches in section 142 of this final rule to 
determine which approach it applies to a securitization exposure. The 
SSFA has been finalized as proposed, with the exception of some 
modifications to the delinquency

[[Page 62142]]

parameter, as discussed in part VIII.H of this preamble.
4. Guarantees and Credit Derivatives Referencing a Securitization 
Exposure
    The current advanced approaches rule includes methods for 
calculating risk-weighted assets for n^th-to-default credit 
derivatives, including first-to-default credit derivatives and second-
or-subsequent-to-default credit derivatives.\204\ The current advanced 
approaches rule, however, does not specify how to treat guarantees or 
credit derivatives (other than n^th-to-default credit 
derivatives) purchased or sold that reference a securitization 
exposure. Accordingly, the proposal included specific treatment for 
credit protection purchased or provided in the form of a guarantee or 
credit derivative (other than an n^th-to-default credit 
derivative) that references a securitization exposure.
---------------------------------------------------------------------------

    \204\ Nth-to-default credit derivative means a credit derivative 
that provides credit protection only for the n^th-
defaulting reference exposure in a group of reference exposures. See 
12 CFR part 3, appendix C, section 42(l) (national banks) and 12 CFR 
part 167, appendix C, section 42(l) (Federal savings associations) 
(OCC); 12 CFR part 208, appendix F, and 12 CFR part 225, appendix G 
(Board).
---------------------------------------------------------------------------

    For a guarantee or credit derivative (other than an n^th-
to-default credit derivative) where the banking organization has 
provided protection, the final rule requires a banking organization 
providing credit protection to determine the risk-based capital 
requirement for the guarantee or credit derivative as if it directly 
holds the portion of the reference exposure covered by the guarantee or 
credit derivative. The banking organization calculates its risk-based 
capital requirement for the guarantee or credit derivative by applying 
either (1) the SFA as provided in section 143 of the final rule to the 
reference exposure if the banking organization and the reference 
exposure qualify for the SFA; or (2) the SSFA as provided in section 
144 of the final rule. If the guarantee or credit derivative and the 
reference securitization exposure do not qualify for the SFA, or the 
SSFA, the banking organization is required to assign a 1,250 percent 
risk weight to the notional amount of protection provided under the 
guarantee or credit derivative.
    The final rule also clarifies how a banking organization may 
recognize a guarantee or credit derivative (other than an 
n^th-to-default credit derivative) purchased as a credit risk 
mitigant for a securitization exposure held by the banking 
organization. A banking organization that purchases an OTC credit 
derivative (other than an n^th-to-default credit derivative) 
that is recognized as a credit risk mitigant for a securitization 
exposure that is not a covered position under the market risk rule is 
not required to compute a separate counterparty credit risk capital 
requirement provided that the banking organization does so consistently 
for all such credit derivatives. The banking organization must either 
include all or exclude all such credit derivatives that are subject to 
a qualifying master netting agreement from any measure used to 
determine counterparty credit risk exposure to all relevant 
counterparties for risk-based capital purposes. If a banking 
organization cannot, or chooses not to, recognize a credit derivative 
that is a securitization exposure as a credit risk mitigant, the bank 
must determine the exposure amount of the credit derivative under the 
treatment for OTC derivatives in section 132. If the banking 
organization purchases the credit protection from a counterparty that 
is a securitization, the banking must determine the risk weight for 
counterparty credit risk according to the securitization framework. If 
the banking organization purchases credit protection from a 
counterparty that is not a securitization, the banking organization 
must determine the risk weight for counterparty credit risk according 
to general risk weights under section 131.
5. Due Diligence Requirements for Securitization Exposures
    As the recent financial crisis unfolded, weaknesses in exposures 
underlying securitizations became apparent and resulted in NRSROs 
downgrading many securitization exposures held by banking 
organizations. The agencies found that many banking organizations 
relied on NRSRO ratings as a proxy for the credit quality of 
securitization exposures they purchased and held without conducting 
their own sufficient independent credit analysis. As a result, some 
banking organizations did not have sufficient capital to absorb the 
losses attributable to these exposures. Accordingly, consistent with 
the 2009 Enhancements, the proposed rule introduced due diligence 
requirements that banking organizations would be required to undertake 
to use the SFA or SSFA. Comments received regarding the proposed due 
diligence requirements and the rationale for adopting the proposed 
treatment in the final rule are discussed in part VIII of the preamble.
6. N^th-to-Default Credit Derivatives
    Consistent with the proposal, the final rule provides that a 
banking organization that provides credit protection through an 
n^th-to-default derivative must assign a risk weight to the 
derivative using the SFA or the SSFA. In the case of credit protection 
sold, a banking organization must determine its exposure in the 
n^th-to-default credit derivative as the largest notional 
dollar amount of all the underlying exposures.
    When applying the SSFA to protection provided in the form of an 
n^th-to-default credit derivative, the attachment point 
(parameter A) is the ratio of the sum of the notional amounts of all 
underlying exposures that are subordinated to the banking 
organization's exposure to the total notional amount of all underlying 
exposures. For purposes of applying the SFA, parameter A is set equal 
to the credit enhancement level (L) used in the SFA formula. In the 
case of a first-to-default credit derivative, there are no underlying 
exposures that are subordinated to the banking organization's exposure. 
In the case of a second-or-subsequent-to default credit derivative, the 
smallest (n-1) underlying exposure(s) are subordinated to the banking 
organization's exposure.
    Under the SSFA, the detachment point (parameter D) is the sum of 
the attachment point and the ratio of the notional amount of the 
banking organization's exposure to the total notional amount of the 
underlying exposures. Under the SFA, Parameter D is set to equal L plus 
the thickness of the tranche (T) under the SFA formula. A banking 
organization that does not use the SFA or SSFA to calculate a risk 
weight for an n^th-to-default credit derivative must assign a 
risk weight of 1,250 percent to the exposure.
    For the treatment of protection purchased through a first-to-
default credit derivative, a banking organization must determine its 
risk-based capital requirement for the underlying exposures as if the 
banking organization had synthetically securitized the underlying 
exposure with the lowest risk-based capital requirement and had 
obtained no credit risk mitigant on the other underlying exposures. A 
banking organization must calculate a risk-based capital requirement 
for counterparty credit risk according to section 132 of the final rule 
for a first-to-default credit derivative that does not meet the rules 
of recognition for guarantees and credit derivatives under section 
134(b).
    For second-or-subsequent-to default credit derivatives, a banking 
organization that obtains credit protection on a group of underlying 
exposures through a n^th-to-default credit derivative that 
meets the rules of recognition of section 134(b) of the final

[[Page 62143]]

rule (other than a first-to-default credit derivative) is permitted to 
recognize the credit risk mitigation benefits of the derivative only if 
the banking organization also has obtained credit protection on the 
same underlying exposures in the form of first-through-(n-1)-to-default 
credit derivatives; or if n-1 of the underlying exposures have already 
defaulted. If a banking organization satisfies these requirements, the 
banking organization determines its risk-based capital requirement for 
the underlying exposures as if the banking organization had only 
synthetically securitized the underlying exposure with the 
n^th smallest risk-based capital requirement and had obtained 
no credit risk mitigant on the other underlying exposures. A banking 
organization that does not fulfill these requirements must calculate a 
risk-based capital requirement for counterparty credit risk according 
to section 132 of the final rule for a n^th-to-default credit 
derivative that does not meet the rules of recognition of section 
134(b) of the final rule.

D. Treatment of Exposures Subject to Deduction

    Under the current advanced approaches rule, a banking organization 
is required to deduct certain exposures from total capital, including 
securitization exposures such as CEIOs, low-rated securitization 
exposures, and high-risk securitization exposures subject to the SFA; 
eligible credit reserves shortfall; and certain failed capital markets 
transactions. Consistent with Basel III, the proposed rule required a 
banking organization to assign a 1,250 percent risk weight to many 
exposures that previously were deducted from capital, except for 
deductions from total capital of insurance underwriting subsidiaries of 
BHCs.
    In the proposal, the agencies and the FDIC noted that such 
treatment would not be equivalent to a deduction from tier 1 capital, 
as the effect of a 1,250 percent risk weight would depend on an 
individual banking organization's current risk-based capital ratios. 
Specifically, when a risk-based capital ratio (either tier 1 or total 
risk-based capital) exceeds 8.0 percent, the effect on that risk-based 
capital ratio of assigning an exposure a 1,250 percent risk weight 
would be more conservative than a deduction from total capital. The 
more a risk-based capital ratio exceeds 8.0 percent, the harsher is the 
effect of a 1,250 percent risk weight on risk-based capital ratios. 
Commenters acknowledged these points and asked the agencies and the 
FDIC to replace the 1,250 percent risk weight with the maximum risk 
weight that would correspond with deduction. Commenters also stated 
that the agencies and the FDIC should consider the effect of the 1,250 
percent risk weight given that the Basel III proposals, over time, 
would require banking organizations to maintain a total risk-based 
capital ratio of at least 10.5 percent to meet the minimum required 
capital ratio plus the capital conservation buffer.
    The agencies are adopting the requirements as proposed, in order to 
provide for comparability in risk-weighted asset measurements across 
institutions. The agencies and the FDIC did not propose to apply a 
1,250 percent risk weight to those exposures currently deducted from 
tier 1 capital under the advanced approaches rule. For example, the 
agencies and the FDIC proposed that an after-tax gain-on-sale that is 
deducted from tier 1 under the advanced approaches rule be deducted 
from common equity tier 1 under the proposed rule. In this regard, the 
agencies and the FDIC also clarified that any asset deducted from 
common equity tier 1, tier 1, or tier 2 capital under the advanced 
approaches rule would not be included in the measure of risk-weighted 
assets under the advanced approaches rule. The agencies have finalized 
these requirements as proposed.

E. Technical Amendments to the Advanced Approaches Rule

    In the proposed rule, the agencies and the FDIC introduced a number 
of amendments to the advanced approaches rule that were designed to 
refine and clarify certain aspects of the rule's implementation. The 
agencies are adopting each of these technical amendments as proposed. 
Additionally, in the final rule, the agencies are amending the 
treatment of defaulted exposures that are covered by government 
guarantees. Each of these revisions is described below.
1. Eligible Guarantees and Contingent U.S. Government Guarantees
    In order to be recognized as an eligible guarantee under the 
advanced approaches rule, the guarantee, among other criteria, must be 
unconditional. The agencies note that this definition would exclude 
certain guarantees provided by the U.S. Government or its agencies that 
would require some action on the part of the banking organization or 
some other third party. However, based on their risk characteristics, 
the agencies believe that these guarantees should be recognized as 
eligible guarantees. Therefore, the agencies are amending the 
definition of eligible guarantee so that it explicitly includes a 
contingent obligation of the U.S. Government or an agency of the U.S. 
Government, the validity of which is dependent on some affirmative 
action on the part of the beneficiary or a third party (for example, 
servicing requirements) irrespective of whether such contingent 
obligation is otherwise considered a conditional guarantee.
    Related to the change to the eligible guarantee definition, the 
agencies have amended the provision in the advanced approaches rule 
pertaining to the 10 percent floor on the LGD for residential mortgage 
exposures. Currently, the rule provides that the LGD for each segment 
of residential mortgage exposures (other than segments of residential 
mortgage exposures for which all or substantially all of the principal 
of each exposure is directly and unconditionally guaranteed by the full 
faith and credit of a sovereign entity) may not be less than 10 
percent. The provision would therefore require a 10 percent LGD floor 
on segments of residential mortgage exposures for which all or 
substantially of the principal are conditionally guaranteed by the U.S. 
government. The agencies have amended the final rule to allow an 
exception from the 10 percent floor in such cases.
2. Calculation of Foreign Exposures for Applicability of the Advanced 
Approaches--Insurance Underwriting Subsidiaries
    A banking organization is subject to the advanced approaches rule 
if it has consolidated assets greater than or equal to $250 billion, or 
if it has total consolidated on-balance sheet foreign exposures of at 
least $10 billion.\205\ For bank holding companies, in particular, the 
advanced approaches rule provides that the $250 billion threshold 
criterion excludes assets held by an insurance underwriting subsidiary. 
However, a similar provision does not exist for the $10 billion 
foreign-exposure threshold criterion. Therefore, for bank holding 
companies and covered SLHCs, the Board is excluding assets held by 
insurance underwriting subsidiaries from the $10 billion in total 
foreign exposures threshold. The Board believes such a parallel 
provision results in a more appropriate scope of application for the 
advanced approaches rule.
---------------------------------------------------------------------------

    \205\ See 12 CFR part 3, appendix C (national banks) and 12 CFR 
part 167, appendix C (Federal savings associations) (OCC); 12 CFR 
part 208, appendix F, and 12 CFR part 225, appendix G (Board).

---------------------------------------------------------------------------

[[Page 62144]]

3. Calculation of Foreign Exposures for Applicability of the Advanced 
Approaches--Changes to Federal Financial Institutions Economic Council 
009
    The agencies are revising the advanced approaches rule to comport 
with changes to the FFIEC's Country Exposure Report (FFIEC 009) that 
occurred after the issuance of the advanced approaches rule in 2007. 
Specifically, the FFIEC 009 replaced the term ``local country claims'' 
with the term ``foreign-office claims.'' Accordingly, the agencies have 
made a similar change under section 100, the section of the final rule 
that makes the rules applicable to a banking organization that has 
consolidated total on-balance sheet foreign exposures equal to $10 
billion or more. As a result, to determine total on-balance sheet 
foreign exposure, a banking organization sums its adjusted cross-border 
claims, local country claims, and cross-border revaluation gains 
calculated in accordance with FFIEC 009. Adjusted cross-border claims 
equal total cross-border claims less claims with the head office or 
guarantor located in another country, plus redistributed guaranteed 
amounts to the country of the head office or guarantor.
4. Applicability of the Final Rule
    The agencies believe that once a banking organization reaches the 
asset size or level of foreign activity that causes it to become 
subject to the advanced approaches, that it should remain subject to 
the advanced approaches rule even if it subsequently drops below the 
asset or foreign exposure threshold. The agencies believe that it is 
appropriate for the primary Federal supervisor to evaluate whether a 
banking organization's business or risk exposure has changed after 
dropping below the thresholds in a manner that it would no longer be 
appropriate for the banking organization to be subject to the advanced 
approaches. As a result, consistent with the proposal, the final rule 
clarifies that once a banking organization is subject to the advanced 
approaches rule under subpart E, it remains subject to subpart E until 
its primary Federal supervisor determines that application of the rule 
would not be appropriate in light of the banking organization's asset 
size, level of complexity, risk profile, or scope of operations. In 
connection with the consideration of a banking organization's level of 
complexity, risk profile, and scope of operations, the agencies also 
may consider a banking organization's interconnectedness and other 
relevant risk-related factors.
5. Change to the Definition of Probability of Default Related to 
Seasoning
    The advanced approaches rule requires an upward adjustment to 
estimated PD for segments of retail exposures for which seasoning 
effects are material. The rationale underlying this requirement was the 
seasoning pattern displayed by some types of retail exposures--that is, 
the exposures have very low default rates in their first year, rising 
default rates in the next few years, and declining default rates for 
the remainder of their terms. Because of the one-year internal ratings-
based (IRB) default horizon, capital based on the very low PDs for 
newly originated, or ``unseasoned,'' loans would be insufficient to 
cover the elevated risk in subsequent years. The upward seasoning 
adjustment to PD was designed to ensure that banking organizations 
would have sufficient capital when default rates for such segments rose 
predictably beginning in year two.
    Since the issuance of the advanced approaches rule, the agencies 
have found the seasoning provision to be problematic. First, it is 
difficult to ensure consistency across institutions, given that there 
is no guidance or criteria for determining when seasoning is 
``material'' or what magnitude of upward adjustment to PD is 
``appropriate.'' Second, the advanced approaches rule lacks flexibility 
by requiring an upward PD adjustment whenever there is a significant 
relationship between a segment's default rate and its age (since 
origination). For example, the upward PD adjustment may be 
inappropriate in cases where (1) the outstanding balance of a segment 
is falling faster over time (due to defaults and prepayments) than the 
default rate is rising; (2) the age (since origination) distribution of 
a portfolio is stable over time; or (3) where the loans in a segment 
are intended, with a high degree of certainty, to be sold or 
securitized within a short time period.
    Therefore, consistent with the proposal, the agencies are deleting 
the regulatory seasoning provision and will instead consider seasoning 
when evaluating a firm's assessment of its capital adequacy from a 
supervisory perspective. In addition to the difficulties in applying 
the advanced approaches rule's seasoning requirements discussed above, 
the agencies believe that seasoning is more appropriately considered 
from a supervisory perspective. First, seasoning involves the 
determination of minimum required capital for a period in excess of the 
12-month time horizon implicit in the advanced approaches risk-based 
capital ratio calculations. It thus falls more appropriately under 
longer-term capital planning and capital adequacy, which are major 
focal points of the internal capital adequacy assessment process. 
Second, seasoning is a major issue only where a banking organization 
has a concentration of unseasoned loans. The risk-based capital ratios 
do not take concentrations of any kind into account; however, they are 
an explicit factor in the internal capital adequacy assessment process.
6. Cash Items in Process of Collection
    Under the current advanced approaches rule, cash items in the 
process of collection are not assigned a risk-based capital treatment 
and, as a result, are subject to a 100 percent risk weight. Under the 
final rule, consistent with the proposal, the agencies are revising the 
advanced approaches rule to risk weight cash items in the process of 
collection at 20 percent of the carrying value, as the agencies believe 
that this treatment is more commensurate with the risk of these 
exposures. A corresponding provision is included in section 32 of the 
final rule.
7. Change to the Definition of Qualifying Revolving Exposure
    The agencies and the FDIC proposed modifying the definition of 
qualifying revolving exposure (QRE) such that certain unsecured and 
unconditionally cancellable exposures where a banking organization 
consistently imposes in practice an upper exposure limit of $100,000 
and requires payment in full every cycle would qualify as QRE. Under 
the previous definition in the advanced approaches rule, only unsecured 
and unconditionally cancellable revolving exposures with a pre-
established maximum exposure amount of $100,000 or less (such as credit 
cards) were classified as QRE. Unsecured, unconditionally cancellable 
exposures that require payment in full and have no communicated maximum 
exposure amount (often referred to as ``charge cards'') were instead 
classified as ``other retail.'' For risk-based capital purposes, this 
classification was material and generally results in substantially 
higher minimum required capital to the extent that the exposure's asset 
value correlation (AVC) would differ if classified as QRE (where it is 
assigned an AVC of 4 percent) or other retail (where AVC varies 
inversely with through-the-cycle PD estimated at the

[[Page 62145]]

segment level and can go as high as almost 16 percent for very low PD 
segments).
    Under the proposed definition, certain charge card products would 
qualify as QRE. Charge card exposures may be viewed as revolving in 
that there is an ability to borrow despite a requirement to pay in 
full. Commenters agreed that charge cards should be included as QRE 
because, compared to credit cards, they generally exhibit lower loss 
rates and loss volatility. Where a banking organization consistently 
imposes in practice an upper exposure limit of $100,000 the agencies 
believe that charge cards are more closely aligned from a risk 
perspective with credit cards than with any type of ``other retail'' 
exposure and are therefore amending the definition of QRE in order to 
more appropriately capture such products under the definition of QRE. 
With respect to a product with a balance that the borrower is required 
to pay in full every month, the exposure would qualify as QRE under the 
final rule as long as its balance does not in practice exceed $100,000. 
If the balance of an exposure were to exceed that amount, it would 
represent evidence that such a limit is not maintained in practice for 
the segment of exposures in which that exposure is placed for risk 
parameter estimation purposes. As a result, that segment of exposures 
would not qualify as QRE over the next 24 month period. In addition, 
the agencies believe that the definition of QRE should be sufficiently 
flexible to encompass products with new features that were not 
envisioned at the time of adopting the advanced approaches rule, 
provided, however, that the banking organization can demonstrate to the 
satisfaction of the primary Federal supervisor that the performance and 
risk characteristics (in particular the volatility of loss rates over 
time) of the new product are consistent with the definition and 
requirements of QRE portfolios.
8. Trade-Related Letters of Credit
    In 2011, the BCBS revised the Basel II advanced internal ratings-
based approach to remove the one-year maturity floor for trade finance 
instruments. Consistent with this revision, the proposed rule specified 
that an exposure's effective maturity must be no greater than five 
years and no less than one year, except that an exposure's effective 
maturity must be no less than one day if the exposure is a trade-
related letter of credit, or if the exposure has an original maturity 
of less than one year and is not part of a banking organization's 
ongoing financing of the obligor. Commenters requested clarification on 
whether short-term self-liquidating trade finance instruments would be 
considered exempt from the one-year maturity floor, as they do not 
constitute an ongoing financing of the obligor. In addition, commenters 
stated that applying the proposed framework for AVCs to trade-related 
letters of credit would result in banking organizations maintaining 
overly conservative capital requirements in relation to the risk of 
trade finance exposures, which could reduce the availability of trade 
finance and increase the cost of providing trade finance for businesses 
globally. As a result, commenters requested that trade finance 
exposures be assigned a separate AVC that would better reflect the 
product's low default rates and low correlation.
    The agencies believe that, in light of the removal of the one-year 
maturity floor, the proposed requirements for trade-related letters of 
credit are appropriate without a separate AVC. In the final rule, the 
agencies are adopting the treatment of trade-related letters of credit 
as proposed. Under the final rule, trade finance exposures that meet 
the stated requirements above may be assigned a maturity lower than one 
year. Section 32 of the final rule includes a provision that similarly 
recognizes the low default rates of these exposures.
9. Defaulted Exposures That Are Guaranteed by the U.S. Government
    Under the current advanced approaches rule, a banking organization 
is required to apply an 8.0 percent capital requirement to the EAD for 
each wholesale exposure to a defaulted obligor and for each segment of 
defaulted retail exposures. The advanced approaches rule does not 
recognize yet-to-be paid protection in the form of guarantees or 
insurance on defaulted exposures. For example, under certain programs, 
a U.S. government agency that provides a guarantee or insurance is not 
required to pay on claims on exposures to defaulted obligors or 
segments of defaulted retail exposures until the collateral is sold. 
The time period from default to sale of collateral can be significant 
and the exposure amount covered by such U.S. sovereign guarantees or 
insurance can be substantial.
    In order to make the treatment for exposures to defaulted obligors 
and segments of defaulted retail exposures more risk sensitive, the 
agencies have decided to amend the advanced approaches rule by 
assigning a 1.6 percent capital requirement to the portion of the EAD 
for each wholesale exposure to a defaulted obligor and each segment of 
defaulted retail exposures that is covered by an eligible guarantee 
from the U.S. government. The portion of the exposure amount for each 
wholesale exposure to a defaulted obligor and each segment of defaulted 
retail exposures not covered by an eligible guarantee from the U.S. 
government continues to be assigned an 8.0 percent capital requirement.
10. Stable Value Wraps
    The agencies are clarifying that a banking organization that 
provides stable value protection, such as through a stable value wrap 
that has provisions and conditions that minimize the wrap's exposure to 
credit risk of the underlying assets in the fund, must treat the 
exposure as if it were an equity derivative on an investment fund and 
determine the adjusted carrying value of the exposure as the sum of the 
adjusted carrying values of any on-balance sheet asset component 
determined according to section 151(b)(1) and the off-balance sheet 
component determined according to section 151(b)(2). That is, the 
adjusted carrying value is the effective notional principal amount of 
the exposure, the size of which is equivalent to a hypothetical on-
balance sheet position in the underlying equity instrument that would 
evidence the same change in fair value (measured in dollars) given a 
small change in the price of the underlying equity instrument without 
subtracting the adjusted carrying value of the on-balance sheet 
component of the exposure as calculated under the same paragraph. Risk-
weighted assets for such an exposure is determined by applying one of 
the three look-through approaches as provided in section 154 of the 
final rule.
11. Treatment of Pre-Sold Construction Loans and Multi-Family 
Residential Loans
    The final rule assigns either a 50 percent or a 100 percent risk 
weight to certain one-to-four family residential pre-sold construction 
loans under the advanced approaches rule, consistent with provisions of 
the RTCRRI Act.\206\ This treatment is consistent with the treatment 
under the general risk-based capital rules and under the standardized 
approach.
---------------------------------------------------------------------------

    \206\ See 12 U.S.C. 1831n, note.
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F. Pillar 3 Disclosures

1. Frequency and Timeliness of Disclosures
    For purposes of the final rule, a banking organization is required 
to

[[Page 62146]]

provide certain qualitative and quantitative public disclosures on a 
quarterly, or in some cases, annual basis, and these disclosures must 
be ``timely.'' Qualitative disclosures that provide a general summary 
of a banking organization's risk-management objectives and policies, 
reporting system, and definitions may be disclosed annually after the 
end of the fourth calendar quarter, provided any significant changes 
are disclosed in the interim. In the preamble to the advanced 
approaches rule, the agencies indicated that quarterly disclosures 
would be timely if they were provided within 45 days after calendar 
quarter-end. The preamble did not specify expectations regarding annual 
disclosures.
    The agencies acknowledge that timing of disclosures required under 
the federal banking laws may not always coincide with the timing of 
disclosures under other federal laws, including federal securities laws 
and their implementing regulations by the SEC. The agencies also 
indicated that a banking organization may use disclosures made pursuant 
to SEC, regulatory reporting, and other disclosure requirements to help 
meet its public disclosure requirements under the advanced approaches 
rule. For calendar quarters that do not correspond to fiscal year end, 
the agencies consider those disclosures that are made within 45 days of 
the end of the calendar quarter (or within 60 days for the limited 
purpose of the banking organization's first reporting period in which 
it is subject to the public disclosure requirements) as timely. In 
general, where a banking organization's fiscal year-end coincides with 
the end of a calendar quarter, the agencies consider qualitative and 
quantitative disclosures to be timely if they are made no later than 
the applicable SEC disclosure deadline for the corresponding Form 10-K 
annual report. In cases where an institution's fiscal year end does not 
coincide with the end of a calendar quarter, the primary Federal 
supervisor would consider the timeliness of disclosures on a case-by-
case basis. In some cases, management may determine that a significant 
change has occurred, such that the most recent reported amounts do not 
reflect the banking organization's capital adequacy and risk profile. 
In those cases, a banking organization needs to disclose the general 
nature of these changes and briefly describe how they are likely to 
affect public disclosures going forward. A banking organization should 
make these interim disclosures as soon as practicable after the 
determination that a significant change has occurred.
2. Enhanced Securitization Disclosure Requirements
    In view of the significant market uncertainty during the recent 
financial crisis caused by the lack of disclosures regarding banking 
organizations' securitization-related exposures, the agencies believe 
that enhanced disclosure requirements are appropriate. Consistent with 
the disclosures introduced by the 2009 Enhancements, the proposal 
amended the qualitative section for Table 9 disclosures 
(Securitization) under section 173 to include the following:
    [ssquf] The nature of the risks inherent in a banking 
organization's securitized assets,
    [ssquf] A description of the policies that monitor changes in the 
credit and market risk of a banking organization's securitization 
exposures,
    [ssquf] A description of a banking organization's policy regarding 
the use of credit risk mitigation for securitization exposures,
    [ssquf] A list of the special purpose entities a banking 
organization uses to securitize exposures and the affiliated entities 
that a bank manages or advises and that invest in securitization 
exposures or the referenced SPEs, and
    [ssquf] A summary of the banking organization's accounting policies 
for securitization activities.
    To the extent possible, the agencies are implementing the 
disclosure requirements included in the 2009 Enhancements in the final 
rule. However, consistent with section 939A of the Dodd-Frank Act, the 
tables do not include those disclosure requirements that are tied to 
the use of ratings.
3. Equity Holdings That Are Not Covered Positions
    The current advanced approaches rule requires banking organizations 
to include in their public disclosures a discussion of ``important 
policies covering the valuation of and accounting for equity holdings 
in the banking book.'' Since ``banking book'' is not a defined term 
under the final rule, the agencies refer to such exposures as equity 
holdings that are not covered positions in the final rule.

XIII. Market Risk Rule

    On August 30, 2012, the agencies and the FDIC revised their 
respective market risk rules to better capture positions subject to 
market risk, reduce pro-cyclicality in market risk capital 
requirements, enhance the rule's sensitivity to risks that were not 
adequately captured under the prior regulatory measurement 
methodologies, and increase transparency through enhanced 
disclosures.\207\
---------------------------------------------------------------------------

    \207\ See 77 FR 53060 (August 30, 2012).
---------------------------------------------------------------------------

    As noted in the introduction of this preamble, the agencies and the 
FDIC proposed to expand the scope of the market risk rule to include 
savings associations and SLHCs, and to codify the market risk rule in a 
manner similar to the other regulatory capital rules in the three 
proposals. In the final rule, consistent with the proposal, the 
agencies have also merged definitions and made appropriate technical 
changes.
    As a general matter, a banking organization that is subject to the 
market risk rule will continue to exclude covered positions (other than 
certain foreign exchange and commodities positions) when calculating 
its risk-weighted assets under the other risk-based capital rules. 
Instead, the banking organization must determine an appropriate capital 
requirement for such positions using the methodologies set forth in the 
final market risk rule. The banking organization then must multiply its 
market risk capital requirement by 12.5 to determine a risk-weighted 
asset amount for its market risk exposures and include that amount in 
its standardized approach risk-weighted assets and for an advanced 
approaches banking organization's advanced approaches risk-weighted 
assets.
    The market risk rule is designed to determine capital requirements 
for trading assets based on general and specific market risk associated 
with these assets. General market risk is the risk of loss in the 
market value of positions resulting from broad market movements, such 
as changes in the general level of interest rates, equity prices, 
foreign exchange rates, or commodity prices. Specific market risk is 
the risk of loss from changes in the fair value of a position due to 
factors other than broad market movements, including event risk 
(changes in market price due to unexpected events specific to a 
particular obligor or position) and default risk.
    The agencies and the FDIC proposed to apply the market risk rule to 
savings associations and SLHCs. Consistent with the proposal, the 
agencies in this final rule have expanded the scope of the market risk 
rule to savings associations and covered SLHCs that meet the stated 
thresholds. The market risk rule applies to any savings association or 
covered SLHC whose trading activity (the gross sum of its

[[Page 62147]]

trading assets and trading liabilities) is equal to 10 percent or more 
of its total assets or $1 billion or more. Each agency retains the 
authority to apply its respective market risk rule to any entity under 
its jurisdiction, regardless of whether it meets either of the 
thresholds described above, if the agency deems it necessary or 
appropriate for safe and sound banking practices.
    Application of the market risk rule to all banking organizations 
with material exposure to market risk is particularly important because 
of banking organizations' increased exposure to traded credit products, 
such as CDSs, asset-backed securities and other structured products, as 
well as other less liquid products. In fact, many of the August 2012 
revisions to the market risk rule were made in response to concerns 
that arose during the recent financial crisis when banking 
organizations holding certain trading assets suffered substantial 
losses. For example, in addition to a market risk capital requirement 
to account for general market risk, the revised rules apply more 
conservative standardized specific risk capital requirements to most 
securitization positions and implement an additional incremental risk 
capital requirement for a banking organization that models specific 
risk for one or more portfolios of debt or, if applicable, equity 
positions. Additionally, to address concerns about the appropriate 
treatment of traded positions that have limited price transparency, a 
banking organization subject to the market risk rule must have a well-
defined valuation process for all covered positions.
    The agencies and the FDIC received comments on the market risk 
rule. One commenter asserted that the effective date for application of 
the market risk rule (and the advanced approaches rule) to SLHCs should 
be deferred until at least July 21, 2015. This commenter also asserted 
that SLHCs with substantial insurance operations should be exempt from 
the advanced approaches and market risk rules if their subsidiary bank 
or savings association comprised less than 5 percent or 10 percent of 
the total assets of the SLHC. As a general matter, savings associations 
and SLHCs do not engage in trading activity to a substantial degree. 
However, the agencies believe that any savings association or covered 
SLHC whose trading activity grows to the extent that it meets either of 
the thresholds should hold capital commensurate with the risk of the 
trading activity and should have in place the prudential risk-
management systems and processes required under the market risk rule. 
Therefore, it is appropriate to expand the scope of the market risk 
rule to apply to savings associations and covered SLHCs as of January 
1, 2015.
    Another commenter asserted that the agencies and the FDIC should 
establish standardized capital requirements for trading operations 
rather than relying on risk modeling techniques because there is no way 
for regulators or market participants to judge whether bank 
calculations of market risk are meaningful. Regarding the use of 
standardized requirements for trading operations rather than reliance 
on risk modeling, banking organizations' models are subject to initial 
approval and ongoing review under the market risk rule. The agencies 
are aware that the BCBS is considering, among other options, greater 
use of standardized approaches for market risk. The agencies would 
consider modifications to the international market risk framework when 
and if it is revised.
    One commenter asserted that regulations should increase the cost of 
excessive use of short-term borrowing to fund long maturity assets. The 
agencies are considering the implications of short-term funding from 
several perspectives outside of the regulatory capital framework. 
Specifically, the agencies expect short-term funding risks would be a 
potential area of focus in forthcoming Basel III liquidity and enhanced 
prudential standards regulations.
    The agencies also have adopted conforming changes to certain 
elements of the market risk rule to reflect changes that are being made 
to other aspects of the regulatory capital framework. These changes are 
designed to correspond to the changes to the CRC references and 
treatment of securitization exposures under subparts D and E of the 
final rule, which are discussed more fully in the standardized and 
advanced approaches sections. See sections VIII.B and XII.C of this 
preamble for a discussion of these changes.
    More specifically, the market risk rule is being amended to 
incorporate a revised definition of parameter W in the SSFA. As 
discussed above, the agencies and the FDIC received comment on the 
existing definition, which assessed a capital penalty if borrowers 
exercised contractual rights to defer payment of principal or interest 
for more than 90 days on exposures underlying a securitization. In 
response to commenters, the agencies are modifying this definition to 
exclude all loans issued under Federally-guaranteed student loan 
programs, and certain consumer loans (including non-Federally 
guaranteed student loans) from being included in this component of 
parameter W.
    The agencies have made a technical amendment to the rule with 
respect to the covered position definition. Previously, the definition 
of covered position excluded equity positions that are not publicly 
traded. The agencies have refined this exception such that a covered 
position may include a position in a non-publicly traded investment 
company, as defined in and registered with the SEC under the Investment 
Company Act of 1940 (15 U.S.C. 80 a-1 et seq.) (or its non-U.S. 
equivalent), provided that all the underlying equities held by the 
investment company are publicly traded. The agencies believe that a 
``look-through'' approach is appropriate in these circumstances because 
of the of the liquidity of the underlying positions, so long as the 
other conditions of a covered position are satisfied.
    The agencies also have clarified where a banking organization 
subject to the market risk rule must make its required market risk 
disclosures and require that these disclosures be timely. The banking 
organization must provide its quantitative disclosures after each 
calendar quarter. In addition, the final rule clarifies that a banking 
organization must provide its qualitative disclosures at least 
annually, after the end of the fourth calendar quarter, provided any 
significant changes are disclosed in the interim.
    The agencies acknowledge that the timing of disclosures under the 
federal banking laws may not always coincide with the timing of 
disclosures required under other federal laws, including disclosures 
required under the federal securities laws and their implementing 
regulations by the SEC. For calendar quarters that do not correspond to 
fiscal year end, the agencies consider those disclosures that are made 
within 45 days of the end of the calendar quarter (or within 60 days 
for the limited purpose of the banking organization's first reporting 
period in which it is subject to the rule) as timely. In general, where 
a banking organization's fiscal year-end coincides with the end of a 
calendar quarter, the agencies consider qualitative and quantitative 
disclosures to be timely if they are made no later than the applicable 
SEC disclosure deadline for the corresponding Form 10-K annual report. 
In cases where an institution's fiscal year end does not coincide with 
the end of a calendar quarter, the primary Federal supervisor would 
consider the timeliness of disclosures on a case-by-case basis. In some 
cases, management may determine that a significant change has occurred,

[[Page 62148]]

such that the most recent reported amounts do not reflect the banking 
organization's capital adequacy and risk profile. In those cases, a 
banking organization needs to disclose the general nature of these 
changes and briefly describe how they are likely to affect public 
disclosures going forward. A banking organization should make these 
interim disclosures as soon as practicable after the determination that 
a significant change has occurred.
    The final rule also clarifies that a banking organization's 
management may provide all of the disclosures required by the market 
risk rule in one place on the banking organization's public Web site or 
may provide the disclosures in more than one public financial report or 
other regulatory reports, provided that the banking organization 
publicly provides a summary table specifically indicating the 
location(s) of all such disclosures.
    The Board also is issuing a notice of proposed rulemaking 
concurrently with this final rule. The notice of proposed rulemaking 
would revise the current market risk rule in Appendix E to incorporate 
the changes to the CRC references and parameter W, as discussed above.

XIV. Additional OCC Technical Amendments

    In addition to the changes described above, the OCC proposed to 
redesignate subpart C (Establishment of Minimum Capital Ratios for an 
Individual Bank), subpart D (Enforcement), and subpart E (Issuance of a 
Directive), as subparts H, I, and J, respectively. The OCC also 
proposed to redesignate section 3.100 (Capital and Surplus), as subpart 
K. The OCC proposed to carry over redesignated subpart K, which 
includes definitions of the terms ``capital'' and ``surplus'' and 
related definitions that are used for determining statutory limits 
applicable to national banks that are based on capital and surplus. In 
addition, the OCC proposed to remove appendices A, B, and C to part 3 
because they would be replaced with the new proposed framework. 
Finally, as part of the integration of the rules governing national 
banks and Federal savings associations, the OCC proposed to make part 3 
applicable to Federal savings associations, make other non-substantive, 
technical amendments, and rescind part 167 (including appendix C) 
(Capital).
    The OCC received no comments on these proposed changes and 
therefore is adopting the proposal as final, except for the following 
changes. The final rule retains the existing 12 CFR part 3, appendices 
A and B for national banks and part 167 (excluding appendix C) for 
Federal savings associations. Because the impact of many of the 
deductions and adjustments to the revised definition of capital are 
phased in over several years, national banks and Federal savings 
associations will need to use the existing rules at 12 CFR part 3, 
appendix A and 12 CFR part 167 (excluding appendix C), respectively, 
pertaining to the definition of capital to determine certain baseline 
regulatory capital amounts. Additionally, because the standardized 
approach risk-weighted asset calculations will not become effective 
until January 1, 2015, national banks and Federal savings associations 
that are not subject to the advanced approaches risk-based capital 
rules will be required to continue using the risk-weighted asset 
calculations set forth at 12 CFR part 3, appendix A and 12 CFR part 167 
(excluding appendix C), respectively, from January 1, 2014, until 
December 31, 2014. National banks that are subject to the market risk 
rule (12 CFR part 3, appendix B), but not the advanced approaches risk-
based capital rules, will need to use the 12 CFR part 3, appendix B, 
from January 1, 2014, until December 31, 2014. Finally, as noted 
earlier in this preamble, national banks and Federal savings 
associations that are subject to the advanced approaches risk-based 
rules must calculate their risk-based capital floor using the risk-
weighted asset calculations set forth at 12 CFR part 3, appendix A, and 
12 CFR part 167 (excluding appendix C), respectively, through December 
31, 2014. Beginning on January 1, 2015, national banks and Federal 
savings associations subject to the advanced approaches risk-based 
capital rules will use the standardized approach risk-weighted asset 
calculations, set forth in new subpart D, when determining their risk-
based capital floor.
    The final rule also removes existing 12 CFR part 167, appendix C 
(Risk-Based Capital Requirements--Internal-Ratings-Based and Advanced 
Measurement Approaches) because it is being replaced with new subpart 
E.
    Finally, as described in section IV.H of this preamble, in 12 CFR 
6.4(b)(5) and (c)(5) this final rule replaces the phrase ``total 
adjusted assets'' with the phrase ``average total assets'' in 12 CFR 
6.4(b)(5) and (c)(5).
    The OCC may need to make additional technical and conforming 
amendments to other OCC rules, such as Sec.  5.46, subordinated debt, 
which contains cross references to part 3 that are being changed 
pursuant to this final rule. The OCC intends to issue a separate 
rulemaking to amend other non-capital regulations that contain cross-
references to provisions of the existing capital rules at 12 CFR part 3 
and appendices A, B, or C (national banks) and 12 CFR part 167 and 
appendix C (Federal savings associations), as necessary, to reference 
the appropriate corresponding provisions of the revised rules.
    With the adoption of this final rule, as a result of the 
integration of the rules governing national banks and Federal savings 
association, all of part 3 will be applicable to Federal savings 
associations, except for subpart K (Interpretations). Thus, under the 
final rule, a Federal savings association will comply with redesignated 
subpart H (Establishment of minimum capital ratios for an individual 
bank or individual Federal savings association), subpart I 
(Enforcement), and subpart J (Issuance of a directive), rather than 12 
CFR 167.3 (Individual minimum capital requirements) and 167.4 (Capital 
directives). The provisions of subparts H, I, and J are substantively 
the same as 12 CFR 167.3 and 167.4, with a few exceptions. Sections 
3.402 (Applicability) and 167.3(b) (Appropriate considerations for 
establishing individual minimum capital requirements) both state that 
the OCC may require higher minimum capital ratios for an individual 
bank in view of its circumstances and provide examples of such 
circumstances. Likewise, both sections 3.403 (Standards for determining 
individual minimum capital ratios) and 167.3(c) (Standards for 
determination of appropriate minimum capital requirements) explain that 
the determination of the appropriate minimum capital level for an 
individual national bank or Federal savings association, respectively, 
is in part a subjective judgment based on agency expertise and these 
sections of the respective national bank and Federal savings 
association regulations provide a list factors that may be considered. 
The list of examples in sections 3.402 and 167.3(b) and in sections 
3.403 and 167.3(c) are similar, but not identical in all respects; and 
consistent with the proposal, the final rule makes no change to the 
list of examples in sections 3.402 and 3.403. The OCC notes that, while 
the final rule omits some of the examples in sections 167.3(b) and (c), 
because the list of examples is illustrative and not exclusive, the OCC 
retains the ability to consider those omitted examples and all other 
relevant items when determining individual minimum capital 
requirements.
    The procedures in Sec.  167.3(d) for responding to a notice of 
proposed

[[Page 62149]]

minimum capital ratios provide that the OCC may shorten the 30-day 
response period for good cause and limit good cause to three specific 
situations. A Federal savings association should be aware that, in 
addition to listing specific circumstances when the OCC may shorten the 
response time, the comparable provision in Sec.  3.404(b)(1) of the 
final rule provides that the OCC, in its discretion, may shorten the 
30-day response time. Thus, there may be additional circumstances in 
which the OCC may shorten the response time for a Federal savings 
association.
    Section 167.3(d)(3) (Decision) states that the OCC's written 
decision on the individual minimum capital requirement with respect to 
a Federal savings association represents final agency action. 
Consistent with the proposal, Sec.  3.404(c) (Decision) of the final 
rule does not include this statement. The OCC notes that inclusion of 
this statement is unnecessary because internal appeals of informal OCC 
enforcement actions, such as a decision on a Federal savings 
association's minimum capital requirement, are reviewable by the OCC's 
Ombudsman's Office. Therefore, omitting this statement in Sec.  
3.404(c) will have no substantive effect.
    Sections 3.601 (Purpose and scope) and Sec.  167.4(a) (Issuance of 
a capital directive), both of which address issuance of a capital 
directive, are very similar but not identical. The final rule adopts 
Sec.  3.601 as proposed. In some cases Sec.  167.4(a) includes more 
detail than Sec.  3.601, and in some cases Sec.  3.601 includes more 
detail than Sec.  167.4(a). For example, Sec.  3.601(b) states that 
violation of a directive may result in assessment of civil money 
penalties in accordance with 12 U.S.C. 3909(d), whereas Sec.  167.4(a) 
does not include such a statement. However, because the International 
Lending Supervision Act (ILSA) applies to Federal savings associations 
and 12 U.S.C. 3909(d) states that the violation of any rule, regulation 
or order issued under the ILSA may result in a civil money penalty, the 
OCC has concluded that inclusion of this language in Sec.  3.601 will 
have no substantive impact on Federal savings associations. 
Furthermore, the OCC has concluded that, notwithstanding any other 
minor differences between Sec.  3.601 and Sec.  167.4(a), those changes 
will have no substantive impact on Federal savings associations.

XV. Abbreviations

ABCP Asset-Backed Commercial Paper
ADC Acquisition, Development, or Construction
AFS Available For Sale
ALLL Allowance for Loan and Lease Losses
AOCI Accumulated Other Comprehensive Income
AVC Asset Value Correlation
BCBS Basel Committee on Banking Supervision
BCBS FAQ Basel Committee on Banking Supervision Frequently Asked 
Questions
BHC Bank Holding Company
CCF Credit Conversion Factor
CCP Central Counterparty
CDFI Community Development Financial Institution
CDS Credit Default Swap
CDSind Index Credit Default Swap
CEIO Credit-Enhancing Interest-Only Strip
CEM Current Exposure Method
CFR Code of Federal Regulations
CFPB Consumer Financial Protection Bureau
CFTC Commodity Futures Trading Commission
CPSS Committee on Payment and Settlement Systems
CRC Country Risk Classifications
CUSIP Committee on Uniform Securities Identification Procedures
CVA Credit Valuation Adjustment
DAC Deferred Acquisition Cost
DCO Derivatives Clearing Organizations
DTA Deferred Tax Asset
DTL Deferred Tax Liability
DvP Delivery-versus-Payment
E Measure of Effectiveness
EAD Exposure at Default
ECL Expected Credit Loss
EE Expected Exposure
EPE Expected Positive Exposure
ERISA Employee Retirement Income Security Act of 1974
ESOP Employee Stock Ownership Plan
FDIC Federal Deposit Insurance Corporation
FDICIA Federal Deposit Insurance Corporation Improvement Act of 1991
FFIEC Federal Financial Institutions Examination Council
FHA Federal Housing Administration
FHLB Federal Home Loan Bank
FHLMC Federal Home Loan Mortgage Corporation
FIRREA Financial Institutions, Reform, Recovery and Enforcement Act
FMU Financial Market Utility
FNMA Federal National Mortgage Association
FRFA Final Regulatory Flexibility Act
GAAP U.S. Generally Accepted Accounting Principles
GNMA Government National Mortgage Association
GSE Government-Sponsored Enterprise
HAMP Home Affordable Mortgage Program
HOLA Home Owners' Loan Act
HTM Held-To-Maturity
HVCRE High-Volatility Commercial Real Estate
IFRS International Financial Reporting Standards
IMM Internal Models Methodology
IOSCO International Organization of Securities Commissions
IRB Internal Ratings-Based
IRFA Initial Regulatory Flexibility Analysis
LGD Loss Given Default
LTV Loan-to-Value Ratio
M Effective Maturity
MBS Mortgage-backed Security
MDB Multilateral Development Bank
MDI Minority Depository Institution
MHC Mutual Holding Company
MSA Mortgage Servicing Assets
NPR Notice of Proposed Rulemaking
NRSRO Nationally Recognized Statistical Rating Organization
OCC Office of the Comptroller of the Currency
OECD Organization for Economic Co-operation and Development
OMB Office of Management and Budget
OTC Over-the-Counter
OTS Office of Thrift Supervision
PCA Prompt Corrective Action
PCCR Purchased Credit Card Relationship
PD Probability of Default
PFE Potential Future Exposure
PMI Private Mortgage Insurance
PMSR Purchased Mortgage Servicing Right
PRA Paperwork Reduction Act of 1995
PSE Public Sector Entities
PvP Payment-versus-Payment
QCCP Qualifying Central Counterparty
QIS Quantitative Impact Study
QM Qualified Mortgages
QRE Qualifying Revolving Exposure
RBA Ratings-Based Approach
RBC Risk-Based Capital
REIT Real Estate Investment Trust
Re-REMIC Resecuritization of Real Estate Mortgage Investment Conduit
RFA Regulatory Flexibility Act
RTCRRI Act Resolution Trust Corporation Refinancing, Restructuring, 
and Improvement Act of 1991
RVC Ratio of Value Change
SAP Statutory Accounting Principles
SEC U.S. Securities and Exchange Commission
SFA Supervisory Formula Approach
SLHC Savings and Loan Holding Company
SPE Special Purpose Entity
SR Supervision and Regulation Letter
SRWA Simple Risk-Weight Approach
SSFA Simplified Supervisory Formula Approach
TruPS Trust Preferred Security
TruPS CDO Trust Preferred Security Collateralized Debt Obligation
UMRA Unfunded Mandates Reform Act of 1995
U.S.C. United States Code
VA Veterans Administration
VaR Value-at-Risk
VOBA Value of Business Acquired
WAM Weighted Average Maturity

XVI. Regulatory Flexibility Act

    In general, section 4 of the Regulatory Flexibility Act (5 U.S.C. 
604) (RFA) requires an agency to prepare a final regulatory flexibility 
analysis (FRFA), for a final rule unless the agency certifies that the 
rule will not, if promulgated, have a significant economic impact on a 
substantial number of small entities (defined as of July 2, 2013, for 
purposes of the RFA to include banking entities with total assets of 
$175 million or less, and beginning on July 22, 2013, to include

[[Page 62150]]

banking entities with total assets of $500 million or less). Pursuant 
to the RFA, the agency must make the final regulatory flexibility 
analysis available to members of the public and must publish the final 
regulatory flexibility analysis, or a summary thereof, in the Federal 
Register. In accordance with section 4 of the RFA, the agencies are 
publishing the following summary of their final regulatory flexibility 
analyses.\208\
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    \208\ Each agency published separate summaries of their initial 
regulatory flexibility analyses (IRFAs) with each of the proposed 
rules in the three NPRs in accordance with Section 3(a) of the 
Regulatory Flexibility Act, 5 U.S.C. 603. In the IRFAs provided in 
connection with the proposed rules, each agency requested comment on 
all aspects of the IRFAs, and, in particular, on any significant 
alternatives to the proposed rules applicable to covered small 
banking organizations that would minimize their impact on those 
entities. In the IRFAs provided by the OCC and the FDIC in 
connection with the advanced approach proposed rule, the OCC and the 
FDIC determined that there would not be a significant economic 
impact on a substantial number of small banking organizations and 
published a certification and a short explanatory statement pursuant 
to section 605(b) of the RFA. In the IRFA provided by the Board in 
connection with the advanced approach proposed rule, the Board 
provided the information required by section 603(a) of the RFA and 
concluded that there would not be a significant economic impact on a 
substantial number of small banking organizations.
---------------------------------------------------------------------------

    For purposes of their respective FRFAs, the OCC analyzed the 
potential economic impact of the final rule on the small entities it 
regulates, including small national banks and small Federal savings 
associations; and the Board analyzed the potential economic impact on 
the small entities it regulates including small state member banks, 
small bank holding companies and small savings and loan holding 
companies.
    As discussed in more detail in section E, below, this final rule 
may have a significant economic impact on a substantial number of the 
small entities under their respective jurisdictions. Accordingly, the 
agencies have prepared the following FRFA pursuant to the RFA.

A. Statement of the Need for, and Objectives of, the Final Rule

    As discussed in the SUPPLEMENTARY INFORMATION of the preamble to 
this final rule, the agencies are revising their regulatory capital 
requirements to promote safe and sound banking practices, implement 
Basel III and other aspects of the Basel capital framework, harmonize 
capital requirements across different types of insured depository 
institutions and depository institution holding companies, and codify 
capital requirements.
    Additionally, this final rule satisfies certain requirements under 
the Dodd-Frank Act by (1) revising regulatory capital requirements to 
remove all references to, and requirements of reliance on, credit 
ratings,\209\ and (2) imposing new or revised minimum capital 
requirements on certain insured depository institutions and depository 
institution holding companies.\210\
---------------------------------------------------------------------------

    \209\ See 15 U.S.C. 78o-7, note.
    \210\ See 12 U.S.C. 5371.
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    Under section 38(c)(1) of the Federal Deposit Insurance Act, the 
agencies are required to prescribe capital standards for insured 
depository institutions that they regulate.\211\ The agencies also must 
``cause banking institutions to achieve and maintain adequate capital 
by establishing minimum levels of capital for such banking 
institutions'' under the International Lending Supervision Act.\212\ In 
addition, among other authorities, the Board may establish capital 
requirements for member banks under the Federal Reserve Act,\213\ for 
bank holding companies under the Bank Holding Company Act,\214\ and for 
savings and loan holding companies under the Home Owners Loan Act.\215\
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    \211\ See 12 U.S.C. 1831o(c).
    \212\ See 12 U.S.C. 3907.
    \213\ See 12 U.S.C. 321-338.
    \214\ See 12 U.S.C. 1844.
    \215\ See 12 U.S.C 1467a(g)(1).
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B. Summary and Assessment of Significant Issues Raised by Public 
Comments in Response to the IRFAs, and a Statement of Changes Made as a 
Result of These Comments

    The agencies and the FDIC received three public comments directly 
addressing the initial regulatory flexibility analyses (IRFAs). One 
commenter questioned the FDIC's assumption that risk-weighted assets 
would increase only 10 percent and questioned reliance on Call Report 
data for this assumption, as the commenter asserted that existing Call 
Report data does not contain the information required to accurately 
analyze the proposal's impact on risk-weighted assets (for example, 
under the Standardized Approach NPR, an increase in the risk weights 
for 1-4 family residential mortgage exposures that are balloon 
mortgages). The commenters also expressed general concern that the 
agencies and the FDIC were underestimating the compliance cost of the 
proposed rules. For instance, one commenter questioned whether small 
banking organizations would have the information required to determine 
the applicable risk weights for residential mortgage exposures, and 
stated that the cost of applying the proposed standards to existing 
exposures was underestimated. Another commenter stated that the 
agencies and the FDIC did not adequately consider the additional costs 
relating to new reporting systems, assimilating data, and preparing 
reports required under the proposed rules.
    To measure the potential impact on small entities for the purposes 
of their respective IRFAs, the agencies used the most current 
regulatory reporting data available and, to address information gaps, 
they applied conservative assumptions. The agencies considered the 
comments they received on the potential impact of the proposed rules, 
and, as discussed in Item F, below, made significant revisions to the 
final rule in response to the concerns expressed regarding the 
potential burden on small banking organizations.
    Commenters expressed concern that the agencies and the FDIC did not 
use a uniform methodology for conducting their IRFAs and suggested that 
the agencies and the FDIC should have compared their analyses prior to 
publishing the proposed rules.
    The agencies and the FDIC coordinated closely in conducting the 
IRFAs to maximize consistency among the methodologies used for 
determining the potential impact on the entities regulated by each 
agency. However, the agencies and the FDIC prepared the individual 
analyses in recognition of the differences among the organizations that 
each agency supervises. In preparing their respective FRFAs, the 
agencies and the FDIC continued to coordinate closely in order to 
ensure maximum consistency and comparability.
    One commenter questioned the alternatives described in the IRFAs. 
This commenter asserted that the alternatives were counter-productive 
and added complexity to the capital framework without any meaningful 
benefit. As discussed throughout the preamble and in Item F, below, the 
agencies have responded to commenters' concerns and sought to mitigate 
the potential compliance burden on community banking organizations 
throughout the final rule.
    The agencies and the FDIC also received a number of more general 
comments regarding the overall burden of the proposed rules. For 
example, many commenters expressed concern that the complexity and 
implementation cost of the proposed rules would exceed the expected 
benefit. According to these commenters, implementation of the proposed 
rules would require software upgrades for new internal reporting 
systems, increased employee training, and the hiring of additional 
employees for compliance purposes.

[[Page 62151]]

    A few commenters also urged the agencies and the FDIC to recognize 
that compliance costs have increased significantly over recent years 
due to other regulatory changes. As discussed throughout the preamble 
and in Item F, below, the agencies recognize the potential compliance 
costs associated with the proposals. Accordingly, for purposes of the 
final rule the agencies modified certain requirements of the proposals, 
such as the proposed mortgage treatment, to help to reduce the 
compliance burden on small banking organizations.

C. Response to Comments Filed by the Chief Counsel for Advocacy of the 
Small Business Administration, and Statement of Changes Made as a 
Result of the Comment

    The Chief Counsel for Advocacy of the Small Business Administration 
(CCA) filed a letter with the agencies and the FDIC providing comments 
on the proposed rules. The CCA generally commended the agencies and the 
FDIC for the IRFAs provided with the proposed rules, and specifically 
commended the agencies and the FDIC for considering the cumulative 
economic impact of the proposals on small banking organizations. The 
CCA acknowledged that the agencies and the FDIC provided lists of 
alternatives being considered, but encouraged the agencies and the FDIC 
to provide more detailed discussion of these alternatives and the 
potential burden reductions associated with the alternatives.
    The CCA acknowledged that the OCC and the FDIC had certified that 
the advanced approaches proposed rule would not have a significant 
economic impact on a substantial number of small banking organizations. 
The CCA noted that the Board did not provide such a certification for 
the advanced approaches proposed rule and suggested that the Board 
either provide the certification for the advanced approaches proposed 
rule or publish a more detailed IRFA, if public comments indicated that 
the advanced approaches proposed rule would have a significant economic 
impact on a substantial number of small banking organizations.
    The CCA encouraged ``the agencies to allow small banks to continue 
under the current framework of Basel I.'' The CCA also urged the 
agencies and the FDIC to give careful consideration to comments 
discussing the impact of the proposed rules on small financial 
institutions and to analyze possible alternatives to reduce this 
impact.
    The CCA expressed concern that aspects of the proposals could be 
problematic and onerous for small community banking organizations. The 
CCA stated that the proposed rules were designed for large, 
international banks and not adapted to the circumstances of community 
banking organizations. Specifically, the CCA expressed concern over 
higher risk weights for certain products, which, the CCA argued, could 
drive community banking organizations into products carrying additional 
risks. The CCA also noted heightened compliance and technology costs 
associated with implementing the proposed rules and raised the 
possibility that community banking organizations may exit the mortgage 
market.
    Although the new regulatory capital framework will carry costs, the 
supervisory interest in improved and uniform capital standards at the 
level of individual banking organizations, as well as the expected 
improvements in the safety and soundness of the U.S. banking system, 
should outweigh the increased burden on small banking organizations. 
The agencies carefully considered all comments received and, in 
particular, the comments that addressed the potential impact of the 
proposed rules on small banking organizations. As discussed throughout 
the preamble and in Item F below, the agencies have made significant 
revisions to the proposed rules that address the concerns raised in the 
CCA's comment, including with respect to the treatment of AOCI, trust 
preferred securities issued by depository holding companies with less 
than $15 billion in total consolidated assets as of December 31, 2009, 
and mortgages.

D. Description and Estimate of Small Entities Affected by the Final 
Rule

    Under regulations issued by the Small Business Administration, a 
small entity includes a depository institution, bank holding company, 
or savings and loan holding company with total assets of $175 million 
or less and beginning July 22, 2013, total assets of $500 million or 
less (a small banking organization).\216\
---------------------------------------------------------------------------

    \216\ See 13 CFR 121.201. Effective July 22, 2013, the Small 
Business Administration revised the size standards for banking 
organizations to $500 million in assets from $175 million in assets. 
78 FR 37409 (June 20, 2013).
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    As of March 31, 2013, the Board supervised approximately 636 small 
state member banks. As of December 31, 2012, there were approximately 
3,802 small bank holding companies and approximately 290 small savings 
and loan holding companies.\217\ The final rule does not apply to small 
bank holding companies that are not engaged in significant nonbanking 
activities, do not conduct significant off-balance sheet activities, 
and do not have a material amount of debt or equity securities 
outstanding that are registered with the SEC. These small bank holding 
companies remain subject to the Board's Small Bank Holding Company 
Policy Statement.\218\ Small state member banks and small savings and 
loan holding companies would be subject to the proposals in this rule.
---------------------------------------------------------------------------

    \217\ Under the prior Small Business Administration threshold of 
$175 million in assets, as of March 31, 2013 the Board supervised 
approximately 369 small state member banks. As of December 31, 2012, 
there were approximately 2,259 small bank holding companies and 
approximately 145 small savings and loan holding companies.
    \218\ See 12 CFR part 225, appendix C. Section 171 of the Dodd-
Frank provides an exemption from its requirements for bank holding 
companies subject to the Small Bank Holding Company Policy Statement 
(as in effect on May 19, 2010). Section 171 does not provide a 
similar exemption for small savings and loan holding companies and 
they are therefore subject to the proposals. 12 U.S.C. 
5371(b)(5)(C).
---------------------------------------------------------------------------

    Under the $175 million threshold, as of December 31, 2012, the OCC 
regulates 737 small entities. Under the $500 million threshold, the OCC 
regulates 1,291 small entities.\219\
---------------------------------------------------------------------------

    \219\ The OCC has calculated the number of small entities based 
on the SBA's size thresholds for commercial banks and savings 
institutions, and trust companies. Consistent with the General 
Principles of Affiliation 13 CFR Sec.  121.103(a), the OCC counts 
the assets of affiliated financial institutions when determining if 
the OCC should classify a bank the OCC supervises as a small entity. 
The OCC used December 31, 2012 to determine size because a 
``financial institution's assets are determined by averaging the 
assets reported on its four quarterly financial statements for the 
preceding year.'' See footnote 8 of the U.S. Small Business 
Administration's Table of Size Standards.
---------------------------------------------------------------------------

E. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements

    The final rule may impact covered small banking organizations in 
several ways. The final rule affects covered small banking 
organizations' regulatory capital requirements by changing the 
qualifying criteria for regulatory capital, including mandatory 
deductions and adjustments, and modifying the risk weight treatment for 
some exposures. The rule also requires covered small banking 
organizations to meet a new minimum common equity tier 1 to risk-
weighted assets ratio of 4.5 percent and an increased minimum tier 1 
capital to risk-weighted assets risk-based capital ratio of 6 percent. 
Under the final rule, all banking organizations would remain subject to 
a minimum tier 1 leverage ratio of no more than 4 percent and an 8 
percent total capital ratio.\220\ The rule

[[Page 62152]]

imposes limitations on capital distributions and discretionary bonus 
payments for covered small banking organizations that do not hold a 
buffer of common equity tier 1 capital above the minimum ratios.
---------------------------------------------------------------------------

    \220\ Banking organizations subject to the advanced approaches 
rules also would be required in 2018 to achieve a minimum tier 1 
capital to total leverage exposure ratio (the supplementary leverage 
ratio) of 3 percent. Advanced approaches banking organizations 
should refer to section 10 of subpart B of the proposed rule and 
section II.B of the preamble for a more detailed discussion of the 
applicable minimum capital ratios.
---------------------------------------------------------------------------

    For those covered small banking organizations that do not engage in 
securitization activities, derivatives activities, and do not have 
exposure to foreign sovereigns or equities, there would be limited 
changes to the way these small banking organizations are required to 
calculate risk-weighted assets. For these organizations, the only two 
risk weights that would change are those that relate to past due 
exposures and acquisition and development real estate loans.
    The final rule includes other changes to the general risk-based 
capital requirements that address the calculation of risk-weighted 
assets:
     Provides a more risk-sensitive approach to exposures to 
non-U.S. sovereigns and non-U.S. public sector entities;
     Replaces references to credit ratings with new measures of 
creditworthiness;
     Provides more comprehensive recognition of collateral and 
guarantees; and
     Provides a more favorable capital treatment for 
transactions cleared through qualifying central counterparties.\221\
---------------------------------------------------------------------------

    \221\ Section 939A of the Dodd-Frank Act requires federal 
agencies to remove references to credit ratings from regulations and 
replace credit ratings with appropriate alternatives. The final rule 
introduces alternative measures of creditworthiness for foreign 
debt, securitization positions, and resecuritization positions.
---------------------------------------------------------------------------

    As a result of the new requirements, some covered small banking 
organizations may have to alter their capital structure (including by 
raising new capital or increasing retention of earnings) in order to 
achieve the new minimum capital requirements and avoid restrictions on 
distributions of capital and discretionary bonus payments.
    The agencies have excluded from this analysis any burden associated 
with changes to the Consolidated Reports of Income and Condition for 
banks (FFIEC 031 and 041; OMB Nos. 7100-0036, 3064-0052, 1557-0081), 
the Financial Statements for Bank Holding Companies (FR Y-9; OMB No. 
7100-0128), and the Capital Assessments and Stress Testing information 
collection (FR Y-14A/Q/M; OMB No. 7100-0341). The agencies are 
proposing information collection changes to reflect the requirements of 
the final rule, and are publishing separately for comment on the 
regulatory reporting requirements that will include associated 
estimates of burden. Further analysis of the projected reporting 
requirements imposed by the final rule is located in the Paperwork 
Reduction Act section, below.
    The agencies estimate that managerial/technical, senior management, 
legal counsel, and administrative/junior analyst skills will be 
necessary for the preparation of reports and records related to this 
final rule.
Board
    To estimate the cost of capital needed to comply with the final 
rule, the Board estimated common equity tier 1, tier 1, and total risk-
based capital as defined under the more stringent eligibility standards 
for capital instruments. The Board also adjusted risk-weighted assets 
for each banking organization to estimate the impact of compliance with 
the changes under final rule and then compared each banking 
organization's risk-based capital ratios to the higher minimums 
required under the final rule. If a banking organization's new measure 
of capital under the final rule would not meet the minimums required 
for ``adequately-capitalized'' under the final rule, the Board 
considered that difference to be a ``shortfall'', or the amount of 
capital that a banking organization would need to raise in order to 
comply with the rule.\222\
---------------------------------------------------------------------------

    \222\ The Board's analysis assumed that the changes included in 
the final rule were on a fully phased-in basis. In addition, for the 
purposes of this analysis, banking organizations that did not meet 
the minimum requirements (undercapitalized institutions) under the 
current rules were excluded in order to isolate the effect of the 
rule on institutions that were otherwise adequately or well-
capitalized.
---------------------------------------------------------------------------

    To estimate each small state member bank's capital risk-based 
capital ratios under the final rule, the Board used currently available 
data from the quarterly Call Reports. The Board arrived at estimates of 
the new numerators of the capital ratios by combining various 
regulatory reporting items to reflect definitional changes to common 
equity tier 1 capital, tier 1 capital, and total capital as described 
in the final rule. The capital ratio denominator, risk-weighted assets, 
will also change under the final rule. The uniqueness of each 
institution's asset portfolio will cause the direction and extent of 
the change in the denominator to vary from institution to institution. 
The Board, however, was able to arrive at a reasonable proxy for risk-
weighted assets under the standardized approach in the final rule by 
using information that is in the Call Reports. In particular, the Board 
adjusted foreign exposures, high volatility commercial real estate, 
past-due loans, and securitization exposures to account for new risk 
weights under the final rule.
    Using the estimates of the new capital levels and standardized 
risk-weighted assets under the final rule, the Board estimated the 
capital shortfall each banking organization would encounter if the rule 
was fully phased in, as discussed above. Table 27 shows the Board's 
estimates of the number of state member banks that would not meet the 
minimum capital requirements according to Call Report data as of March 
30, 2013. This table also shows the projected Basel III capital 
shortfall for those banking organizations were the final rule fully 
implemented. Because institutions must simultaneously meet all of the 
minimum capital requirements, the largest shortfall amount represents 
our estimate of the amount of capital Board-regulated banking 
organizations will need to accumulate to meet new minimum capital 
requirements under the final rule, fully implemented.
    Because SLHCs are not currently subject to regulatory capital 
reporting requirements, the Board is unable to use reporting 
information (as was done for small state member banks) to estimate 
capital and risk-weighted assets under the final rule for small SLHCs. 
Therefore, this analysis does not include an estimation of the capital 
shortfall for small SLHCs.

[[Page 62153]]



 Table 27--Projected Number of Small State Member Banks With Less Than $500 Million in Total Assets a Basel III
 Capital Shortfall and $ Amount of Basel III Capital Shortfall Under the Standardized Approach, Fully Phased-In
----------------------------------------------------------------------------------------------------------------
                                          Projected number of state member       Projected Basel III capital
                                            banks with Basel III capital       shortfall for state member banks
                                            shortfall (fully phased-in)               (fully phased-in)
----------------------------------------------------------------------------------------------------------------
Common Equity Tier 1 to Risk-weighted                                    0                                   $0
 Assets...............................
Tier 1 to Risk-weighted Assets........                                   0                                    0
Minimum Total Capital + Conservation                                     9                                 11.3
 Buffer...............................
----------------------------------------------------------------------------------------------------------------

    As shown in Table 27, the Board estimates that all small state 
member banks that meet the minimum requirements under the current rules 
will meet both the new common equity tier 1 minimum of 4.5 percent and 
the 6 percent minimum for tier 1 capital. The Board estimates that nine 
small state member banks will need to increase capital by a combined 
$11.3 million by January 1, 2019 in order to meet the minimum total 
capital, including conservation buffer.\223\
---------------------------------------------------------------------------

    \223\ The Board estimates that under the Small Business 
Administration's prior $175 million asset threshold, all small state 
member banks that meet the minimum requirements under the current 
rules will meet both the new common equity tier 1 minimum of 4.5 
percent and the 6 percent minimum for tier 1 capital. The Board 
estimates that two small state member banks will need to increase 
capital by a combined $1.08 million by January 1, 2019 in order to 
meet the minimum total capital, including conservation buffer.
---------------------------------------------------------------------------

    To estimate the cost to small state member banks of the new capital 
requirement, the Board examined the effect of this requirement on 
capital structure and the overall cost of capital.\224\ The cost of 
financing a bank or any firm is the weighted average cost of its 
various financing sources, which amounts to a weighted average cost of 
capital reflecting many different types of debt and equity financing. 
Because interest payments on debt are tax deductible, a more leveraged 
capital structure reduces corporate taxes, thereby lowering funding 
costs, and the weighted average cost of financing tends to decline as 
leverage increases. Thus, an increase in required equity capital would 
force a bank to deleverage and--all else equal--would increase the cost 
of capital for that bank.
---------------------------------------------------------------------------

    \224\ See Merton H. Miller, (1995), ``Do the M & M propositions 
apply to banks?'' Journal of Banking & Finance, Vol. 19, pp. 483-
489.
---------------------------------------------------------------------------

    This increased cost in the most burdensome year would be tax 
benefits foregone: The capital requirement ($11.3 million), multiplied 
by the interest rate on the debt displaced and by the effective 
marginal tax rate for the banks affected by the final rule. The 
effective marginal corporate tax rate is affected not only by the 
statutory federal and state rates, but also by the probability of 
positive earnings and the offsetting effects of personal taxes on 
required bond yields. Graham (2000) considers these factors and 
estimates a median marginal tax benefit of $9.40 per $100 of interest. 
Using an estimated interest rate on debt of 6 percent, the Board 
estimated that the annual tax benefits foregone on $11.3 million of 
capital switching from debt to equity is approximately $6,391 per year 
($1.08 million * 0.06 (interest rate) * 0.094 (median marginal tax 
savings)).\225\ On average, the cost is approximately $710 per small 
state member bank per year.\226\
---------------------------------------------------------------------------

    \225\ See John R. Graham, (2000), How Big Are the Tax Benefits 
of Debt?, Journal of Finance, Vol. 55, No. 5, pp. 1901-1941. Graham 
points out that ignoring the offsetting effects of personal taxes 
would increase the median marginal tax rate to $31.5 per $100 of 
interest.
    \226\ The Board estimates that under the Small Business 
Administration's prior $175 million asset threshold, that the annual 
tax benefits foregone on $1.08 million of capital switching from 
debt to equity is approximately $610 per year ($1.08 million * 0.06 
(interest rate) * 0.094 (median marginal tax savings)). On average, 
the cost is approximately $305 per small state member bank per year 
under the $175 million threshold.
---------------------------------------------------------------------------

    As shown in Table 28, the Board also estimated that the cost of 
implementing the creditworthiness in the final rule will be 
approximately $27.3 million for small state member banks. For the nine 
small state member banks that also have to raise additional capital, 
the Board estimates that the cost of the final rule will be 
approximately $43,710. For all other small state member banks, the 
Board estimated the cost of the final rule as $43,000 per 
institution.\227\
---------------------------------------------------------------------------

    \227\ The Board estimates that under the Small Business 
Administration's prior $175 million asset threshold, the cost of 
implementing the creditworthiness in the final rule will be 
approximately $15.8 million for small state member banks (369 
institutions * $42,925 cost per institution). For the two small 
state member banks that also have to raise additional capital, the 
Board estimates that the cost of the final rule will be 
approximately $43,305. For all other small state member banks, the 
Board estimated the cost of the final rule as $43,000 per 
institution.

 Table 28--Estimated Costs of Creditworthiness Measurement Activities for State Member Banks With Less Than $500
                                             Million in Total Assets
----------------------------------------------------------------------------------------------------------------
                                       Number of        Estimated hours   Estimated cost per
           Institution               institutions       per institution       institution       Estimated cost
----------------------------------------------------------------------------------------------------------------
Small state member banks (assets                636                 505             $42,925         $27,300,300
 < $500 million)................
----------------------------------------------------------------------------------------------------------------

    Because the Board has followed phased-in approach to reporting 
requirements for savings and loan holding companies, the Board does not 
possess the same detailed financial information on small savings and 
loan holding companies as it possesses regarding other small banking 
organizations. The Board, however, sought comment on the potential 
impact of the proposed requirements on small savings and loan holding 
companies. Several commenters expressed concern that the Federal 
Reserve's Small Bank Holding Company Policy Statement does not apply to 
savings and loan holding companies with total consolidated assets less 
than $500 million. These commenters noted that small savings and loan 
holding companies presently do not have capital structures that would 
allow them to comply with the requirements of the Basel III proposal 
and requested that the Small Bank Holding Company Policy exemption be 
extended to small savings and loan holding companies.

[[Page 62154]]

    For small savings and loan holding companies, the compliance 
burdens described above may be greater than for those of other covered 
small banking organizations. Small savings and loan holding companies 
previously have not been subject to regulatory capital requirements and 
reporting requirements tied regulatory capital requirements. Small 
savings and loan holding companies may therefore need to invest 
additional resources in establishing internal systems (including 
purchasing software or hiring new personnel or training existing 
personnel) or raising capital to achieve compliance with the new 
minimum capital requirements and avoid restrictions on distributions of 
capital and discretionary bonus payments the requirements of the final 
rule.
    Covered small banking organizations that would have to raise 
additional capital to comply with the requirements of the proposals may 
incur certain costs, including costs associated with issuance of 
regulatory capital instruments. The agencies have sought to minimize 
the burden of raising additional capital by providing for transitional 
arrangements that phase-in the new capital requirements over several 
years, allowing banking organizations time to accumulate additional 
capital through retained earnings as well as raising capital in the 
market. While the final rule establishes a narrower definition of 
regulatory capital--in the form of a minimum common equity tier 1 
capital ratio, a higher minimum tier 1 capital ratio, and more 
stringent limitations on and deductions from capital--the vast majority 
of capital instruments currently held by small covered banking 
organizations, such as common stock and noncumulative perpetual 
preferred stock, would remain eligible as regulatory capital 
instruments under the proposed requirements.
OCC
    To estimate the cost of capital needed to comply with the final 
rule, the OCC estimated common equity tier 1, tier 1, and total risk-
based capital as defined under the more stringent eligibility standards 
for capital instruments. The OCC also adjusted risk-weighted assets for 
each banking organization to estimate the impact of compliance with the 
changes under final rule and then compared each banking organization's 
risk-based capital ratios to the higher minimums required under the 
final rule. If a banking organization's new measure of capital under 
the final rule would not meet the minimums required for ``adequately-
capitalized'' under the final rule, the OCC considered that difference 
to be a ``shortfall'', or the amount of capital that a banking 
organization would need to raise in order to comply with the rule.\228\
---------------------------------------------------------------------------

    \228\ The OCC's analysis assumed that the changes included in 
the final rule were on a fully phased-in basis. In addition, for the 
purposes of this analysis, the amount of additional capital 
necessary for a banking organization that is currently 
undercapitalized to meet the current requirements was excluded in 
order to isolate the effect of the final rule from the requirements 
of the current rules.
---------------------------------------------------------------------------

    To estimate each national bank or federal savings association's 
capital risk-based capital ratios under the final rule, the OCC used 
currently available data from the quarterly Call Reports. The OCC 
arrived at estimates of the new numerators of the capital ratios by 
combining various regulatory reporting items to reflect definitional 
changes to common equity tier 1 capital, tier 1 capital, and total 
capital as described in the final rule. The capital ratio denominator, 
risk-weighted assets, will also change under the final rule. The 
uniqueness of each institution's asset portfolio will cause the 
direction and extent of the change in the denominator to vary from 
institution to institution. The OCC, however, was able to arrive at a 
reasonable proxy for risk-weighted assets under the standardized 
approach in the final rule by using information that is in the Call 
Reports. In particular, the OCC adjusted foreign exposures, high 
volatility commercial real estate, past-due loans, and securitization 
exposures to account for new risk weights under the final rule.
    Using the estimates of the new capital levels and standardized 
risk-weighted assets under the final rule, the OCC estimated the 
capital shortfall each banking organization would encounter if the rule 
was fully phased in, as discussed above.
    Table 29 shows the OCC's estimates of the number of small national 
banks and federal savings associations that would not meet the minimum 
capital requirements according to Call Report data as of March 31, 
2013. Table 30, which also uses Call Report Data as of March 31, 2013, 
shows the projected Basel III capital shortfalls for those banking 
organizations during the final rule phase-in periods. Because 
institutions must simultaneously meet all of the minimum capital 
requirements, the largest shortfall amount represents our estimate of 
the amount of capital small OCC-regulated banking organizations will 
need to accumulate to meet new minimum capital requirements under the 
final rule, fully implemented.

   Table 29--Projected Cumulative Number of Institutions Short of Basel III Capital Transition Schedule, OCC-Regulated Institutions With Consolidated
                                                 Banking Assets of $500 Million or less, March 31, 2013
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                           Jan. 1, 2016
                                         Mar. 31, 2013     Jan. 1, 2014    Jan. 1, 2015        (PCA)       Jan. 1, 2017    Jan. 1, 2018    Jan. 1, 2019
--------------------------------------------------------------------------------------------------------------------------------------------------------
Common Equity to Risk-Weighted Assets                  3               8              13              22              22              22              22
Tier 1 to Risk-Weighted Assets.......                  7              14              17              31              31              31              31
Minimum Total Capital + Conservation                  23  ..............  ..............              25              28              33              41
 Buffer..............................
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 62155]]


 Table 30--Projected Cumulative Basel III Capital Shortfall, OCC-Regulated Institutions With Consolidated Banking Assets of $500 Million or Less, ($ in
                                                                Millions) March 31, 2013
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                           Jan. 1, 2016
                                         Mar. 31, 2013     Jan. 1, 2014    Jan. 1, 2015        (PCA)       Jan. 1, 2017    Jan. 1, 2018    Jan. 1, 2019
--------------------------------------------------------------------------------------------------------------------------------------------------------
Common Equity to Risk-Weighted Assets              $13.0           $33.1           $40.0           $84.9           $84.9           $84.9           $84.9
Tier 1 to Risk-Weighted Assets.......               20.9            45.5            56.5           114.9           114.9           114.9           114.9
Minimum Total Capital + Conservation                67.3  ..............  ..............            86.7           102.9           134.0           163.6
 Buffer..............................
--------------------------------------------------------------------------------------------------------------------------------------------------------

    The OCC estimates that 41 small national banks and federal savings 
associations will need to increase capital by a combined $163.6 million 
by January 1, 2019 in order to meet the minimum total capital, 
including conservation buffer.\229\
---------------------------------------------------------------------------

    \229\ The OCC estimates that under the Small Business 
Administration's prior $175 million asset threshold, 21 small OCC-
regulated institutions will need to increase capital by a combined 
$54.1 million by January 1, 2019, in order to meet the minimum total 
capital, including conservation buffer.
---------------------------------------------------------------------------

    To estimate the cost to small national banks and federal savings 
associations of the new capital requirement, the OCC examined the 
effect of this requirement on capital structure and the overall cost of 
capital.\230\ The cost of financing a bank or any firm is the weighted 
average cost of its various financing sources, which amounts to a 
weighted average cost of capital reflecting many different types of 
debt and equity financing. Because interest payments on debt are tax 
deductible, a more leveraged capital structure reduces corporate taxes, 
thereby lowering funding costs, and the weighted average cost of 
financing tends to decline as leverage increases. Thus, an increase in 
required equity capital would force a bank to deleverage and--all else 
equal--would increase the cost of capital for that bank.
---------------------------------------------------------------------------

    \230\ See Merton H. Miller, (1995), ``Do the M & M propositions 
apply to banks?'' Journal of Banking & Finance, Vol. 19, pp. 483-
489.
---------------------------------------------------------------------------

    This increased cost in the most burdensome year would be tax 
benefits foregone: The capital requirement ($163.6 million), multiplied 
by the interest rate on the debt displaced and by the effective 
marginal tax rate for the banks affected by the final rule. The 
effective marginal corporate tax rate is affected not only by the 
statutory federal and state rates, but also by the probability of 
positive earnings and the offsetting effects of personal taxes on 
required bond yields. Graham (2000) considers these factors and 
estimates a median marginal tax benefit of $9.40 per $100 of interest. 
Using an estimated interest rate on debt of 6 percent, the OCC 
estimated that the annual tax benefits foregone on $163.6 million of 
capital switching from debt to equity is approximately $0.9 million per 
year ($163.6 million * 0.06 (interest rate) * 0.094 (median marginal 
tax savings)).\231\ On average, the cost is approximately $22,500 per 
small national bank and federal savings association per year.\232\
---------------------------------------------------------------------------

    \231\ See John R. Graham, (2000), How Big Are the Tax Benefits 
of Debt?, Journal of Finance, Vol. 55, No. 5, pp. 1901-1941. Graham 
points out that ignoring the offsetting effects of personal taxes 
would increase the median marginal tax rate to $31.5 per $100 of 
interest.
    \232\ The OCC estimates that under the Small Business 
Administration's prior $175 million asset threshold, 21 small OCC-
regulated institutions will need to increase capital by a combined 
$54.1 million by January 1, 2019. The OCC estimates that the cost of 
lost tax benefits associated with increasing total capital by $54.1 
million will be approximately $0.3 million per year ($54.1 million * 
0.06 (interest rate) * 0.094 (median marginal tax savings)). On 
average, the cost is approximately $14,500 per institution per year 
under the $175 million threshold.
---------------------------------------------------------------------------

    As shown in Table 31, the OCC also estimated that the cost of 
implementing the creditworthiness in the final rule will be 
approximately $55.4 million for small national banks and federal 
savings associations ($43,00 per small OCC-regulated institution). For 
the 41 small state national banks and federal savings associations that 
also have to raise additional capital, the OCC estimates that the cost 
of the final rule will be approximately $65,500. For all other small 
national banks and federal savings associations, the OCC estimated the 
cost of the final rule as $43,000 per institution.\233\
---------------------------------------------------------------------------

    \233\ The OCC estimates that under the Small Business 
Administration's prior $175 million asset threshold, the cost of 
implementing the creditworthiness in the final rule will be 
approximately $31.6 million for small national banks and federal 
savings associations (737 institutions * $42,925 cost per 
institution). For the 41 small national banks and federal savings 
associations that also have to raise additional capital, the OCC 
estimates that the cost of the final rule will be approximately 
$57,500. For all other small national banks and federal savings 
associations, the OCC estimated the cost of the final rule as 
$43,000 per institution.

      Table 31--Estimated Costs of Creditworthiness Measurement Activities, OCC-Regulated Institutions With
                       Consolidated Banking Assets of $500 Million or Less, March 31, 2013
----------------------------------------------------------------------------------------------------------------
                                    Number of OCC-
           Institution                 regulated        Estimated hours   Estimated cost per    Estimated cost
                                     institutions       per institution       institution
----------------------------------------------------------------------------------------------------------------
Small national banks and federal              1,291                 505             $42,925         $55,416,175
 savings associations...........
----------------------------------------------------------------------------------------------------------------

To determine if the final rule has a significant economic impact on 
small entities the OCC compared the estimated annual cost with annual 
noninterest expense and annual salaries and employee benefits for each 
OCC-regulated small entity. If the estimated annual cost is greater 
than or equal to 2.5 percent of total noninterest expense or 5 percent 
of annual salaries and employee benefits, the OCC classifies the impact 
as significant. The OCC estimates that the final rule will have a 
significant economic impact on 240 small OCC-regulated entities using 
the $500 million threshold. Following the same procedure, the final 
rule will have a significant economic impact on 219

[[Page 62156]]

small OCC-regulated entities using the $175 million threshold. 
Accordingly, using five percent as the threshold for a substantial 
number of small entities, the OCC finds that under either SBA size 
threshold, the final rule will have a significant economic impact on a 
substantial number of small entities.

F. Steps Taken To Minimize the Economic Impact on Small Entities; 
Significant Alternatives

    In response to commenters' concerns about the potential 
implementation burden on small banking organizations, the agencies have 
made several significant revisions to the proposals for purposes of the 
final rule, as discussed above. Under the final rule, non-advanced 
approaches banking organizations will be permitted to elect to exclude 
amounts reported as AOCI when calculating regulatory capital, to the 
same extent currently permitted under the general risk-based capital 
rules.\234\ In addition, for purposes of calculating risk-weighted 
assets under the standardized approach, the agencies are not adopting 
the proposed treatment for 1-4 family residential mortgages, which 
would have required banking organizations to categorize residential 
mortgage loans into one of two categories based on certain underwriting 
standards and product features, and then risk weight each loan based on 
its loan-to-value ratio. The agencies also are retaining the 120-day 
safe harbor from recourse treatment for loans transferred pursuant to 
an early default provision. The agencies believe that these changes 
will meaningfully reduce the compliance burden of the final rule for 
small banking organizations. For instance, in contrast to the proposal, 
the final rule does not require banking organizations to review 
existing mortgage loan files, purchase new software to track loan-to-
value ratios, train employees on the new risk-weight methodology, or 
hold more capital for exposures that would have been deemed category 2 
under the proposed rule, removing the proposed distinction between risk 
weights for category 1 and 2 residential mortgage exposures.
---------------------------------------------------------------------------

    \234\ For most non-advanced approaches banking organizations, 
this will be a one-time only election. However, in certain limited 
circumstances, such as a merger of organizations that have made 
different elections, the primary Federal supervisory may permit the 
resultant entity to make a new election.
---------------------------------------------------------------------------

    Similarly, the option to elect to retain the current treatment of 
AOCI will reduce the burden associated with managing the volatility in 
regulatory capital resulting from changes in the value of a banking 
organization's AFS debt securities portfolio due to shifting interest 
rate environments. Additionally, the final rule grandfathers the 
regulatory capital treatment of trust preferred securities issued by 
certain small banking organizations prior to May 19, 2010, as permitted 
by section 171 of the Dodd-Frank Act, to reduce the amount of capital 
small banking organizations must raise to comply with the final rule. 
These modifications to the proposed rule should substantially reduce 
compliance burden for small banking organizations.
    This Supplementary Information section includes statements of 
factual, policy, and legal reasons for selecting alternatives adopted 
in this final rule and why each one of the other significant 
alternatives to the final rule considered by the agencies and which 
affect small entities was rejected.

XVII. Paperwork Reduction Act

    In accordance with the requirements of the Paperwork Reduction Act 
(PRA) of 1995 (44 U.S.C. 3501-3521), the agencies may not conduct or 
sponsor, and the respondent is not required to respond to, an 
information collection unless it displays a currently valid Office of 
Management and Budget (OMB) control number.
    In conjunction with the proposed rules, the OCC and FDIC submitted 
the information collection requirements contained therein to OMB for 
review. In response, OMB filed comments with the OCC and FDIC in 
accordance with 5 CFR 1320.11(c) withholding PRA approval and 
instructing that the collection should be resubmitted to OMB at the 
final rule stage. As instructed by OMB, the information collection 
requirements contained in this final rule have been submitted by the 
OCC and FDIC to OMB for review under the PRA, under OMB Control Nos. 
1557-0234 and 3064-0153. In accordance with the PRA (44 U.S.C. 3506; 5 
CFR part 1320, Appendix A.1), the Board has reviewed the final rule 
under the authority delegated by OMB. The Board's OMB Control No. is 
7100-0313.
    The final rule contains information collection requirements subject 
to the PRA. They are found in sections --.3, --.22, --.35, --.37, 
--.41, --.42, --.62, --.63 (including tables), --.121 through --.124, 
--.132, --.141, --.142, --.153, --.173 (including tables). The 
information collection requirements contained in sections --.203 
through --.212 concerning market risk are approved by OMB under Control 
Nos. 1557-0247, 7100-0314, and 3064-0178.
    A total of nine comments were received concerning paperwork. Seven 
expressed concern regarding the increase in paperwork resulting from 
the rule. They addressed the concept of paperwork generally and not 
within the context of the PRA.
    One comment addressed cost, competitiveness, and qualitative impact 
statements, and noted the lack of cost estimates. It was unclear 
whether the commenter was referring to cost estimates for regulatory 
burden, which are included in the preamble to the rule, or cost 
estimates regarding the PRA burden, which are included in the 
submissions (information collection requests) made to OMB by the 
agencies regarding the final rule. All of the agencies' submissions are 
publicly available at www.reginfo.gov.
    One commenter seemed to indicate that the agencies' and the FDIC's 
burden estimates are overstated. The commenter stated that, for their 
institution, the PRA burden will parallel that of interest rate risk 
(240 hours per year). The agencies' estimates far exceed that figure, 
so no change to the estimates would be necessary. The agencies' 
continue to believe that their estimates are reasonable averages that 
are not overstated.
    The agencies have an ongoing interest in your comments. Comments 
are invited on:
    (a) Whether the collection of information is necessary for the 
proper performance of the agencies' functions, including whether the 
information has practical utility;
    (b) The accuracy of the estimates of the burden of the information 
collection, including the validity of the methodology and assumptions 
used;
    (c) Ways to enhance the quality, utility, and clarity of the 
information to be collected;
    (d) Ways to minimize the burden of the information collection on 
respondents, including through the use of automated collection 
techniques or other forms of information technology; and
    (e) Estimates of capital or start-up costs and costs of operation, 
maintenance, and purchase of services to provide information.

XVIII. Plain Language

    Section 722 of the Gramm-Leach-Bliley Act requires the Federal 
banking agencies to use plain language in all proposed and rules 
published after January 1, 2000. The agencies have sought to present 
the proposed rule in a simple and straightforward manner and did not 
receive any comments on the use of plain language.

[[Page 62157]]

XIX. OCC Unfunded Mandates Reform Act of 1995 Determinations

    Section 202 of the Unfunded Mandates Reform Act of 1995 (UMRA) (2 
U.S.C. 1532 et seq.) requires that an agency prepare a written 
statement before promulgating a rule that includes a Federal mandate 
that may result in the expenditure by State, local, and Tribal 
governments, in the aggregate, or by the private sector of $100 million 
or more (adjusted annually for inflation) in any one year. If a written 
statement is required, the UMRA (2 U.S.C. 1535) also requires an agency 
to identify and consider a reasonable number of regulatory alternatives 
before promulgating a rule and from those alternatives, either select 
the least costly, most cost-effective or least burdensome alternative 
that achieves the objectives of the rule, or provide a statement with 
the rule explaining why such an option was not chosen.
    Under this rule, the changes to minimum capital requirements 
include a new common equity tier 1 capital ratio, a higher minimum tier 
1 capital ratio, a supplementary leverage ratio for advanced approaches 
banks, new thresholds for prompt corrective action purposes, a new 
capital conservation buffer, and a new countercyclical capital buffer 
for advanced approaches banks. To estimate the impact of this rule on 
bank capital needs, the OCC estimated the amount of capital banks will 
need to raise to meet the new minimum standards relative to the amount 
of capital they currently hold. To estimate new capital ratios and 
requirements, the OCC used currently available data from banks' 
quarterly Consolidated Reports of Condition and Income (Call Reports) 
to approximate capital under the proposed rule. Most banks have raised 
their capital levels well above the existing minimum requirements and, 
after comparing existing levels with the proposed new requirements, the 
OCC has determined that its proposed rule will not result in 
expenditures by State, local, and Tribal governments, or by the private 
sector, of $100 million or more. Accordingly, the UMRA does not require 
that a written statement accompany this rule.

Text of Common Rule

Part [----]--CAPITAL ADEQUACY OF [BANK]s

Sec.
Subpart A--General Provisions
--.1 Purpose, applicability, reservations of authority, and timing.
--.2 Definitions.
--.3 Operational requirements for certain exposures.
--.4 through --.9 [RESERVED]
Subpart B--Capital Ratio Requirements and Buffers
--.10 Minimum capital requirements.
--.11 Capital conservation buffer and countercyclical capital buffer 
amount.
--.12 through --.19 [RESERVED]
Subpart C--Definition of Capital
--.20 Capital components and eligibility criteria for regulatory 
capital instruments.
--.21 Minority interest.
--.22 Regulatory capital adjustments and deductions.
--.23 through --.29 [RESERVED]
Subpart D--Risk-weighted Assets--Standardized Approach
--.30 Applicability.

Risk-Weighted Assets for General Credit Risk

--.31 Mechanics for calculating risk-weighted assets for general 
credit risk.
--.32 General risk weights.
--.33 Off-balance sheet exposures.
--.34 OTC derivative contracts.
--.35 Cleared transactions.
--.36 Guarantees and credit derivatives: Substitution treatment.
--.37 Collateralized transactions.

Risk-Weighted Assets for Unsettled Transactions

--.38 Unsettled transactions.
--.39 through --.40 [RESERVED]

Risk-Weighted Assets for Securitization Exposures

--.41 Operational requirements for securitization exposures.
--.42 Risk-weighted assets for securitization exposures.
--.43 Simplified supervisory formula approach (SSFA) and the gross-
up approach.
--.44 Securitization exposures to which the SSFA and gross-up 
approach do not apply.
--.45 Recognition of credit risk mitigants for securitization 
exposures.
--.46 through --.50 [RESERVED]

Risk-Weighted Assets for Equity Exposures

--.51 Introduction and exposure measurement.
--.52 Simple risk-weight approach (SRWA).
--.53 Equity exposures to investment funds.
--.54 through --.60 [RESERVED]

Disclosures

--.61 Purpose and scope.
--.62 Disclosure requirements.
--.63 Disclosures by [BANK]s described in Sec.  --.61.
--.64 through --.99 [RESERVED]
Subpart E--Risk-Weighted Assets--Internal Ratings-Based and Advanced 
Measurement Approaches
--.100 Purpose, applicability, and principle of conservatism.
--.101 Definitions.
--.102 through --.120 [RESERVED]

Qualification

--.121 Qualification process.
--.122 Qualification requirements.
--.123 Ongoing qualification.
--.124 Merger and acquisition transitional arrangements.
--.125 through --.130 [RESERVED]

Risk-Weighted Assets For General Credit Risk

--.131 Mechanics for calculating total wholesale and retail risk-
weighted assets.
--.132 Counterparty credit risk of repo-style transactions, eligible 
margin loans, and OTC derivative contracts.
--.133 Cleared transactions.
--.134 Guarantees and credit derivatives: PD substitution and LGD 
adjustment approaches.
--.135 Guarantees and credit derivatives: Double default treatment.
--.136 Unsettled transactions.
--.137 through --.140 [RESERVED]

Risk-Weighted Assets for Securitization Exposures

--.141 Operational criteria for recognizing the transfer of risk.
--.142 Risk-weighted assets for securitization exposures.
--.143 Supervisory formula approach (SFA).
--.144 Simplified supervisory formula approach (SSFA).
--.145 Recognition of credit risk mitigants for securitization 
exposures.
--.146 through --.150 [RESERVED]

Risk-Weighted Assets For Equity Exposures

--.151 Introduction and exposure measurement.
--.152 Simple risk weight approach (SRWA).
--.153 Internal models approach (IMA).
--.154 Equity exposures to investment funds.
--.155 Equity derivative contracts.
--.166 through --.160 [RESERVED]

Risk-Weighted Assets For Operational Risk

--.161 Qualification requirements for incorporation of operational 
risk mitigants.
--.162 Mechanics of risk-weighted asset calculation.
--.163 through --.170 [RESERVED]

Disclosures

--.171 Purpose and scope.
--.172 Disclosure requirements.
--.173 Disclosures by certain advanced approaches [BANKS].
--.174 through --.200 [RESERVED]
Subpart F--Risk-weighted Assets--Market Risk
--.201 Purpose, applicability, and reservation of authority.
--.202 Definitions.
--.203 Requirements for application of this subpart F.
--.204 Measure for market risk.
--.205 VaR-based measure.

[[Page 62158]]

--.206 Stressed VaR-based measure.
--.207 Specific risk.
--.208 Incremental risk.
--.209 Comprehensive risk.
--.210 Standardized measurement method for specific risk.
--.211 Simplified supervisory formula approach (SSFA).
--.212 Market risk disclosures.
--.213 through --.299 [RESERVED]

Subpart G--Transition Provisions

--.300 Transitions.

Subpart A--General Provisions


Sec.  --.1  Purpose, applicability, reservations of authority, and 
timing.

    (a) Purpose. This [PART] establishes minimum capital requirements 
and overall capital adequacy standards for [BANK]s. This [PART] 
includes methodologies for calculating minimum capital requirements, 
public disclosure requirements related to the capital requirements, and 
transition provisions for the application of this [PART].
    (b) Limitation of authority. Nothing in this [PART] shall be read 
to limit the authority of the [AGENCY] to take action under other 
provisions of law, including action to address unsafe or unsound 
practices or conditions, deficient capital levels, or violations of law 
or regulation, under section 8 of the Federal Deposit Insurance Act.
    (c) Applicability. Subject to the requirements in paragraphs (d) 
and (f) of this section:
    (1) Minimum capital requirements and overall capital adequacy 
standards. Each [BANK] must calculate its minimum capital requirements 
and meet the overall capital adequacy standards in subpart B of this 
part.
    (2) Regulatory capital. Each [BANK] must calculate its regulatory 
capital in accordance with subpart C of this part.
    (3) Risk-weighted assets. (i) Each [BANK] must use the 
methodologies in subpart D of this part (and subpart F of this part for 
a market risk [BANK]) to calculate standardized total risk-weighted 
assets.
    (ii) Each advanced approaches [BANK] must use the methodologies in 
subpart E (and subpart F of this part for a market risk [BANK]) to 
calculate advanced approaches total risk-weighted assets.
    (4) Disclosures. (i) Except for an advanced approaches [BANK] that 
is making public disclosures pursuant to the requirements in subpart E 
of this part, each [BANK] with total consolidated assets of $50 billion 
or more must make the public disclosures described in subpart D of this 
part.
    (ii) Each market risk [BANK] must make the public disclosures 
described in subpart F of this part.
    (iii) Each advanced approaches [BANK] must make the public 
disclosures described in subpart E of this part.
    (d) Reservation of authority. (1) Additional capital in the 
aggregate. The [AGENCY] may require a [BANK] to hold an amount of 
regulatory capital greater than otherwise required under this part if 
the [AGENCY] determines that the [BANK]'s capital requirements under 
this part are not commensurate with the [BANK]'s credit, market, 
operational, or other risks.
    (2) Regulatory capital elements. (i) If the [AGENCY] determines 
that a particular common equity tier 1, additional tier 1, or tier 2 
capital element has characteristics or terms that diminish its ability 
to absorb losses, or otherwise present safety and soundness concerns, 
the [AGENCY] may require the [BANK] to exclude all or a portion of such 
element from common equity tier 1 capital, additional tier 1 capital, 
or tier 2 capital, as appropriate.
    (ii) Notwithstanding the criteria for regulatory capital 
instruments set forth in subpart C of this part, the [AGENCY] may find 
that a capital element may be included in a [BANK]'s common equity tier 
1 capital, additional tier 1 capital, or tier 2 capital on a permanent 
or temporary basis consistent with the loss absorption capacity of the 
element and in accordance with Sec.  --.20(e).
    (3) Risk-weighted asset amounts. If the [AGENCY] determines that 
the risk-weighted asset amount calculated under this part by the [BANK] 
for one or more exposures is not commensurate with the risks associated 
with those exposures, the [AGENCY] may require the [BANK] to assign a 
different risk-weighted asset amount to the exposure(s) or to deduct 
the amount of the exposure(s) from its regulatory capital.
    (4) Total leverage. If the [AGENCY] determines that the leverage 
exposure amount, or the amount reflected in the [BANK]'s reported 
average total consolidated assets, for an on- or off-balance sheet 
exposure calculated by a [BANK] under Sec.  --.10 is inappropriate for 
the exposure(s) or the circumstances of the [BANK], the [AGENCY] may 
require the [BANK] to adjust this exposure amount in the numerator and 
the denominator for purposes of the leverage ratio calculations.
    (5) Consolidation of certain exposures. The [AGENCY] may determine 
that the risk-based capital treatment for an exposure or the treatment 
provided to an entity that is not consolidated on the [BANK]'s balance 
sheet is not commensurate with the risk of the exposure and the 
relationship of the [BANK] to the entity. Upon making this 
determination, the [AGENCY] may require the [BANK] to treat the 
exposure or entity as if it were consolidated on the balance sheet of 
the [BANK] for purposes of determining the [BANK]'s risk-based capital 
requirements and calculating the [BANK]'s risk-based capital ratios 
accordingly. The [AGENCY] will look to the substance of, and risk 
associated with, the transaction, as well as other relevant factors the 
[AGENCY] deems appropriate in determining whether to require such 
treatment.
    (6) Other reservation of authority. With respect to any deduction 
or limitation required under this part, the [AGENCY] may require a 
different deduction or limitation, provided that such alternative 
deduction or limitation is commensurate with the [BANK]'s risk and 
consistent with safety and soundness.
    (e) Notice and response procedures. In making a determination under 
this section, the [AGENCY] will apply notice and response procedures in 
the same manner as the notice and response procedures in [12 CFR 3.404, 
(OCC); 12 CFR 263.202 (Board)].
    (f) Timing. (1) Subject to the transition provisions in subpart G 
of this part, an advanced approaches [BANK] that is not a savings and 
loan holding company must:
    (i) Except as described in paragraph (f)(1)(ii) of this section, 
beginning on January 1, 2014, calculate advanced approaches total risk-
weighted assets in accordance with subpart E and, if applicable, 
subpart F of this part and, beginning on January 1, 2015, calculate 
standardized total risk-weighted assets in accordance with subpart D 
and, if applicable, subpart F of this part;
    (ii) From January 1, 2014 to December 31, 2014:
    (A) Calculate risk-weighted assets in accordance with the general 
risk-based capital rules under [12 CFR part 3, appendix A and, if 
applicable, appendix B (national banks), or 12 CFR part 167 (Federal 
savings associations) (OCC); 12 CFR parts 208 or 225, appendix A, and, 
if applicable, appendix E (state member banks or bank holding 
companies, respectively) (Board)] \1\ and substitute

[[Page 62159]]

such risk-weighted assets for standardized total risk-weighted assets 
for purposes of Sec.  --.10;
---------------------------------------------------------------------------

    \1\ For the purpose of calculating its general risk-based 
capital ratios from January 1, 2014 to December 31, 2014, an 
advanced approaches [BANK] shall adjust, as appropriate, its risk-
weighted asset measure (as that amount is calculated under [12 CFR 
part 3, appendix A, Sec. 3 and, if applicable, 12 CFR part 3, 
appendix B (national banks), or 12 CFR part 167 (Federal savings 
associations) (OCC); 12 CFR parts 208 and 225, and, if applicable, 
appendix E (state member banks or bank holding companies, 
respectively) (Board)] in the general risk-based capital rules) by 
excluding those assets that are deducted from its regulatory capital 
under Sec.  --.22.
---------------------------------------------------------------------------

    (B) If applicable, calculate general market risk equivalent assets 
in accordance with [12 CFR part 3, appendix B, section 4(a)(3) 
(national banks) (OCC); 12 CFR parts 208 or 225, appendix E, section 
4(a)(3) (state member banks or bank holding companies, respectively) 
(Board); and 12 CFR part 325, appendix C, section 4(a)(3) (state 
nonmember banks and state savings associations)] and substitute such 
general market risk equivalent assets for standardized market risk-
weighted assets for purposes of Sec.  --.20(d)(3); and
    (C) Substitute the corresponding provision or provisions of [12 CFR 
part 3, appendix A, and, if applicable, appendix B (national banks), or 
12 CFR part 167 (Federal savings associations) (OCC)); 12 CFR parts 208 
or 225, appendix A, and, if applicable, appendix E (state member banks 
or bank holding companies, respectively) (Board)] for any reference to 
subpart D of this part in: Sec.  --.121(c); Sec.  --.124(a) and (b); 
Sec.  --.144(b); Sec.  --.154(c) and (d); Sec.  --.202(b) (definition 
of covered position in paragraph (b)(3)(iv)); and Sec.  --.211(b);\2\
---------------------------------------------------------------------------

    \2\ In addition, for purposes of Sec.  --.201(c)(3), from 
January 1, 2014 to December 31, 2014, for any circumstance in which 
the [AGENCY] may require a [BANK] to calculate risk-based capital 
requirements for specific positions or portfolios under subpart D of 
this part, the [AGENCY] will instead require the [BANK] to make such 
calculations according to [12 CFR part 3, appendix A, Sec. 3, 
appendix A, section 3 and, if applicable, 12 CFR part 3, appendix B 
(national banks), or 12 CFR part 167 (Federal savings associations) 
(OCC); 12 CFR parts 208 and 225, appendix A and, if applicable, 
appendix E (state member banks or bank holding companies, 
respectively) (Board)].
---------------------------------------------------------------------------

    (iii) Beginning on January 1, 2014, calculate and maintain minimum 
capital ratios in accordance with subparts A, B, and C of this part, 
provided, however, that such [BANK] must:
    (A) From January 1, 2014 to December 31, 2014, maintain a minimum 
common equity tier 1 capital ratio of 4 percent, a minimum tier 1 
capital ratio of 5.5 percent, a minimum total capital ratio of 8 
percent, and a minimum leverage ratio of 4 percent; and
    (B) From January 1, 2015 to December 31, 2017, an advanced 
approaches [BANK]:
    (1) Is not required to maintain a supplementary leverage ratio; and
    (2) Must calculate a supplementary leverage ratio in accordance 
with Sec.  --.10(c), and must report the calculated supplementary 
leverage ratio on any applicable regulatory reports.
    (2) Subject to the transition provisions in subpart G of this part, 
a [BANK] that is not an advanced approaches [BANK] or a savings and 
loan holding company that is an advanced approaches [BANK] must:
    (i) Beginning on January 1, 2015, calculate standardized total 
risk-weighted assets in accordance with subpart D, and if applicable, 
subpart F of this part; and
    (ii) Beginning on January 1, 2015, calculate and maintain minimum 
capital ratios in accordance with subparts A, B and C of this part, 
provided, however, that from January 1, 2015 to December 31, 2017, a 
savings and loan holding company that is an advanced approaches [BANK]:
    (A) Is not required to maintain a supplementary leverage ratio; and
    (B) Must calculate a supplementary leverage ratio in accordance 
with Sec.  --.10(c), and must report the calculated supplementary 
leverage ratio on any applicable regulatory reports.
    (3) Beginning on January 1, 2016, and subject to the transition 
provisions in subpart G of this part, a [BANK] is subject to 
limitations on distributions and discretionary bonus payments with 
respect to its capital conservation buffer and any applicable 
countercyclical capital buffer amount, in accordance with subpart B of 
this part.


Sec.  --.2  Definitions.

    As used in this part:
    Additional tier 1 capital is defined in Sec.  --.20(c).
    Advanced approaches [BANK] means a [BANK] that is described in 
Sec.  --.100(b)(1).
    Advanced approaches total risk-weighted assets means:
    (1) The sum of:
    (i) Credit-risk-weighted assets;
    (ii) Credit valuation adjustment (CVA) risk-weighted assets;
    (iii) Risk-weighted assets for operational risk; and
    (iv) For a market risk [BANK] only, advanced market risk-weighted 
assets; minus
    (2) Excess eligible credit reserves not included in the [BANK]'s 
tier 2 capital.
    Advanced market risk-weighted assets means the advanced measure for 
market risk calculated under Sec.  --.204 multiplied by 12.5.
    Affiliate with respect to a company, means any company that 
controls, is controlled by, or is under common control with, the 
company.
    Allocated transfer risk reserves means reserves that have been 
established in accordance with section 905(a) of the International 
Lending Supervision Act, against certain assets whose value U.S. 
supervisory authorities have found to be significantly impaired by 
protracted transfer risk problems.
    Allowances for loan and lease losses (ALLL) means valuation 
allowances that have been established through a charge against earnings 
to cover estimated credit losses on loans, lease financing receivables 
or other extensions of credit as determined in accordance with GAAP. 
ALLL excludes ``allocated transfer risk reserves.'' For purposes of 
this part, ALLL includes allowances that have been established through 
a charge against earnings to cover estimated credit losses associated 
with off-balance sheet credit exposures as determined in accordance 
with GAAP.
    Asset-backed commercial paper (ABCP) program means a program 
established primarily for the purpose of issuing commercial paper that 
is investment grade and backed by underlying exposures held in a 
bankruptcy-remote special purpose entity (SPE).
    Asset-backed commercial paper (ABCP) program sponsor means a [BANK] 
that:
    (1) Establishes an ABCP program;
    (2) Approves the sellers permitted to participate in an ABCP 
program;
    (3) Approves the exposures to be purchased by an ABCP program; or
    (4) Administers the ABCP program by monitoring the underlying 
exposures, underwriting or otherwise arranging for the placement of 
debt or other obligations issued by the program, compiling monthly 
reports, or ensuring compliance with the program documents and with the 
program's credit and investment policy.
    Bank holding company means a bank holding company as defined in 
section 2 of the Bank Holding Company Act.
    Bank Holding Company Act means the Bank Holding Company Act of 
1956, as amended (12 U.S.C. 1841 et seq.).
    Bankruptcy remote means, with respect to an entity or asset, that 
the entity or asset would be excluded from an insolvent entity's estate 
in receivership, insolvency, liquidation, or similar proceeding.
    Call Report means Consolidated Reports of Condition and Income.
    Carrying value means, with respect to an asset, the value of the 
asset on the balance sheet of the [BANK], determined in accordance with 
GAAP.
    Central counterparty (CCP) means a counterparty (for example, a 
clearing house) that facilitates trades between counterparties in one 
or more financial markets by either guaranteeing trades or novating 
contracts.
    CFTC means the U.S. Commodity Futures Trading Commission.

[[Page 62160]]

    Clean-up call means a contractual provision that permits an 
originating [BANK] or servicer to call securitization exposures before 
their stated maturity or call date.
    Cleared transaction means an exposure associated with an 
outstanding derivative contract or repo-style transaction that a [BANK] 
or clearing member has entered into with a central counterparty (that 
is, a transaction that a central counterparty has accepted).
    (1) The following transactions are cleared transactions:
    (i) A transaction between a CCP and a [BANK] that is a clearing 
member of the CCP where the [BANK] enters into the transaction with the 
CCP for the [BANK]'s own account;
    (ii) A transaction between a CCP and a [BANK] that is a clearing 
member of the CCP where the [BANK] is acting as a financial 
intermediary on behalf of a clearing member client and the transaction 
offsets another transaction that satisfies the requirements set forth 
in Sec.  --.3(a);
    (iii) A transaction between a clearing member client [BANK] and a 
clearing member where the clearing member acts as a financial 
intermediary on behalf of the clearing member client and enters into an 
offsetting transaction with a CCP, provided that the requirements set 
forth in Sec.  --.3(a) are met; or
    (iv) A transaction between a clearing member client [BANK] and a 
CCP where a clearing member guarantees the performance of the clearing 
member client [BANK] to the CCP and the transaction meets the 
requirements of Sec.  --.3(a)(2) and (3).
    (2) The exposure of a [BANK] that is a clearing member to its 
clearing member client is not a cleared transaction where the [BANK] is 
either acting as a financial intermediary and enters into an offsetting 
transaction with a CCP or where the [BANK] provides a guarantee to the 
CCP on the performance of the client.\3\
---------------------------------------------------------------------------

    \3\ For the standardized approach treatment of these exposures, 
see Sec.  --.34(e) (OTC derivative contracts) or Sec.  --.37(c) 
(repo-style transactions). For the advanced approaches treatment of 
these exposures, see Sec. Sec.  --.132(c)(8) and (d) (OTC derivative 
contracts) or Sec. Sec.  --.132(b) and Sec.  --.132(d) (repo-style 
transactions) and for calculation of the margin period of risk, see 
Sec. Sec.  --.132(d)(5)(iii)(C) (OTC derivative contracts) and Sec.  
--.132(d)(5)(iii)(A) (repo-style transactions).
---------------------------------------------------------------------------

    Clearing member means a member of, or direct participant in, a CCP 
that is entitled to enter into transactions with the CCP.
    Clearing member client means a party to a cleared transaction 
associated with a CCP in which a clearing member acts either as a 
financial intermediary with respect to the party or guarantees the 
performance of the party to the CCP.
    Collateral agreement means a legal contract that specifies the time 
when, and circumstances under which, a counterparty is required to 
pledge collateral to a [BANK] for a single financial contract or for 
all financial contracts in a netting set and confers upon the [BANK] a 
perfected, first-priority security interest (notwithstanding the prior 
security interest of any custodial agent), or the legal equivalent 
thereof, in the collateral posted by the counterparty under the 
agreement. This security interest must provide the [BANK] with a right 
to close out the financial positions and liquidate the collateral upon 
an event of default of, or failure to perform by, the counterparty 
under the collateral agreement. A contract would not satisfy this 
requirement if the [BANK]'s exercise of rights under the agreement may 
be stayed or avoided under applicable law in the relevant 
jurisdictions, other than in receivership, conservatorship, resolution 
under the Federal Deposit Insurance Act, Title II of the Dodd-Frank 
Act, or under any similar insolvency law applicable to GSEs.
    Commitment means any legally binding arrangement that obligates a 
[BANK] to extend credit or to purchase assets.
    Commodity derivative contract means a commodity-linked swap, 
purchased commodity-linked option, forward commodity-linked contract, 
or any other instrument linked to commodities that gives rise to 
similar counterparty credit risks.
    Commodity Exchange Act means the Commodity Exchange Act of 1936 (7 
U.S.C. 1 et seq.)
    Common equity tier 1 capital is defined in Sec.  --.20(b).
    Common equity tier 1 minority interest means the common equity tier 
1 capital of a depository institution or foreign bank that is:
    (1) A consolidated subsidiary of a [BANK]; and
    (2) Not owned by the [BANK].
    Company means a corporation, partnership, limited liability 
company, depository institution, business trust, special purpose 
entity, association, or similar organization.
    Control. A person or company controls a company if it:
    (1) Owns, controls, or holds with power to vote 25 percent or more 
of a class of voting securities of the company; or
    (2) Consolidates the company for financial reporting purposes.
    Corporate exposure means an exposure to a company that is not:
    (1) An exposure to a sovereign, the Bank for International 
Settlements, the European Central Bank, the European Commission, the 
International Monetary Fund, a multi-lateral development bank (MDB), a 
depository institution, a foreign bank, a credit union, or a public 
sector entity (PSE);
    (2) An exposure to a GSE;
    (3) A residential mortgage exposure;
    (4) A pre-sold construction loan;
    (5) A statutory multifamily mortgage;
    (6) A high volatility commercial real estate (HVCRE) exposure;
    (7) A cleared transaction;
    (8) A default fund contribution;
    (9) A securitization exposure;
    (10) An equity exposure; or
    (11) An unsettled transaction.
    Country risk classification (CRC) with respect to a sovereign, 
means the most recent consensus CRC published by the Organization for 
Economic Cooperation and Development (OECD) as of December 31st of the 
prior calendar year that provides a view of the likelihood that the 
sovereign will service its external debt.
    Covered savings and loan holding company means a top-tier savings 
and loan holding company other than:
    (1) A top-tier savings and loan holding company that is:
    (i) A grandfathered unitary savings and loan holding company as 
defined in section 10(c)(9)(A) of HOLA; and
    (ii) As of June 30 of the previous calendar year, derived 50 
percent or more of its total consolidated assets or 50 percent of its 
total revenues on an enterprise-wide basis (as calculated under GAAP) 
from activities that are not financial in nature under section 4(k) of 
the Bank Holding Company Act (12 U.S.C. 1842(k));
    (2) A top-tier savings and loan holding company that is an 
insurance underwriting company; or
    (3)(i) A top-tier savings and loan holding company that, as of June 
30 of the previous calendar year, held 25 percent or more of its total 
consolidated assets in subsidiaries that are insurance underwriting 
companies (other than assets associated with insurance for credit 
risk); and
    (ii) For purposes of paragraph (3)(i) of this definition, the 
company must calculate its total consolidated assets in accordance with 
GAAP, or if the company does not calculate its total consolidated 
assets under GAAP for any regulatory purpose (including compliance with 
applicable securities laws), the company may estimate its total 
consolidated assets, subject to review and adjustment by the Board.

[[Page 62161]]

    Credit derivative means a financial contract executed under 
standard industry credit derivative documentation that allows one party 
(the protection purchaser) to transfer the credit risk of one or more 
exposures (reference exposure(s)) to another party (the protection 
provider) for a certain period of time.
    Credit-enhancing interest-only strip (CEIO) means an on-balance 
sheet asset that, in form or in substance:
    (1) Represents a contractual right to receive some or all of the 
interest and no more than a minimal amount of principal due on the 
underlying exposures of a securitization; and
    (2) Exposes the holder of the CEIO to credit risk directly or 
indirectly associated with the underlying exposures that exceeds a pro 
rata share of the holder's claim on the underlying exposures, whether 
through subordination provisions or other credit-enhancement 
techniques.
    Credit-enhancing representations and warranties means 
representations and warranties that are made or assumed in connection 
with a transfer of underlying exposures (including loan servicing 
assets) and that obligate a [BANK] to protect another party from losses 
arising from the credit risk of the underlying exposures. Credit-
enhancing representations and warranties include provisions to protect 
a party from losses resulting from the default or nonperformance of the 
counterparties of the underlying exposures or from an insufficiency in 
the value of the collateral backing the underlying exposures. Credit-
enhancing representations and warranties do not include:
    (1) Early default clauses and similar warranties that permit the 
return of, or premium refund clauses covering, 1-4 family residential 
first mortgage loans that qualify for a 50 percent risk weight for a 
period not to exceed 120 days from the date of transfer. These 
warranties may cover only those loans that were originated within 1 
year of the date of transfer;
    (2) Premium refund clauses that cover assets guaranteed, in whole 
or in part, by the U.S. Government, a U.S. Government agency or a GSE, 
provided the premium refund clauses are for a period not to exceed 120 
days from the date of transfer; or
    (3) Warranties that permit the return of underlying exposures in 
instances of misrepresentation, fraud, or incomplete documentation.
    Credit risk mitigant means collateral, a credit derivative, or a 
guarantee.
    Credit-risk-weighted assets means 1.06 multiplied by the sum of:
    (1) Total wholesale and retail risk-weighted assets as calculated 
under Sec.  --.131;
    (2) Risk-weighted assets for securitization exposures as calculated 
under Sec.  --.142; and
    (3) Risk-weighted assets for equity exposures as calculated under 
Sec.  --.151.
    Credit union means an insured credit union as defined under the 
Federal Credit Union Act (12 U.S.C. 1752 et seq.).
    Current exposure means, with respect to a netting set, the larger 
of zero or the fair value of a transaction or portfolio of transactions 
within the netting set that would be lost upon default of the 
counterparty, assuming no recovery on the value of the transactions. 
Current exposure is also called replacement cost.
    Current exposure methodology means the method of calculating the 
exposure amount for over-the-counter derivative contracts in Sec.  
--.34(a) and exposure at default (EAD) in Sec.  --.132(c)(5) or (6), as 
applicable.
    Custodian means a financial institution that has legal custody of 
collateral provided to a CCP.
    Default fund contribution means the funds contributed or 
commitments made by a clearing member to a CCP's mutualized loss 
sharing arrangement.
    Depository institution means a depository institution as defined in 
section 3 of the Federal Deposit Insurance Act.
    Depository institution holding company means a bank holding company 
or savings and loan holding company.
    Derivative contract means a financial contract whose value is 
derived from the values of one or more underlying assets, reference 
rates, or indices of asset values or reference rates. Derivative 
contracts include interest rate derivative contracts, exchange rate 
derivative contracts, equity derivative contracts, commodity derivative 
contracts, credit derivative contracts, and any other instrument that 
poses similar counterparty credit risks. Derivative contracts also 
include unsettled securities, commodities, and foreign exchange 
transactions with a contractual settlement or delivery lag that is 
longer than the lesser of the market standard for the particular 
instrument or five business days.
    Discretionary bonus payment means a payment made to an executive 
officer of a [BANK], where:
    (1) The [BANK] retains discretion as to whether to make, and the 
amount of, the payment until the payment is awarded to the executive 
officer;
    (2) The amount paid is determined by the [BANK] without prior 
promise to, or agreement with, the executive officer; and
    (3) The executive officer has no contractual right, whether express 
or implied, to the bonus payment.
    Distribution means:
    (1) A reduction of tier 1 capital through the repurchase of a tier 
1 capital instrument or by other means, except when a [BANK], within 
the same quarter when the repurchase is announced, fully replaces a 
tier 1 capital instrument it has repurchased by issuing another capital 
instrument that meets the eligibility criteria for:
    (i) A common equity tier 1 capital instrument if the instrument 
being repurchased was part of the [BANK]'s common equity tier 1 
capital, or
    (ii) A common equity tier 1 or additional tier 1 capital instrument 
if the instrument being repurchased was part of the [BANK]'s tier 1 
capital;
    (2) A reduction of tier 2 capital through the repurchase, or 
redemption prior to maturity, of a tier 2 capital instrument or by 
other means, except when a [BANK], within the same quarter when the 
repurchase or redemption is announced, fully replaces a tier 2 capital 
instrument it has repurchased by issuing another capital instrument 
that meets the eligibility criteria for a tier 1 or tier 2 capital 
instrument;
    (3) A dividend declaration or payment on any tier 1 capital 
instrument;
    (4) A dividend declaration or interest payment on any tier 2 
capital instrument if the [BANK] has full discretion to permanently or 
temporarily suspend such payments without triggering an event of 
default; or
    (5) Any similar transaction that the [AGENCY] determines to be in 
substance a distribution of capital.
    Dodd-Frank Act means the Dodd-Frank Wall Street Reform and Consumer 
Protection Act of 2010 (Pub. L. 111-203, 124 Stat. 1376).
    Early amortization provision means a provision in the documentation 
governing a securitization that, when triggered, causes investors in 
the securitization exposures to be repaid before the original stated 
maturity of the securitization exposures, unless the provision:
    (1) Is triggered solely by events not directly related to the 
performance of the underlying exposures or the originating [BANK] (such 
as material changes in tax laws or regulations); or
    (2) Leaves investors fully exposed to future draws by borrowers on 
the underlying exposures even after the provision is triggered.

[[Page 62162]]

    Effective notional amount means for an eligible guarantee or 
eligible credit derivative, the lesser of the contractual notional 
amount of the credit risk mitigant and the exposure amount (or EAD for 
purposes of subpart E of this part) of the hedged exposure, multiplied 
by the percentage coverage of the credit risk mitigant.
    Eligible ABCP liquidity facility means a liquidity facility 
supporting ABCP, in form or in substance, that is subject to an asset 
quality test at the time of draw that precludes funding against assets 
that are 90 days or more past due or in default. Notwithstanding the 
preceding sentence, a liquidity facility is an eligible ABCP liquidity 
facility if the assets or exposures funded under the liquidity facility 
that do not meet the eligibility requirements are guaranteed by a 
sovereign that qualifies for a 20 percent risk weight or lower.
    Eligible clean-up call means a clean-up call that:
    (1) Is exercisable solely at the discretion of the originating 
[BANK] or servicer;
    (2) Is not structured to avoid allocating losses to securitization 
exposures held by investors or otherwise structured to provide credit 
enhancement to the securitization; and
    (3)(i) For a traditional securitization, is only exercisable when 
10 percent or less of the principal amount of the underlying exposures 
or securitization exposures (determined as of the inception of the 
securitization) is outstanding; or
    (ii) For a synthetic securitization, is only exercisable when 10 
percent or less of the principal amount of the reference portfolio of 
underlying exposures (determined as of the inception of the 
securitization) is outstanding.
    Eligible credit derivative means a credit derivative in the form of 
a credit default swap, n^th-to-default swap, total return 
swap, or any other form of credit derivative approved by the [AGENCY], 
provided that:
    (1) The contract meets the requirements of an eligible guarantee 
and has been confirmed by the protection purchaser and the protection 
provider;
    (2) Any assignment of the contract has been confirmed by all 
relevant parties;
    (3) If the credit derivative is a credit default swap or 
n^th-to-default swap, the contract includes the following 
credit events:
    (i) Failure to pay any amount due under the terms of the reference 
exposure, subject to any applicable minimal payment threshold that is 
consistent with standard market practice and with a grace period that 
is closely in line with the grace period of the reference exposure; and
    (ii) Receivership, insolvency, liquidation, conservatorship or 
inability of the reference exposure issuer to pay its debts, or its 
failure or admission in writing of its inability generally to pay its 
debts as they become due, and similar events;
    (4) The terms and conditions dictating the manner in which the 
contract is to be settled are incorporated into the contract;
    (5) If the contract allows for cash settlement, the contract 
incorporates a robust valuation process to estimate loss reliably and 
specifies a reasonable period for obtaining post-credit event 
valuations of the reference exposure;
    (6) If the contract requires the protection purchaser to transfer 
an exposure to the protection provider at settlement, the terms of at 
least one of the exposures that is permitted to be transferred under 
the contract provide that any required consent to transfer may not be 
unreasonably withheld;
    (7) If the credit derivative is a credit default swap or 
n^th-to-default swap, the contract clearly identifies the 
parties responsible for determining whether a credit event has 
occurred, specifies that this determination is not the sole 
responsibility of the protection provider, and gives the protection 
purchaser the right to notify the protection provider of the occurrence 
of a credit event; and
    (8) If the credit derivative is a total return swap and the [BANK] 
records net payments received on the swap as net income, the [BANK] 
records offsetting deterioration in the value of the hedged exposure 
(either through reductions in fair value or by an addition to 
reserves).
    Eligible credit reserves means all general allowances that have 
been established through a charge against earnings to cover estimated 
credit losses associated with on- or off-balance sheet wholesale and 
retail exposures, including the ALLL associated with such exposures, 
but excluding allocated transfer risk reserves established pursuant to 
12 U.S.C. 3904 and other specific reserves created against recognized 
losses.
    Eligible guarantee means a guarantee from an eligible guarantor 
that:
    (1) Is written;
    (2) Is either:
    (i) Unconditional, or
    (ii) A contingent obligation of the U.S. government or its 
agencies, the enforceability of which is dependent upon some 
affirmative action on the part of the beneficiary of the guarantee or a 
third party (for example, meeting servicing requirements);
    (3) Covers all or a pro rata portion of all contractual payments of 
the obligated party on the reference exposure;
    (4) Gives the beneficiary a direct claim against the protection 
provider;
    (5) Is not unilaterally cancelable by the protection provider for 
reasons other than the breach of the contract by the beneficiary;
    (6) Except for a guarantee by a sovereign, is legally enforceable 
against the protection provider in a jurisdiction where the protection 
provider has sufficient assets against which a judgment may be attached 
and enforced;
    (7) Requires the protection provider to make payment to the 
beneficiary on the occurrence of a default (as defined in the 
guarantee) of the obligated party on the reference exposure in a timely 
manner without the beneficiary first having to take legal actions to 
pursue the obligor for payment;
    (8) Does not increase the beneficiary's cost of credit protection 
on the guarantee in response to deterioration in the credit quality of 
the reference exposure; and
    (9) Is not provided by an affiliate of the [BANK], unless the 
affiliate is an insured depository institution, foreign bank, 
securities broker or dealer, or insurance company that:
    (i) Does not control the [BANK]; and
    (ii) Is subject to consolidated supervision and regulation 
comparable to that imposed on depository institutions, U.S. securities 
broker-dealers, or U.S. insurance companies (as the case may be).
    Eligible guarantor means:
    (1) A sovereign, the Bank for International Settlements, the 
International Monetary Fund, the European Central Bank, the European 
Commission, a Federal Home Loan Bank, Federal Agricultural Mortgage 
Corporation (Farmer Mac), a multilateral development bank (MDB), a 
depository institution, a bank holding company, a savings and loan 
holding company, a credit union, a foreign bank, or a qualifying 
central counterparty; or
    (2) An entity (other than a special purpose entity):
    (i) That at the time the guarantee is issued or anytime thereafter, 
has issued and outstanding an unsecured debt security without credit 
enhancement that is investment grade;
    (ii) Whose creditworthiness is not positively correlated with the 
credit risk of the exposures for which it has provided guarantees; and
    (iii) That is not an insurance company engaged predominately in the 
business of providing credit protection (such as a monoline bond 
insurer or re-insurer).

[[Page 62163]]

    Eligible margin loan means:
    (1) An extension of credit where:
    (i) The extension of credit is collateralized exclusively by liquid 
and readily marketable debt or equity securities, or gold;
    (ii) The collateral is marked-to-fair value daily, and the 
transaction is subject to daily margin maintenance requirements; and
    (iii) The extension of credit is conducted under an agreement that 
provides the [BANK] the right to accelerate and terminate the extension 
of credit and to liquidate or set-off collateral promptly upon an event 
of default, including upon an event of receivership, insolvency, 
liquidation, conservatorship, or similar proceeding, of the 
counterparty, provided that, in any such case, any exercise of rights 
under the agreement will not be stayed or avoided under applicable law 
in the relevant jurisdictions, other than in receivership, 
conservatorship, resolution under the Federal Deposit Insurance Act, 
Title II of the Dodd-Frank Act, or under any similar insolvency law 
applicable to GSEs.\4\
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    \4\ This requirement is met where all transactions under the 
agreement are (i) executed under U.S. law and (ii) constitute 
``securities contracts'' under section 555 of the Bankruptcy Code 
(11 U.S.C. 555), qualified financial contracts under section 
11(e)(8) of the Federal Deposit Insurance Act, or netting contracts 
between or among financial institutions under sections 401-407 of 
the Federal Deposit Insurance Corporation Improvement Act or the 
Federal Reserve Board's Regulation EE (12 CFR part 231).
---------------------------------------------------------------------------

    (2) In order to recognize an exposure as an eligible margin loan 
for purposes of this subpart, a [BANK] must comply with the 
requirements of Sec.  --.3(b) with respect to that exposure.
    Eligible servicer cash advance facility means a servicer cash 
advance facility in which:
    (1) The servicer is entitled to full reimbursement of advances, 
except that a servicer may be obligated to make non-reimbursable 
advances for a particular underlying exposure if any such advance is 
contractually limited to an insignificant amount of the outstanding 
principal balance of that exposure;
    (2) The servicer's right to reimbursement is senior in right of 
payment to all other claims on the cash flows from the underlying 
exposures of the securitization; and
    (3) The servicer has no legal obligation to, and does not make 
advances to the securitization if the servicer concludes the advances 
are unlikely to be repaid.
    Employee stock ownership plan has the same meaning as in 29 CFR 
2550.407d-6.
    Equity derivative contract means an equity-linked swap, purchased 
equity-linked option, forward equity-linked contract, or any other 
instrument linked to equities that gives rise to similar counterparty 
credit risks.
    Equity exposure means:
    (1) A security or instrument (whether voting or non-voting) that 
represents a direct or an indirect ownership interest in, and is a 
residual claim on, the assets and income of a company, unless:
    (i) The issuing company is consolidated with the [BANK] under GAAP;
    (ii) The [BANK] is required to deduct the ownership interest from 
tier 1 or tier 2 capital under this part;
    (iii) The ownership interest incorporates a payment or other 
similar obligation on the part of the issuing company (such as an 
obligation to make periodic payments); or
    (iv) The ownership interest is a securitization exposure;
    (2) A security or instrument that is mandatorily convertible into a 
security or instrument described in paragraph (1) of this definition;
    (3) An option or warrant that is exercisable for a security or 
instrument described in paragraph (1) of this definition; or
    (4) Any other security or instrument (other than a securitization 
exposure) to the extent the return on the security or instrument is 
based on the performance of a security or instrument described in 
paragraph (1) of this definition.
    ERISA means the Employee Retirement Income and Security Act of 1974 
(29 U.S.C. 1001 et seq.).
    Exchange rate derivative contract means a cross-currency interest 
rate swap, forward foreign-exchange contract, currency option 
purchased, or any other instrument linked to exchange rates that gives 
rise to similar counterparty credit risks.
    Executive officer means a person who holds the title or, without 
regard to title, salary, or compensation, performs the function of one 
or more of the following positions: President, chief executive officer, 
executive chairman, chief operating officer, chief financial officer, 
chief investment officer, chief legal officer, chief lending officer, 
chief risk officer, or head of a major business line, and other staff 
that the board of directors of the [BANK] deems to have equivalent 
responsibility.
    Expected credit loss (ECL) means:
    (1) For a wholesale exposure to a non-defaulted obligor or segment 
of non-defaulted retail exposures that is carried at fair value with 
gains and losses flowing through earnings or that is classified as 
held-for-sale and is carried at the lower of cost or fair value with 
losses flowing through earnings, zero.
    (2) For all other wholesale exposures to non-defaulted obligors or 
segments of non-defaulted retail exposures, the product of the 
probability of default (PD) times the loss given default (LGD) times 
the exposure at default (EAD) for the exposure or segment.
    (3) For a wholesale exposure to a defaulted obligor or segment of 
defaulted retail exposures, the [BANK]'s impairment estimate for 
allowance purposes for the exposure or segment.
    (4) Total ECL is the sum of expected credit losses for all 
wholesale and retail exposures other than exposures for which the 
[BANK] has applied the double default treatment in Sec.  --.135.
    Exposure amount means:
    (1) For the on-balance sheet component of an exposure (other than 
an available-for-sale or held-to-maturity security, if the [BANK] has 
made an AOCI opt-out election (as defined in Sec.  --.22(b)(2)); an OTC 
derivative contract; a repo-style transaction or an eligible margin 
loan for which the [BANK] determines the exposure amount under Sec.  
--.37; a cleared transaction; a default fund contribution; or a 
securitization exposure), the [BANK]'s carrying value of the exposure.
    (2) For a security (that is not a securitization exposure, equity 
exposure, or preferred stock classified as an equity security under 
GAAP) classified as available-for-sale or held-to-maturity if the 
[BANK] has made an AOCI opt-out election (as defined in Sec.  
--.22(b)(2)), the [BANK]'s carrying value (including net accrued but 
unpaid interest and fees) for the exposure less any net unrealized 
gains on the exposure and plus any net unrealized losses on the 
exposure.
    (3) For available-for-sale preferred stock classified as an equity 
security under GAAP if the [BANK] has made an AOCI opt-out election (as 
defined in Sec.  --.22(b)(2)), the [BANK]'s carrying value of the 
exposure less any net unrealized gains on the exposure that are 
reflected in such carrying value but excluded from the [BANK]'s 
regulatory capital components.
    (4) For the off-balance sheet component of an exposure (other than 
an OTC derivative contract; a repo-style transaction or an eligible 
margin loan for which the [BANK] calculates the exposure amount under 
Sec.  --.37; a cleared transaction; a default fund contribution; or a 
securitization exposure), the notional amount of the off-balance sheet 
component multiplied by the appropriate credit conversion factor (CCF) 
in Sec.  --.33.

[[Page 62164]]

    (5) For an exposure that is an OTC derivative contract, the 
exposure amount determined under Sec.  --.34.
    (6) For an exposure that is a cleared transaction, the exposure 
amount determined under Sec.  --.35.
    (7) For an exposure that is an eligible margin loan or repo-style 
transaction for which the bank calculates the exposure amount as 
provided in Sec.  --.37, the exposure amount determined under Sec.  
--.37.
    (8) For an exposure that is a securitization exposure, the exposure 
amount determined under Sec.  --.42.
    Federal Deposit Insurance Act means the Federal Deposit Insurance 
Act (12 U.S.C. 1813).
    Federal Deposit Insurance Corporation Improvement Act means the 
Federal Deposit Insurance Corporation Improvement Act of 1991 (12 
U.S.C. 4401).
    Financial collateral means collateral:
    (1) In the form of:
    (i) Cash on deposit with the [BANK] (including cash held for the 
[BANK] by a third-party custodian or trustee);
    (ii) Gold bullion;
    (iii) Long-term debt securities that are not resecuritization 
exposures and that are investment grade;
    (iv) Short-term debt instruments that are not resecuritization 
exposures and that are investment grade;
    (v) Equity securities that are publicly traded;
    (vi) Convertible bonds that are publicly traded; or
    (vii) Money market fund shares and other mutual fund shares if a 
price for the shares is publicly quoted daily; and
    (2) In which the [BANK] has a perfected, first-priority security 
interest or, outside of the United States, the legal equivalent thereof 
(with the exception of cash on deposit and notwithstanding the prior 
security interest of any custodial agent).
    Financial institution means:
    (1) A bank holding company; savings and loan holding company; 
nonbank financial institution supervised by the Board under Title I of 
the Dodd-Frank Act; depository institution; foreign bank; credit union; 
industrial loan company, industrial bank, or other similar institution 
described in section 2 of the Bank Holding Company Act; national 
association, state member bank, or state non-member bank that is not a 
depository institution; insurance company; securities holding company 
as defined in section 618 of the Dodd-Frank Act; broker or dealer 
registered with the SEC under section 15 of the Securities Exchange 
Act; futures commission merchant as defined in section 1a of the 
Commodity Exchange Act; swap dealer as defined in section 1a of the 
Commodity Exchange Act; or security-based swap dealer as defined in 
section 3 of the Securities Exchange Act;
    (2) Any designated financial market utility, as defined in section 
803 of the Dodd-Frank Act;
    (3) Any entity not domiciled in the United States (or a political 
subdivision thereof) that is supervised and regulated in a manner 
similar to entities described in paragraphs (1) or (2) of this 
definition; or
    (4) Any other company:
    (i) Of which the [BANK] owns:
    (A) An investment in GAAP equity instruments of the company with an 
adjusted carrying value or exposure amount equal to or greater than $10 
million; or
    (B) More than 10 percent of the company's issued and outstanding 
common shares (or similar equity interest), and
    (ii) Which is predominantly engaged in the following activities:
    (A) Lending money, securities or other financial instruments, 
including servicing loans;
    (B) Insuring, guaranteeing, indemnifying against loss, harm, 
damage, illness, disability, or death, or issuing annuities;
    (C) Underwriting, dealing in, making a market in, or investing as 
principal in securities or other financial instruments; or
    (D) Asset management activities (not including investment or 
financial advisory activities).
    (5) For the purposes of this definition, a company is 
``predominantly engaged'' in an activity or activities if:
    (i) 85 percent or more of the total consolidated annual gross 
revenues (as determined in accordance with applicable accounting 
standards) of the company is either of the two most recent calendar 
years were derived, directly or indirectly, by the company on a 
consolidated basis from the activities; or
    (ii) 85 percent or more of the company's consolidated total assets 
(as determined in accordance with applicable accounting standards) as 
of the end of either of the two most recent calendar years were related 
to the activities.
    (6) Any other company that the [AGENCY] may determine is a 
financial institution based on activities similar in scope, nature, or 
operation to those of the entities included in paragraphs (1) through 
(4) of this definition.
    (7) For purposes of this part, ``financial institution'' does not 
include the following entities:
    (i) GSEs;
    (ii) Small business investment companies, as defined in section 102 
of the Small Business Investment Act of 1958 (15 U.S.C. 662);
    (iii) Entities designated as Community Development Financial 
Institutions (CDFIs) under 12 U.S.C. 4701 et seq. and 12 CFR part 1805;
    (iv) Entities registered with the SEC under the Investment Company 
Act of 1940 (15 U.S.C. 80a-1) or foreign equivalents thereof;
    (v) Entities to the extent that the [BANK]'s investment in such 
entities would qualify as a community development investment under 
section 24 (Eleventh) of the National Bank Act; and
    (vi) An employee benefit plan as defined in paragraphs (3) and (32) 
of section 3 of ERISA, a ``governmental plan'' (as defined in 29 U.S.C. 
1002(32)) that complies with the tax deferral qualification 
requirements provided in the Internal Revenue Code, or any similar 
employee benefit plan established under the laws of a foreign 
jurisdiction.
    First-lien residential mortgage exposure means a residential 
mortgage exposure secured by a first lien.
    Foreign bank means a foreign bank as defined in Sec.  211.2 of the 
Federal Reserve Board's Regulation K (12 CFR 211.2) (other than a 
depository institution).
    Forward agreement means a legally binding contractual obligation to 
purchase assets with certain drawdown at a specified future date, not 
including commitments to make residential mortgage loans or forward 
foreign exchange contracts.
    GAAP means generally accepted accounting principles as used in the 
United States.
    Gain-on-sale means an increase in the equity capital of a [BANK] 
(as reported on [Schedule RC of the Call Report or Schedule HC of the 
FR Y-9C]) resulting from a traditional securitization (other than an 
increase in equity capital resulting from the [BANK]'s receipt of cash 
in connection with the securitization or reporting of a mortgage 
servicing asset on [Schedule RC of the Call Report or Schedule HC of 
the FRY-9C]).
    General obligation means a bond or similar obligation that is 
backed by the full faith and credit of a public sector entity (PSE).
    Government-sponsored enterprise (GSE) means an entity established 
or chartered by the U.S. government to serve public purposes specified 
by the U.S. Congress but whose debt obligations are not explicitly 
guaranteed by the full faith and credit of the U.S. government.

[[Page 62165]]

    Guarantee means a financial guarantee, letter of credit, insurance, 
or other similar financial instrument (other than a credit derivative) 
that allows one party (beneficiary) to transfer the credit risk of one 
or more specific exposures (reference exposure) to another party 
(protection provider).
    High volatility commercial real estate (HVCRE) exposure means a 
credit facility that, prior to conversion to permanent financing, 
finances or has financed the acquisition, development, or construction 
(ADC) of real property, unless the facility finances:
    (1) One- to four-family residential properties;
    (2) Real property that:
    (i) Would qualify as an investment in community development under 
12 U.S.C. 338a or 12 U.S.C. 24 (Eleventh), as applicable, or as a 
``qualified investment'' under [12 CFR part 25 (national bank), 12 CFR 
part 195 (Federal savings association) (OCC); 12 CFR part 228 (Board)], 
and
    (ii) Is not an ADC loan to any entity described in [12 CFR part 
25.12(g)(3) (national banks) and 12 CFR 195.12(g)(3) (Federal savings 
associations) (OCC); 12 CFR 208.22(a)(3) or 228.12(g)(3) (Board)], 
unless it is otherwise described in paragraph (1), (2)(i), (3) or (4) 
of this definition;
    (3) The purchase or development of agricultural land, which 
includes all land known to be used or usable for agricultural purposes 
(such as crop and livestock production), provided that the valuation of 
the agricultural land is based on its value for agricultural purposes 
and the valuation does not take into consideration any potential use of 
the land for non-agricultural commercial development or residential 
development; or
    (4) Commercial real estate projects in which:
    (i) The loan-to-value ratio is less than or equal to the applicable 
maximum supervisory loan-to-value ratio in the [AGENCY]'s real estate 
lending standards at [12 CFR part 34, subpart D (national banks) and 12 
CFR part 160, subparts A and B (Federal savings associations) (OCC); 12 
CFR part 208, appendix C (Board)];
    (ii) The borrower has contributed capital to the project in the 
form of cash or unencumbered readily marketable assets (or has paid 
development expenses out-of-pocket) of at least 15 percent of the real 
estate's appraised ``as completed'' value; and
    (iii) The borrower contributed the amount of capital required by 
paragraph (4)(ii) of this definition before the [BANK] advances funds 
under the credit facility, and the capital contributed by the borrower, 
or internally generated by the project, is contractually required to 
remain in the project throughout the life of the project. The life of a 
project concludes only when the credit facility is converted to 
permanent financing or is sold or paid in full. Permanent financing may 
be provided by the [BANK] that provided the ADC facility as long as the 
permanent financing is subject to the [BANK]'s underwriting criteria 
for long-term mortgage loans.
    Home country means the country where an entity is incorporated, 
chartered, or similarly established.
    Indirect exposure means an exposure that arises from the [BANK]'s 
investment in an investment fund which holds an investment in the 
[BANK]'s own capital instrument or an investment in the capital of an 
unconsolidated financial institution.
    Insurance company means an insurance company as defined in section 
201 of the Dodd-Frank Act (12 U.S.C. 5381).
    Insurance underwriting company means an insurance company as 
defined in section 201 of the Dodd-Frank Act (12 U.S.C. 5381) that 
engages in insurance underwriting activities.
    Insured depository institution means an insured depository 
institution as defined in section 3 of the Federal Deposit Insurance 
Act.
    Interest rate derivative contract means a single-currency interest 
rate swap, basis swap, forward rate agreement, purchased interest rate 
option, when-issued securities, or any other instrument linked to 
interest rates that gives rise to similar counterparty credit risks.
    International Lending Supervision Act means the International 
Lending Supervision Act of 1983 (12 U.S.C. 3907).
    Investing bank means, with respect to a securitization, a [BANK] 
that assumes the credit risk of a securitization exposure (other than 
an originating [BANK] of the securitization). In the typical synthetic 
securitization, the investing [BANK] sells credit protection on a pool 
of underlying exposures to the originating [BANK].
    Investment fund means a company:
    (1) Where all or substantially all of the assets of the company are 
financial assets; and
    (2) That has no material liabilities.
    Investment grade means that the entity to which the [BANK] is 
exposed through a loan or security, or the reference entity with 
respect to a credit derivative, has adequate capacity to meet financial 
commitments for the projected life of the asset or exposure. Such an 
entity or reference entity has adequate capacity to meet financial 
commitments if the risk of its default is low and the full and timely 
repayment of principal and interest is expected.
    Investment in the capital of an unconsolidated financial 
institution means a net long position calculated in accordance with 
Sec.  --.22(h) in an instrument that is recognized as capital for 
regulatory purposes by the primary supervisor of an unconsolidated 
regulated financial institution and is an instrument that is part of 
the GAAP equity of an unconsolidated unregulated financial institution, 
including direct, indirect, and synthetic exposures to capital 
instruments, excluding underwriting positions held by the [BANK] for 
five or fewer business days.
    Investment in the [BANK]'s own capital instrument means a net long 
position calculated in accordance with Sec.  --.22(h) in the [BANK]'s 
own common stock instrument, own additional tier 1 capital instrument 
or own tier 2 capital instrument, including direct, indirect, or 
synthetic exposures to such capital instruments. An investment in the 
[BANK]'s own capital instrument includes any contractual obligation to 
purchase such capital instrument.
    Junior-lien residential mortgage exposure means a residential 
mortgage exposure that is not a first-lien residential mortgage 
exposure.
    Main index means the Standard & Poor's 500 Index, the FTSE All-
World Index, and any other index for which the [BANK] can demonstrate 
to the satisfaction of the [AGENCY] that the equities represented in 
the index have comparable liquidity, depth of market, and size of bid-
ask spreads as equities in the Standard & Poor's 500 Index and FTSE 
All-World Index.
    Market risk [BANK] means a [BANK] that is described in Sec.  
--.201(b).
    Money market fund means an investment fund that is subject to 17 
CFR 270.2a-7 or any foreign equivalent thereof.
    Mortgage servicing assets (MSAs) means the contractual rights owned 
by a [BANK] to service for a fee mortgage loans that are owned by 
others.
    Multilateral development bank (MDB) means the International Bank 
for Reconstruction and Development, the Multilateral Investment 
Guarantee Agency, the International Finance Corporation, the Inter-
American Development Bank, the Asian Development Bank, the African 
Development Bank, the European Bank for Reconstruction and Development, 
the European Investment Bank, the European Investment Fund, the Nordic 
Investment Bank, the Caribbean Development Bank, the Islamic

[[Page 62166]]

Development Bank, the Council of Europe Development Bank, and any other 
multilateral lending institution or regional development bank in which 
the U.S. government is a shareholder or contributing member or which 
the [AGENCY] determines poses comparable credit risk.
    National Bank Act means the National Bank Act (12 U.S.C. 24).
    Netting set means a group of transactions with a single 
counterparty that are subject to a qualifying master netting agreement 
or a qualifying cross-product master netting agreement. For purposes of 
calculating risk-based capital requirements using the internal models 
methodology in subpart E of this part, this term does not cover a 
transaction:
    (1) That is not subject to such a master netting agreement; or
    (2) Where the [BANK] has identified specific wrong-way risk.
    Non-significant investment in the capital of an unconsolidated 
financial institution means an investment in the capital of an 
unconsolidated financial institution where the [BANK] owns 10 percent 
or less of the issued and outstanding common stock of the 
unconsolidated financial institution.
    N^th-to-default credit derivative means a credit 
derivative that provides credit protection only for the n^th-
defaulting reference exposure in a group of reference exposures.
    Operating entity means a company established to conduct business 
with clients with the intention of earning a profit in its own right.
    Original maturity with respect to an off-balance sheet commitment 
means the length of time between the date a commitment is issued and:
    (1) For a commitment that is not subject to extension or renewal, 
the stated expiration date of the commitment; or
    (2) For a commitment that is subject to extension or renewal, the 
earliest date on which the [BANK] can, at its option, unconditionally 
cancel the commitment.
    Originating [BANK], with respect to a securitization, means a 
[BANK] that:
    (1) Directly or indirectly originated or securitized the underlying 
exposures included in the securitization; or
    (2) Serves as an ABCP program sponsor to the securitization.
    Over-the-counter (OTC) derivative contract means a derivative 
contract that is not a cleared transaction. An OTC derivative includes 
a transaction:
    (1) Between a [BANK] that is a clearing member and a counterparty 
where the [BANK] is acting as a financial intermediary and enters into 
a cleared transaction with a CCP that offsets the transaction with the 
counterparty; or
    (2) In which a [BANK] that is a clearing member provides a CCP a 
guarantee on the performance of the counterparty to the transaction.
    Performance standby letter of credit (or performance bond) means an 
irrevocable obligation of a [BANK] to pay a third-party beneficiary 
when a customer (account party) fails to perform on any contractual 
nonfinancial or commercial obligation. To the extent permitted by law 
or regulation, performance standby letters of credit include 
arrangements backing, among other things, subcontractors' and 
suppliers' performance, labor and materials contracts, and construction 
bids.
    Pre-sold construction loan means any one-to-four family residential 
construction loan to a builder that meets the requirements of section 
618(a)(1) or (2) of the Resolution Trust Corporation Refinancing, 
Restructuring, and Improvement Act of 1991 (12 U.S.C. 1831n note) and 
the following criteria:
    (1) The loan is made in accordance with prudent underwriting 
standards, meaning that the [BANK] has obtained sufficient 
documentation that the buyer of the home has a legally binding written 
sales contract and has a firm written commitment for permanent 
financing of the home upon completion;
    (2) The purchaser is an individual(s) that intends to occupy the 
residence and is not a partnership, joint venture, trust, corporation, 
or any other entity (including an entity acting as a sole 
proprietorship) that is purchasing one or more of the residences for 
speculative purposes;
    (3) The purchaser has entered into a legally binding written sales 
contract for the residence;
    (4) The purchaser has not terminated the contract;
    (5) The purchaser has made a substantial earnest money deposit of 
no less than 3 percent of the sales price, which is subject to 
forfeiture if the purchaser terminates the sales contract; provided 
that, the earnest money deposit shall not be subject to forfeiture by 
reason of breach or termination of the sales contract on the part of 
the builder;
    (6) The earnest money deposit must be held in escrow by the [BANK] 
or an independent party in a fiduciary capacity, and the escrow 
agreement must provide that in an event of default arising from the 
cancellation of the sales contract by the purchaser of the residence, 
the escrow funds shall be used to defray any cost incurred by the 
[BANK];
    (7) The builder must incur at least the first 10 percent of the 
direct costs of construction of the residence (that is, actual costs of 
the land, labor, and material) before any drawdown is made under the 
loan;
    (8) The loan may not exceed 80 percent of the sales price of the 
presold residence; and
    (9) The loan is not more than 90 days past due, or on nonaccrual.
    Protection amount (P) means, with respect to an exposure hedged by 
an eligible guarantee or eligible credit derivative, the effective 
notional amount of the guarantee or credit derivative, reduced to 
reflect any currency mismatch, maturity mismatch, or lack of 
restructuring coverage (as provided in Sec. Sec.  --.36 or --.134, as 
appropriate).
    Publicly-traded means traded on:
    (1) Any exchange registered with the SEC as a national securities 
exchange under section 6 of the Securities Exchange Act; or
    (2) Any non-U.S.-based securities exchange that:
    (i) Is registered with, or approved by, a national securities 
regulatory authority; and
    (ii) Provides a liquid, two-way market for the instrument in 
question.
    Public sector entity (PSE) means a state, local authority, or other 
governmental subdivision below the sovereign level.
    Qualifying central counterparty (QCCP) means a central counterparty 
that:
    (1)(i) Is a designated financial market utility (FMU) under Title 
VIII of the Dodd-Frank Act;
    (ii) If not located in the United States, is regulated and 
supervised in a manner equivalent to a designated FMU; or
    (iii) Meets the following standards:
    (A) The central counterparty requires all parties to contracts 
cleared by the counterparty to be fully collateralized on a daily 
basis;
    (B) The [BANK] demonstrates to the satisfaction of the [AGENCY] 
that the central counterparty:
    (1) Is in sound financial condition;
    (2) Is subject to supervision by the Board, the CFTC, or the 
Securities Exchange Commission (SEC), or, if the central counterparty 
is not located in the United States, is subject to effective oversight 
by a national supervisory authority in its home country; and
    (3) Meets or exceeds the risk-management standards for central 
counterparties set forth in regulations established by the Board, the 
CFTC, or the SEC under Title VII or Title VIII of the Dodd-Frank Act; 
or if the central counterparty is not located in the United States, 
meets or exceeds similar

[[Page 62167]]

risk-management standards established under the law of its home country 
that are consistent with international standards for central 
counterparty risk management as established by the relevant standard 
setting body of the Bank of International Settlements; and
    (2)(i) Provides the [BANK] with the central counterparty's 
hypothetical capital requirement or the information necessary to 
calculate such hypothetical capital requirement, and other information 
the [BANK] is required to obtain under Sec. Sec.  --.35(d)(3) and 
--.133(d)(3);
    (ii) Makes available to the [AGENCY] and the CCP's regulator the 
information described in paragraph (2)(i) of this definition; and
    (iii) Has not otherwise been determined by the [AGENCY] to not be a 
QCCP due to its financial condition, risk profile, failure to meet 
supervisory risk management standards, or other weaknesses or 
supervisory concerns that are inconsistent with the risk weight 
assigned to qualifying central counterparties under Sec. Sec.  --.35 
and --.133.
    (3) Exception. A QCCP that fails to meet the requirements of a QCCP 
in the future may still be treated as a QCCP under the conditions 
specified in Sec.  --.3(f).
    Qualifying master netting agreement means a written, legally 
enforceable agreement provided that:
    (1) The agreement creates a single legal obligation for all 
individual transactions covered by the agreement upon an event of 
default, including upon an event of receivership, insolvency, 
liquidation, or similar proceeding, of the counterparty;
    (2) The agreement provides the [BANK] the right to accelerate, 
terminate, and close-out on a net basis all transactions under the 
agreement and to liquidate or set-off collateral promptly upon an event 
of default, including upon an event of receivership, insolvency, 
liquidation, or similar proceeding, of the counterparty, provided that, 
in any such case, any exercise of rights under the agreement will not 
be stayed or avoided under applicable law in the relevant 
jurisdictions, other than in receivership, conservatorship, resolution 
under the Federal Deposit Insurance Act, Title II of the Dodd-Frank 
Act, or under any similar insolvency law applicable to GSEs;
    (3) The agreement does not contain a walkaway clause (that is, a 
provision that permits a non-defaulting counterparty to make a lower 
payment than it otherwise would make under the agreement, or no payment 
at all, to a defaulter or the estate of a defaulter, even if the 
defaulter or the estate of the defaulter is a net creditor under the 
agreement); and
    (4) In order to recognize an agreement as a qualifying master 
netting agreement for purposes of this subpart, a [BANK] must comply 
with the requirements of Sec.  --.3(d) with respect to that agreement.
    Regulated financial institution means a financial institution 
subject to consolidated supervision and regulation comparable to that 
imposed on the following U.S. financial institutions: Depository 
institutions, depository institution holding companies, nonbank 
financial companies supervised by the Board, designated financial 
market utilities, securities broker-dealers, credit unions, or 
insurance companies.
    Repo-style transaction means a repurchase or reverse repurchase 
transaction, or a securities borrowing or securities lending 
transaction, including a transaction in which the [BANK] acts as agent 
for a customer and indemnifies the customer against loss, provided 
that:
    (1) The transaction is based solely on liquid and readily 
marketable securities, cash, or gold;
    (2) The transaction is marked-to-fair value daily and subject to 
daily margin maintenance requirements;
    (3)(i) The transaction is a ``securities contract'' or ``repurchase 
agreement'' under section 555 or 559, respectively, of the Bankruptcy 
Code (11 U.S.C. 555 or 559), a qualified financial contract under 
section 11(e)(8) of the Federal Deposit Insurance Act, or a netting 
contract between or among financial institutions under sections 401-407 
of the Federal Deposit Insurance Corporation Improvement Act or the 
Federal Reserve Board's Regulation EE (12 CFR part 231); or
    (ii) If the transaction does not meet the criteria set forth in 
paragraph (3)(i) of this definition, then either:
    (A) The transaction is executed under an agreement that provides 
the [BANK] the right to accelerate, terminate, and close-out the 
transaction on a net basis and to liquidate or set-off collateral 
promptly upon an event of default, including upon an event of 
receivership, insolvency, liquidation, or similar proceeding, of the 
counterparty, provided that, in any such case, any exercise of rights 
under the agreement will not be stayed or avoided under applicable law 
in the relevant jurisdictions, other than in receivership, 
conservatorship, resolution under the Federal Deposit Insurance Act, 
Title II of the Dodd-Frank Act, or under any similar insolvency law 
applicable to GSEs; or
    (B) The transaction is:
    (1) Either overnight or unconditionally cancelable at any time by 
the [BANK]; and
    (2) Executed under an agreement that provides the [BANK] the right 
to accelerate, terminate, and close-out the transaction on a net basis 
and to liquidate or set-off collateral promptly upon an event of 
counterparty default; and
    (4) In order to recognize an exposure as a repo-style transaction 
for purposes of this subpart, a [BANK] must comply with the 
requirements of Sec.  --.3(e) of this part with respect to that 
exposure.
    Resecuritization means a securitization which has more than one 
underlying exposure and in which one or more of the underlying 
exposures is a securitization exposure.
    Resecuritization exposure means:
    (1) An on- or off-balance sheet exposure to a resecuritization;
    (2) An exposure that directly or indirectly references a 
resecuritization exposure.
    (3) An exposure to an asset-backed commercial paper program is not 
a resecuritization exposure if either:
    (i) The program-wide credit enhancement does not meet the 
definition of a resecuritization exposure; or
    (ii) The entity sponsoring the program fully supports the 
commercial paper through the provision of liquidity so that the 
commercial paper holders effectively are exposed to the default risk of 
the sponsor instead of the underlying exposures.
    Residential mortgage exposure means an exposure (other than a 
securitization exposure, equity exposure, statutory multifamily 
mortgage, or presold construction loan) that is:
    (1) An exposure that is primarily secured by a first or subsequent 
lien on one-to-four family residential property; or
    (2)(i) An exposure with an original and outstanding amount of $1 
million or less that is primarily secured by a first or subsequent lien 
on residential property that is not one-to-four family; and
    (ii) For purposes of calculating capital requirements under subpart 
E of this part, is managed as part of a segment of exposures with 
homogeneous risk characteristics and not on an individual-exposure 
basis.
    Revenue obligation means a bond or similar obligation that is an 
obligation of a PSE, but which the PSE is committed to repay with 
revenues from the specific project financed rather than general tax 
funds.
    Savings and loan holding company means a savings and loan holding

[[Page 62168]]

company as defined in section 10 of the Home Owners' Loan Act (12 
U.S.C. 1467a).
    Securities and Exchange Commission (SEC) means the U.S. Securities 
and Exchange Commission.
    Securities Exchange Act means the Securities Exchange Act of 1934 
(15 U.S.C. 78).
    Securitization exposure means:
    (1) An on-balance sheet or off-balance sheet credit exposure 
(including credit-enhancing representations and warranties) that arises 
from a traditional securitization or synthetic securitization 
(including a resecuritization), or
    (2) An exposure that directly or indirectly references a 
securitization exposure described in paragraph (1) of this definition.
    Securitization special purpose entity (securitization SPE) means a 
corporation, trust, or other entity organized for the specific purpose 
of holding underlying exposures of a securitization, the activities of 
which are limited to those appropriate to accomplish this purpose, and 
the structure of which is intended to isolate the underlying exposures 
held by the entity from the credit risk of the seller of the underlying 
exposures to the entity.
    Separate account means a legally segregated pool of assets owned 
and held by an insurance company and maintained separately from the 
insurance company's general account assets for the benefit of an 
individual contract holder. To be a separate account:
    (1) The account must be legally recognized as a separate account 
under applicable law;
    (2) The assets in the account must be insulated from general 
liabilities of the insurance company under applicable law in the event 
of the insurance company's insolvency;
    (3) The insurance company must invest the funds within the account 
as directed by the contract holder in designated investment 
alternatives or in accordance with specific investment objectives or 
policies; and
    (4) All investment gains and losses, net of contract fees and 
assessments, must be passed through to the contract holder, provided 
that the contract may specify conditions under which there may be a 
minimum guarantee but must not include contract terms that limit the 
maximum investment return available to the policyholder.
    Servicer cash advance facility means a facility under which the 
servicer of the underlying exposures of a securitization may advance 
cash to ensure an uninterrupted flow of payments to investors in the 
securitization, including advances made to cover foreclosure costs or 
other expenses to facilitate the timely collection of the underlying 
exposures.
    Significant investment in the capital of an unconsolidated 
financial institution means an investment in the capital of an 
unconsolidated financial institution where the [BANK] owns more than 10 
percent of the issued and outstanding common stock of the 
unconsolidated financial institution.
    Small Business Act means the Small Business Act (15 U.S.C. 632).
    Small Business Investment Act means the Small Business Investment 
Act of 1958 (15 U.S.C. 682).
    Sovereign means a central government (including the U.S. 
government) or an agency, department, ministry, or central bank of a 
central government.
    Sovereign default means noncompliance by a sovereign with its 
external debt service obligations or the inability or unwillingness of 
a sovereign government to service an existing loan according to its 
original terms, as evidenced by failure to pay principal and interest 
timely and fully, arrearages, or restructuring.
    Sovereign exposure means:
    (1) A direct exposure to a sovereign; or
    (2) An exposure directly and unconditionally backed by the full 
faith and credit of a sovereign.
    Specific wrong-way risk means wrong-way risk that arises when 
either:
    (1) The counterparty and issuer of the collateral supporting the 
transaction; or
    (2) The counterparty and the reference asset of the transaction, 
are affiliates or are the same entity.
    Standardized market risk-weighted assets means the standardized 
measure for market risk calculated under Sec.  --.204 multiplied by 
12.5.
    Standardized total risk-weighted assets means:
    (1) The sum of:
    (i) Total risk-weighted assets for general credit risk as 
calculated under Sec.  --.31;
    (ii) Total risk-weighted assets for cleared transactions and 
default fund contributions as calculated under Sec.  --.35;
    (iii) Total risk-weighted assets for unsettled transactions as 
calculated under Sec.  --.38;
    (iv) Total risk-weighted assets for securitization exposures as 
calculated under Sec.  --.42;
    (v) Total risk-weighted assets for equity exposures as calculated 
under Sec. Sec.  --.52 and --.53; and
    (vi) For a market risk [BANK] only, standardized market risk-
weighted assets; minus
    (2) Any amount of the [BANK]'s allowance for loan and lease losses 
that is not included in tier 2 capital and any amount of allocated 
transfer risk reserves.
    Statutory multifamily mortgage means a loan secured by a 
multifamily residential property that meets the requirements under 
section 618(b)(1) of the Resolution Trust Corporation Refinancing, 
Restructuring, and Improvement Act of 1991, and that meets the 
following criteria: \5\
---------------------------------------------------------------------------

    \5\ The types of loans that qualify as loans secured by 
multifamily residential properties are listed in the instructions 
for preparation of the [REGULATORY REPORT].
---------------------------------------------------------------------------

    (1) The loan is made in accordance with prudent underwriting 
standards;
    (2) The principal amount of the loan at origination does not exceed 
80 percent of the value of the property (or 75 percent of the value of 
the property if the loan is based on an interest rate that changes over 
the term of the loan) where the value of the property is the lower of 
the acquisition cost of the property or the appraised (or, if 
appropriate, evaluated) value of the property;
    (3) All principal and interest payments on the loan must have been 
made on a timely basis in accordance with the terms of the loan for at 
least one year prior to applying a 50 percent risk weight to the loan, 
or in the case where an existing owner is refinancing a loan on the 
property, all principal and interest payments on the loan being 
refinanced must have been made on a timely basis in accordance with the 
terms of the loan for at least one year prior to applying a 50 percent 
risk weight to the loan;
    (4) Amortization of principal and interest on the loan must occur 
over a period of not more than 30 years and the minimum original 
maturity for repayment of principal must not be less than 7 years;
    (5) Annual net operating income (before making any payment on the 
loan) generated by the property securing the loan during its most 
recent fiscal year must not be less than 120 percent of the loan's 
current annual debt service (or 115 percent of current annual debt 
service if the loan is based on an interest rate that changes over the 
term of the loan) or, in the case of a cooperative or other not-for-
profit housing project, the property must generate sufficient cash flow 
to provide comparable protection to the [BANK]; and
    (6) The loan is not more than 90 days past due, or on nonaccrual.
    Subsidiary means, with respect to a company, a company controlled 
by that company.

[[Page 62169]]

    Synthetic exposure means an exposure whose value is linked to the 
value of an investment in the [BANK]'s own capital instrument or to the 
value of an investment in the capital of an unconsolidated financial 
institution.
    Synthetic securitization means a transaction in which:
    (1) All or a portion of the credit risk of one or more underlying 
exposures is retained or transferred to one or more third parties 
through the use of one or more credit derivatives or guarantees (other 
than a guarantee that transfers only the credit risk of an individual 
retail exposure);
    (2) The credit risk associated with the underlying exposures has 
been separated into at least two tranches reflecting different levels 
of seniority;
    (3) Performance of the securitization exposures depends upon the 
performance of the underlying exposures; and
    (4) All or substantially all of the underlying exposures are 
financial exposures (such as loans, commitments, credit derivatives, 
guarantees, receivables, asset-backed securities, mortgage-backed 
securities, other debt securities, or equity securities).
    Tier 1 capital means the sum of common equity tier 1 capital and 
additional tier 1 capital.
    Tier 1 minority interest means the tier 1 capital of a consolidated 
subsidiary of a [BANK] that is not owned by the [BANK].
    Tier 2 capital is defined in Sec.  --.20(d).
    Total capital means the sum of tier 1 capital and tier 2 capital.
    Total capital minority interest means the total capital of a 
consolidated subsidiary of a [BANK] that is not owned by the [BANK].
    Total leverage exposure means the sum of the following:
    (1) The balance sheet carrying value of all of the [BANK]'s on-
balance sheet assets, less amounts deducted from tier 1 capital under 
Sec.  --.22(a), (c), and (d);
    (2) The potential future credit exposure (PFE) amount for each 
derivative contract to which the [BANK] is a counterparty (or each 
single-product netting set of such transactions) determined in 
accordance with Sec.  --.34, but without regard to Sec.  --.34(b);
    (3) 10 percent of the notional amount of unconditionally 
cancellable commitments made by the [BANK]; and
    (4) The notional amount of all other off-balance sheet exposures of 
the [BANK] (excluding securities lending, securities borrowing, reverse 
repurchase transactions, derivatives and unconditionally cancellable 
commitments).
    Traditional securitization means a transaction in which:
    (1) All or a portion of the credit risk of one or more underlying 
exposures is transferred to one or more third parties other than 
through the use of credit derivatives or guarantees;
    (2) The credit risk associated with the underlying exposures has 
been separated into at least two tranches reflecting different levels 
of seniority;
    (3) Performance of the securitization exposures depends upon the 
performance of the underlying exposures;
    (4) All or substantially all of the underlying exposures are 
financial exposures (such as loans, commitments, credit derivatives, 
guarantees, receivables, asset-backed securities, mortgage-backed 
securities, other debt securities, or equity securities);
    (5) The underlying exposures are not owned by an operating company;
    (6) The underlying exposures are not owned by a small business 
investment company defined in section 302 of the Small Business 
Investment Act;
    (7) The underlying exposures are not owned by a firm an investment 
in which qualifies as a community development investment under section 
24(Eleventh) of the National Bank Act;
    (8) The [AGENCY] may determine that a transaction in which the 
underlying exposures are owned by an investment firm that exercises 
substantially unfettered control over the size and composition of its 
assets, liabilities, and off-balance sheet exposures is not a 
traditional securitization based on the transaction's leverage, risk 
profile, or economic substance;
    (9) The [AGENCY] may deem a transaction that meets the definition 
of a traditional securitization, notwithstanding paragraph (5), (6), or 
(7) of this definition, to be a traditional securitization based on the 
transaction's leverage, risk profile, or economic substance; and
    (10) The transaction is not:
    (i) An investment fund;
    (ii) A collective investment fund (as defined in [12 CFR 9.18 
(national bank) and 12 CFR 151.40 (Federal saving association) (OCC); 
12 CFR 208.34 (Board)];
    (iii) An employee benefit plan (as defined in paragraphs (3) and 
(32) of section 3 of ERISA), a ``governmental plan'' (as defined in 29 
U.S.C. 1002(32)) that complies with the tax deferral qualification 
requirements provided in the Internal Revenue Code, or any similar 
employee benefit plan established under the laws of a foreign 
jurisdiction;
    (iv) A synthetic exposure to the capital of a financial institution 
to the extent deducted from capital under Sec.  --.22; or
    (v) Registered with the SEC under the Investment Company Act of 
1940 (15 U.S.C. 80a-1) or foreign equivalents thereof.
    Tranche means all securitization exposures associated with a 
securitization that have the same seniority level.
    Two-way market means a market where there are independent bona fide 
offers to buy and sell so that a price reasonably related to the last 
sales price or current bona fide competitive bid and offer quotations 
can be determined within one day and settled at that price within a 
relatively short time frame conforming to trade custom.
    Unconditionally cancelable means with respect to a commitment, that 
a [BANK] may, at any time, with or without cause, refuse to extend 
credit under the commitment (to the extent permitted under applicable 
law).
    Underlying exposures means one or more exposures that have been 
securitized in a securitization transaction.
    Unregulated financial institution means, for purposes of Sec.  
--.131, a financial institution that is not a regulated financial 
institution, including any financial institution that would meet the 
definition of ``financial institution'' under this section but for the 
ownership interest thresholds set forth in paragraph (4)(i) of that 
definition.
    U.S. Government agency means an instrumentality of the U.S. 
Government whose obligations are fully and explicitly guaranteed as to 
the timely payment of principal and interest by the full faith and 
credit of the U.S. Government.
    Value-at-Risk (VaR) means the estimate of the maximum amount that 
the value of one or more exposures could decline due to market price or 
rate movements during a fixed holding period within a stated confidence 
interval.
    Wrong-way risk means the risk that arises when an exposure to a 
particular counterparty is positively correlated with the probability 
of default of such counterparty itself.


Sec.  --.3  Operational requirements for counterparty credit risk.

    For purposes of calculating risk-weighted assets under subparts D 
and E of this part:
    (a) Cleared transaction. In order to recognize certain exposures as 
cleared transactions pursuant to paragraphs (1)(ii), (iii) or (iv) of 
the definition of ``cleared transaction'' in Sec.  --.2, the

[[Page 62170]]

exposures must meet the applicable requirements set forth in this 
paragraph (a).
    (1) The offsetting transaction must be identified by the CCP as a 
transaction for the clearing member client.
    (2) The collateral supporting the transaction must be held in a 
manner that prevents the [BANK] from facing any loss due to an event of 
default, including from a liquidation, receivership, insolvency, or 
similar proceeding of either the clearing member or the clearing 
member's other clients. Omnibus accounts established under 17 CFR parts 
190 and 300 satisfy the requirements of this paragraph (a).
    (3) The [BANK] must conduct sufficient legal review to conclude 
with a well-founded basis (and maintain sufficient written 
documentation of that legal review) that in the event of a legal 
challenge (including one resulting from a default or receivership, 
insolvency, liquidation, or similar proceeding) the relevant court and 
administrative authorities would find the arrangements of paragraph 
(a)(2) of this section to be legal, valid, binding and enforceable 
under the law of the relevant jurisdictions.
    (4) The offsetting transaction with a clearing member must be 
transferable under the transaction documents and applicable laws in the 
relevant jurisdiction(s) to another clearing member should the clearing 
member default, become insolvent, or enter receivership, insolvency, 
liquidation, or similar proceedings.
    (b) Eligible margin loan. In order to recognize an exposure as an 
eligible margin loan as defined in Sec.  --.2, a [BANK] must conduct 
sufficient legal review to conclude with a well-founded basis (and 
maintain sufficient written documentation of that legal review) that 
the agreement underlying the exposure:
    (1) Meets the requirements of paragraph (1)(iii) of the definition 
of eligible margin loan in Sec.  --.2, and
    (2) Is legal, valid, binding, and enforceable under applicable law 
in the relevant jurisdictions.
    (c) Qualifying cross-product master netting agreement. In order to 
recognize an agreement as a qualifying cross-product master netting 
agreement as defined in Sec.  --.101, a [BANK] must obtain a written 
legal opinion verifying the validity and enforceability of the 
agreement under applicable law of the relevant jurisdictions if the 
counterparty fails to perform upon an event of default, including upon 
receivership, insolvency, liquidation, or similar proceeding.
    (d) Qualifying master netting agreement. In order to recognize an 
agreement as a qualifying master netting agreement as defined in Sec.  
--.2, a [BANK] must:
    (1) Conduct sufficient legal review to conclude with a well-founded 
basis (and maintain sufficient written documentation of that legal 
review) that:
    (i) The agreement meets the requirements of paragraph (2) of the 
definition of qualifying master netting agreement in Sec.  --.2; and
    (ii) In the event of a legal challenge (including one resulting 
from default or from receivership, insolvency, liquidation, or similar 
proceeding) the relevant court and administrative authorities would 
find the agreement to be legal, valid, binding, and enforceable under 
the law of the relevant jurisdictions; and
    (2) Establish and maintain written procedures to monitor possible 
changes in relevant law and to ensure that the agreement continues to 
satisfy the requirements of the definition of qualifying master netting 
agreement in Sec.  --.2.
    (e) Repo-style transaction. In order to recognize an exposure as a 
repo-style transaction as defined in Sec.  --.2, a [BANK] must conduct 
sufficient legal review to conclude with a well-founded basis (and 
maintain sufficient written documentation of that legal review) that 
the agreement underlying the exposure:
    (1) Meets the requirements of paragraph (3) of the definition of 
repo-style transaction in Sec.  --.2, and
    (2) Is legal, valid, binding, and enforceable under applicable law 
in the relevant jurisdictions.
    (f) Failure of a QCCP to satisfy the rule's requirements. If a 
[BANK] determines that a CCP ceases to be a QCCP due to the failure of 
the CCP to satisfy one or more of the requirements set forth in 
paragraphs (2)(i) through (2)(iii) of the definition of a QCCP in Sec.  
--.2, the [BANK] may continue to treat the CCP as a QCCP for up to 
three months following the determination. If the CCP fails to remedy 
the relevant deficiency within three months after the initial 
determination, or the CCP fails to satisfy the requirements set forth 
in paragraphs (2)(i) through (2)(iii) of the definition of a QCCP 
continuously for a three-month period after remedying the relevant 
deficiency, a [BANK] may not treat the CCP as a QCCP for the purposes 
of this part until after the [BANK] has determined that the CCP has 
satisfied the requirements in paragraphs (2)(i) through (2)(iii) of the 
definition of a QCCP for three continuous months.


Sec. Sec.  --.4 through --.9  [Reserved]

Subpart B--Capital Ratio Requirements and Buffers


Sec.  --.10  Minimum capital requirements.

    (a) Minimum capital requirements. A [BANK] must maintain the 
following minimum capital ratios:
    (1) A common equity tier 1 capital ratio of 4.5 percent.
    (2) A tier 1 capital ratio of 6 percent.
    (3) A total capital ratio of 8 percent.
    (4) A leverage ratio of 4 percent.
    (5) For advanced approaches [BANK]s, a supplementary leverage ratio 
of 3 percent.
    (b) Standardized capital ratio calculations. Other than as provided 
in paragraph (c) of this section:
    (1) Common equity tier 1 capital ratio. A [BANK]'s common equity 
tier 1 capital ratio is the ratio of the [BANK]'s common equity tier 1 
capital to standardized total risk-weighted assets;
    (2) Tier 1 capital ratio. A [BANK]'s tier 1 capital ratio is the 
ratio of the [BANK]'s tier 1 capital to standardized total risk-
weighted assets;
    (3) Total capital ratio. A [BANK]'s total capital ratio is the 
ratio of the [BANK]'s total capital to standardized total risk-weighted 
assets; and
    (4) Leverage ratio. A [BANK]'s leverage ratio is the ratio of the 
[BANK]'s tier 1 capital to the [BANK]'s average total consolidated 
assets as reported on the [BANK]'s [REGULATORY REPORT] minus amounts 
deducted from tier 1 capital under Sec.  --.22(a), (c) and (d).
    (c) Advanced approaches capital ratio calculations. An advanced 
approaches [BANK] that has completed the parallel run process and 
received notification from the [AGENCY] pursuant to Sec.  --.121(d) 
must determine its regulatory capital ratios as described in this 
paragraph (c).
    (1) Common equity tier 1 capital ratio. The [BANK]'s common equity 
tier 1 capital ratio is the lower of:
    (i) The ratio of the [BANK]'s common equity tier 1 capital to 
standardized total risk-weighted assets; and
    (ii) The ratio of the [BANK]'s common equity tier 1 capital to 
advanced approaches total risk-weighted assets.
    (2) Tier 1 capital ratio. The [BANK]'s tier 1 capital ratio is the 
lower of:
    (i) The ratio of the [BANK]'s tier 1 capital to standardized total 
risk-weighted assets; and
    (ii) The ratio of the [BANK]'s tier 1 capital to advanced 
approaches total risk-weighted assets.
    (3) Total capital ratio. The [BANK]'s total capital ratio is the 
lower of:

[[Page 62171]]

    (i) The ratio of the [BANK]'s total capital to standardized total 
risk-weighted assets; and
    (ii) The ratio of the [BANK]'s advanced-approaches-adjusted total 
capital to advanced approaches total risk-weighted assets. A [BANK]'s 
advanced-approaches-adjusted total capital is the [BANK]'s total 
capital after being adjusted as follows:
    (A) An advanced approaches [BANK] must deduct from its total 
capital any allowance for loan and lease losses included in its tier 2 
capital in accordance with Sec.  --.20(d)(3); and
    (B) An advanced approaches [BANK] must add to its total capital any 
eligible credit reserves that exceed the [BANK]'s total expected credit 
losses to the extent that the excess reserve amount does not exceed 0.6 
percent of the [BANK]'s credit risk-weighted assets.
    (4) Supplementary leverage ratio. An advanced approaches [BANK]'s 
supplementary leverage ratio is the simple arithmetic mean of the ratio 
of its tier 1 capital to total leverage exposure calculated as of the 
last day of each month in the reporting quarter.
    (d) Capital adequacy. (1) Notwithstanding the minimum requirements 
in this part, a [BANK] must maintain capital commensurate with the 
level and nature of all risks to which the [BANK] is exposed. The 
supervisory evaluation of a [BANK]'s capital adequacy is based on an 
individual assessment of numerous factors, including those listed at 
[12 CFR 3.10 (national banks), 12 CFR 167.3(c) (Federal savings 
associations) and 12 CFR 208.4 (state member banks)].
    (2) A [BANK] must have a process for assessing its overall capital 
adequacy in relation to its risk profile and a comprehensive strategy 
for maintaining an appropriate level of capital.


Sec.  --.11  Capital conservation buffer and countercyclical capital 
buffer amount.

    (a) Capital conservation buffer. (1) Composition of the capital 
conservation buffer. The capital conservation buffer is composed solely 
of common equity tier 1 capital.
    (2) Definitions. For purposes of this section, the following 
definitions apply:
    (i) Eligible retained income. The eligible retained income of a 
[BANK] is the [BANK]'s net income for the four calendar quarters 
preceding the current calendar quarter, based on the [BANK]'s quarterly 
[REGULATORY REPORT]s, net of any distributions and associated tax 
effects not already reflected in net income.
    (ii) Maximum payout ratio. The maximum payout ratio is the 
percentage of eligible retained income that a [BANK] can pay out in the 
form of distributions and discretionary bonus payments during the 
current calendar quarter. The maximum payout ratio is based on the 
[BANK]'s capital conservation buffer, calculated as of the last day of 
the previous calendar quarter, as set forth in Table 1 to Sec.  --.11.
    (iii) Maximum payout amount. A [BANK]'s maximum payout amount for 
the current calendar quarter is equal to the [BANK]'s eligible retained 
income, multiplied by the applicable maximum payout ratio, as set forth 
in Table 1 to Sec.  --.11.
    (iv) Private sector credit exposure. Private sector credit exposure 
means an exposure to a company or an individual that is not an exposure 
to a sovereign, the Bank for International Settlements, the European 
Central Bank, the European Commission, the International Monetary Fund, 
a MDB, a PSE, or a GSE.
    (3) Calculation of capital conservation buffer. (i) A [BANK]'s 
capital conservation buffer is equal to the lowest of the following 
ratios, calculated as of the last day of the previous calendar quarter 
based on the [BANK]'s most recent [REGULATORY REPORT]:
    (A) The [BANK]'s common equity tier 1 capital ratio minus the 
[BANK]'s minimum common equity tier 1 capital ratio requirement under 
Sec.  --.10;
    (B) The [BANK]'s tier 1 capital ratio minus the [BANK]'s minimum 
tier 1 capital ratio requirement under Sec.  --.10; and
    (C) The [BANK]'s total capital ratio minus the [BANK]'s minimum 
total capital ratio requirement under Sec.  --.10; or
    (ii) Notwithstanding paragraphs (a)(3)(i)(A)-(C) of this section, 
if the [BANK]'s common equity tier 1, tier 1 or total capital ratio is 
less than or equal to the [BANK]'s minimum common equity tier 1, tier 1 
or total capital ratio requirement under Sec.  --.10, respectively, the 
[BANK]'s capital conservation buffer is zero.
    (4) Limits on distributions and discretionary bonus payments. (i) A 
[BANK] shall not make distributions or discretionary bonus payments or 
create an obligation to make such distributions or payments during the 
current calendar quarter that, in the aggregate, exceed the maximum 
payout amount.
    (ii) A [BANK] with a capital conservation buffer that is greater 
than 2.5 percent plus 100 percent of its applicable countercyclical 
capital buffer, in accordance with paragraph (b) of this section, is 
not subject to a maximum payout amount under this section.
    (iii) Negative eligible retained income. Except as provided in 
paragraph (a)(4)(iv) of this section, a [BANK] may not make 
distributions or discretionary bonus payments during the current 
calendar quarter if the [BANK]'s:
    (A) Eligible retained income is negative; and
    (B) Capital conservation buffer was less than 2.5 percent as of the 
end of the previous calendar quarter.
    (iv) Prior approval. Notwithstanding the limitations in paragraphs 
(a)(4)(i) through (iii) of this section, the [AGENCY] may permit a 
[BANK] to make a distribution or discretionary bonus payment upon a 
request of the [BANK], if the [AGENCY] determines that the distribution 
or discretionary bonus payment would not be contrary to the purposes of 
this section, or to the safety and soundness of the [BANK]. In making 
such a determination, the [AGENCY] will consider the nature and extent 
of the request and the particular circumstances giving rise to the 
request.

      Table 1 to Sec.   --.11--Calculation of Maximum Payout Amount
------------------------------------------------------------------------
                                        Maximum payout ratio  (as a
   Capital conservation buffer        percentage of eligible retained
                                                  income)
------------------------------------------------------------------------
Greater than 2.5 percent plus 100  No payout ratio limitation applies.
 percent of the [BANK]'s
 applicable countercyclical
 capital buffer amount.
Less than or equal to 2.5 percent  60 percent.
 plus 100 percent of the [BANK]'s
 applicable countercyclical
 capital buffer amount, and
 greater than 1.875 percent plus
 75 percent of the [BANK]'s
 applicable countercyclical
 capital buffer amount.
Less than or equal to 1.875        40 percent.
 percent plus 75 percent of the
 [BANK]'s applicable
 countercyclical capital buffer
 amount, and greater than 1.25
 percent plus 50 percent of the
 [BANK]'s applicable
 countercyclical capital buffer
 amount.

[[Page 62172]]

 
Less than or equal to 1.25         20 percent.
 percent plus 50 percent of the
 [BANK]'s applicable
 countercyclical capital buffer
 amount, and greater than 0.625
 percent plus 25 percent of the
 [BANK]'s applicable
 countercyclical capital buffer
 amount.
Less than or equal to 0.625        0 percent.
 percent plus 25 percent of the
 [BANK]'s applicable
 countercyclical capital buffer
 amount.
------------------------------------------------------------------------

    (v) Other limitations on distributions. Additional limitations on 
distributions may apply to a [BANK] under [12 CFR part 3, subparts H 
and I; 12 CFR part 5.46, 12 CFR part 5, subpart E; 12 CFR part 6 (OCC); 
12 CFR 225.4; 12 CFR 225.8; 12 CFR 263.202 (Board)].
    (b) Countercyclical capital buffer amount. (1) General. An advanced 
approaches [BANK] must calculate a countercyclical capital buffer 
amount in accordance with the following paragraphs for purposes of 
determining its maximum payout ratio under Table 1 to Sec.  --.11.
    (i) Extension of capital conservation buffer. The countercyclical 
capital buffer amount is an extension of the capital conservation 
buffer as described in paragraph (a) of this section.
    (ii) Amount. An advanced approaches [BANK] has a countercyclical 
capital buffer amount determined by calculating the weighted average of 
the countercyclical capital buffer amounts established for the national 
jurisdictions where the [BANK]'s private sector credit exposures are 
located, as specified in paragraphs (b)(2) and (3) of this section.
    (iii) Weighting. The weight assigned to a jurisdiction's 
countercyclical capital buffer amount is calculated by dividing the 
total risk-weighted assets for the [BANK]'s private sector credit 
exposures located in the jurisdiction by the total risk-weighted assets 
for all of the [BANK]'s private sector credit exposures. The 
methodology a [BANK] uses for determining risk-weighted assets for 
purposes of this paragraph (b) must be the methodology that determines 
its risk-based capital ratios under Sec.  --.10. Notwithstanding the 
previous sentence, the risk-weighted asset amount for a private sector 
credit exposure that is a covered position under subpart F of this part 
is its specific risk add-on as determined under Sec.  --.210 multiplied 
by 12.5.
    (iv) Location. (A) Except as provided in paragraphs (b)(1)(iv)(B) 
and (b)(1)(iv)(C) of this section, the location of a private sector 
credit exposure is the national jurisdiction where the borrower is 
located (that is, where it is incorporated, chartered, or similarly 
established or, if the borrower is an individual, where the borrower 
resides).
    (B) If, in accordance with subparts D or E of this part, the [BANK] 
has assigned to a private sector credit exposure a risk weight 
associated with a protection provider on a guarantee or credit 
derivative, the location of the exposure is the national jurisdiction 
where the protection provider is located.
    (C) The location of a securitization exposure is the location of 
the underlying exposures, or, if the underlying exposures are located 
in more than one national jurisdiction, the national jurisdiction where 
the underlying exposures with the largest aggregate unpaid principal 
balance are located. For purposes of this paragraph (b), the location 
of an underlying exposure shall be the location of the borrower, 
determined consistent with paragraph (b)(1)(iv)(A) of this section.
    (2) Countercyclical capital buffer amount for credit exposures in 
the United States--(i) Initial countercyclical capital buffer amount 
with respect to credit exposures in the United States. The initial 
countercyclical capital buffer amount in the United States is zero.
    (ii) Adjustment of the countercyclical capital buffer amount. The 
[AGENCY] will adjust the countercyclical capital buffer amount for 
credit exposures in the United States in accordance with applicable 
law.\6\
---------------------------------------------------------------------------

    \6\ The [AGENCY] expects that any adjustment will be based on a 
determination made jointly by the Board, OCC, and FDIC.
---------------------------------------------------------------------------

    (iii) Range of countercyclical capital buffer amount. The [AGENCY] 
will adjust the countercyclical capital buffer amount for credit 
exposures in the United States between zero percent and 2.5 percent of 
risk-weighted assets.
    (iv) Adjustment determination. The [AGENCY] will base its decision 
to adjust the countercyclical capital buffer amount under this section 
on a range of macroeconomic, financial, and supervisory information 
indicating an increase in systemic risk including, but not limited to, 
the ratio of credit to gross domestic product, a variety of asset 
prices, other factors indicative of relative credit and liquidity 
expansion or contraction, funding spreads, credit condition surveys, 
indices based on credit default swap spreads, options implied 
volatility, and measures of systemic risk.
    (v) Effective date of adjusted countercyclical capital buffer 
amount. (A) Increase adjustment. A determination by the [AGENCY] under 
paragraph (b)(2)(ii) of this section to increase the countercyclical 
capital buffer amount will be effective 12 months from the date of 
announcement, unless the [AGENCY] establishes an earlier effective date 
and includes a statement articulating the reasons for the earlier 
effective date.
    (B) Decrease adjustment. A determination by the [AGENCY] to 
decrease the established countercyclical capital buffer amount under 
paragraph (b)(2)(ii) of this section will be effective on the day 
following announcement of the final determination or the earliest date 
permissible under applicable law or regulation, whichever is later.
    (vi) Twelve month sunset. The countercyclical capital buffer amount 
will return to zero percent 12 months after the effective date that the 
adjusted countercyclical capital buffer amount is announced, unless the 
[AGENCY] announces a decision to maintain the adjusted countercyclical 
capital buffer amount or adjust it again before the expiration of the 
12-month period.
    (3) Countercyclical capital buffer amount for foreign 
jurisdictions. The [AGENCY] will adjust the countercyclical capital 
buffer amount for private sector credit exposures to reflect decisions 
made by foreign jurisdictions consistent with due process requirements 
described in paragraph (b)(2) of this section.


Sec. Sec.  --.12 through --.19  [Reserved]

Subpart C--Definition of Capital


Sec.  --.20  Capital components and eligibility criteria for regulatory 
capital instruments.

    (a) Regulatory capital components. A [BANK]'s regulatory capital 
components are:
    (1) Common equity tier 1 capital;

[[Page 62173]]

    (2) Additional tier 1 capital; and
    (3) Tier 2 capital.
    (b) Common equity tier 1 capital. Common equity tier 1 capital is 
the sum of the common equity tier 1 capital elements in this paragraph 
(b), minus regulatory adjustments and deductions in Sec.  --.22. The 
common equity tier 1 capital elements are:
    (1) Any common stock instruments (plus any related surplus) issued 
by the [BANK], net of treasury stock, and any capital instruments 
issued by mutual banking organizations, that meet all the following 
criteria:
    (i) The instrument is paid-in, issued directly by the [BANK], and 
represents the most subordinated claim in a receivership, insolvency, 
liquidation, or similar proceeding of the [BANK];
    (ii) The holder of the instrument is entitled to a claim on the 
residual assets of the [BANK] that is proportional with the holder's 
share of the [BANK]'s issued capital after all senior claims have been 
satisfied in a receivership, insolvency, liquidation, or similar 
proceeding;
    (iii) The instrument has no maturity date, can only be redeemed via 
discretionary repurchases with the prior approval of the [AGENCY], and 
does not contain any term or feature that creates an incentive to 
redeem;
    (iv) The [BANK] did not create at issuance of the instrument 
through any action or communication an expectation that it will buy 
back, cancel, or redeem the instrument, and the instrument does not 
include any term or feature that might give rise to such an 
expectation;
    (v) Any cash dividend payments on the instrument are paid out of 
the [BANK]'s net income, retained earnings, or surplus related to 
common stock, and are not subject to a limit imposed by the contractual 
terms governing the instrument;
    (vi) The [BANK] has full discretion at all times to refrain from 
paying any dividends and making any other distributions on the 
instrument without triggering an event of default, a requirement to 
make a payment-in-kind, or an imposition of any other restrictions on 
the [BANK];
    (vii) Dividend payments and any other distributions on the 
instrument may be paid only after all legal and contractual obligations 
of the [BANK] have been satisfied, including payments due on more 
senior claims;
    (viii) The holders of the instrument bear losses as they occur 
equally, proportionately, and simultaneously with the holders of all 
other common stock instruments before any losses are borne by holders 
of claims on the [BANK] with greater priority in a receivership, 
insolvency, liquidation, or similar proceeding;
    (ix) The paid-in amount is classified as equity under GAAP;
    (x) The [BANK], or an entity that the [BANK] controls, did not 
purchase or directly or indirectly fund the purchase of the instrument;
    (xi) The instrument is not secured, not covered by a guarantee of 
the [BANK] or of an affiliate of the [BANK], and is not subject to any 
other arrangement that legally or economically enhances the seniority 
of the instrument;
    (xii) The instrument has been issued in accordance with applicable 
laws and regulations; and
    (xiii) The instrument is reported on the [BANK]'s regulatory 
financial statements separately from other capital instruments.
    (2) Retained earnings.
    (3) Accumulated other comprehensive income (AOCI) as reported under 
GAAP.\7\
---------------------------------------------------------------------------

    \7\ See Sec.  --.22 for specific adjustments related to AOCI.
---------------------------------------------------------------------------

    (4) Any common equity tier 1 minority interest, subject to the 
limitations in Sec.  --.21(c).
    (5) Notwithstanding the criteria for common stock instruments 
referenced above, a [BANK]'s common stock issued and held in trust for 
the benefit of its employees as part of an employee stock ownership 
plan does not violate any of the criteria in paragraph (b)(1)(iii), 
paragraph (b)(1)(iv) or paragraph (b)(1)(xi) of this section, provided 
that any repurchase of the stock is required solely by virtue of ERISA 
for an instrument of a [BANK] that is not publicly-traded. In addition, 
an instrument issued by a [BANK] to its employee stock ownership plan 
does not violate the criterion in paragraph (b)(1)(x) of this section.
    (c) Additional tier 1 capital. Additional tier 1 capital is the sum 
of additional tier 1 capital elements and any related surplus, minus 
the regulatory adjustments and deductions in Sec.  --.22. Additional 
tier 1 capital elements are:
    (1) Instruments (plus any related surplus) that meet the following 
criteria:
    (i) The instrument is issued and paid-in;
    (ii) The instrument is subordinated to depositors, general 
creditors, and subordinated debt holders of the [BANK] in a 
receivership, insolvency, liquidation, or similar proceeding;
    (iii) The instrument is not secured, not covered by a guarantee of 
the [BANK] or of an affiliate of the [BANK], and not subject to any 
other arrangement that legally or economically enhances the seniority 
of the instrument;
    (iv) The instrument has no maturity date and does not contain a 
dividend step-up or any other term or feature that creates an incentive 
to redeem; and
    (v) If callable by its terms, the instrument may be called by the 
[BANK] only after a minimum of five years following issuance, except 
that the terms of the instrument may allow it to be called earlier than 
five years upon the occurrence of a regulatory event that precludes the 
instrument from being included in additional tier 1 capital, a tax 
event, or if the issuing entity is required to register as an 
investment company pursuant to the Investment Company Act of 1940 (15 
U.S.C. 80a-1 et seq.). In addition:
    (A) The [BANK] must receive prior approval from the [AGENCY] to 
exercise a call option on the instrument.
    (B) The [BANK] does not create at issuance of the instrument, 
through any action or communication, an expectation that the call 
option will be exercised.
    (C) Prior to exercising the call option, or immediately thereafter, 
the [BANK] must either: Replace the instrument to be called with an 
equal amount of instruments that meet the criteria under paragraph (b) 
of this section or this paragraph (c); \8\ or demonstrate to the 
satisfaction of the [AGENCY] that following redemption, the [BANK] will 
continue to hold capital commensurate with its risk.
---------------------------------------------------------------------------

    \8\ Replacement can be concurrent with redemption of existing 
additional tier 1 capital instruments.
---------------------------------------------------------------------------

    (vi) Redemption or repurchase of the instrument requires prior 
approval from the [AGENCY].
    (vii) The [BANK] has full discretion at all times to cancel 
dividends or other distributions on the instrument without triggering 
an event of default, a requirement to make a payment-in-kind, or an 
imposition of other restrictions on the [BANK] except in relation to 
any distributions to holders of common stock or instruments that are 
pari passu with the instrument.
    (viii) Any distributions on the instrument are paid out of the 
[BANK]'s net income, retained earnings, or surplus related to other 
additional tier 1 capital instruments.
    (ix) The instrument does not have a credit-sensitive feature, such 
as a dividend rate that is reset periodically based in whole or in part 
on the [BANK]'s credit quality, but may have a dividend rate that is 
adjusted periodically independent of the [BANK]'s credit quality, in 
relation to

[[Page 62174]]

general market interest rates or similar adjustments.
    (x) The paid-in amount is classified as equity under GAAP.
    (xi) The [BANK], or an entity that the [BANK] controls, did not 
purchase or directly or indirectly fund the purchase of the instrument.
    (xii) The instrument does not have any features that would limit or 
discourage additional issuance of capital by the [BANK], such as 
provisions that require the [BANK] to compensate holders of the 
instrument if a new instrument is issued at a lower price during a 
specified time frame.
    (xiii) If the instrument is not issued directly by the [BANK] or by 
a subsidiary of the [BANK] that is an operating entity, the only asset 
of the issuing entity is its investment in the capital of the [BANK], 
and proceeds must be immediately available without limitation to the 
[BANK] or to the [BANK]'s top-tier holding company in a form which 
meets or exceeds all of the other criteria for additional tier 1 
capital instruments.\9\
---------------------------------------------------------------------------

    \9\ De minimis assets related to the operation of the issuing 
entity can be disregarded for purposes of this criterion.
---------------------------------------------------------------------------

    (xiv) For an advanced approaches [BANK], the governing agreement, 
offering circular, or prospectus of an instrument issued after the date 
upon which the [BANK] becomes subject to this part as set forth in 
Sec.  --.1(f) must disclose that the holders of the instrument may be 
fully subordinated to interests held by the U.S. government in the 
event that the [BANK] enters into a receivership, insolvency, 
liquidation, or similar proceeding.
    (2) Tier 1 minority interest, subject to the limitations in Sec.  
--.21(d), that is not included in the [BANK]'s common equity tier 1 
capital.
    (3) Any and all instruments that qualified as tier 1 capital under 
the [AGENCY]'s general risk-based capital rules under [12 CFR part 3, 
appendix A (national banks), 12 CFR 167 (Federal savings associations) 
(OCC); 12 CFR part 208, appendix A, 12 CFR part 225, appendix A 
(Board)] as then in effect, that were issued under the Small Business 
Jobs Act of 2010 \10\ or prior to October 4, 2010, under the Emergency 
Economic Stabilization Act of 2008.\11\
---------------------------------------------------------------------------

    \10\ Public Law 111-240; 124 Stat. 2504 (2010).
    \11\ Public Law 110-343, 122 Stat. 3765 (2008).
---------------------------------------------------------------------------

    (4) Notwithstanding the criteria for additional tier 1 capital 
instruments referenced above:
    (i) An instrument issued by a [BANK] and held in trust for the 
benefit of its employees as part of an employee stock ownership plan 
does not violate any of the criteria in paragraph (c)(1)(iii) of this 
section, provided that any repurchase is required solely by virtue of 
ERISA for an instrument of a [BANK] that is not publicly-traded. In 
addition, an instrument issued by a [BANK] to its employee stock 
ownership plan does not violate the criteria in paragraph (c)(1)(v) or 
paragraph (c)(1)(xi) of this section; and
    (ii) An instrument with terms that provide that the instrument may 
be called earlier than five years upon the occurrence of a rating 
agency event does not violate the criterion in paragraph (c)(1)(v) of 
this section provided that the instrument was issued and included in a 
[BANK]'s tier 1 capital prior to January 1, 2014, and that such 
instrument satisfies all other criteria under this Sec.  --.20(c).
    (d) Tier 2 Capital. Tier 2 capital is the sum of tier 2 capital 
elements and any related surplus, minus regulatory adjustments and 
deductions in Sec.  --.22. Tier 2 capital elements are:
    (1) Instruments (plus related surplus) that meet the following 
criteria:
    (i) The instrument is issued and paid-in;
    (ii) The instrument is subordinated to depositors and general 
creditors of the [BANK];
    (iii) The instrument is not secured, not covered by a guarantee of 
the [BANK] or of an affiliate of the [BANK], and not subject to any 
other arrangement that legally or economically enhances the seniority 
of the instrument in relation to more senior claims;
    (iv) The instrument has a minimum original maturity of at least 
five years. At the beginning of each of the last five years of the life 
of the instrument, the amount that is eligible to be included in tier 2 
capital is reduced by 20 percent of the original amount of the 
instrument (net of redemptions) and is excluded from regulatory capital 
when the remaining maturity is less than one year. In addition, the 
instrument must not have any terms or features that require, or create 
significant incentives for, the [BANK] to redeem the instrument prior 
to maturity; \12\ and
---------------------------------------------------------------------------

    \12\ An instrument that by its terms automatically converts into 
a tier 1 capital instrument prior to five years after issuance 
complies with the five-year maturity requirement of this criterion.
---------------------------------------------------------------------------

    (v) The instrument, by its terms, may be called by the [BANK] only 
after a minimum of five years following issuance, except that the terms 
of the instrument may allow it to be called sooner upon the occurrence 
of an event that would preclude the instrument from being included in 
tier 2 capital, a tax event, or if the issuing entity is required to 
register as an investment company pursuant to the Investment Company 
Act of 1940 (15 U.S.C. 80a-1 et seq.). In addition:
    (A) The [BANK] must receive the prior approval of the [AGENCY] to 
exercise a call option on the instrument.
    (B) The [BANK] does not create at issuance, through action or 
communication, an expectation the call option will be exercised.
    (C) Prior to exercising the call option, or immediately thereafter, 
the [BANK] must either: Replace any amount called with an equivalent 
amount of an instrument that meets the criteria for regulatory capital 
under this section; \13\ or demonstrate to the satisfaction of the 
[AGENCY] that following redemption, the [BANK] would continue to hold 
an amount of capital that is commensurate with its risk.
---------------------------------------------------------------------------

    \13\ A [BANK] may replace tier 2 capital instruments concurrent 
with the redemption of existing tier 2 capital instruments.
---------------------------------------------------------------------------

    (vi) The holder of the instrument must have no contractual right to 
accelerate payment of principal or interest on the instrument, except 
in the event of a receivership, insolvency, liquidation, or similar 
proceeding of the [BANK].
    (vii) The instrument has no credit-sensitive feature, such as a 
dividend or interest rate that is reset periodically based in whole or 
in part on the [BANK]'s credit standing, but may have a dividend rate 
that is adjusted periodically independent of the [BANK]'s credit 
standing, in relation to general market interest rates or similar 
adjustments.
    (viii) The [BANK], or an entity that the [BANK] controls, has not 
purchased and has not directly or indirectly funded the purchase of the 
instrument.
    (ix) If the instrument is not issued directly by the [BANK] or by a 
subsidiary of the [BANK] that is an operating entity, the only asset of 
the issuing entity is its investment in the capital of the [BANK], and 
proceeds must be immediately available without limitation to the [BANK] 
or the [BANK]'s top-tier holding company in a form that meets or 
exceeds all the other criteria for tier 2 capital instruments under 
this section.\14\
---------------------------------------------------------------------------

    \14\ A [BANK] may disregard de minimis assets related to the 
operation of the issuing entity for purposes of this criterion.
---------------------------------------------------------------------------

    (x) Redemption of the instrument prior to maturity or repurchase 
requires the prior approval of the [AGENCY].
    (xi) For an advanced approaches [BANK], the governing agreement, 
offering circular, or prospectus of an instrument issued after the date 
on which the advanced approaches [BANK]

[[Page 62175]]

becomes subject to this part under Sec.  --.1(f) must disclose that the 
holders of the instrument may be fully subordinated to interests held 
by the U.S. government in the event that the [BANK] enters into a 
receivership, insolvency, liquidation, or similar proceeding.
    (2) Total capital minority interest, subject to the limitations set 
forth in Sec.  --.21(e), that is not included in the [BANK]'s tier 1 
capital.
    (3) ALLL up to 1.25 percent of the [BANK]'s standardized total 
risk-weighted assets not including any amount of the ALLL (and 
excluding in the case of a market risk [BANK], its standardized market 
risk-weighted assets).
    (4) Any instrument that qualified as tier 2 capital under the 
[AGENCY]'s general risk-based capital rules under [12 CFR part 3, 
appendix A, 12 CFR 167 (OCC); 12 CFR part 208, appendix A, 12 CFR part 
225, appendix A (Board)] as then in effect, that were issued under the 
Small Business Jobs Act of 2010,\15\ or prior to October 4, 2010, under 
the Emergency Economic Stabilization Act of 2008.\16\
---------------------------------------------------------------------------

    \15\ Public Law 111-240; 124 Stat. 2504 (2010).
    \16\ Public Law 110-343, 122 Stat. 3765 (2008).
---------------------------------------------------------------------------

    (5) For a [BANK] that makes an AOCI opt-out election (as defined in 
paragraph (b)(2) of this section), 45 percent of pretax net unrealized 
gains on available-for-sale preferred stock classified as an equity 
security under GAAP and available-for-sale equity exposures.
    (6) Notwithstanding the criteria for tier 2 capital instruments 
referenced above, an instrument with terms that provide that the 
instrument may be called earlier than five years upon the occurrence of 
a rating agency event does not violate the criterion in paragraph 
(d)(1)(v) of this section provided that the instrument was issued and 
included in a [BANK]'s tier 1 or tier 2 capital prior to January 1, 
2014, and that such instrument satisfies all other criteria under this 
paragraph (d).
    (e) [AGENCY] approval of a capital element. (1) A [BANK] must 
receive [AGENCY] prior approval to include a capital element (as listed 
in this section) in its common equity tier 1 capital, additional tier 1 
capital, or tier 2 capital unless the element:
    (i) Was included in a [BANK]'s tier 1 capital or tier 2 capital 
prior to May 19, 2010 in accordance with the [AGENCY]'s risk-based 
capital rules that were effective as of that date and the underlying 
instrument may continue to be included under the criteria set forth in 
this section; or
    (ii) Is equivalent, in terms of capital quality and ability to 
absorb losses with respect to all material terms, to a regulatory 
capital element the [AGENCY] determined may be included in regulatory 
capital pursuant to paragraph (e)(3) of this section.
    (2) When considering whether a [BANK] may include a regulatory 
capital element in its common equity tier 1 capital, additional tier 1 
capital, or tier 2 capital, the [AGENCY] will consult with the [other 
Federal banking agencies].
    (3) After determining that a regulatory capital element may be 
included in a [BANK]'s common equity tier 1 capital, additional tier 1 
capital, or tier 2 capital, the [AGENCY] will make its decision 
publicly available, including a brief description of the material terms 
of the regulatory capital element and the rationale for the 
determination.


Sec.  --.21  Minority interest.

    (a) Applicability. For purposes of Sec.  --.20, a [BANK] is subject 
to the minority interest limitations in this section if:
    (1) A consolidated subsidiary of the [BANK] has issued regulatory 
capital that is not owned by the [BANK]; and
    (2) For each relevant regulatory capital ratio of the consolidated 
subsidiary, the ratio exceeds the sum of the subsidiary's minimum 
regulatory capital requirements plus its capital conservation buffer.
    (b) Difference in capital adequacy standards at the subsidiary 
level. For purposes of the minority interest calculations in this 
section, if the consolidated subsidiary issuing the capital is not 
subject to capital adequacy standards similar to those of the [BANK], 
the [BANK] must assume that the capital adequacy standards of the 
[BANK] apply to the subsidiary.
    (c) Common equity tier 1 minority interest includable in the common 
equity tier 1 capital of the [BANK]. For each consolidated subsidiary 
of a [BANK], the amount of common equity tier 1 minority interest the 
[BANK] may include in common equity tier 1 capital is equal to:
    (1) The common equity tier 1 minority interest of the subsidiary; 
minus
    (2) The percentage of the subsidiary's common equity tier 1 capital 
that is not owned by the [BANK], multiplied by the difference between 
the common equity tier 1 capital of the subsidiary and the lower of:
    (i) The amount of common equity tier 1 capital the subsidiary must 
hold, or would be required to hold pursuant to paragraph (b) of this 
section, to avoid restrictions on distributions and discretionary bonus 
payments under Sec.  --.11 or equivalent standards established by the 
subsidiary's home country supervisor; or
    (ii)(A) The standardized total risk-weighted assets of the [BANK] 
that relate to the subsidiary multiplied by
    (B) The common equity tier 1 capital ratio the subsidiary must 
maintain to avoid restrictions on distributions and discretionary bonus 
payments under Sec.  --.11 or equivalent standards established by the 
subsidiary's home country supervisor.
    (d) Tier 1 minority interest includable in the tier 1 capital of 
the [BANK]. For each consolidated subsidiary of the [BANK], the amount 
of tier 1 minority interest the [BANK] may include in tier 1 capital is 
equal to:
    (1) The tier 1 minority interest of the subsidiary; minus
    (2) The percentage of the subsidiary's tier 1 capital that is not 
owned by the [BANK] multiplied by the difference between the tier 1 
capital of the subsidiary and the lower of:
    (i) The amount of tier 1 capital the subsidiary must hold, or would 
be required to hold pursuant to paragraph (b) of this section, to avoid 
restrictions on distributions and discretionary bonus payments under 
Sec.  --.11 or equivalent standards established by the subsidiary's 
home country supervisor, or
    (ii)(A) The standardized total risk-weighted assets of the [BANK] 
that relate to the subsidiary multiplied by
    (B) The tier 1 capital ratio the subsidiary must maintain to avoid 
restrictions on distributions and discretionary bonus payments under 
Sec.  --.11 or equivalent standards established by the subsidiary's 
home country supervisor.
    (e) Total capital minority interest includable in the total capital 
of the [BANK]. For each consolidated subsidiary of the [BANK], the 
amount of total capital minority interest the [BANK] may include in 
total capital is equal to:
    (1) The total capital minority interest of the subsidiary; minus
    (2) The percentage of the subsidiary's total capital that is not 
owned by the [BANK] multiplied by the difference between the total 
capital of the subsidiary and the lower of:
    (i) The amount of total capital the subsidiary must hold, or would 
be required to hold pursuant to paragraph (b) of this section, to avoid 
restrictions on distributions and discretionary bonus payments under 
Sec.  --.11 or equivalent standards established by the subsidiary's 
home country supervisor, or

[[Page 62176]]

    (ii)(A) The standardized total risk-weighted assets of the [BANK] 
that relate to the subsidiary multiplied by
    (B) The total capital ratio the subsidiary must maintain to avoid 
restrictions on distributions and discretionary bonus payments under 
Sec.  --.11 or equivalent standards established by the subsidiary's 
home country supervisor.


Sec.  --.22  Regulatory capital adjustments and deductions.

    (a) Regulatory capital deductions from common equity tier 1 
capital. A [BANK] must deduct from the sum of its common equity tier 1 
capital elements the items set forth in this paragraph (a):
    (1) Goodwill, net of associated deferred tax liabilities (DTLs) in 
accordance with paragraph (e) of this section, including goodwill that 
is embedded in the valuation of a significant investment in the capital 
of an unconsolidated financial institution in the form of common stock 
(and that is reflected in the consolidated financial statements of the 
[BANK]), in accordance with paragraph (d) of this section;
    (2) Intangible assets, other than MSAs, net of associated DTLs in 
accordance with paragraph (e) of this section;
    (3) Deferred tax assets (DTAs) that arise from net operating loss 
and tax credit carryforwards net of any related valuation allowances 
and net of DTLs in accordance with paragraph (e) of this section;
    (4) Any gain-on-sale in connection with a securitization exposure;
    (5)(i) Any defined benefit pension fund net asset, net of any 
associated DTL in accordance with paragraph (e) of this section, held 
by a depository institution holding company. With the prior approval of 
the [AGENCY], this deduction is not required for any defined benefit 
pension fund net asset to the extent the depository institution holding 
company has unrestricted and unfettered access to the assets in that 
fund.
    (ii) For an insured depository institution, no deduction is 
required.
    (iii) A [BANK] must risk weight any portion of the defined benefit 
pension fund asset that is not deducted under paragraphs (a)(5)(i) or 
(a)(5)(ii) of this section as if the [BANK] directly holds a 
proportional ownership share of each exposure in the defined benefit 
pension fund.
    (6) For an advanced approaches [BANK] that has completed the 
parallel run process and that has received notification from the 
[AGENCY] pursuant to Sec.  --.121(d), the amount of expected credit 
loss that exceeds its eligible credit reserves; and
    (7) With respect to a financial subsidiary, the aggregate amount of 
the [BANK]'s outstanding equity investment, including retained 
earnings, in its financial subsidiaries (as defined in [12 CFR 5.39 
(OCC); 12 CFR 208.77 (Board))]. A [BANK] must not consolidate the 
assets and liabilities of a financial subsidiary with those of the 
parent bank, and no other deduction is required under paragraph (c) of 
this section for investments in the capital instruments of financial 
subsidiaries.
    (b) Regulatory adjustments to common equity tier 1 capital. (1) A 
[BANK] must adjust the sum of common equity tier 1 capital elements 
pursuant to the requirements set forth in this paragraph (b). Such 
adjustments to common equity tier 1 capital must be made net of the 
associated deferred tax effects.
    (i) A [BANK] that makes an AOCI opt-out election (as defined in 
paragraph (b)(2) of this section), must make the adjustments required 
under Sec.  --.22(b)(2)(i).
    (ii) A [BANK] that is an advanced approaches [BANK], and a [BANK] 
that has not made an AOCI opt-out election (as defined in paragraph 
(b)(2) of this section), must deduct any accumulated net gains and add 
any accumulated net losses on cash flow hedges included in AOCI that 
relate to the hedging of items that are not recognized at fair value on 
the balance sheet.
    (iii) A [BANK] must deduct any net gain and add any net loss 
related to changes in the fair value of liabilities that are due to 
changes in the [BANK]'s own credit risk. An advanced approaches [BANK] 
also must deduct the credit spread premium over the risk free rate for 
derivatives that are liabilities.
    (2) AOCI opt-out election. (i) A [BANK] that is not an advanced 
approaches [BANK] may make a one-time election to opt out of the 
requirement to include all components of AOCI (with the exception of 
accumulated net gains and losses on cash flow hedges related to items 
that are not fair-valued on the balance sheet) in common equity tier 1 
capital (AOCI opt-out election). A [BANK] that makes an AOCI opt-out 
election in accordance with this paragraph (b)(2) must adjust common 
equity tier 1 capital as follows:
    (A) Subtract any net unrealized gains and add any net unrealized 
losses on available-for-sale securities;
    (B) Subtract any net unrealized losses on available-for-sale 
preferred stock classified as an equity security under GAAP and 
available-for-sale equity exposures;
    (C) Subtract any accumulated net gains and add any accumulated net 
losses on cash flow hedges;
    (D) Subtract any amounts recorded in AOCI attributed to defined 
benefit postretirement plans resulting from the initial and subsequent 
application of the relevant GAAP standards that pertain to such plans 
(excluding, at the [BANK]'s option, the portion relating to pension 
assets deducted under paragraph (a)(5) of this section); and
    (E) Subtract any net unrealized gains and add any net unrealized 
losses on held-to-maturity securities that are included in AOCI.
    (ii) A [BANK] that is not an advanced approaches [BANK] must make 
its AOCI opt-out election in its [REGULATORY REPORT] filed for the 
first regulatory reporting period after the date required for such 
[BANK] to comply with subpart A of this part as set forth in Sec.  
--.1(f).
    (iii) With respect to a [BANK] that is not an advanced approaches 
[BANK], each of its subsidiary banking organizations that is subject to 
regulatory capital requirements issued by the Board of Governors of the 
Federal Reserve, the Federal Deposit Insurance Corporation, or the 
Office of the Comptroller of the Currency \17\ must elect the same 
option as the [BANK] pursuant to this paragraph (b)(2).
---------------------------------------------------------------------------

    \17\ These rules include the regulatory capital requirements set 
forth at 12 CFR part 3 (OCC); 12 CFR part 225 (Board); 12 CFR part 
325, and 12 CFR part 390 (FDIC).
---------------------------------------------------------------------------

    (iv) With prior notice to the [AGENCY], a [BANK] resulting from a 
merger, acquisition, or purchase transaction and that is not an 
advanced approaches [BANK] may change its AOCI opt-out election in its 
[REGULATORY REPORT] filed for the first reporting period after the date 
required for such [BANK] to comply with subpart A of this part as set 
forth in Sec.  --.1(f) if:
    (A) Other than as set forth in paragraph (b)(2)(iv)(C) of this 
section, the merger, acquisition, or purchase transaction involved the 
acquisition or purchase of all or substantially all of either the 
assets or voting stock of another banking organization that is subject 
to regulatory capital requirements issued by the Board of Governors of 
the Federal Reserve, the Federal Deposit Insurance Corporation, or the 
Office of the Comptroller of the Currency; \18\
---------------------------------------------------------------------------

    \18\ These rules include the regulatory capital requirements set 
forth at 12 CFR part 3 (OCC); 12 CFR part 225 (Board); 12 CFR part 
325, and 12 CFR part 390 (FDIC).

---------------------------------------------------------------------------

[[Page 62177]]

    (B) Prior to the merger, acquisition, or purchase transaction, only 
one of the banking organizations involved in the transaction made an 
AOCI opt-out election under this section; and
    (C) A [BANK] may, with the prior approval of the [AGENCY], change 
its AOCI opt-out election under this paragraph (b) in the case of a 
merger, acquisition, or purchase transaction that meets the 
requirements set forth at paragraph (b)(2)(iv)(B) of this section, but 
does not meet the requirements of paragraph (b)(2)(iv)(A). In making 
such a determination, the [AGENCY] may consider the terms of the 
merger, acquisition, or purchase transaction, as well as the extent of 
any changes to the risk profile, complexity, and scope of operations of 
the [BANK] resulting from the merger, acquisition, or purchase 
transaction.
    (c) Deductions from regulatory capital related to investments in 
capital instruments \19\--(1) Investment in the [BANK]'s own capital 
instruments. A [BANK] must deduct an investment in the [BANK]'s own 
capital instruments as follows:
---------------------------------------------------------------------------

    \19\ The [BANK] must calculate amounts deducted under paragraphs 
(c) through (f) of this section after it calculates the amount of 
ALLL includable in tier 2 capital under Sec.  --.20(d)(3).
---------------------------------------------------------------------------

    (i) A [BANK] must deduct an investment in the [BANK]'s own common 
stock instruments from its common equity tier 1 capital elements to the 
extent such instruments are not excluded from regulatory capital under 
Sec.  --.20(b)(1);
    (ii) A [BANK] must deduct an investment in the [BANK]'s own 
additional tier 1 capital instruments from its additional tier 1 
capital elements; and
    (iii) A [BANK] must deduct an investment in the [BANK]'s own tier 2 
capital instruments from its tier 2 capital elements.
    (2) Corresponding deduction approach. For purposes of subpart C of 
this part, the corresponding deduction approach is the methodology used 
for the deductions from regulatory capital related to reciprocal cross 
holdings (as described in paragraph (c)(3) of this section), non-
significant investments in the capital of unconsolidated financial 
institutions (as described in paragraph (c)(4) of this section), and 
non-common stock significant investments in the capital of 
unconsolidated financial institutions (as described in paragraph (c)(5) 
of this section). Under the corresponding deduction approach, a [BANK] 
must make deductions from the component of capital for which the 
underlying instrument would qualify if it were issued by the [BANK] 
itself, as described in paragraphs (c)(2)(i)-(iii) of this section. If 
the [BANK] does not have a sufficient amount of a specific component of 
capital to effect the required deduction, the shortfall must be 
deducted according to paragraph (f) of this section.
    (i) If an investment is in the form of an instrument issued by a 
financial institution that is not a regulated financial institution, 
the [BANK] must treat the instrument as:
    (A) A common equity tier 1 capital instrument if it is common stock 
or represents the most subordinated claim in liquidation of the 
financial institution; and
    (B) An additional tier 1 capital instrument if it is subordinated 
to all creditors of the financial institution and is senior in 
liquidation only to common shareholders.
    (ii) If an investment is in the form of an instrument issued by a 
regulated financial institution and the instrument does not meet the 
criteria for common equity tier 1, additional tier 1 or tier 2 capital 
instruments under Sec.  --.20, the [BANK] must treat the instrument as:
    (A) A common equity tier 1 capital instrument if it is common stock 
included in GAAP equity or represents the most subordinated claim in 
liquidation of the financial institution;
    (B) An additional tier 1 capital instrument if it is included in 
GAAP equity, subordinated to all creditors of the financial 
institution, and senior in a receivership, insolvency, liquidation, or 
similar proceeding only to common shareholders; and
    (C) A tier 2 capital instrument if it is not included in GAAP 
equity but considered regulatory capital by the primary supervisor of 
the financial institution.
    (iii) If an investment is in the form of a non-qualifying capital 
instrument (as defined in Sec.  --.300(c)), the [BANK] must treat the 
instrument as:
    (A) An additional tier 1 capital instrument if such instrument was 
included in the issuer's tier 1 capital prior to May 19, 2010; or
    (B) A tier 2 capital instrument if such instrument was included in 
the issuer's tier 2 capital (but not includable in tier 1 capital) 
prior to May 19, 2010.
    (3) Reciprocal cross holdings in the capital of financial 
institutions. A [BANK] must deduct investments in the capital of other 
financial institutions it holds reciprocally, where such reciprocal 
cross holdings result from a formal or informal arrangement to swap, 
exchange, or otherwise intend to hold each other's capital instruments, 
by applying the corresponding deduction approach.
    (4) Non-significant investments in the capital of unconsolidated 
financial institutions. (i) A [BANK] must deduct its non-significant 
investments in the capital of unconsolidated financial institutions (as 
defined in Sec.  --.2) that, in the aggregate, exceed 10 percent of the 
sum of the [BANK]'s common equity tier 1 capital elements minus all 
deductions from and adjustments to common equity tier 1 capital 
elements required under paragraphs (a) through (c)(3) of this section 
(the 10 percent threshold for non-significant investments) by applying 
the corresponding deduction approach.\20\ The deductions described in 
this section are net of associated DTLs in accordance with paragraph 
(e) of this section. In addition, a [BANK] that underwrites a failed 
underwriting, with the prior written approval of the [AGENCY], for the 
period of time stipulated by the [AGENCY], is not required to deduct a 
non-significant investment in the capital of an unconsolidated 
financial institution pursuant to this paragraph (c) to the extent the 
investment is related to the failed underwriting.\21\
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    \20\ With the prior written approval of the [AGENCY], for the 
period of time stipulated by the [AGENCY], a [BANK] is not required 
to deduct a non-significant investment in the capital instrument of 
an unconsolidated financial institution pursuant to this paragraph 
if the financial institution is in distress and if such investment 
is made for the purpose of providing financial support to the 
financial institution, as determined by the [AGENCY].
    \21\ Any non-significant investments in the capital of 
unconsolidated financial institutions that do not exceed the 10 
percent threshold for non-significant investments under this section 
must be assigned the appropriate risk weight under subparts D, E, or 
F of this part, as applicable.
---------------------------------------------------------------------------

    (ii) The amount to be deducted under this section from a specific 
capital component is equal to:
    (A) The [BANK]'s non-significant investments in the capital of 
unconsolidated financial institutions exceeding the 10 percent 
threshold for non-significant investments, multiplied by
    (B) The ratio of the [BANK]'s non-significant investments in the 
capital of unconsolidated financial institutions in the form of such 
capital component to the [BANK]'s total non-significant investments in 
unconsolidated financial institutions.
    (5) Significant investments in the capital of unconsolidated 
financial institutions that are not in the form of common stock. A 
[BANK] must deduct its significant investments in the capital of 
unconsolidated financial institutions that are not in the form of 
common stock by applying the corresponding

[[Page 62178]]

deduction approach.\22\ The deductions described in this section are 
net of associated DTLs in accordance with paragraph (e) of this 
section. In addition, with the prior written approval of the [AGENCY], 
for the period of time stipulated by the [AGENCY], a [BANK] that 
underwrites a failed underwriting is not required to deduct a 
significant investment in the capital of an unconsolidated financial 
institution pursuant to this paragraph (c) if such investment is 
related to such failed underwriting.
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    \22\ With prior written approval of the [AGENCY], for the period 
of time stipulated by the [AGENCY], a [BANK] is not required to 
deduct a significant investment in the capital instrument of an 
unconsolidated financial institution in distress which is not in the 
form of common stock pursuant to this section if such investment is 
made for the purpose of providing financial support to the financial 
institution as determined by the [AGENCY].
---------------------------------------------------------------------------

    (d) Items subject to the 10 and 15 percent common equity tier 1 
capital deduction thresholds. (1) A [BANK] must deduct from common 
equity tier 1 capital elements the amount of each of the items set 
forth in this paragraph (d) that, individually, exceeds 10 percent of 
the sum of the [BANK]'s common equity tier 1 capital elements, less 
adjustments to and deductions from common equity tier 1 capital 
required under paragraphs (a) through (c) of this section (the 10 
percent common equity tier 1 capital deduction threshold).
    (i) DTAs arising from temporary differences that the [BANK] could 
not realize through net operating loss carrybacks, net of any related 
valuation allowances and net of DTLs, in accordance with paragraph (e) 
of this section. A [BANK] is not required to deduct from the sum of its 
common equity tier 1 capital elements DTAs (net of any related 
valuation allowances and net of DTLs, in accordance with Sec.  
--.22(e)) arising from timing differences that the [BANK] could realize 
through net operating loss carrybacks. The [BANK] must risk weight 
these assets at 100 percent. For a [BANK] that is a member of a 
consolidated group for tax purposes, the amount of DTAs that could be 
realized through net operating loss carrybacks may not exceed the 
amount that the [BANK] could reasonably expect to have refunded by its 
parent holding company.
    (ii) MSAs net of associated DTLs, in accordance with paragraph (e) 
of this section.
    (iii) Significant investments in the capital of unconsolidated 
financial institutions in the form of common stock, net of associated 
DTLs in accordance with paragraph (e) of this section.\23\ Significant 
investments in the capital of unconsolidated financial institutions in 
the form of common stock subject to the 10 percent common equity tier 1 
capital deduction threshold may be reduced by any goodwill embedded in 
the valuation of such investments deducted by the [BANK] pursuant to 
paragraph (a)(1) of this section. In addition, with the prior written 
approval of the [AGENCY], for the period of time stipulated by the 
[AGENCY], a [BANK] that underwrites a failed underwriting is not 
required to deduct a significant investment in the capital of an 
unconsolidated financial institution in the form of common stock 
pursuant to this paragraph (d) if such investment is related to such 
failed underwriting.
---------------------------------------------------------------------------

    \23\ With the prior written approval of the [AGENCY], for the 
period of time stipulated by the [AGENCY], a [BANK] is not required 
to deduct a significant investment in the capital instrument of an 
unconsolidated financial institution in distress in the form of 
common stock pursuant to this section if such investment is made for 
the purpose of providing financial support to the financial 
institution as determined by the [AGENCY].
---------------------------------------------------------------------------

    (2) A [BANK] must deduct from common equity tier 1 capital elements 
the items listed in paragraph (d)(1) of this section that are not 
deducted as a result of the application of the 10 percent common equity 
tier 1 capital deduction threshold, and that, in aggregate, exceed 
17.65 percent of the sum of the [BANK]'s common equity tier 1 capital 
elements, minus adjustments to and deductions from common equity tier 1 
capital required under paragraphs (a) through (c) of this section, 
minus the items listed in paragraph (d)(1) of this section (the 15 
percent common equity tier 1 capital deduction threshold). Any goodwill 
that has been deducted under paragraph (a)(1) of this section can be 
excluded from the significant investments in the capital of 
unconsolidated financial institutions in the form of common stock.\24\
---------------------------------------------------------------------------

    \24\ The amount of the items in paragraph (d) of this section 
that is not deducted from common equity tier 1 capital pursuant to 
this section must be included in the risk-weighted assets of the 
[BANK] and assigned a 250 percent risk weight.
---------------------------------------------------------------------------

    (3) For purposes of calculating the amount of DTAs subject to the 
10 and 15 percent common equity tier 1 capital deduction thresholds, a 
[BANK] may exclude DTAs and DTLs relating to adjustments made to common 
equity tier 1 capital under paragraph (b) of this section. A [BANK] 
that elects to exclude DTAs relating to adjustments under paragraph (b) 
of this section also must exclude DTLs and must do so consistently in 
all future calculations. A [BANK] may change its exclusion preference 
only after obtaining the prior approval of the [AGENCY].
    (e) Netting of DTLs against assets subject to deduction. (1) Except 
as described in paragraph (e)(3) of this section, netting of DTLs 
against assets that are subject to deduction under this section is 
permitted, but not required, if the following conditions are met:
    (i) The DTL is associated with the asset; and
    (ii) The DTL would be extinguished if the associated asset becomes 
impaired or is derecognized under GAAP.
    (2) A DTL may only be netted against a single asset.
    (3) For purposes of calculating the amount of DTAs subject to the 
threshold deduction in paragraph (d) of this section, the amount of 
DTAs that arise from net operating loss and tax credit carryforwards, 
net of any related valuation allowances, and of DTAs arising from 
temporary differences that the [BANK] could not realize through net 
operating loss carrybacks, net of any related valuation allowances, may 
be offset by DTLs (that have not been netted against assets subject to 
deduction pursuant to paragraph (e)(1) of this section) subject to the 
conditions set forth in this paragraph (e).
    (i) Only the DTAs and DTLs that relate to taxes levied by the same 
taxation authority and that are eligible for offsetting by that 
authority may be offset for purposes of this deduction.
    (ii) The amount of DTLs that the [BANK] nets against DTAs that 
arise from net operating loss and tax credit carryforwards, net of any 
related valuation allowances, and against DTAs arising from temporary 
differences that the [BANK] could not realize through net operating 
loss carrybacks, net of any related valuation allowances, must be 
allocated in proportion to the amount of DTAs that arise from net 
operating loss and tax credit carryforwards (net of any related 
valuation allowances, but before any offsetting of DTLs) and of DTAs 
arising from temporary differences that the [BANK] could not realize 
through net operating loss carrybacks (net of any related valuation 
allowances, but before any offsetting of DTLs), respectively.
    (4) A [BANK] may offset DTLs embedded in the carrying value of a 
leveraged lease portfolio acquired in a business combination that are 
not recognized under GAAP against DTAs that are subject to paragraph 
(d) of this section in accordance with this paragraph (e).
    (5) A [BANK] must net DTLs against assets subject to deduction 
under this section in a consistent manner from reporting period to 
reporting period. A [BANK] may change its preference

[[Page 62179]]

regarding the manner in which it nets DTLs against specific assets 
subject to deduction under this section only after obtaining the prior 
approval of the [AGENCY].
    (f) Insufficient amounts of a specific regulatory capital component 
to effect deductions. Under the corresponding deduction approach, if a 
[BANK] does not have a sufficient amount of a specific component of 
capital to effect the required deduction after completing the 
deductions required under paragraph (d) of this section, the [BANK] 
must deduct the shortfall from the next higher (that is, more 
subordinated) component of regulatory capital.
    (g) Treatment of assets that are deducted. A [BANK] must exclude 
from standardized total risk-weighted assets and, as applicable, 
advanced approaches total risk-weighted assets any item deducted from 
regulatory capital under paragraphs (a), (c), and (d) of this section.
    (h) Net long position. (1) For purposes of calculating an 
investment in the [BANK]'s own capital instrument and an investment in 
the capital of an unconsolidated financial institution under this 
section, the net long position is the gross long position in the 
underlying instrument determined in accordance with paragraph (h)(2) of 
this section, as adjusted to recognize a short position in the same 
instrument calculated in accordance with paragraph (h)(3) of this 
section.
    (2) Gross long position. The gross long position is determined as 
follows:
    (i) For an equity exposure that is held directly, the adjusted 
carrying value as that term is defined in Sec.  --.51(b);
    (ii) For an exposure that is held directly and is not an equity 
exposure or a securitization exposure, the exposure amount as that term 
is defined in Sec.  --.2;
    (iii) For an indirect exposure, the [BANK]'s carrying value of the 
investment in the investment fund, provided that, alternatively:
    (A) A [BANK] may, with the prior approval of the [AGENCY], use a 
conservative estimate of the amount of its investment in its own 
capital instruments or the capital of an unconsolidated financial 
institution held through a position in an index; or
    (B) A [BANK] may calculate the gross long position for the [BANK]'s 
own capital instruments or the capital of an unconsolidated financial 
institution by multiplying the [BANK]'s carrying value of its 
investment in the investment fund by either:
    (1) The highest stated investment limit (in percent) for 
investments in the [BANK]'s own capital instruments or the capital of 
unconsolidated financial institutions as stated in the prospectus, 
partnership agreement, or similar contract defining permissible 
investments of the investment fund; or
    (2) The investment fund's actual holdings of own capital 
instruments or the capital of unconsolidated financial institutions.
    (iv) For a synthetic exposure, the amount of the [BANK]'s loss on 
the exposure if the reference capital instrument were to have a value 
of zero.
    (3) Adjustments to reflect a short position. In order to adjust the 
gross long position to recognize a short position in the same 
instrument, the following criteria must be met:
    (i) The maturity of the short position must match the maturity of 
the long position, or the short position has a residual maturity of at 
least one year (maturity requirement); or
    (ii) For a position that is a trading asset or trading liability 
(whether on- or off-balance sheet) as reported on the [BANK]'s 
[REGULATORY REPORT], if the [BANK] has a contractual right or 
obligation to sell the long position at a specific point in time and 
the counterparty to the contract has an obligation to purchase the long 
position if the [BANK] exercises its right to sell, this point in time 
may be treated as the maturity of the long position such that the 
maturity of the long position and short position are deemed to match 
for purposes of the maturity requirement, even if the maturity of the 
short position is less than one year; and
    (iii) For an investment in the [BANK]'s own capital instrument 
under paragraph (c)(1) of this section or an investment in a capital of 
an unconsolidated financial institution under paragraphs (c)(4), 
(c)(5), and (d)(1)(iii) of this section.
    (A) A [BANK] may only net a short position against a long position 
in the [BANK]'s own capital instrument under paragraph (c)(1) of this 
section if the short position involves no counterparty credit risk.
    (B) A gross long position in a [BANK]'s own capital instrument or 
in a capital instrument of an unconsolidated financial institution 
resulting from a position in an index may be netted against a short 
position in the same index. Long and short positions in the same index 
without maturity dates are considered to have matching maturities.
    (C) A short position in an index that is hedging a long cash or 
synthetic position in a [BANK]'s own capital instrument or in a capital 
instrument of an unconsolidated financial institution can be decomposed 
to provide recognition of the hedge. More specifically, the portion of 
the index that is composed of the same underlying instrument that is 
being hedged may be used to offset the long position if both the long 
position being hedged and the short position in the index are reported 
as a trading asset or trading liability (whether on- or off-balance 
sheet) on the [BANK]'s [REGULATORY REPORT], and the hedge is deemed 
effective by the [BANK]'s internal control processes, which have not 
been found to be inadequate by the [AGENCY].


Sec. Sec.  --.23 through --.29  [Reserved]

Subpart D--Risk-Weighted Assets--Standardized Approach


Sec.  --.30  Applicability.

    (a) This subpart sets forth methodologies for determining risk-
weighted assets for purposes of the generally applicable risk-based 
capital requirements for all [BANK]s.
    (b) Notwithstanding paragraph (a) of this section, a market risk 
[BANK] must exclude from its calculation of risk-weighted assets under 
this subpart the risk-weighted asset amounts of all covered positions, 
as defined in subpart F of this part (except foreign exchange positions 
that are not trading positions, OTC derivative positions, cleared 
transactions, and unsettled transactions).

Risk-Weighted Assets For General Credit Risk


Sec.  --.31  Mechanics for calculating risk-weighted assets for general 
credit risk.

    (a) General risk-weighting requirements. A [BANK] must apply risk 
weights to its exposures as follows:
    (1) A [BANK] must determine the exposure amount of each on-balance 
sheet exposure, each OTC derivative contract, and each off-balance 
sheet commitment, trade and transaction-related contingency, guarantee, 
repo-style transaction, financial standby letter of credit, forward 
agreement, or other similar transaction that is not:
    (i) An unsettled transaction subject to Sec.  --.38;
    (ii) A cleared transaction subject to Sec.  --.35;
    (iii) A default fund contribution subject to Sec.  --.35;
    (iv) A securitization exposure subject to Sec. Sec.  --.41 through 
--.45; or
    (v) An equity exposure (other than an equity OTC derivative 
contract) subject to Sec. Sec.  --.51 through --.53.
    (2) The [BANK] must multiply each exposure amount by the risk 
weight appropriate to the exposure based on

[[Page 62180]]

the exposure type or counterparty, eligible guarantor, or financial 
collateral to determine the risk-weighted asset amount for each 
exposure.
    (b) Total risk-weighted assets for general credit risk equals the 
sum of the risk-weighted asset amounts calculated under this section.


Sec.  --.32  General risk weights.

    (a) Sovereign exposures--(1) Exposures to the U.S. government. (i) 
Notwithstanding any other requirement in this subpart, a [BANK] must 
assign a zero percent risk weight to:
    (A) An exposure to the U.S. government, its central bank, or a U.S. 
government agency; and
    (B) The portion of an exposure that is directly and unconditionally 
guaranteed by the U.S. government, its central bank, or a U.S. 
government agency. This includes a deposit or other exposure, or the 
portion of a deposit or other exposure, that is insured or otherwise 
unconditionally guaranteed by the FDIC or National Credit Union 
Administration.
    (ii) A [BANK] must assign a 20 percent risk weight to the portion 
of an exposure that is conditionally guaranteed by the U.S. government, 
its central bank, or a U.S. government agency. This includes an 
exposure, or the portion of an exposure, that is conditionally 
guaranteed by the FDIC or National Credit Union Administration.
    (2) Other sovereign exposures. In accordance with Table 1 to Sec.  
--.32, a [BANK] must assign a risk weight to a sovereign exposure based 
on the CRC applicable to the sovereign or the sovereign's OECD 
membership status if there is no CRC applicable to the sovereign.

      Table 1 to Sec.   --.32--Risk Weights for Sovereign Exposures
------------------------------------------------------------------------
                                                            Risk weight
                                                           (in percent)
------------------------------------------------------------------------
CRC:
  0-1...................................................               0
  2.....................................................              20
  3.....................................................              50
  4-6...................................................             100
  7.....................................................             150
OECD Member with No CRC.................................               0
Non-OECD Member with No CRC.............................             100
Sovereign Default.......................................             150
------------------------------------------------------------------------

    (3) Certain sovereign exposures. Notwithstanding paragraph (a)(2) 
of this section, a [BANK] may assign to a sovereign exposure a risk 
weight that is lower than the applicable risk weight in Table 1 to 
Sec.  --.32 if:
    (i) The exposure is denominated in the sovereign's currency;
    (ii) The [BANK] has at least an equivalent amount of liabilities in 
that currency; and
    (iii) The risk weight is not lower than the risk weight that the 
home country supervisor allows [BANK]s under its jurisdiction to assign 
to the same exposures to the sovereign.
    (4) Exposures to a non-OECD member sovereign with no CRC. Except as 
provided in paragraphs (a)(3), (a)(5) and (a)(6) of this section, a 
[BANK] must assign a 100 percent risk weight to an exposure to a 
sovereign if the sovereign does not have a CRC.
    (5) Exposures to an OECD member sovereign with no CRC. Except as 
provided in paragraph (a)(6) of this section, a [BANK] must assign a 0 
percent risk weight to an exposure to a sovereign that is a member of 
the OECD if the sovereign does not have a CRC.
    (6) Sovereign default. A [BANK] must assign a 150 percent risk 
weight to a sovereign exposure immediately upon determining that an 
event of sovereign default has occurred, or if an event of sovereign 
default has occurred during the previous five years.
    (b) Certain supranational entities and multilateral development 
banks (MDBs). A [BANK] must assign a zero percent risk weight to an 
exposure to the Bank for International Settlements, the European 
Central Bank, the European Commission, the International Monetary Fund, 
or an MDB.
    (c) Exposures to GSEs. (1) A [BANK] must assign a 20 percent risk 
weight to an exposure to a GSE other than an equity exposure or 
preferred stock.
    (2) A [BANK] must assign a 100 percent risk weight to preferred 
stock issued by a GSE.
    (d) Exposures to depository institutions, foreign banks, and credit 
unions--(1) Exposures to U.S. depository institutions and credit 
unions. A [BANK] must assign a 20 percent risk weight to an exposure to 
a depository institution or credit union that is organized under the 
laws of the United States or any state thereof, except as otherwise 
provided under paragraph (d)(3) of this section.
    (2) Exposures to foreign banks. (i) Except as otherwise provided 
under paragraphs (d)(2)(iv) and (d)(3) of this section, a [BANK] must 
assign a risk weight to an exposure to a foreign bank, in accordance 
with Table 2 to Sec.  --.32, based on the CRC that corresponds to the 
foreign bank's home country or the OECD membership status of the 
foreign bank's home country if there is no CRC applicable to the 
foreign bank's home country.

  Table 2 to Sec.   --.32--Risk Weights for Exposures to Foreign Banks
------------------------------------------------------------------------
                                                            Risk weight
                                                           (in percent)
------------------------------------------------------------------------
CRC:
  0-1...................................................              20
  2.....................................................              50
  3.....................................................             100
  4-7...................................................             150
OECD Member with No CRC.................................              20
Non-OECD Member with No CRC.............................             100
Sovereign Default.......................................             150
------------------------------------------------------------------------

    (ii) A [BANK] must assign a 20 percent risk weight to an exposure 
to a foreign bank whose home country is a member of the OECD and does 
not have a CRC.
    (iii) A [BANK] must assign a 100 percent risk weight to an exposure 
to a foreign bank whose home country is not a member of the OECD and 
does not have a CRC, with the exception of self-liquidating, trade-
related contingent items that arise from the movement of goods, and 
that have a maturity of three months or less, which may be assigned a 
20 percent risk weight.
    (iv) A [BANK] must assign a 150 percent risk weight to an exposure 
to a foreign bank immediately upon determining that an event of 
sovereign default has occurred in the bank's home country, or if an 
event of sovereign default has occurred in the foreign bank's home 
country during the previous five years.
    (3) A [BANK] must assign a 100 percent risk weight to an exposure 
to a financial institution if the exposure may be included in that 
financial institution's capital unless the exposure is:
    (i) An equity exposure;
    (ii) A significant investment in the capital of an unconsolidated 
financial institution in the form of common stock pursuant to Sec.  
--.22(d)(iii);
    (iii) Deducted from regulatory capital under Sec.  --.22; or
    (iv) Subject to a 150 percent risk weight under paragraph 
(d)(2)(iv) or Table 2 of paragraph (d)(2) of this section.
    (e) Exposures to public sector entities (PSEs)--(1) Exposures to 
U.S. PSEs. (i) A [BANK] must assign a 20 percent risk weight to a 
general obligation exposure to a PSE that is organized under the laws 
of the United States or any state or political subdivision thereof.
    (ii) A [BANK] must assign a 50 percent risk weight to a revenue 
obligation exposure to a PSE that is organized under the laws of the 
United States or any state or political subdivision thereof.

[[Page 62181]]

    (2) Exposures to foreign PSEs. (i) Except as provided in paragraphs 
(e)(1) and (e)(3) of this section, a [BANK] must assign a risk weight 
to a general obligation exposure to a PSE, in accordance with Table 3 
to Sec.  --.32, based on the CRC that corresponds to the PSE's home 
country or the OECD membership status of the PSE's home country if 
there is no CRC applicable to the PSE's home country.
    (ii) Except as provided in paragraphs (e)(1) and (e)(3) of this 
section, a [BANK] must assign a risk weight to a revenue obligation 
exposure to a PSE, in accordance with Table 4 to Sec.  --.32, based on 
the CRC that corresponds to the PSE's home country; or the OECD 
membership status of the PSE's home country if there is no CRC 
applicable to the PSE's home country.
    (3) A [BANK] may assign a lower risk weight than would otherwise 
apply under Tables 3 or 4 to Sec.  --.32 to an exposure to a foreign 
PSE if:
    (i) The PSE's home country supervisor allows banks under its 
jurisdiction to assign a lower risk weight to such exposures; and
    (ii) The risk weight is not lower than the risk weight that 
corresponds to the PSE's home country in accordance with Table 1 to 
Sec.  --.32.

     Table 3 to Sec.   --.32--Risk Weights for Non-U.S. PSE General
                               Obligations
------------------------------------------------------------------------
                                                            Risk weight
                                                           (in percent)
------------------------------------------------------------------------
CRC:
  0-1...................................................              20
  2.....................................................              50
  3.....................................................             100
  4-7...................................................             150
OECD Member with No CRC.................................              20
Non-OECD Member with No CRC.............................             100
Sovereign Default.......................................             150
------------------------------------------------------------------------


     Table 4 to Sec.   --.32--Risk Weights for Non-U.S. PSE Revenue
                               Obligations
------------------------------------------------------------------------
                                                            Risk weight
                                                           (in percent)
------------------------------------------------------------------------
CRC:
  0-1...................................................              50
  2-3...................................................             100
  4-7...................................................             150
OECD Member with No CRC.................................              50
Non-OECD Member with No CRC.............................             100
Sovereign Default.......................................             150
------------------------------------------------------------------------

    (4) Exposures to PSEs from an OECD member sovereign with no CRC. 
(i) A [BANK] must assign a 20 percent risk weight to a general 
obligation exposure to a PSE whose home country is an OECD member 
sovereign with no CRC.
    (ii) A [BANK] must assign a 50 percent risk weight to a revenue 
obligation exposure to a PSE whose home country is an OECD member 
sovereign with no CRC.
    (5) Exposures to PSEs whose home country is not an OECD member 
sovereign with no CRC. A [BANK] must assign a 100 percent risk weight 
to an exposure to a PSE whose home country is not a member of the OECD 
and does not have a CRC.
    (6) A [BANK] must assign a 150 percent risk weight to a PSE 
exposure immediately upon determining that an event of sovereign 
default has occurred in a PSE's home country or if an event of 
sovereign default has occurred in the PSE's home country during the 
previous five years.
    (f) Corporate exposures. A [BANK] must assign a 100 percent risk 
weight to all its corporate exposures.
    (g) Residential mortgage exposures. (1) A [BANK] must assign a 50 
percent risk weight to a first-lien residential mortgage exposure that:
    (i) Is secured by a property that is either owner-occupied or 
rented;
    (ii) Is made in accordance with prudent underwriting standards, 
including standards relating to the loan amount as a percent of the 
appraised value of the property;
    (iii) Is not 90 days or more past due or carried in nonaccrual 
status; and
    (iv) Is not restructured or modified.
    (2) A [BANK] must assign a 100 percent risk weight to a first-lien 
residential mortgage exposure that does not meet the criteria in 
paragraph (g)(1) of this section, and to junior-lien residential 
mortgage exposures.
    (3) For the purpose of this paragraph (g), if a [BANK] holds the 
first-lien and junior-lien(s) residential mortgage exposures, and no 
other party holds an intervening lien, the [BANK] must combine the 
exposures and treat them as a single first-lien residential mortgage 
exposure.
    (4) A loan modified or restructured solely pursuant to the U.S. 
Treasury's Home Affordable Mortgage Program is not modified or 
restructured for purposes of this section.
    (h) Pre-sold construction loans. A [BANK] must assign a 50 percent 
risk weight to a pre-sold construction loan unless the purchase 
contract is cancelled, in which case a [BANK] must assign a 100 percent 
risk weight.
    (i) Statutory multifamily mortgages. A [BANK] must assign a 50 
percent risk weight to a statutory multifamily mortgage.
    (j) High-volatility commercial real estate (HVCRE) exposures. A 
[BANK] must assign a 150 percent risk weight to an HVCRE exposure.
    (k) Past due exposures. Except for a sovereign exposure or a 
residential mortgage exposure, a [BANK] must determine a risk weight 
for an exposure that is 90 days or more past due or on nonaccrual 
according to the requirements set forth in this paragraph (k).
    (1) A [BANK] must assign a 150 percent risk weight to the portion 
of the exposure that is not guaranteed or that is unsecured.
    (2) A [BANK] may assign a risk weight to the guaranteed portion of 
a past due exposure based on the risk weight that applies under Sec.  
--.36 if the guarantee or credit derivative meets the requirements of 
that section.
    (3) A [BANK] may assign a risk weight to the collateralized portion 
of a past due exposure based on the risk weight that applies under 
Sec.  --.37 if the collateral meets the requirements of that section.
    (l) Other assets. (1) A [BANK] must assign a zero percent risk 
weight to cash owned and held in all offices of the [BANK] or in 
transit; to gold bullion held in the [BANK]'s own vaults or held in 
another depository institution's vaults on an allocated basis, to the 
extent the gold bullion assets are offset by gold bullion liabilities; 
and to exposures that arise from the settlement of cash transactions 
(such as equities, fixed income, spot foreign exchange and spot 
commodities) with a central counterparty where there is no assumption 
of ongoing counterparty credit risk by the central counterparty after 
settlement of the trade and associated default fund contributions.
    (2) A [BANK] must assign a 20 percent risk weight to cash items in 
the process of collection.
    (3) A [BANK] must assign a 100 percent risk weight to DTAs arising 
from temporary differences that the [BANK] could realize through net 
operating loss carrybacks.
    (4) A [BANK] must assign a 250 percent risk weight to the portion 
of each of the following items that is not deducted from common equity 
tier 1 capital pursuant to Sec.  --.22(d):
    (i) MSAs; and
    (ii) DTAs arising from temporary differences that the [BANK] could 
not realize through net operating loss carrybacks.
    (5) A [BANK] must assign a 100 percent risk weight to all assets 
not specifically assigned a different risk weight under this subpart 
and that are

[[Page 62182]]

not deducted from tier 1 or tier 2 capital pursuant to Sec.  --.22.
    (6) Notwithstanding the requirements of this section, a [BANK] may 
assign an asset that is not included in one of the categories provided 
in this section to the risk weight category applicable under the 
capital rules applicable to bank holding companies and savings and loan 
holding companies at 12 CFR part 217, provided that all of the 
following conditions apply:
    (i) The [BANK] is not authorized to hold the asset under applicable 
law other than debt previously contracted or similar authority; and
    (ii) The risks associated with the asset are substantially similar 
to the risks of assets that are otherwise assigned to a risk weight 
category of less than 100 percent under this subpart.


Sec.  --.33  Off-balance sheet exposures.

    (a) General. (1) A [BANK] must calculate the exposure amount of an 
off-balance sheet exposure using the credit conversion factors (CCFs) 
in paragraph (b) of this section.
    (2) Where a [BANK] commits to provide a commitment, the [BANK] may 
apply the lower of the two applicable CCFs.
    (3) Where a [BANK] provides a commitment structured as a 
syndication or participation, the [BANK] is only required to calculate 
the exposure amount for its pro rata share of the commitment.
    (4) Where a [BANK] provides a commitment, enters into a repurchase 
agreement, or provides a credit-enhancing representation and warranty, 
and such commitment, repurchase agreement, or credit-enhancing 
representation and warranty is not a securitization exposure, the 
exposure amount shall be no greater than the maximum contractual amount 
of the commitment, repurchase agreement, or credit-enhancing 
representation and warranty, as applicable.
    (b) Credit conversion factors--(1) Zero percent CCF. A [BANK] must 
apply a zero percent CCF to the unused portion of a commitment that is 
unconditionally cancelable by the [BANK].
    (2) 20 percent CCF. A [BANK] must apply a 20 percent CCF to the 
amount of:
    (i) Commitments with an original maturity of one year or less that 
are not unconditionally cancelable by the [BANK]; and
    (ii) Self-liquidating, trade-related contingent items that arise 
from the movement of goods, with an original maturity of one year or 
less.
    (3) 50 percent CCF. A [BANK] must apply a 50 percent CCF to the 
amount of:
    (i) Commitments with an original maturity of more than one year 
that are not unconditionally cancelable by the [BANK]; and
    (ii) Transaction-related contingent items, including performance 
bonds, bid bonds, warranties, and performance standby letters of 
credit.
    (4) 100 percent CCF. A [BANK] must apply a 100 percent CCF to the 
amount of the following off-balance-sheet items and other similar 
transactions:
    (i) Guarantees;
    (ii) Repurchase agreements (the off-balance sheet component of 
which equals the sum of the current fair values of all positions the 
[BANK] has sold subject to repurchase);
    (iii) Credit-enhancing representations and warranties that are not 
securitization exposures;
    (iv) Off-balance sheet securities lending transactions (the off-
balance sheet component of which equals the sum of the current fair 
values of all positions the [BANK] has lent under the transaction);
    (v) Off-balance sheet securities borrowing transactions (the off-
balance sheet component of which equals the sum of the current fair 
values of all non-cash positions the [BANK] has posted as collateral 
under the transaction);
    (vi) Financial standby letters of credit; and
    (vii) Forward agreements.


Sec.  --.34  OTC derivative contracts.

    (a) Exposure amount--(1) Single OTC derivative contract. Except as 
modified by paragraph (b) of this section, the exposure amount for a 
single OTC derivative contract that is not subject to a qualifying 
master netting agreement is equal to the sum of the [BANK]'s current 
credit exposure and potential future credit exposure (PFE) on the OTC 
derivative contract.
    (i) Current credit exposure. The current credit exposure for a 
single OTC derivative contract is the greater of the mark-to-fair value 
of the OTC derivative contract or zero.
    (ii) PFE. (A) The PFE for a single OTC derivative contract, 
including an OTC derivative contract with a negative mark-to-fair 
value, is calculated by multiplying the notional principal amount of 
the OTC derivative contract by the appropriate conversion factor in 
Table 1 to Sec.  --.34.
    (B) For purposes of calculating either the PFE under this paragraph 
(a) or the gross PFE under paragraph (a)(2) of this section for 
exchange rate contracts and other similar contracts in which the 
notional principal amount is equivalent to the cash flows, notional 
principal amount is the net receipts to each party falling due on each 
value date in each currency.
    (C) For an OTC derivative contract that does not fall within one of 
the specified categories in Table 1 to Sec.  --.34, the PFE must be 
calculated using the appropriate ``other'' conversion factor.
    (D) A [BANK] must use an OTC derivative contract's effective 
notional principal amount (that is, the apparent or stated notional 
principal amount multiplied by any multiplier in the OTC derivative 
contract) rather than the apparent or stated notional principal amount 
in calculating PFE.
    (E) The PFE of the protection provider of a credit derivative is 
capped at the net present value of the amount of unpaid premiums.

[[Page 62183]]



                                      Table 1 to Sec.   --.34--Conversion Factor Matrix for Derivative Contracts\1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                         Credit
                                                                              Foreign       Credit       (non-                    Precious
                                                                 Interest     exchange   (investment  investment-                  metals
                    Remaining maturity \2\                         rate       rate and      grade        grade        Equity      (except       Other
                                                                                gold      reference    reference                   gold)
                                                                                          asset) \3\     asset)
--------------------------------------------------------------------------------------------------------------------------------------------------------
One year or less.............................................         0.00         0.01         0.05         0.10         0.06         0.07         0.10
Greater than one year and less than or equal to five years...        0.005         0.05         0.05         0.10         0.08         0.07         0.12
Greater than five years......................................        0.015        0.075         0.05         0.10         0.10         0.08         0.15
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ For a derivative contract with multiple exchanges of principal, the conversion factor is multiplied by the number of remaining payments in the
  derivative contract.
\2\ For an OTC derivative contract that is structured such that on specified dates any outstanding exposure is settled and the terms are reset so that
  the fair value of the contract is zero, the remaining maturity equals the time until the next reset date. For an interest rate derivative contract
  with a remaining maturity of greater than one year that meets these criteria, the minimum conversion factor is 0.005.
\3\ A [BANK] must use the column labeled ``Credit (investment-grade reference asset)'' for a credit derivative whose reference asset is an outstanding
  unsecured long-term debt security without credit enhancement that is investment grade. A [BANK] must use the column labeled ``Credit (non-investment-
  grade reference asset)'' for all other credit derivatives.

    (2) Multiple OTC derivative contracts subject to a qualifying 
master netting agreement. Except as modified by paragraph (b) of this 
section, the exposure amount for multiple OTC derivative contracts 
subject to a qualifying master netting agreement is equal to the sum of 
the net current credit exposure and the adjusted sum of the PFE amounts 
for all OTC derivative contracts subject to the qualifying master 
netting agreement.
    (i) Net current credit exposure. The net current credit exposure is 
the greater of the net sum of all positive and negative mark-to-fair 
values of the individual OTC derivative contracts subject to the 
qualifying master netting agreement or zero.
    (ii) Adjusted sum of the PFE amounts. The adjusted sum of the PFE 
amounts, Anet, is calculated as Anet = (0.4 x Agross) + (0.6 x NGR x 
Agross),

where:

(A) Agross = the gross PFE (that is, the sum of the PFE amounts as 
determined under paragraph (a)(1)(ii) of this section for each 
individual derivative contract subject to the qualifying master 
netting agreement); and
(B) Net-to-gross Ratio (NGR) = the ratio of the net current credit 
exposure to the gross current credit exposure. In calculating the 
NGR, the gross current credit exposure equals the sum of the 
positive current credit exposures (as determined under paragraph 
(a)(1)(i) of this section) of all individual derivative contracts 
subject to the qualifying master netting agreement.

    (b) Recognition of credit risk mitigation of collateralized OTC 
derivative contracts: (1) A [BANK] may recognize the credit risk 
mitigation benefits of financial collateral that secures an OTC 
derivative contract or multiple OTC derivative contracts subject to a 
qualifying master netting agreement (netting set) by using the simple 
approach in Sec.  --.37(b).
    (2) As an alternative to the simple approach, a [BANK] may 
recognize the credit risk mitigation benefits of financial collateral 
that secures such a contract or netting set if the financial collateral 
is marked-to-fair value on a daily basis and subject to a daily margin 
maintenance requirement by applying a risk weight to the exposure as if 
it were uncollateralized and adjusting the exposure amount calculated 
under paragraph (a)(1) or (2) of this section using the collateral 
haircut approach in Sec.  --.37(c). The [BANK] must substitute the 
exposure amount calculated under paragraph (a)(1) or (2) of this 
section for [Sigma]E in the equation in Sec.  --.37(c)(2).
    (c) Counterparty credit risk for OTC credit derivatives. (1) 
Protection purchasers. A [BANK] that purchases an OTC credit derivative 
that is recognized under Sec.  --.36 as a credit risk mitigant for an 
exposure that is not a covered position under subpart F is not required 
to compute a separate counterparty credit risk capital requirement 
under Sec.  --.32 provided that the [BANK] does so consistently for all 
such credit derivatives. The [BANK] must either include all or exclude 
all such credit derivatives that are subject to a qualifying master 
netting agreement from any measure used to determine counterparty 
credit risk exposure to all relevant counterparties for risk-based 
capital purposes.
    (2) Protection providers. (i) A [BANK] that is the protection 
provider under an OTC credit derivative must treat the OTC credit 
derivative as an exposure to the underlying reference asset. The [BANK] 
is not required to compute a counterparty credit risk capital 
requirement for the OTC credit derivative under Sec.  --.32, provided 
that this treatment is applied consistently for all such OTC credit 
derivatives. The [BANK] must either include all or exclude all such OTC 
credit derivatives that are subject to a qualifying master netting 
agreement from any measure used to determine counterparty credit risk 
exposure.
    (ii) The provisions of this paragraph (c)(2) apply to all relevant 
counterparties for risk-based capital purposes unless the [BANK] is 
treating the OTC credit derivative as a covered position under subpart 
F, in which case the [BANK] must compute a supplemental counterparty 
credit risk capital requirement under this section.
    (d) Counterparty credit risk for OTC equity derivatives. (1) A 
[BANK] must treat an OTC equity derivative contract as an equity 
exposure and compute a risk-weighted asset amount for the OTC equity 
derivative contract under Sec. Sec.  --.51 through --.53 (unless the 
[BANK] is treating the contract as a covered position under subpart F 
of this part).
    (2) In addition, the [BANK] must also calculate a risk-based 
capital requirement for the counterparty credit risk of an OTC equity 
derivative contract under this section if the [BANK] is treating the 
contract as a covered position under subpart F of this part.
    (3) If the [BANK] risk weights the contract under the Simple Risk-
Weight Approach (SRWA) in Sec.  --.52, the [BANK] may choose not to 
hold risk-based capital against the counterparty credit risk of the OTC 
equity derivative contract, as long as it does so for all such 
contracts. Where the OTC equity derivative contracts are subject to a 
qualified master netting agreement, a [BANK] using the SRWA must either 
include all or exclude all of the contracts from any measure used to 
determine counterparty credit risk exposure.
    (e) Clearing member [BANK]'s exposure amount. A clearing member 
[BANK]'s exposure amount for an OTC

[[Page 62184]]

derivative contract or netting set of OTC derivative contracts where 
the [BANK] is either acting as a financial intermediary and enters into 
an offsetting transaction with a QCCP or where the [BANK] provides a 
guarantee to the QCCP on the performance of the client equals the 
exposure amount calculated according to paragraph (a)(1) or (2) of this 
section multiplied by the scaling factor 0.71. If the [BANK] determines 
that a longer period is appropriate, the [BANK] must use a larger 
scaling factor to adjust for a longer holding period as follows:
[GRAPHIC] [TIFF OMITTED] TR11OC13.015


where

H = the holding period greater than five days. Additionally, the 
[AGENCY] may require the [BANK] to set a longer holding period if 
the [AGENCY] determines that a longer period is appropriate due to 
the nature, structure, or characteristics of the transaction or is 
commensurate with the risks associated with the transaction.

Sec.  --.35  Cleared transactions.

    (a) General requirements--(1) Clearing member clients. A [BANK] 
that is a clearing member client must use the methodologies described 
in paragraph (b) of this section to calculate risk-weighted assets for 
a cleared transaction.
    (2) Clearing members. A [BANK] that is a clearing member must use 
the methodologies described in paragraph (c) of this section to 
calculate its risk-weighted assets for a cleared transaction and 
paragraph (d) of this section to calculate its risk-weighted assets for 
its default fund contribution to a CCP.
    (b) Clearing member client [BANK]s--(1) Risk-weighted assets for 
cleared transactions. (i) To determine the risk-weighted asset amount 
for a cleared transaction, a [BANK] that is a clearing member client 
must multiply the trade exposure amount for the cleared transaction, 
calculated in accordance with paragraph (b)(2) of this section, by the 
risk weight appropriate for the cleared transaction, determined in 
accordance with paragraph (b)(3) of this section.
    (ii) A clearing member client [BANK]'s total risk-weighted assets 
for cleared transactions is the sum of the risk-weighted asset amounts 
for all its cleared transactions.
    (2) Trade exposure amount. (i) For a cleared transaction that is 
either a derivative contract or a netting set of derivative contracts, 
the trade exposure amount equals:
    (A) The exposure amount for the derivative contract or netting set 
of derivative contracts, calculated using the methodology used to 
calculate exposure amount for OTC derivative contracts under Sec.  
--.34; plus
    (B) The fair value of the collateral posted by the clearing member 
client [BANK] and held by the CCP, clearing member, or custodian in a 
manner that is not bankruptcy remote.
    (ii) For a cleared transaction that is a repo-style transaction or 
netting set of repo-style transactions, the trade exposure amount 
equals:
    (A) The exposure amount for the repo-style transaction calculated 
using the methodologies under Sec.  --.37(c); plus
    (B) The fair value of the collateral posted by the clearing member 
client [BANK] and held by the CCP, clearing member, or custodian in a 
manner that is not bankruptcy remote.
    (3) Cleared transaction risk weights. (i) For a cleared transaction 
with a QCCP, a clearing member client [BANK] must apply a risk weight 
of:
    (A) 2 percent if the collateral posted by the [BANK] to the QCCP or 
clearing member is subject to an arrangement that prevents any losses 
to the clearing member client [BANK] due to the joint default or a 
concurrent insolvency, liquidation, or receivership proceeding of the 
clearing member and any other clearing member clients of the clearing 
member; and the clearing member client [BANK] has conducted sufficient 
legal review to conclude with a well-founded basis (and maintains 
sufficient written documentation of that legal review) that in the 
event of a legal challenge (including one resulting from an event of 
default or from liquidation, insolvency, or receivership proceedings) 
the relevant court and administrative authorities would find the 
arrangements to be legal, valid, binding and enforceable under the law 
of the relevant jurisdictions; or
    (B) 4 percent if the requirements of Sec. --.35(b)(3)(A) are not 
met.
    (ii) For a cleared transaction with a CCP that is not a QCCP, a 
clearing member client [BANK] must apply the risk weight appropriate 
for the CCP according to Sec.  --.32.
    (4) Collateral. (i) Notwithstanding any other requirements in this 
section, collateral posted by a clearing member client [BANK] that is 
held by a custodian (in its capacity as custodian) in a manner that is 
bankruptcy remote from the CCP, the custodian, clearing member and 
other clearing member clients of the clearing member, is not subject to 
a capital requirement under this section.
    (ii) A clearing member client [BANK] must calculate a risk-weighted 
asset amount for any collateral provided to a CCP, clearing member, or 
custodian in connection with a cleared transaction in accordance with 
the requirements under Sec.  --.32.
    (c) Clearing member [BANK]s--(1) Risk-weighted assets for cleared 
transactions.
    (i) To determine the risk-weighted asset amount for a cleared 
transaction, a clearing member [BANK] must multiply the trade exposure 
amount for the cleared transaction, calculated in accordance with 
paragraph (c)(2) of this section, by the risk weight appropriate for 
the cleared transaction, determined in accordance with paragraph (c)(3) 
of this section.
    (ii) A clearing member [BANK]'s total risk-weighted assets for 
cleared transactions is the sum of the risk-weighted asset amounts for 
all of its cleared transactions.
    (2) Trade exposure amount. A clearing member [BANK] must calculate 
its trade exposure amount for a cleared transaction as follows:
    (i) For a cleared transaction that is either a derivative contract 
or a netting set of derivative contracts, the trade exposure amount 
equals:
    (A) The exposure amount for the derivative contract, calculated 
using the methodology to calculate exposure amount for OTC derivative 
contracts under Sec.  --.34; plus
    (B) The fair value of the collateral posted by the clearing member 
[BANK] and held by the CCP in a manner that is not bankruptcy remote.
    (ii) For a cleared transaction that is a repo-style transaction or 
netting set of repo-style transactions, trade exposure amount equals:
    (A) The exposure amount for repo-style transactions calculated 
using methodologies under Sec.  --.37(c); plus
    (B) The fair value of the collateral posted by the clearing member 
[BANK] and held by the CCP in a manner that is not bankruptcy remote.
    (3) Cleared transaction risk weight. (i) A clearing member [BANK] 
must apply a risk weight of 2 percent to the trade exposure amount for 
a cleared transaction with a QCCP.
    (ii) For a cleared transaction with a CCP that is not a QCCP, a 
clearing member [BANK] must apply the risk weight appropriate for the 
CCP according to Sec.  --.32.
    (4) Collateral. (i) Notwithstanding any other requirement in this 
section, collateral posted by a clearing member [BANK] that is held by 
a custodian in a manner that is bankruptcy remote

[[Page 62185]]

from the CCP is not subject to a capital requirement under this 
section.
    (ii) A clearing member [BANK] must calculate a risk-weighted asset 
amount for any collateral provided to a CCP, clearing member, or a 
custodian in connection with a cleared transaction in accordance with 
requirements under Sec.  --.32.
    (d) Default fund contributions. (1) General requirement. A clearing 
member [BANK] must determine the risk-weighted asset amount for a 
default fund contribution to a CCP at least quarterly, or more 
frequently if, in the opinion of the [BANK] or the [AGENCY], there is a 
material change in the financial condition of the CCP.
    (2) Risk-weighted asset amount for default fund contributions to 
non-qualifying CCPs. A clearing member [BANK]'s risk-weighted asset 
amount for default fund contributions to CCPs that are not QCCPs equals 
the sum of such default fund contributions multiplied by 1,250 percent, 
or an amount determined by the [AGENCY], based on factors such as size, 
structure and membership characteristics of the CCP and riskiness of 
its transactions, in cases where such default fund contributions may be 
unlimited.
    (3) Risk-weighted asset amount for default fund contributions to 
QCCPs. A clearing member [BANK]'s risk-weighted asset amount for 
default fund contributions to QCCPs equals the sum of its capital 
requirement, KCM for each QCCP, as calculated under the 
methodology set forth in paragraphs (d)(3)(i) through (iii) of this 
section (Method 1), multiplied by 1,250 percent or in paragraphs 
(d)(3)(iv) of this section (Method 2).
    (i) Method 1. The hypothetical capital requirement of a QCCP 
(KCCP) equals:
[GRAPHIC] [TIFF OMITTED] TR11OC13.058

Where:

    (A) EBRMi = the exposure amount for each transaction 
cleared through the QCCP by clearing member i, calculated in 
accordance with Sec.  --.34 for OTC derivative contracts and Sec.  
--.37(c)(2) for repo-style transactions, provided that:
    (1) For purposes of this section, in calculating the exposure 
amount the [BANK] may replace the formula provided in Sec.  
--.34(a)(2)(ii) with the following: Anet = (0.15 x Agross) + (0.85 x 
NGR x Agross); and
    (2) For option derivative contracts that are cleared 
transactions, the PFE described in Sec.  --.34(a)(1)(ii) must be 
adjusted by multiplying the notional principal amount of the 
derivative contract by the appropriate conversion factor in Table 1 
to Sec.  --.34 and the absolute value of the option's delta, that 
is, the ratio of the change in the value of the derivative contract 
to the corresponding change in the price of the underlying asset.
    (3) For repo-style transactions, when applying Sec.  
--.37(c)(2), the [BANK] must use the methodology in Sec.  
--.37(c)(3);
    (B) VMi = any collateral posted by clearing member i 
to the QCCP that it is entitled to receive from the QCCP, but has 
not yet received, and any collateral that the QCCP has actually 
received from clearing member i;
    (C) IMi = the collateral posted as initial margin by 
clearing member i to the QCCP;
    (D) DFi = the funded portion of clearing member i's 
default fund contribution that will be applied to reduce the QCCP's 
loss upon a default by clearing member i;
    (E) RW = 20 percent, except when the [AGENCY] has determined 
that a higher risk weight is more appropriate based on the specific 
characteristics of the QCCP and its clearing members; and
    (F) Where a QCCP has provided its KCCP, a [BANK] must 
rely on such disclosed figure instead of calculating KCCP 
under this paragraph (d), unless the [BANK] determines that a more 
conservative figure is appropriate based on the nature, structure, 
or characteristics of the QCCP.

    (ii) For a [BANK] that is a clearing member of a QCCP with a 
default fund supported by funded commitments, KCM equals:
[GRAPHIC] [TIFF OMITTED] TR11OC13.016

    Subscripts 1 and 2 denote the clearing members with the two largest 
ANet values. For purposes of this paragraph (d), for 
derivatives ANet is defined in Sec.  --.34(a)(2)(ii) and for 
repo-style transactions, ANet means the exposure amount as 
defined in Sec.  --.37(c)(2) using the methodology in Sec.  
--.37(c)(3);
    (B) N = the number of clearing members in the QCCP;
    (C) DFCCP = the QCCP's own funds and other financial 
resources that would be used to cover its losses before clearing 
members' default fund contributions are used to cover losses;
    (D) DFCM = funded default fund contributions from all 
clearing members and any other clearing member

[[Page 62186]]

contributed financial resources that are available to absorb mutualized 
QCCP losses;
    (E) DF = DFCCP + DFCM (that is, the total 
funded default fund contribution);
[GRAPHIC] [TIFF OMITTED] TR11OC13.017

Where:

(1) DFi = the [BANK]'s unfunded commitment to the default 
fund;
(2) DFCM = the total of all clearing members' unfunded 
commitment to the default fund; and
(3) K*CM as defined in paragraph (d)(3)(ii) of this section.

    (B) For a [BANK] that is a clearing member of a QCCP with a 
default fund supported by unfunded commitments and is unable to 
calculate KCM using the methodology described in 
paragraph (d)(3)(iii) of this section, KCM equals:

[[Page 62187]]

[GRAPHIC] [TIFF OMITTED] TR11OC13.018

Where:

(1) IMi = the [BANK]'s initial margin posted to the QCCP;
(2) IMCM = the total of initial margin posted to the 
QCCP; and
(3)K*CM as defined in paragraph (d)(3)(ii) of this section.

    (iv) Method 2. A clearing member [BANK]'s risk-weighted asset 
amount for its default fund contribution to a QCCP, RWADF, 
equals:

RWADF = Min {12.5 * DF; 0.18 * TE{time} 

Where:

(A) TE = the [BANK]'s trade exposure amount to the QCCP, calculated 
according to section 35(c)(2);
(B) DF = the funded portion of the [BANK]'s default fund 
contribution to the QCCP.

    (4) Total risk-weighted assets for default fund contributions. 
Total risk-weighted assets for default fund contributions is the sum of 
a clearing member [BANK]'s risk-weighted assets for all of its default 
fund contributions to all CCPs of which the [BANK] is a clearing 
member.


Sec.  --.36  Guarantees and credit derivatives: substitution treatment.

    (a) Scope--(1) General. A [BANK] may recognize the credit risk 
mitigation benefits of an eligible guarantee or eligible credit 
derivative by substituting the risk weight associated with the 
protection provider for the risk weight assigned to an exposure, as 
provided under this section.
    (2) This section applies to exposures for which:
    (i) Credit risk is fully covered by an eligible guarantee or 
eligible credit derivative; or
    (ii) Credit risk is covered on a pro rata basis (that is, on a 
basis in which the [BANK] and the protection provider share losses 
proportionately) by an eligible guarantee or eligible credit 
derivative.
    (3) Exposures on which there is a tranching of credit risk 
(reflecting at least two different levels of seniority) generally are 
securitization exposures subject to Sec. Sec.  --.41 through --.45.
    (4) If multiple eligible guarantees or eligible credit derivatives 
cover a single exposure described in this section, a [BANK] may treat 
the hedged exposure as multiple separate exposures each covered by a 
single eligible guarantee or eligible credit derivative and may 
calculate a separate risk-weighted asset amount for each separate 
exposure as described in paragraph (c) of this section.
    (5) If a single eligible guarantee or eligible credit derivative 
covers multiple hedged exposures described in paragraph (a)(2) of this 
section, a [BANK] must treat each hedged exposure as covered by a 
separate eligible guarantee or eligible credit derivative and must 
calculate a separate risk-weighted asset amount for each exposure as 
described in paragraph (c) of this section.
    (b) Rules of recognition. (1) A [BANK] may only recognize the 
credit risk mitigation benefits of eligible guarantees and eligible 
credit derivatives.
    (2) A [BANK] may only recognize the credit risk mitigation benefits 
of an eligible credit derivative to hedge an exposure that is different 
from the credit derivative's reference exposure used for determining 
the derivative's cash settlement value, deliverable obligation, or 
occurrence of a credit event if:
    (i) The reference exposure ranks pari passu with, or is 
subordinated to, the hedged exposure; and
    (ii) The reference exposure and the hedged exposure are to the same 
legal entity, and legally enforceable cross-default or cross-
acceleration clauses are in place to ensure payments under the credit 
derivative are triggered when the obligated party of the hedged 
exposure fails to pay under the terms of the hedged exposure.
    (c) Substitution approach--(1) Full coverage. If an eligible 
guarantee or eligible credit derivative meets the conditions in 
paragraphs (a) and (b) of this section and the protection amount (P) of 
the guarantee or credit derivative is greater than or equal to the 
exposure amount of the hedged exposure, a [BANK] may recognize the 
guarantee or credit derivative in determining the risk-weighted asset 
amount for the hedged exposure by substituting the risk weight 
applicable to the guarantor or credit derivative protection provider 
under Sec.  --.32 for the risk weight assigned to the exposure.
    (2) Partial coverage. If an eligible guarantee or eligible credit 
derivative meets the conditions in Sec. Sec.  --.36(a) and --.37(b) and 
the protection amount (P) of the guarantee or credit derivative is less 
than the exposure amount of the hedged exposure, the [BANK] must treat 
the hedged exposure as two separate exposures (protected and 
unprotected) in order to recognize the credit risk mitigation benefit 
of the guarantee or credit derivative.
    (i) The [BANK] may calculate the risk-weighted asset amount for the 
protected exposure under Sec.  --.32, where the applicable risk weight 
is the risk weight applicable to the guarantor or credit derivative 
protection provider.
    (ii) The [BANK] must calculate the risk-weighted asset amount for 
the unprotected exposure under Sec.  --.32, where the applicable risk 
weight is that of the unprotected portion of the hedged exposure.
    (iii) The treatment provided in this section is applicable when the 
credit risk of an exposure is covered on a partial pro rata basis and 
may be applicable when an adjustment is made to the effective notional 
amount of the guarantee or credit derivative under paragraphs (d), (e), 
or (f) of this section.
    (d) Maturity mismatch adjustment. (1) A [BANK] that recognizes an 
eligible guarantee or eligible credit derivative in determining the 
risk-weighted asset amount for a hedged exposure must adjust the 
effective notional amount of the credit risk mitigant to reflect any 
maturity mismatch between the hedged exposure and the credit risk 
mitigant.
    (2) A maturity mismatch occurs when the residual maturity of a 
credit risk mitigant is less than that of the hedged exposure(s).
    (3) The residual maturity of a hedged exposure is the longest 
possible remaining time before the obligated party of the hedged 
exposure is scheduled to fulfil its obligation on the hedged exposure. 
If a credit risk mitigant has embedded options that may reduce its 
term, the [BANK] (protection purchaser) must use the shortest possible 
residual maturity for the credit risk mitigant. If a call is at the 
discretion of the protection provider, the residual maturity of the 
credit risk mitigant is at the first call date. If the call is at the 
discretion of the [BANK] (protection purchaser), but the terms of the 
arrangement at origination of the credit risk mitigant contain a 
positive incentive for the [BANK] to call the transaction before 
contractual maturity, the remaining time to the first call date is the 
residual maturity of the credit risk mitigant.
    (4) A credit risk mitigant with a maturity mismatch may be 
recognized only if its original maturity is greater than or equal to 
one year and its residual maturity is greater than three months.
    (5) When a maturity mismatch exists, the [BANK] must apply the 
following adjustment to reduce the effective notional amount of the 
credit risk mitigant: Pm = E x (t-0.25)/(T-0.25), where:

(i) Pm = effective notional amount of the credit risk mitigant, 
adjusted for maturity mismatch;
(ii) E = effective notional amount of the credit risk mitigant;
(iii) t = the lesser of T or the residual maturity of the credit 
risk mitigant, expressed in years; and

[[Page 62188]]

(iv) T = the lesser of five or the residual maturity of the hedged 
exposure, expressed in years.

    (e) Adjustment for credit derivatives without restructuring as a 
credit event. If a [BANK] recognizes an eligible credit derivative that 
does not include as a credit event a restructuring of the hedged 
exposure involving forgiveness or postponement of principal, interest, 
or fees that results in a credit loss event (that is, a charge-off, 
specific provision, or other similar debit to the profit and loss 
account), the [BANK] must apply the following adjustment to reduce the 
effective notional amount of the credit derivative: Pr = Pm x 0.60, 
where:

(1) Pr = effective notional amount of the credit risk mitigant, 
adjusted for lack of restructuring event (and maturity mismatch, if 
applicable); and
(2) Pm = effective notional amount of the credit risk mitigant 
(adjusted for maturity mismatch, if applicable).

    (f) Currency mismatch adjustment. (1) If a [BANK] recognizes an 
eligible guarantee or eligible credit derivative that is denominated in 
a currency different from that in which the hedged exposure is 
denominated, the [BANK] must apply the following formula to the 
effective notional amount of the guarantee or credit derivative: Pc = 
Pr x (1-HFX), where:

(i) Pc = effective notional amount of the credit risk mitigant, 
adjusted for currency mismatch (and maturity mismatch and lack of 
restructuring event, if applicable);
(ii) Pr = effective notional amount of the credit risk mitigant 
(adjusted for maturity mismatch and lack of restructuring event, if 
applicable); and
(iii) HFX = haircut appropriate for the currency mismatch 
between the credit risk mitigant and the hedged exposure.

    (2) A [BANK] must set HFX equal to eight percent unless 
it qualifies for the use of and uses its own internal estimates of 
foreign exchange volatility based on a ten-business-day holding period. 
A [BANK] qualifies for the use of its own internal estimates of foreign 
exchange volatility if it qualifies for the use of its own-estimates 
haircuts in Sec.  --.37(c)(4).
    (3) A [BANK] must adjust HFX calculated in paragraph 
(f)(2) of this section upward if the [BANK] revalues the guarantee or 
credit derivative less frequently than once every 10 business days 
using the following square root of time formula:
[GRAPHIC] [TIFF OMITTED] TR11OC13.021

Sec.  --.37  Collateralized transactions.

    (a) General. (1) To recognize the risk-mitigating effects of 
financial collateral, a [BANK] may use:
    (i) The simple approach in paragraph (b) of this section for any 
exposure; or
    (ii) The collateral haircut approach in paragraph (c) of this 
section for repo-style transactions, eligible margin loans, 
collateralized derivative contracts, and single-product netting sets of 
such transactions.
    (2) A [BANK] may use any approach described in this section that is 
valid for a particular type of exposure or transaction; however, it 
must use the same approach for similar exposures or transactions.
    (b) The simple approach--(1) General requirements. (i) A [BANK] may 
recognize the credit risk mitigation benefits of financial collateral 
that secures any exposure.
    (ii) To qualify for the simple approach, the financial collateral 
must meet the following requirements:
    (A) The collateral must be subject to a collateral agreement for at 
least the life of the exposure;
    (B) The collateral must be revalued at least every six months; and
    (C) The collateral (other than gold) and the exposure must be 
denominated in the same currency.
    (2) Risk weight substitution. (i) A [BANK] may apply a risk weight 
to the portion of an exposure that is secured by the fair value of 
financial collateral (that meets the requirements of paragraph (b)(1) 
of this section) based on the risk weight assigned to the collateral 
under Sec.  --.32. For repurchase agreements, reverse repurchase 
agreements, and securities lending and borrowing transactions, the 
collateral is the instruments, gold, and cash the [BANK] has borrowed, 
purchased subject to resale, or taken as collateral from the 
counterparty under the transaction. Except as provided in paragraph 
(b)(3) of this section, the risk weight assigned to the collateralized 
portion of the exposure may not be less than 20 percent.
    (ii) A [BANK] must apply a risk weight to the unsecured portion of 
the exposure based on the risk weight applicable to the exposure under 
this subpart.
    (3) Exceptions to the 20 percent risk-weight floor and other 
requirements. Notwithstanding paragraph (b)(2)(i) of this section:
    (i) A [BANK] may assign a zero percent risk weight to an exposure 
to an OTC derivative contract that is marked-to-market on a daily basis 
and subject to a daily margin maintenance requirement, to the extent 
the contract is collateralized by cash on deposit.
    (ii) A [BANK] may assign a 10 percent risk weight to an exposure to 
an OTC derivative contract that is marked-to-market daily and subject 
to a daily margin maintenance requirement, to the extent that the 
contract is collateralized by an exposure to a sovereign that qualifies 
for a zero percent risk weight under Sec.  --.32.
    (iii) A [BANK] may assign a zero percent risk weight to the 
collateralized portion of an exposure where:
    (A) The financial collateral is cash on deposit; or
    (B) The financial collateral is an exposure to a sovereign that 
qualifies for a zero percent risk weight under Sec.  --.32, and the 
[BANK] has discounted the fair value of the collateral by 20 percent.
    (c) Collateral haircut approach--(1) General. A [BANK] may 
recognize the credit risk mitigation benefits of financial collateral 
that secures an eligible margin loan, repo-style transaction, 
collateralized derivative contract, or single-product netting set of 
such transactions, and of any collateral that secures a repo-style 
transaction that is included in the [BANK]'s VaR-based measure under 
subpart F of this part by using the collateral haircut approach in this 
section. A [BANK] may use the standard supervisory haircuts in 
paragraph (c)(3) of this section or, with prior written approval of the 
[AGENCY], its own estimates of haircuts according to paragraph (c)(4) 
of this section.
    (2) Exposure amount equation. A [BANK] must determine the exposure 
amount for an eligible margin loan, repo-style transaction, 
collateralized derivative contract, or a single-product netting set of 
such transactions by setting the exposure amount equal to

[[Page 62189]]

max {0, [([Sigma]E - [Sigma]C) + [Sigma](Es x Hs) + [Sigma](Efx x 
Hfx)]{time} , where:

    (i)(A) For eligible margin loans and repo-style transactions and 
netting sets thereof, [Sigma]E equals the value of the exposure (the 
sum of the current fair values of all instruments, gold, and cash 
the [BANK] has lent, sold subject to repurchase, or posted as 
collateral to the counterparty under the transaction (or netting 
set)); and
    (B) For collateralized derivative contracts and netting sets 
thereof, [Sigma]E equals the exposure amount of the OTC derivative 
contract (or netting set) calculated under Sec.  --.34 (a)(1) or 
(2).
    (ii) [Sigma]C equals the value of the collateral (the sum of the 
current fair values of all instruments, gold and cash the [BANK] has 
borrowed, purchased subject to resale, or taken as collateral from 
the counterparty under the transaction (or netting set));
    (iii) Es equals the absolute value of the net position in a 
given instrument or in gold (where the net position in the 
instrument or gold equals the sum of the current fair values of the 
instrument or gold the [BANK] has lent, sold subject to repurchase, 
or posted as collateral to the counterparty minus the sum of the 
current fair values of that same instrument or gold the [BANK] has 
borrowed, purchased subject to resale, or taken as collateral from 
the counterparty);
    (iv) Hs equals the market price volatility haircut appropriate 
to the instrument or gold referenced in Es;
    (v) Efx equals the absolute value of the net position of 
instruments and cash in a currency that is different from the 
settlement currency (where the net position in a given currency 
equals the sum of the current fair values of any instruments or cash 
in the currency the [BANK] has lent, sold subject to repurchase, or 
posted as collateral to the counterparty minus the sum of the 
current fair values of any instruments or cash in the currency the 
[BANK] has borrowed, purchased subject to resale, or taken as 
collateral from the counterparty); and
    (vi) Hfx equals the haircut appropriate to the mismatch between 
the currency referenced in Efx and the settlement currency.

    (3) Standard supervisory haircuts. (i) A [BANK] must use the 
haircuts for market price volatility (Hs) provided in Table 1 to Sec.  
--.37, as adjusted in certain circumstances in accordance with the 
requirements of paragraphs (c)(3)(iii) and (iv) of this section.

                                   Table 1 to Sec.   --.37--Standard Supervisory Market Price Volatility Haircuts \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                Haircut (in percent) assigned based on:
                                                               ------------------------------------------------------------------------ Investment grade
                                                                   Sovereign issuers risk weight     Non-sovereign issuers risk weight   securitization
                       Residual maturity                          under Sec.   --.32 (in percent)     under Sec.   --.32 (in percent)     exposures (in
                                                               -----------------\2\----------------------------------------------------     percent)
                                                                   Zero      20 or 50       100         20          50          100
--------------------------------------------------------------------------------------------------------------------------------------------------------
Less than or equal to 1 year..................................         0.5         1.0        15.0         1.0         2.0         4.0               4.0
Greater than 1 year and less than or equal to 5 years.........         2.0         3.0        15.0         4.0         6.0         8.0              12.0
Greater than 5 years..........................................         4.0         6.0        15.0         8.0        12.0        16.0              24.0
--------------------------------------------------------------------------------------------------------------------------------------------------------
Main index equities (including convertible bonds) and gold...........................15.0.........
--------------------------------------------------------------------------------------------------------------------------------------------------------
Other publicly traded equities (including convertible bonds).........................25.0.........
--------------------------------------------------------------------------------------------------------------------------------------------------------
Mutual funds.....................................................Highest haircut applicable to any security in
                                                                          which the fund can invest.
--------------------------------------------------------------------------------------------------------------------------------------------------------
Cash collateral held.................................................................Zero.........
--------------------------------------------------------------------------------------------------------------------------------------------------------
Other exposure types.................................................................25.0.........
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ The market price volatility haircuts in Table 1 to Sec.   --.37 are based on a 10 business-day holding period.
\2\ Includes a foreign PSE that receives a zero percent risk weight.

    (ii) For currency mismatches, a [BANK] must use a haircut for 
foreign exchange rate volatility (Hfx) of 8.0 percent, as adjusted in 
certain circumstances under paragraphs (c)(3)(iii) and (iv) of this 
section.
    (iii) For repo-style transactions, a [BANK] may multiply the 
standard supervisory haircuts provided in paragraphs (c)(3)(i) and (ii) 
of this section by the square root of \1/2\ (which equals 0.707107).
    (iv) If the number of trades in a netting set exceeds 5,000 at any 
time during a quarter, a [BANK] must adjust the supervisory haircuts 
provided in paragraphs (c)(3)(i) and (ii) of this section upward on the 
basis of a holding period of twenty business days for the following 
quarter except in the calculation of the exposure amount for purposes 
of Sec.  --.35. If a netting set contains one or more trades involving 
illiquid collateral or an OTC derivative that cannot be easily 
replaced, a [BANK] must adjust the supervisory haircuts upward on the 
basis of a holding period of twenty business days. If over the two 
previous quarters more than two margin disputes on a netting set have 
occurred that lasted more than the holding period, then the [BANK] must 
adjust the supervisory haircuts upward for that netting set on the 
basis of a holding period that is at least two times the minimum 
holding period for that netting set. A [BANK] must adjust the standard 
supervisory haircuts upward using the following formula:
[GRAPHIC] [TIFF OMITTED] TR11OC13.022


    (A) TM equals a holding period of longer than 10 
business days for eligible margin loans and derivative contracts or 
longer than 5 business days for repo-style transactions;
    (B) HS equals the standard supervisory haircut; and
    (C) TS equals 10 business days for eligible margin 
loans and derivative contracts or 5 business days for repo-style 
transactions.

    (v) If the instrument a [BANK] has lent, sold subject to 
repurchase, or posted as collateral does not meet the definition of 
financial collateral, the [BANK] must use a 25.0 percent haircut for 
market price volatility (Hs).
    (4) Own internal estimates for haircuts. With the prior written 
approval of the [AGENCY], a [BANK] may calculate haircuts (Hs and Hfx) 
using its own internal estimates of the volatilities of market prices 
and foreign exchange rates:
    (i) To receive [AGENCY] approval to use its own internal estimates, 
a [BANK]

[[Page 62190]]

must satisfy the following minimum standards:
    (A) A [BANK] must use a 99th percentile one-tailed confidence 
interval.
    (B) The minimum holding period for a repo-style transaction is five 
business days and for an eligible margin loan is ten business days 
except for transactions or netting sets for which paragraph 
(c)(4)(i)(C) of this section applies. When a [BANK] calculates an own-
estimates haircut on a TN-day holding period, which is 
different from the minimum holding period for the transaction type, the 
applicable haircut (HM) is calculated using the following 
square root of time formula:
[GRAPHIC] [TIFF OMITTED] TR11OC13.023


    (1) TM equals 5 for repo-style transactions and 10 
for eligible margin loans;
    (2) TN equals the holding period used by the [BANK] 
to derive HN; and
    (3) HN equals the haircut based on the holding period 
TN.

    (C) If the number of trades in a netting set exceeds 5,000 at any 
time during a quarter, a [BANK] must calculate the haircut using a 
minimum holding period of twenty business days for the following 
quarter except in the calculation of the exposure amount for purposes 
of Sec.  --.35. If a netting set contains one or more trades involving 
illiquid collateral or an OTC derivative that cannot be easily 
replaced, a [BANK] must calculate the haircut using a minimum holding 
period of twenty business days. If over the two previous quarters more 
than two margin disputes on a netting set have occurred that lasted 
more than the holding period, then the [BANK] must calculate the 
haircut for transactions in that netting set on the basis of a holding 
period that is at least two times the minimum holding period for that 
netting set.
    (D) A [BANK] is required to calculate its own internal estimates 
with inputs calibrated to historical data from a continuous 12-month 
period that reflects a period of significant financial stress 
appropriate to the security or category of securities.
    (E) A [BANK] must have policies and procedures that describe how it 
determines the period of significant financial stress used to calculate 
the [BANK]'s own internal estimates for haircuts under this section and 
must be able to provide empirical support for the period used. The 
[BANK] must obtain the prior approval of the [AGENCY] for, and notify 
the [AGENCY] if the [BANK] makes any material changes to, these 
policies and procedures.
    (F) Nothing in this section prevents the [AGENCY] from requiring a 
[BANK] to use a different period of significant financial stress in the 
calculation of own internal estimates for haircuts.
    (G) A [BANK] must update its data sets and calculate haircuts no 
less frequently than quarterly and must also reassess data sets and 
haircuts whenever market prices change materially.
    (ii) With respect to debt securities that are investment grade, a 
[BANK] may calculate haircuts for categories of securities. For a 
category of securities, the [BANK] must calculate the haircut on the 
basis of internal volatility estimates for securities in that category 
that are representative of the securities in that category that the 
[BANK] has lent, sold subject to repurchase, posted as collateral, 
borrowed, purchased subject to resale, or taken as collateral. In 
determining relevant categories, the [BANK] must at a minimum take into 
account:
    (A) The type of issuer of the security;
    (B) The credit quality of the security;
    (C) The maturity of the security; and
    (D) The interest rate sensitivity of the security.
    (iii) With respect to debt securities that are not investment grade 
and equity securities, a [BANK] must calculate a separate haircut for 
each individual security.
    (iv) Where an exposure or collateral (whether in the form of cash 
or securities) is denominated in a currency that differs from the 
settlement currency, the [BANK] must calculate a separate currency 
mismatch haircut for its net position in each mismatched currency based 
on estimated volatilities of foreign exchange rates between the 
mismatched currency and the settlement currency.
    (v) A [BANK]'s own estimates of market price and foreign exchange 
rate volatilities may not take into account the correlations among 
securities and foreign exchange rates on either the exposure or 
collateral side of a transaction (or netting set) or the correlations 
among securities and foreign exchange rates between the exposure and 
collateral sides of the transaction (or netting set).

Risk-Weighted Assets for Unsettled Transactions


Sec.  --.38  Unsettled transactions.

    (a) Definitions. For purposes of this section:
    (1) Delivery-versus-payment (DvP) transaction means a securities or 
commodities transaction in which the buyer is obligated to make payment 
only if the seller has made delivery of the securities or commodities 
and the seller is obligated to deliver the securities or commodities 
only if the buyer has made payment.
    (2) Payment-versus-payment (PvP) transaction means a foreign 
exchange transaction in which each counterparty is obligated to make a 
final transfer of one or more currencies only if the other counterparty 
has made a final transfer of one or more currencies.
    (3) A transaction has a normal settlement period if the contractual 
settlement period for the transaction is equal to or less than the 
market standard for the instrument underlying the transaction and equal 
to or less than five business days.
    (4) Positive current exposure of a [BANK] for a transaction is the 
difference between the transaction value at the agreed settlement price 
and the current market price of the transaction, if the difference 
results in a credit exposure of the [BANK] to the counterparty.
    (b) Scope. This section applies to all transactions involving 
securities, foreign exchange instruments, and commodities that have a 
risk of delayed settlement or delivery. This section does not apply to:
    (1) Cleared transactions that are marked-to-market daily and 
subject to daily receipt and payment of variation margin;
    (2) Repo-style transactions, including unsettled repo-style 
transactions;
    (3) One-way cash payments on OTC derivative contracts; or
    (4) Transactions with a contractual settlement period that is 
longer than the normal settlement period (which are treated as OTC 
derivative contracts as provided in Sec.  --.34).
    (c) System-wide failures. In the case of a system-wide failure of a 
settlement, clearing system or central counterparty, the [AGENCY] may 
waive risk-based capital requirements for unsettled and failed 
transactions until the situation is rectified.
    (d) Delivery-versus-payment (DvP) and payment-versus-payment (PvP) 
transactions. A [BANK] must hold risk-based capital against any DvP or 
PvP transaction with a normal settlement period if the [BANK]'s 
counterparty has not made delivery or payment within five business days 
after the settlement date. The [BANK] must determine its risk-weighted 
asset amount for such a transaction by multiplying the positive current 
exposure of the transaction for the [BANK] by the appropriate risk 
weight in Table 1 to Sec.  --.38.

[[Page 62191]]



     Table 1 to Sec.   --.38--Risk Weights for Unsettled DvP and PvP
                              Transactions
------------------------------------------------------------------------
                                                         Risk weight to
                                                          be applied to
 Number of business days after  contractual settlement  positive current
                         date                             exposure (in
                                                            percent)
------------------------------------------------------------------------
From 5 to 15..........................................             100.0
From 16 to 30.........................................             625.0
From 31 to 45.........................................             937.5
46 or more............................................           1,250.0
------------------------------------------------------------------------

    (e) Non-DvP/non-PvP (non-delivery-versus-payment/non-payment-
versus-payment) transactions. (1) A [BANK] must hold risk-based capital 
against any non-DvP/non-PvP transaction with a normal settlement period 
if the [BANK] has delivered cash, securities, commodities, or 
currencies to its counterparty but has not received its corresponding 
deliverables by the end of the same business day. The [BANK] must 
continue to hold risk-based capital against the transaction until the 
[BANK] has received its corresponding deliverables.
    (2) From the business day after the [BANK] has made its delivery 
until five business days after the counterparty delivery is due, the 
[BANK] must calculate the risk-weighted asset amount for the 
transaction by treating the current fair value of the deliverables owed 
to the [BANK] as an exposure to the counterparty and using the 
applicable counterparty risk weight under Sec.  --.32.
    (3) If the [BANK] has not received its deliverables by the fifth 
business day after counterparty delivery was due, the [BANK] must 
assign a 1,250 percent risk weight to the current fair value of the 
deliverables owed to the [BANK].
    (f) Total risk-weighted assets for unsettled transactions. Total 
risk-weighted assets for unsettled transactions is the sum of the risk-
weighted asset amounts of all DvP, PvP, and non-DvP/non-PvP 
transactions.


Sec. Sec.  --.39 through --.40  [Reserved]

Risk-Weighted Assets for Securitization Exposures


Sec.  --.41  Operational requirements for securitization exposures.

    (a) Operational criteria for traditional securitizations. A [BANK] 
that transfers exposures it has originated or purchased to a 
securitization SPE or other third party in connection with a 
traditional securitization may exclude the exposures from the 
calculation of its risk-weighted assets only if each condition in this 
section is satisfied. A [BANK] that meets these conditions must hold 
risk-based capital against any credit risk it retains in connection 
with the securitization. A [BANK] that fails to meet these conditions 
must hold risk-based capital against the transferred exposures as if 
they had not been securitized and must deduct from common equity tier 1 
capital any after-tax gain-on-sale resulting from the transaction. The 
conditions are:
    (1) The exposures are not reported on the [BANK]'s consolidated 
balance sheet under GAAP;
    (2) The [BANK] has transferred to one or more third parties credit 
risk associated with the underlying exposures;
    (3) Any clean-up calls relating to the securitization are eligible 
clean-up calls; and
    (4) The securitization does not:
    (i) Include one or more underlying exposures in which the borrower 
is permitted to vary the drawn amount within an agreed limit under a 
line of credit; and
    (ii) Contain an early amortization provision.
    (b) Operational criteria for synthetic securitizations. For 
synthetic securitizations, a [BANK] may recognize for risk-based 
capital purposes the use of a credit risk mitigant to hedge underlying 
exposures only if each condition in this paragraph (b) is satisfied. A 
[BANK] that meets these conditions must hold risk-based capital against 
any credit risk of the exposures it retains in connection with the 
synthetic securitization. A [BANK] that fails to meet these conditions 
or chooses not to recognize the credit risk mitigant for purposes of 
this section must instead hold risk-based capital against the 
underlying exposures as if they had not been synthetically securitized. 
The conditions are:
    (1) The credit risk mitigant is:
    (i) Financial collateral;
    (ii) A guarantee that meets all criteria as set forth in the 
definition of ``eligible guarantee'' in Sec.  --.2, except for the 
criteria in paragraph (3) of that definition; or
    (iii) A credit derivative that meets all criteria as set forth in 
the definition of ``eligible credit derivative'' in Sec.  --.2, except 
for the criteria in paragraph (3) of the definition of ``eligible 
guarantee'' in Sec.  --.2.
    (2) The [BANK] transfers credit risk associated with the underlying 
exposures to one or more third parties, and the terms and conditions in 
the credit risk mitigants employed do not include provisions that:
    (i) Allow for the termination of the credit protection due to 
deterioration in the credit quality of the underlying exposures;
    (ii) Require the [BANK] to alter or replace the underlying 
exposures to improve the credit quality of the underlying exposures;
    (iii) Increase the [BANK]'s cost of credit protection in response 
to deterioration in the credit quality of the underlying exposures;
    (iv) Increase the yield payable to parties other than the [BANK] in 
response to a deterioration in the credit quality of the underlying 
exposures; or
    (v) Provide for increases in a retained first loss position or 
credit enhancement provided by the [BANK] after the inception of the 
securitization;
    (3) The [BANK] obtains a well-reasoned opinion from legal counsel 
that confirms the enforceability of the credit risk mitigant in all 
relevant jurisdictions; and
    (4) Any clean-up calls relating to the securitization are eligible 
clean-up calls.
    (c) Due diligence requirements for securitization exposures. (1) 
Except for exposures that are deducted from common equity tier 1 
capital and exposures subject to Sec.  --.42(h), if a [BANK] is unable 
to demonstrate to the satisfaction of the [AGENCY] a comprehensive 
understanding of the features of a securitization exposure that would 
materially affect the performance of the exposure, the [BANK] must 
assign the securitization exposure a risk weight of 1,250 percent. The 
[BANK]'s analysis must be commensurate with the complexity of the 
securitization exposure and the materiality of the exposure in relation 
to its capital.
    (2) A [BANK] must demonstrate its comprehensive understanding of a 
securitization exposure under paragraph (c)(1) of this section, for 
each securitization exposure by:
    (i) Conducting an analysis of the risk characteristics of a 
securitization exposure prior to acquiring the exposure, and 
documenting such analysis within three business days after acquiring 
the exposure, considering:
    (A) Structural features of the securitization that would materially 
impact the performance of the exposure, for example, the contractual 
cash flow waterfall, waterfall-related triggers, credit enhancements, 
liquidity enhancements, fair value triggers, the performance of 
organizations that service the exposure, and deal-specific definitions 
of default;
    (B) Relevant information regarding the performance of the 
underlying credit exposure(s), for example, the percentage of loans 30, 
60, and 90 days past due; default rates; prepayment rates; loans in 
foreclosure; property types; occupancy;

[[Page 62192]]

average credit score or other measures of creditworthiness; average LTV 
ratio; and industry and geographic diversification data on the 
underlying exposure(s);
    (C) Relevant market data of the securitization, for example, bid-
ask spread, most recent sales price and historic price volatility, 
trading volume, implied market rating, and size, depth and 
concentration level of the market for the securitization; and
    (D) For resecuritization exposures, performance information on the 
underlying securitization exposures, for example, the issuer name and 
credit quality, and the characteristics and performance of the 
exposures underlying the securitization exposures; and
    (ii) On an on-going basis (no less frequently than quarterly), 
evaluating, reviewing, and updating as appropriate the analysis 
required under paragraph (c)(1) of this section for each securitization 
exposure.


Sec.  --.42  Risk-weighted assets for securitization exposures.

    (a) Securitization risk weight approaches. Except as provided 
elsewhere in this section or in Sec.  --.41:
    (1) A [BANK] must deduct from common equity tier 1 capital any 
after-tax gain-on-sale resulting from a securitization and apply a 
1,250 percent risk weight to the portion of a CEIO that does not 
constitute after-tax gain-on-sale.
    (2) If a securitization exposure does not require deduction under 
paragraph (a)(1) of this section, a [BANK] may assign a risk weight to 
the securitization exposure using the simplified supervisory formula 
approach (SSFA) in accordance with Sec. Sec.  --.43(a) through --.43(d) 
and subject to the limitation under paragraph (e) of this section. 
Alternatively, a [BANK] that is not subject to subpart F of this part 
may assign a risk weight to the securitization exposure using the 
gross-up approach in accordance with Sec.  --.43(e), provided, however, 
that such [BANK] must apply either the SSFA or the gross-up approach 
consistently across all of its securitization exposures, except as 
provided in paragraphs (a)(1), (a)(3), and (a)(4) of this section.
    (3) If a securitization exposure does not require deduction under 
paragraph (a)(1) of this section and the [BANK] cannot, or chooses not 
to apply the SSFA or the gross-up approach to the exposure, the [BANK] 
must assign a risk weight to the exposure as described in Sec.  --.44.
    (4) If a securitization exposure is a derivative contract (other 
than protection provided by a [BANK] in the form of a credit 
derivative) that has a first priority claim on the cash flows from the 
underlying exposures (notwithstanding amounts due under interest rate 
or currency derivative contracts, fees due, or other similar payments), 
a [BANK] may choose to set the risk-weighted asset amount of the 
exposure equal to the amount of the exposure as determined in paragraph 
(c) of this section.
    (b) Total risk-weighted assets for securitization exposures. A 
[BANK]'s total risk-weighted assets for securitization exposures equals 
the sum of the risk-weighted asset amount for securitization exposures 
that the [BANK] risk weights under Sec. Sec.  --.41(c), --.42(a)(1), 
and --.43, --.44, or --.45, and paragraphs (e) through (j) of this 
section, as applicable.
    (c) Exposure amount of a securitization exposure--(1) On-balance 
sheet securitization exposures. The exposure amount of an on-balance 
sheet securitization exposure (excluding an available-for-sale or held-
to-maturity security where the [BANK] has made an AOCI opt-out election 
under Sec.  --.22(b)(2), a repo-style transaction, eligible margin 
loan, OTC derivative contract, or cleared transaction) is equal to the 
carrying value of the exposure.
    (2) On-balance sheet securitization exposures held by a [BANK] that 
has made an AOCI opt-out election. The exposure amount of an on-balance 
sheet securitization exposure that is an available-for-sale or held-to-
maturity security held by a [BANK] that has made an AOCI opt-out 
election under Sec.  --.22(b)(2) is the [BANK]'s carrying value 
(including net accrued but unpaid interest and fees), less any net 
unrealized gains on the exposure and plus any net unrealized losses on 
the exposure.
    (3) Off-balance sheet securitization exposures. (i) Except as 
provided in paragraph (j) of this section, the exposure amount of an 
off-balance sheet securitization exposure that is not a repo-style 
transaction, eligible margin loan, cleared transaction (other than a 
credit derivative), or an OTC derivative contract (other than a credit 
derivative) is the notional amount of the exposure. For an off-balance 
sheet securitization exposure to an ABCP program, such as an eligible 
ABCP liquidity facility, the notional amount may be reduced to the 
maximum potential amount that the [BANK] could be required to fund 
given the ABCP program's current underlying assets (calculated without 
regard to the current credit quality of those assets).
    (ii) A [BANK] must determine the exposure amount of an eligible 
ABCP liquidity facility for which the SSFA does not apply by 
multiplying the notional amount of the exposure by a CCF of 50 percent.
    (iii) A [BANK] must determine the exposure amount of an eligible 
ABCP liquidity facility for which the SSFA applies by multiplying the 
notional amount of the exposure by a CCF of 100 percent.
    (4) Repo-style transactions, eligible margin loans, and derivative 
contracts. The exposure amount of a securitization exposure that is a 
repo-style transaction, eligible margin loan, or derivative contract 
(other than a credit derivative) is the exposure amount of the 
transaction as calculated under Sec.  --.34 or Sec.  --.37, as 
applicable.
    (d) Overlapping exposures. If a [BANK] has multiple securitization 
exposures that provide duplicative coverage to the underlying exposures 
of a securitization (such as when a [BANK] provides a program-wide 
credit enhancement and multiple pool-specific liquidity facilities to 
an ABCP program), the [BANK] is not required to hold duplicative risk-
based capital against the overlapping position. Instead, the [BANK] may 
apply to the overlapping position the applicable risk-based capital 
treatment that results in the highest risk-based capital requirement.
    (e) Implicit support. If a [BANK] provides support to a 
securitization in excess of the [BANK]'s contractual obligation to 
provide credit support to the securitization (implicit support):
    (1) The [BANK] must include in risk-weighted assets all of the 
underlying exposures associated with the securitization as if the 
exposures had not been securitized and must deduct from common equity 
tier 1 capital any after-tax gain-on-sale resulting from the 
securitization; and
    (2) The [BANK] must disclose publicly:
    (i) That it has provided implicit support to the securitization; 
and
    (ii) The risk-based capital impact to the [BANK] of providing such 
implicit support.
    (f) Undrawn portion of a servicer cash advance facility. (1) 
Notwithstanding any other provision of this subpart, a [BANK] that is a 
servicer under an eligible servicer cash advance facility is not 
required to hold risk-based capital against potential future cash 
advance payments that it may be required to provide under the contract 
governing the facility.
    (2) For a [BANK] that acts as a servicer, the exposure amount for a 
servicer cash advance facility that is not an eligible servicer cash 
advance facility is equal to the amount of all potential future cash 
advance payments that the

[[Page 62193]]

[BANK] may be contractually required to provide during the subsequent 
12 month period under the contract governing the facility.
    (g) Interest-only mortgage-backed securities. Regardless of any 
other provisions in this subpart, the risk weight for a non-credit-
enhancing interest-only mortgage-backed security may not be less than 
100 percent.
    (h) Small-business loans and leases on personal property 
transferred with retained contractual exposure. (1) Regardless of any 
other provision of this subpart, a [BANK] that has transferred small-
business loans and leases on personal property (small-business 
obligations) with recourse must include in risk-weighted assets only 
its contractual exposure to the small-business obligations if all the 
following conditions are met:
    (i) The transaction must be treated as a sale under GAAP.
    (ii) The [BANK] establishes and maintains, pursuant to GAAP, a non-
capital reserve sufficient to meet the [BANK]'s reasonably estimated 
liability under the contractual obligation.
    (iii) The small-business obligations are to businesses that meet 
the criteria for a small-business concern established by the Small 
Business Administration under section 3(a) of the Small Business Act 
(15 U.S.C. 632 et seq.).
    (iv) The [BANK] is well capitalized, as defined in [12 CFR 6.4 
(OCC); 12 CFR 208.43 (Board)]. For purposes of determining whether a 
[BANK] is well capitalized for purposes of this paragraph (h), the 
[BANK]'s capital ratios must be calculated without regard to the 
capital treatment for transfers of small-business obligations under 
this paragraph (h).
    (2) The total outstanding amount of contractual exposure retained 
by a [BANK] on transfers of small-business obligations receiving the 
capital treatment specified in paragraph (h)(1) of this section cannot 
exceed 15 percent of the [BANK]'s total capital.
    (3) If a [BANK] ceases to be well capitalized under [12 CFR 6.4 
(OCC); 12 CFR 208.43 (Board)] or exceeds the 15 percent capital 
limitation provided in paragraph (h)(2) of this section, the capital 
treatment under paragraph (h)(1) of this section will continue to apply 
to any transfers of small-business obligations with retained 
contractual exposure that occurred during the time that the [BANK] was 
well capitalized and did not exceed the capital limit.
    (4) The risk-based capital ratios of the [BANK] must be calculated 
without regard to the capital treatment for transfers of small-business 
obligations specified in paragraph (h)(1) of this section for purposes 
of:
    (i) Determining whether a [BANK] is adequately capitalized, 
undercapitalized, significantly undercapitalized, or critically 
undercapitalized under the [AGENCY]'s prompt corrective action 
regulations; and
    (ii) Reclassifying a well-capitalized [BANK] to adequately 
capitalized and requiring an adequately capitalized [BANK] to comply 
with certain mandatory or discretionary supervisory actions as if the 
[BANK] were in the next lower prompt-corrective-action category.
    (i) Nth-to-default credit derivatives--(1) Protection provider. A 
[BANK] may assign a risk weight using the SSFA in Sec.  --.43 to an 
n^th-to-default credit derivative in accordance with this 
paragraph (i). A [BANK] must determine its exposure in the 
n^th-to-default credit derivative as the largest notional 
amount of all the underlying exposures.
    (2) For purposes of determining the risk weight for an 
n^th-to-default credit derivative using the SSFA, the [BANK] 
must calculate the attachment point and detachment point of its 
exposure as follows:
    (i) The attachment point (parameter A) is the ratio of the sum of 
the notional amounts of all underlying exposures that are subordinated 
to the [BANK]'s exposure to the total notional amount of all underlying 
exposures. The ratio is expressed as a decimal value between zero and 
one. In the case of a first-to-default credit derivative, there are no 
underlying exposures that are subordinated to the [BANK]'s exposure. In 
the case of a second-or-subsequent-to-default credit derivative, the 
smallest (n-1) notional amounts of the underlying exposure(s) are 
subordinated to the [BANK]'s exposure.
    (ii) The detachment point (parameter D) equals the sum of parameter 
A plus the ratio of the notional amount of the [BANK]'s exposure in the 
n^th-to-default credit derivative to the total notional 
amount of all underlying exposures. The ratio is expressed as a decimal 
value between zero and one.
    (3) A [BANK] that does not use the SSFA to determine a risk weight 
for its n^th-to-default credit derivative must assign a risk 
weight of 1,250 percent to the exposure.
    (4) Protection purchaser--(i) First-to-default credit derivatives. 
A [BANK] that obtains credit protection on a group of underlying 
exposures through a first-to-default credit derivative that meets the 
rules of recognition of Sec.  --.36(b) must determine its risk-based 
capital requirement for the underlying exposures as if the [BANK] 
synthetically securitized the underlying exposure with the smallest 
risk-weighted asset amount and had obtained no credit risk mitigant on 
the other underlying exposures. A [BANK] must calculate a risk-based 
capital requirement for counterparty credit risk according to Sec.  
--.34 for a first-to-default credit derivative that does not meet the 
rules of recognition of Sec.  --.36(b).
    (ii) Second-or-subsequent-to-default credit derivatives. (A) A 
[BANK] that obtains credit protection on a group of underlying 
exposures through a n^th-to-default credit derivative that 
meets the rules of recognition of Sec.  --.36(b) (other than a first-
to-default credit derivative) may recognize the credit risk mitigation 
benefits of the derivative only if:
    (1) The [BANK] also has obtained credit protection on the same 
underlying exposures in the form of first-through-(n-1)-to-default 
credit derivatives; or
    (2) If n-1 of the underlying exposures have already defaulted.
    (B) If a [BANK] satisfies the requirements of paragraph 
(i)(4)(ii)(A) of this section, the [BANK] must determine its risk-based 
capital requirement for the underlying exposures as if the [BANK] had 
only synthetically securitized the underlying exposure with the 
n^th smallest risk-weighted asset amount and had obtained no 
credit risk mitigant on the other underlying exposures.
    (C) A [BANK] must calculate a risk-based capital requirement for 
counterparty credit risk according to Sec.  --.34 for a n^th-
to-default credit derivative that does not meet the rules of 
recognition of Sec.  --.36(b).
    (j) Guarantees and credit derivatives other than nth-to-default 
credit derivatives--(1) Protection provider. For a guarantee or credit 
derivative (other than an n^th-to-default credit derivative) 
provided by a [BANK] that covers the full amount or a pro rata share of 
a securitization exposure's principal and interest, the [BANK] must 
risk weight the guarantee or credit derivative as if it holds the 
portion of the reference exposure covered by the guarantee or credit 
derivative.
    (2) Protection purchaser. (i) A [BANK] that purchases a guarantee 
or OTC credit derivative (other than an n^th-to-default 
credit derivative) that is recognized under Sec.  --.45 as a credit 
risk mitigant (including via collateral recognized under Sec.  --.37) 
is not required to compute a separate counterparty credit risk capital 
requirement under Sec.  --.31, in accordance with 34(c).
    (ii) If a [BANK] cannot, or chooses not to, recognize a purchased 
credit

[[Page 62194]]

derivative as a credit risk mitigant under Sec.  --.45, the [BANK] must 
determine the exposure amount of the credit derivative under Sec.  
--.34.
    (A) If the [BANK] purchases credit protection from a counterparty 
that is not a securitization SPE, the [BANK] must determine the risk 
weight for the exposure according to general risk weights under Sec.  
--.32.
    (B) If the [BANK] purchases the credit protection from a 
counterparty that is a securitization SPE, the [BANK] must determine 
the risk weight for the exposure according to section Sec.  --.42, 
including Sec.  --.42(a)(4) for a credit derivative that has a first 
priority claim on the cash flows from the underlying exposures of the 
securitization SPE (notwithstanding amounts due under interest rate or 
currency derivative contracts, fees due, or other similar payments).


Sec.  --.43  Simplified supervisory formula approach (SSFA) and the 
gross-up approach.

    (a) General requirements for the SSFA. To use the SSFA to determine 
the risk weight for a securitization exposure, a [BANK] must have data 
that enables it to assign accurately the parameters described in 
paragraph (b) of this section. Data used to assign the parameters 
described in paragraph (b) of this section must be the most currently 
available data; if the contracts governing the underlying exposures of 
the securitization require payments on a monthly or quarterly basis, 
the data used to assign the parameters described in paragraph (b) of 
this section must be no more than 91 calendar days old. A [BANK] that 
does not have the appropriate data to assign the parameters described 
in paragraph (b) of this section must assign a risk weight of 1,250 
percent to the exposure.
    (b) SSFA parameters. To calculate the risk weight for a 
securitization exposure using the SSFA, a [BANK] must have accurate 
information on the following five inputs to the SSFA calculation:
    (1) KG is the weighted-average (with unpaid principal 
used as the weight for each exposure) total capital requirement of the 
underlying exposures calculated using this subpart. KG is 
expressed as a decimal value between zero and one (that is, an average 
risk weight of 100 percent represents a value of KG equal to 
0.08).
    (2) Parameter W is expressed as a decimal value between zero and 
one. Parameter W is the ratio of the sum of the dollar amounts of any 
underlying exposures of the securitization that meet any of the 
criteria as set forth in paragraphs (b)(2)(i) through (vi) of this 
section to the balance, measured in dollars, of underlying exposures:
    (i) Ninety days or more past due;
    (ii) Subject to a bankruptcy or insolvency proceeding;
    (iii) In the process of foreclosure;
    (iv) Held as real estate owned;
    (v) Has contractually deferred payments for 90 days or more, other 
than principal or interest payments deferred on:
    (A) Federally-guaranteed student loans, in accordance with the 
terms of those guarantee programs; or
    (B) Consumer loans, including non-federally-guaranteed student 
loans, provided that such payments are deferred pursuant to provisions 
included in the contract at the time funds are disbursed that provide 
for period(s) of deferral that are not initiated based on changes in 
the creditworthiness of the borrower; or
    (vi) Is in default.
    (3) Parameter A is the attachment point for the exposure, which 
represents the threshold at which credit losses will first be allocated 
to the exposure. Except as provided in Sec.  --.42(i) for 
n^th-to-default credit derivatives, parameter A equals the 
ratio of the current dollar amount of underlying exposures that are 
subordinated to the exposure of the [BANK] to the current dollar amount 
of underlying exposures. Any reserve account funded by the accumulated 
cash flows from the underlying exposures that is subordinated to the 
[BANK]'s securitization exposure may be included in the calculation of 
parameter A to the extent that cash is present in the account. 
Parameter A is expressed as a decimal value between zero and one.
    (4) Parameter D is the detachment point for the exposure, which 
represents the threshold at which credit losses of principal allocated 
to the exposure would result in a total loss of principal. Except as 
provided in section 42(i) for n^th-to-default credit 
derivatives, parameter D equals parameter A plus the ratio of the 
current dollar amount of the securitization exposures that are pari 
passu with the exposure (that is, have equal seniority with respect to 
credit risk) to the current dollar amount of the underlying exposures. 
Parameter D is expressed as a decimal value between zero and one.
    (5) A supervisory calibration parameter, p, is equal to 0.5 for 
securitization exposures that are not resecuritization exposures and 
equal to 1.5 for resecuritization exposures.
    (c) Mechanics of the SSFA. KG and W are used to 
calculate KA, the augmented value of KG, which 
reflects the observed credit quality of the underlying exposures. 
KA is defined in paragraph (d) of this section. The values 
of parameters A and D, relative to KA determine the risk 
weight assigned to a securitization exposure as described in paragraph 
(d) of this section. The risk weight assigned to a securitization 
exposure, or portion of a securitization exposure, as appropriate, is 
the larger of the risk weight determined in accordance with this 
paragraph (c) or paragraph (d) of this section and a risk weight of 20 
percent.
    (1) When the detachment point, parameter D, for a securitization 
exposure is less than or equal to KA, the exposure must be 
assigned a risk weight of 1,250 percent.
    (2) When the attachment point, parameter A, for a securitization 
exposure is greater than or equal to KA, the [BANK] must 
calculate the risk weight in accordance with paragraph (d) of this 
section.
    (3) When A is less than KA and D is greater than 
KA, the risk weight is a weighted-average of 1,250 percent 
and 1,250 percent times KSSFA calculated in accordance with 
paragraph (d) of this section. For the purpose of this weighted-average 
calculation:

[[Page 62195]]

[GRAPHIC] [TIFF OMITTED] TR11OC13.024

    (e) Gross-up approach--(1) Applicability. A [BANK] that is not 
subject to subpart F of this part may apply the gross-up approach set 
forth in this section instead of the SSFA to determine the risk weight 
of its securitization exposures, provided that it applies the gross-up 
approach to all of its securitization exposures, except as otherwise 
provided for certain securitization exposures in Sec. Sec.  --.44 and 
--.45.
    (2) To use the gross-up approach, a [BANK] must calculate the 
following four inputs:
    (i) Pro rata share, which is the par value of the [BANK]'s 
securitization exposure as a percent of the par value of the tranche in 
which the securitization exposure resides;
    (ii) Enhanced amount, which is the par value of tranches that are 
more senior to the tranche in which the [BANK]'s securitization 
resides;
    (iii) Exposure amount of the [BANK]'s securitization exposure 
calculated under Sec.  --.42(c); and
    (iv) Risk weight, which is the weighted-average risk weight of 
underlying exposures of the securitization as calculated under this 
subpart.
    (3) Credit equivalent amount. The credit equivalent amount of a 
securitization exposure under this section equals the sum of:
    (i) The exposure amount of the [BANK]'s securitization exposure; 
and
    (ii) The pro rata share multiplied by the enhanced amount, each 
calculated in accordance with paragraph (e)(2) of this section.
    (4) Risk-weighted assets. To calculate risk-weighted assets for a 
securitization exposure under the gross-up approach, a [BANK] must 
apply the risk weight

[[Page 62196]]

required under paragraph (e)(2) of this section to the credit 
equivalent amount calculated in paragraph (e)(3) of this section.
    (f) Limitations. Notwithstanding any other provision of this 
section, a [BANK] must assign a risk weight of not less than 20 percent 
to a securitization exposure.


Sec.  --.44  Securitization exposures to which the SSFA and gross-up 
approach do not apply.

    (a) General requirement. A [BANK] must assign a 1,250 percent risk 
weight to all securitization exposures to which the [BANK] does not 
apply the SSFA or the gross-up approach under Sec.  --.43, except as 
set forth in this section.
    (b) Eligible ABCP liquidity facilities. A [BANK] may determine the 
risk-weighted asset amount of an eligible ABCP liquidity facility by 
multiplying the exposure amount by the highest risk weight applicable 
to any of the individual underlying exposures covered by the facility.
    (c) A securitization exposure in a second loss position or better 
to an ABCP program--(1) Risk weighting. A [BANK] may determine the 
risk-weighted asset amount of a securitization exposure that is in a 
second loss position or better to an ABCP program that meets the 
requirements of paragraph (c)(2) of this section by multiplying the 
exposure amount by the higher of the following risk weights:
    (i) 100 percent; and
    (ii) The highest risk weight applicable to any of the individual 
underlying exposures of the ABCP program.
    (2) Requirements. (i) The exposure is not an eligible ABCP 
liquidity facility;
    (ii) The exposure must be economically in a second loss position or 
better, and the first loss position must provide significant credit 
protection to the second loss position;
    (iii) The exposure qualifies as investment grade; and
    (iv) The [BANK] holding the exposure must not retain or provide 
protection to the first loss position.


Sec.  --.45  Recognition of credit risk mitigants for securitization 
exposures.

    (a) General. (1) An originating [BANK] that has obtained a credit 
risk mitigant to hedge its exposure to a synthetic or traditional 
securitization that satisfies the operational criteria provided in 
Sec.  --.41 may recognize the credit risk mitigant under Sec. Sec.  
--.36 or --.37, but only as provided in this section.
    (2) An investing [BANK] that has obtained a credit risk mitigant to 
hedge a securitization exposure may recognize the credit risk mitigant 
under Sec. Sec.  --.36 or--.37, but only as provided in this section.
    (b) Mismatches. A [BANK] must make any applicable adjustment to the 
protection amount of an eligible guarantee or credit derivative as 
required in Sec.  --.36(d), (e), and (f) for any hedged securitization 
exposure. In the context of a synthetic securitization, when an 
eligible guarantee or eligible credit derivative covers multiple hedged 
exposures that have different residual maturities, the [BANK] must use 
the longest residual maturity of any of the hedged exposures as the 
residual maturity of all hedged exposures.


Sec. Sec.  --.46 through --.50  [Reserved]

Risk-Weighted Assets for Equity Exposures


Sec.  --.51  Introduction and exposure measurement.

    (a) General. (1) To calculate its risk-weighted asset amounts for 
equity exposures that are not equity exposures to an investment fund, a 
[BANK] must use the Simple Risk-Weight Approach (SRWA) provided in 
--.52. A [BANK] must use the look-through approaches provided in Sec.  
--.53 to calculate its risk-weighted asset amounts for equity exposures 
to investment funds.
    (2) A [BANK] must treat an investment in a separate account (as 
defined in Sec.  --.2) as if it were an equity exposure to an 
investment fund as provided in Sec.  --.53.
    (3) Stable value protection. (i) Stable value protection means a 
contract where the provider of the contract is obligated to pay:
    (A) The policy owner of a separate account an amount equal to the 
shortfall between the fair value and cost basis of the separate account 
when the policy owner of the separate account surrenders the policy; or
    (B) The beneficiary of the contract an amount equal to the 
shortfall between the fair value and book value of a specified 
portfolio of assets.
    (ii) A [BANK] that purchases stable value protection on its 
investment in a separate account must treat the portion of the carrying 
value of its investment in the separate account attributable to the 
stable value protection as an exposure to the provider of the 
protection and the remaining portion of the carrying value of its 
separate account as an equity exposure to an investment fund.
    (iii) A [BANK] that provides stable value protection must treat the 
exposure as an equity derivative with an adjusted carrying value 
determined as the sum of paragraphs (b)(1) and (3) of this section.
    (b) Adjusted carrying value. For purposes of Sec. Sec.  --.51 
through --.53, the adjusted carrying value of an equity exposure is:
    (1) For the on-balance sheet component of an equity exposure (other 
than an equity exposure that is classified as available-for-sale where 
the [BANK] has made an AOCI opt-out election under Sec.  --.22(b)(2)), 
the [BANK]'s carrying value of the exposure;
    (2) For the on-balance sheet component of an equity exposure that 
is classified as available-for-sale where the [BANK] has made an AOCI 
opt-out election under Sec.  --.22(b)(2), the [BANK]'s carrying value 
of the exposure less any net unrealized gains on the exposure that are 
reflected in such carrying value but excluded from the [BANK]'s 
regulatory capital components;
    (3) For the off-balance sheet component of an equity exposure that 
is not an equity commitment, the effective notional principal amount of 
the exposure, the size of which is equivalent to a hypothetical on-
balance sheet position in the underlying equity instrument that would 
evidence the same change in fair value (measured in dollars) given a 
small change in the price of the underlying equity instrument, minus 
the adjusted carrying value of the on-balance sheet component of the 
exposure as calculated in paragraph (b)(1) of this section; and
    (4) For a commitment to acquire an equity exposure (an equity 
commitment), the effective notional principal amount of the exposure is 
multiplied by the following conversion factors (CFs):
    (i) Conditional equity commitments with an original maturity of one 
year or less receive a CF of 20 percent.
    (ii) Conditional equity commitments with an original maturity of 
over one year receive a CF of 50 percent.
    (iii) Unconditional equity commitments receive a CF of 100 percent.


Sec.  --.52  Simple risk-weight approach (SRWA).

    (a) General. Under the SRWA, a [BANK]'s total risk-weighted assets 
for equity exposures equals the sum of the risk-weighted asset amounts 
for each of the [BANK]'s individual equity exposures (other than equity 
exposures to an investment fund) as determined under this section and 
the risk-weighted asset amounts for each of the [BANK]'s individual 
equity exposures to an investment fund as determined under Sec.  --.53.

[[Page 62197]]

    (b) SRWA computation for individual equity exposures. A [BANK] must 
determine the risk-weighted asset amount for an individual equity 
exposure (other than an equity exposure to an investment fund) by 
multiplying the adjusted carrying value of the equity exposure or the 
effective portion and ineffective portion of a hedge pair (as defined 
in paragraph (c) of this section) by the lowest applicable risk weight 
in this paragraph (b).
    (1) Zero percent risk weight equity exposures. An equity exposure 
to a sovereign, the Bank for International Settlements, the European 
Central Bank, the European Commission, the International Monetary Fund, 
an MDB, and any other entity whose credit exposures receive a zero 
percent risk weight under Sec.  --.32 may be assigned a zero percent 
risk weight.
    (2) 20 percent risk weight equity exposures. An equity exposure to 
a PSE, Federal Home Loan Bank or the Federal Agricultural Mortgage 
Corporation (Farmer Mac) must be assigned a 20 percent risk weight.
    (3) 100 percent risk weight equity exposures. The equity exposures 
set forth in this paragraph (b)(3) must be assigned a 100 percent risk 
weight.
    (i) Community development equity exposures. An equity exposure that 
qualifies as a community development investment under section 24 
(Eleventh) of the National Bank Act, excluding equity exposures to an 
unconsolidated small business investment company and equity exposures 
held through a consolidated small business investment company described 
in section 302 of the Small Business Investment Act.
    (ii) Effective portion of hedge pairs. The effective portion of a 
hedge pair.
    (iii) Non-significant equity exposures. Equity exposures, excluding 
significant investments in the capital of an unconsolidated financial 
institution in the form of common stock and exposures to an investment 
firm that would meet the definition of a traditional securitization 
were it not for the application of paragraph (8) of that definition in 
Sec.  --.2 and has greater than immaterial leverage, to the extent that 
the aggregate adjusted carrying value of the exposures does not exceed 
10 percent of the [BANK]'s total capital.
    (A) To compute the aggregate adjusted carrying value of a [BANK]'s 
equity exposures for purposes of this section, the [BANK] may exclude 
equity exposures described in paragraphs (b)(1), (b)(2), (b)(3)(i), and 
(b)(3)(ii) of this section, the equity exposure in a hedge pair with 
the smaller adjusted carrying value, and a proportion of each equity 
exposure to an investment fund equal to the proportion of the assets of 
the investment fund that are not equity exposures or that meet the 
criterion of paragraph (b)(3)(i) of this section. If a [BANK] does not 
know the actual holdings of the investment fund, the [BANK] may 
calculate the proportion of the assets of the fund that are not equity 
exposures based on the terms of the prospectus, partnership agreement, 
or similar contract that defines the fund's permissible investments. If 
the sum of the investment limits for all exposure classes within the 
fund exceeds 100 percent, the [BANK] must assume for purposes of this 
section that the investment fund invests to the maximum extent possible 
in equity exposures.
    (B) When determining which of a [BANK]'s equity exposures qualify 
for a 100 percent risk weight under this paragraph (b), a [BANK] first 
must include equity exposures to unconsolidated small business 
investment companies or held through consolidated small business 
investment companies described in section 302 of the Small Business 
Investment Act, then must include publicly traded equity exposures 
(including those held indirectly through investment funds), and then 
must include non-publicly traded equity exposures (including those held 
indirectly through investment funds).
    (4) 250 percent risk weight equity exposures. Significant 
investments in the capital of unconsolidated financial institutions in 
the form of common stock that are not deducted from capital pursuant to 
Sec.  --.22(d) are assigned a 250 percent risk weight.
    (5) 300 percent risk weight equity exposures. A publicly traded 
equity exposure (other than an equity exposure described in paragraph 
(b)(7) of this section and including the ineffective portion of a hedge 
pair) must be assigned a 300 percent risk weight.
    (6) 400 percent risk weight equity exposures. An equity exposure 
(other than an equity exposure described in paragraph (b)(7)) of this 
section that is not publicly traded must be assigned a 400 percent risk 
weight.
    (7) 600 percent risk weight equity exposures. An equity exposure to 
an investment firm must be assigned a 600 percent risk weight, provided 
that the investment firm:
    (i) Would meet the definition of a traditional securitization were 
it not for the application of paragraph (8) of that definition; and
    (ii) Has greater than immaterial leverage.
    (c) Hedge transactions--(1) Hedge pair. A hedge pair is two equity 
exposures that form an effective hedge so long as each equity exposure 
is publicly traded or has a return that is primarily based on a 
publicly traded equity exposure.
    (2) Effective hedge. Two equity exposures form an effective hedge 
if the exposures either have the same remaining maturity or each has a 
remaining maturity of at least three months; the hedge relationship is 
formally documented in a prospective manner (that is, before the [BANK] 
acquires at least one of the equity exposures); the documentation 
specifies the measure of effectiveness (E) the [BANK] will use for the 
hedge relationship throughout the life of the transaction; and the 
hedge relationship has an E greater than or equal to 0.8. A [BANK] must 
measure E at least quarterly and must use one of three alternative 
measures of E as set forth in this paragraph (c).
    (i) Under the dollar-offset method of measuring effectiveness, the 
[BANK] must determine the ratio of value change (RVC). The RVC is the 
ratio of the cumulative sum of the changes in value of one equity 
exposure to the cumulative sum of the changes in the value of the other 
equity exposure. If RVC is positive, the hedge is not effective and E 
equals 0. If RVC is negative and greater than or equal to -1 (that is, 
between zero and -1), then E equals the absolute value of RVC. If RVC 
is negative and less than -1, then E equals 2 plus RVC.
    (ii) Under the variability-reduction method of measuring 
effectiveness:

[[Page 62198]]

[GRAPHIC] [TIFF OMITTED] TR11OC13.027

    (iii) Under the regression method of measuring effectiveness, E 
equals the coefficient of determination of a regression in which the 
change in value of one exposure in a hedge pair is the dependent 
variable and the change in value of the other exposure in a hedge pair 
is the independent variable. However, if the estimated regression 
coefficient is positive, then E equals zero.
    (3) The effective portion of a hedge pair is E multiplied by the 
greater of the adjusted carrying values of the equity exposures forming 
a hedge pair.
    (4) The ineffective portion of a hedge pair is (1-E) multiplied by 
the greater of the adjusted carrying values of the equity exposures 
forming a hedge pair.


Sec.  --.53  Equity exposures to investment funds.

    (a) Available approaches. (1) Unless the exposure meets the 
requirements for a community development equity exposure under Sec.  
--.52(b)(3)(i), a [BANK] must determine the risk-weighted asset amount 
of an equity exposure to an investment fund under the full look-through 
approach described in paragraph (b) of this section, the simple 
modified look-through approach described in paragraph (c) of this 
section, or the alterative modified look-through approach described 
paragraph (d) of this section, provided, however, that the minimum risk 
weight that may be assigned to an equity exposure under this section is 
20 percent.
    (2) The risk-weighted asset amount of an equity exposure to an 
investment fund that meets the requirements for a community development 
equity exposure in Sec.  --.52(b)(3)(i) is its adjusted carrying value.
    (3) If an equity exposure to an investment fund is part of a hedge 
pair and the [BANK] does not use the full look-through approach, the 
[BANK] must use the ineffective portion of the hedge pair as determined 
under Sec.  --.52(c) as the adjusted carrying value for the equity 
exposure to the investment fund. The risk-weighted asset amount of the 
effective portion of the hedge pair is equal to its adjusted carrying 
value.
    (b) Full look-through approach. A [BANK] that is able to calculate 
a risk-weighted asset amount for its proportional ownership share of 
each exposure held by the investment fund (as calculated under this 
subpart as if the proportional ownership share of the adjusted carrying 
value of each exposure were held directly by the [BANK]) may set the 
risk-weighted asset amount of the [BANK]'s exposure to the fund equal 
to the product of:
    (1) The aggregate risk-weighted asset amounts of the exposures held 
by the fund as if they were held directly by the [BANK]; and
    (2) The [BANK]'s proportional ownership share of the fund.
    (c) Simple modified look-through approach. Under the simple 
modified look-through approach, the risk-weighted asset amount for a 
[BANK]'s equity exposure to an investment fund equals the adjusted 
carrying value of the equity exposure multiplied by the highest risk 
weight that applies to any exposure the fund is permitted to hold under 
the prospectus, partnership agreement, or similar agreement that 
defines the fund's permissible investments (excluding derivative 
contracts that are used for hedging rather than speculative purposes 
and that do not constitute a material portion of the fund's exposures).
    (d) Alternative modified look-through approach. Under the 
alternative modified look-through approach, a [BANK] may assign the 
adjusted carrying value of an equity exposure to an investment fund on 
a pro rata basis to different risk weight categories under this subpart 
based on the investment limits in the fund's prospectus, partnership 
agreement, or similar contract that defines the fund's permissible 
investments. The risk-weighted asset amount for the [BANK]'s equity 
exposure to the investment fund equals the sum of each portion of the 
adjusted carrying value assigned to an exposure type multiplied by the 
applicable risk weight under this subpart. If the sum of the investment 
limits for all exposure types within the fund exceeds 100 percent, the 
[BANK] must assume that the fund invests to the maximum extent 
permitted under its investment limits in the exposure type with the 
highest applicable risk weight under this subpart and continues to make 
investments in order of the exposure type with the next highest 
applicable risk weight under this subpart until the maximum total 
investment level is reached. If more than one exposure type applies to 
an exposure, the [BANK] must use the highest applicable risk weight. A 
[BANK] may exclude derivative contracts held by the fund that are used 
for hedging rather than for speculative purposes and do not constitute 
a material portion of the fund's exposures.


Sec. Sec.  --.54 through --.60  [Reserved]

Disclosures


Sec.  --.61  Purpose and scope.

    Sections --.61---.63 of this subpart establish public disclosure 
requirements related to the capital requirements described in subpart B 
of this part for a [BANK] with total consolidated assets of $50 billion 
or more as reported on the [BANK]'s most recent year-end [REGULATORY 
REPORT] that is not an advanced approaches [BANK] making public 
disclosures pursuant to Sec.  --.172. An advanced approaches [BANK] 
that has not received approval from the [AGENCY] to exit parallel run 
pursuant to Sec.  --.121(d) is subject to the disclosure requirements 
described in Sec. Sec.  --.62 and --.63. Such a [BANK] must comply with

[[Page 62199]]

Sec.  --.62 unless it is a consolidated subsidiary of a bank holding 
company, savings and loan holding company, or depository institution 
that is subject to these disclosure requirements or a subsidiary of a 
non-U.S. banking organization that is subject to comparable public 
disclosure requirements in its home jurisdiction. For purposes of this 
section, total consolidated assets are determined based on the average 
of the [BANK]'s total consolidated assets in the four most recent 
quarters as reported on the [REGULATORY REPORT]; or the average of the 
[BANK]'s total consolidated assets in the most recent consecutive 
quarters as reported quarterly on the [BANK]'s [REGULATORY REPORT] if 
the [BANK] has not filed such a report for each of the most recent four 
quarters.


Sec.  --.62  Disclosure requirements.

    (a) A [BANK] described in Sec.  --.61 must provide timely public 
disclosures each calendar quarter of the information in the applicable 
tables in Sec.  --.63. If a significant change occurs, such that the 
most recent reported amounts are no longer reflective of the [BANK]'s 
capital adequacy and risk profile, then a brief discussion of this 
change and its likely impact must be disclosed as soon as practicable 
thereafter. Qualitative disclosures that typically do not change each 
quarter (for example, a general summary of the [BANK]'s risk management 
objectives and policies, reporting system, and definitions) may be 
disclosed annually after the end of the fourth calendar quarter, 
provided that any significant changes are disclosed in the interim. The 
[BANK]'s management may provide all of the disclosures required by 
Sec. Sec.  --.61 through --.63 in one place on the [BANK]'s public Web 
site or may provide the disclosures in more than one public financial 
report or other regulatory reports, provided that the [BANK] publicly 
provides a summary table specifically indicating the location(s) of all 
such disclosures.
    (b) A [BANK] described in Sec.  --.61 must have a formal disclosure 
policy approved by the board of directors that addresses its approach 
for determining the disclosures it makes. The policy must address the 
associated internal controls and disclosure controls and procedures. 
The board of directors and senior management are responsible for 
establishing and maintaining an effective internal control structure 
over financial reporting, including the disclosures required by this 
subpart, and must ensure that appropriate review of the disclosures 
takes place. One or more senior officers of the [BANK] must attest that 
the disclosures meet the requirements of this subpart.
    (c) If a [BANK] described in Sec.  --.61 concludes that specific 
commercial or financial information that it would otherwise be required 
to disclose under this section would be exempt from disclosure by the 
[AGENCY] under the Freedom of Information Act (5 U.S.C. 552), then the 
[BANK] is not required to disclose that specific information pursuant 
to this section, but must disclose more general information about the 
subject matter of the requirement, together with the fact that, and the 
reason why, the specific items of information have not been disclosed.


Sec.  --.63  Disclosures by [BANK]s described in Sec.  --.61.

    (a) Except as provided in Sec.  --.62, a [BANK] described in Sec.  
--.61 must make the disclosures described in Tables 1 through 10 of 
this section. The [BANK] must make these disclosures publicly available 
for each of the last three years (that is, twelve quarters) or such 
shorter period beginning on January 1, 2015.
    (b) A [BANK] must publicly disclose each quarter the following:
    (1) Common equity tier 1 capital, additional tier 1 capital, tier 2 
capital, tier 1 and total capital ratios, including the regulatory 
capital elements and all the regulatory adjustments and deductions 
needed to calculate the numerator of such ratios;
    (2) Total risk-weighted assets, including the different regulatory 
adjustments and deductions needed to calculate total risk-weighted 
assets;
    (3) Regulatory capital ratios during any transition periods, 
including a description of all the regulatory capital elements and all 
regulatory adjustments and deductions needed to calculate the numerator 
and denominator of each capital ratio during any transition period; and
    (4) A reconciliation of regulatory capital elements as they relate 
to its balance sheet in any audited consolidated financial statements.

              Table 1 to Sec.   --.63--Scope of Application
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative Disclosures.......  (a)..............  The name of the top
                                                    corporate entity in
                                                    the group to which
                                                    subpart D of this
                                                    part applies.
                                (b)..............  A brief description
                                                    of the differences
                                                    in the basis for
                                                    consolidating
                                                    entities \1\ for
                                                    accounting and
                                                    regulatory purposes,
                                                    with a description
                                                    of those entities:
                                                   (1) That are fully
                                                    consolidated;
                                                   (2) That are
                                                    deconsolidated and
                                                    deducted from total
                                                    capital;
                                                   (3) For which the
                                                    total capital
                                                    requirement is
                                                    deducted; and
                                                   (4) That are neither
                                                    consolidated nor
                                                    deducted (for
                                                    example, where the
                                                    investment in the
                                                    entity is assigned a
                                                    risk weight in
                                                    accordance with this
                                                    subpart).
                                (c)..............  Any restrictions, or
                                                    other major
                                                    impediments, on
                                                    transfer of funds or
                                                    total capital within
                                                    the group.
                                (d)..............  The aggregate amount
                                                    of surplus capital
                                                    of insurance
                                                    subsidiaries
                                                    included in the
                                                    total capital of the
                                                    consolidated group.
                                (e)..............  The aggregate amount
                                                    by which actual
                                                    total capital is
                                                    less than the
                                                    minimum total
                                                    capital requirement
                                                    in all subsidiaries,
                                                    with total capital
                                                    requirements and the
                                                    name(s) of the
                                                    subsidiaries with
                                                    such deficiencies.
------------------------------------------------------------------------
\1\ Entities include securities, insurance and other financial
  subsidiaries, commercial subsidiaries (where permitted), and
  significant minority equity investments in insurance, financial and
  commercial entities.


               Table 2 to Sec.   --.63--Capital Structure
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative Disclosures.......  (a)..............  Summary information
                                                    on the terms and
                                                    conditions of the
                                                    main features of all
                                                    regulatory capital
                                                    instruments.
Quantitative Disclosures......  (b)..............  The amount of common
                                                    equity tier 1
                                                    capital, with
                                                    separate disclosure
                                                    of:
                                                   (1) Common stock and
                                                    related surplus;

[[Page 62200]]

 
                                                   (2) Retained
                                                    earnings;
                                                   (3) Common equity
                                                    minority interest;
                                                   (4) AOCI; and
                                                   (5) Regulatory
                                                    adjustments and
                                                    deductions made to
                                                    common equity tier 1
                                                    capital.
                                (c)..............  The amount of tier 1
                                                    capital, with
                                                    separate disclosure
                                                    of:
                                                   (1) Additional tier 1
                                                    capital elements,
                                                    including additional
                                                    tier 1 capital
                                                    instruments and tier
                                                    1 minority interest
                                                    not included in
                                                    common equity tier 1
                                                    capital; and
                                                   (2) Regulatory
                                                    adjustments and
                                                    deductions made to
                                                    tier 1 capital.
                                (d)..............  The amount of total
                                                    capital, with
                                                    separate disclosure
                                                    of:
                                                   (1) Tier 2 capital
                                                    elements, including
                                                    tier 2 capital
                                                    instruments and
                                                    total capital
                                                    minority interest
                                                    not included in tier
                                                    1 capital; and
                                                   (2) Regulatory
                                                    adjustments and
                                                    deductions made to
                                                    total capital.
------------------------------------------------------------------------


                Table 3 to Sec.   --.63--Capital Adequacy
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative disclosures.......  (a)..............  A summary discussion
                                                    of the [BANK]'s
                                                    approach to
                                                    assessing the
                                                    adequacy of its
                                                    capital to support
                                                    current and future
                                                    activities.
Quantitative disclosures......  (b)..............  Risk-weighted assets
                                                    for:
                                                   (1) Exposures to
                                                    sovereign entities;
                                                   (2) Exposures to
                                                    certain
                                                    supranational
                                                    entities and MDBs;
                                                   (3) Exposures to
                                                    depository
                                                    institutions,
                                                    foreign banks, and
                                                    credit unions;
                                                   (4) Exposures to
                                                    PSEs;
                                                   (5) Corporate
                                                    exposures;
                                                   (6) Residential
                                                    mortgage exposures;
                                                   (7) Statutory
                                                    multifamily
                                                    mortgages and pre-
                                                    sold construction
                                                    loans;
                                                   (8) HVCRE loans;
                                                   (9) Past due loans;
                                                   (10) Other assets;
                                                   (11) Cleared
                                                    transactions;
                                                   (12) Default fund
                                                    contributions;
                                                   (13) Unsettled
                                                    transactions;
                                                   (14) Securitization
                                                    exposures; and
                                                   (15) Equity
                                                    exposures.
                                (c)..............  Standardized market
                                                    risk-weighted assets
                                                    as calculated under
                                                    subpart F of this
                                                    part.
                                (d)..............  Common equity tier 1,
                                                    tier 1 and total
                                                    risk-based capital
                                                    ratios:
                                                   (1) For the top
                                                    consolidated group;
                                                    and
                                                   (2) For each
                                                    depository
                                                    institution
                                                    subsidiary.
                                (e)..............  Total standardized
                                                    risk-weighted
                                                    assets.
------------------------------------------------------------------------


          Table 4 to Sec.   --.63--Capital Conservation Buffer
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Quantitative Disclosures......  (a)..............  At least quarterly,
                                                    the [BANK] must
                                                    calculate and
                                                    publicly disclose
                                                    the capital
                                                    conservation buffer
                                                    as described under
                                                    Sec.   --.11.
                                (b)..............  At least quarterly,
                                                    the [BANK] must
                                                    calculate and
                                                    publicly disclose
                                                    the eligible
                                                    retained income of
                                                    the [BANK], as
                                                    described under Sec.
                                                      --.11.
                                (c)..............  At least quarterly,
                                                    the [BANK] must
                                                    calculate and
                                                    publicly disclose
                                                    any limitations it
                                                    has on distributions
                                                    and discretionary
                                                    bonus payments
                                                    resulting from the
                                                    capital conservation
                                                    buffer framework
                                                    described under Sec.
                                                      --.11, including
                                                    the maximum payout
                                                    amount for the
                                                    quarter.
------------------------------------------------------------------------

    (c) General qualitative disclosure requirement. For each separate 
risk area described in Tables 5 through 10, the [BANK] must describe 
its risk management objectives and policies, including: Strategies and 
processes; the structure and organization of the relevant risk 
management function; the scope and nature of risk reporting and/or 
measurement systems; policies for hedging and/or mitigating risk and 
strategies and processes for monitoring the continuing effectiveness of 
hedges/mitigants.

      Table 5 to Sec.   --.63 \1\--Credit Risk: General Disclosures
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative Disclosures.......  (a)..............  The general
                                                    qualitative
                                                    disclosure
                                                    requirement with
                                                    respect to credit
                                                    risk (excluding
                                                    counterparty credit
                                                    risk disclosed in
                                                    accordance with
                                                    Table 6), including
                                                    the:
                                                   (1) Policy for
                                                    determining past due
                                                    or delinquency
                                                    status;
                                                   (2) Policy for
                                                    placing loans on
                                                    nonaccrual;
                                                   (3) Policy for
                                                    returning loans to
                                                    accrual status;
                                                   (4) Definition of and
                                                    policy for
                                                    identifying impaired
                                                    loans (for financial
                                                    accounting
                                                    purposes);

[[Page 62201]]

 
                                                   (5) Description of
                                                    the methodology that
                                                    the [BANK] uses to
                                                    estimate its
                                                    allowance for loan
                                                    and lease losses,
                                                    including
                                                    statistical methods
                                                    used where
                                                    applicable;
                                                   (6) Policy for
                                                    charging-off
                                                    uncollectible
                                                    amounts; and
                                                   (7) Discussion of the
                                                    [BANK]'s credit risk
                                                    management policy.
Quantitative Disclosures......  (b)..............  Total credit risk
                                                    exposures and
                                                    average credit risk
                                                    exposures, after
                                                    accounting offsets
                                                    in accordance with
                                                    GAAP, without taking
                                                    into account the
                                                    effects of credit
                                                    risk mitigation
                                                    techniques (for
                                                    example, collateral
                                                    and netting not
                                                    permitted under
                                                    GAAP), over the
                                                    period categorized
                                                    by major types of
                                                    credit exposure. For
                                                    example, [BANK]s
                                                    could use categories
                                                    similar to that used
                                                    for financial
                                                    statement purposes.
                                                    Such categories
                                                    might include, for
                                                    instance
                                                   (1) Loans, off-
                                                    balance sheet
                                                    commitments, and
                                                    other non-derivative
                                                    off-balance sheet
                                                    exposures;
                                                   (2) Debt securities;
                                                    and
                                                   (3) OTC
                                                    derivatives.\2\
                                (c)..............  Geographic
                                                    distribution of
                                                    exposures,
                                                    categorized in
                                                    significant areas by
                                                    major types of
                                                    credit exposure.\3\
                                (d)..............  Industry or
                                                    counterparty type
                                                    distribution of
                                                    exposures,
                                                    categorized by major
                                                    types of credit
                                                    exposure.
                                (e)..............  By major industry or
                                                    counterparty type:
                                                   (1) Amount of
                                                    impaired loans for
                                                    which there was a
                                                    related allowance
                                                    under GAAP;
                                                   (2) Amount of
                                                    impaired loans for
                                                    which there was no
                                                    related allowance
                                                    under GAAP;
                                                   (3) Amount of loans
                                                    past due 90 days and
                                                    on nonaccrual;
                                                   (4) Amount of loans
                                                    past due 90 days and
                                                    still accruing; \4\
                                                   (5) The balance in
                                                    the allowance for
                                                    loan and lease
                                                    losses at the end of
                                                    each period,
                                                    disaggregated on the
                                                    basis of the
                                                    [BANK]'s impairment
                                                    method. To
                                                    disaggregate the
                                                    information required
                                                    on the basis of
                                                    impairment
                                                    methodology, an
                                                    entity shall
                                                    separately disclose
                                                    the amounts based on
                                                    the requirements in
                                                    GAAP; and
                                                   (6) Charge-offs
                                                    during the period.
                                (f)..............  Amount of impaired
                                                    loans and, if
                                                    available, the
                                                    amount of past due
                                                    loans categorized by
                                                    significant
                                                    geographic areas
                                                    including, if
                                                    practical, the
                                                    amounts of
                                                    allowances related
                                                    to each geographical
                                                    area,\5\ further
                                                    categorized as
                                                    required by GAAP.
                                (g)..............  Reconciliation of
                                                    changes in ALLL.\6\
                                (h)..............  Remaining contractual
                                                    maturity delineation
                                                    (for example, one
                                                    year or less) of the
                                                    whole portfolio,
                                                    categorized by
                                                    credit exposure.
------------------------------------------------------------------------
\1\ Table 5 does not cover equity exposures, which should be reported in
  Table 9.
\2\ See, for example, ASC Topic 815-10 and 210, as they may be amended
  from time to time.
\3\ Geographical areas may consist of individual countries, groups of
  countries, or regions within countries. A [BANK] might choose to
  define the geographical areas based on the way the [BANK]'s portfolio
  is geographically managed. The criteria used to allocate the loans to
  geographical areas must be specified.
\4\ A [BANK] is encouraged also to provide an analysis of the aging of
  past-due loans.
\5\ The portion of the general allowance that is not allocated to a
  geographical area should be disclosed separately.
\6\ The reconciliation should include the following: A description of
  the allowance; the opening balance of the allowance; charge-offs taken
  against the allowance during the period; amounts provided (or
  reversed) for estimated probable loan losses during the period; any
  other adjustments (for example, exchange rate differences, business
  combinations, acquisitions and disposals of subsidiaries), including
  transfers between allowances; and the closing balance of the
  allowance. Charge-offs and recoveries that have been recorded directly
  to the income statement should be disclosed separately.


Table 6 to Sec.   --.63--General Disclosure for Counterparty Credit Risk-
                            Related Exposures
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative Disclosures.......  (a)..............  The general
                                                    qualitative
                                                    disclosure
                                                    requirement with
                                                    respect to OTC
                                                    derivatives,
                                                    eligible margin
                                                    loans, and repo-
                                                    style transactions,
                                                    including a
                                                    discussion of:
                                                   (1) The methodology
                                                    used to assign
                                                    credit limits for
                                                    counterparty credit
                                                    exposures;
                                                   (2) Policies for
                                                    securing collateral,
                                                    valuing and managing
                                                    collateral, and
                                                    establishing credit
                                                    reserves;
                                                   (3) The primary types
                                                    of collateral taken;
                                                    and
                                                   (4) The impact of the
                                                    amount of collateral
                                                    the [BANK] would
                                                    have to provide
                                                    given a
                                                    deterioration in the
                                                    [BANK]'s own
                                                    creditworthiness.
Quantitative Disclosures......  (b)..............  Gross positive fair
                                                    value of contracts,
                                                    collateral held
                                                    (including type, for
                                                    example, cash,
                                                    government
                                                    securities), and net
                                                    unsecured credit
                                                    exposure.\1\ A
                                                    [BANK] also must
                                                    disclose the
                                                    notional value of
                                                    credit derivative
                                                    hedges purchased for
                                                    counterparty credit
                                                    risk protection and
                                                    the distribution of
                                                    current credit
                                                    exposure by exposure
                                                    type.\2\

[[Page 62202]]

 
                                (c)..............  Notional amount of
                                                    purchased and sold
                                                    credit derivatives,
                                                    segregated between
                                                    use for the [BANK]'s
                                                    own credit portfolio
                                                    and in its
                                                    intermediation
                                                    activities,
                                                    including the
                                                    distribution of the
                                                    credit derivative
                                                    products used,
                                                    categorized further
                                                    by protection bought
                                                    and sold within each
                                                    product group.
------------------------------------------------------------------------
\1\ Net unsecured credit exposure is the credit exposure after
  considering both the benefits from legally enforceable netting
  agreements and collateral arrangements without taking into account
  haircuts for price volatility, liquidity, etc.
\2\ This may include interest rate derivative contracts, foreign
  exchange derivative contracts, equity derivative contracts, credit
  derivatives, commodity or other derivative contracts, repo-style
  transactions, and eligible margin loans.


           Table 7 to Sec.   --.63--Credit Risk Mitigation 1 2
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative Disclosures.......  (a)..............  The general
                                                    qualitative
                                                    disclosure
                                                    requirement with
                                                    respect to credit
                                                    risk mitigation,
                                                    including:
                                                   (1) Policies and
                                                    processes for
                                                    collateral valuation
                                                    and management;
                                                   (2) A description of
                                                    the main types of
                                                    collateral taken by
                                                    the [BANK];
                                                   (3) The main types of
                                                    guarantors/credit
                                                    derivative
                                                    counterparties and
                                                    their
                                                    creditworthiness;
                                                    and
                                                   (4) Information about
                                                    (market or credit)
                                                    risk concentrations
                                                    with respect to
                                                    credit risk
                                                    mitigation.
Quantitative Disclosures......  (b)..............  For each separately
                                                    disclosed credit
                                                    risk portfolio, the
                                                    total exposure that
                                                    is covered by
                                                    eligible financial
                                                    collateral, and
                                                    after the
                                                    application of
                                                    haircuts.
                                (c)..............  For each separately
                                                    disclosed portfolio,
                                                    the total exposure
                                                    that is covered by
                                                    guarantees/credit
                                                    derivatives and the
                                                    risk-weighted asset
                                                    amount associated
                                                    with that exposure.
------------------------------------------------------------------------
\1\ At a minimum, a [BANK] must provide the disclosures in Table 7 in
  relation to credit risk mitigation that has been recognized for the
  purposes of reducing capital requirements under this subpart. Where
  relevant, [BANK]s are encouraged to give further information about
  mitigants that have not been recognized for that purpose.
\2\ Credit derivatives that are treated, for the purposes of this
  subpart, as synthetic securitization exposures should be excluded from
  the credit risk mitigation disclosures and included within those
  relating to securitization (Table 8).


                 Table 8 to Sec.   --.63--Securitization
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative Disclosures.......  (a)..............  The general
                                                    qualitative
                                                    disclosure
                                                    requirement with
                                                    respect to a
                                                    securitization
                                                    (including synthetic
                                                    securitizations),
                                                    including a
                                                    discussion of:
                                                   (1) The [BANK]'s
                                                    objectives for
                                                    securitizing assets,
                                                    including the extent
                                                    to which these
                                                    activities transfer
                                                    credit risk of the
                                                    underlying exposures
                                                    away from the [BANK]
                                                    to other entities
                                                    and including the
                                                    type of risks
                                                    assumed and retained
                                                    with
                                                    resecuritization
                                                    activity; \1\
                                                   (2) The nature of the
                                                    risks (e.g.
                                                    liquidity risk)
                                                    inherent in the
                                                    securitized assets;
                                                   (3) The roles played
                                                    by the [BANK] in the
                                                    securitization
                                                    process \2\ and an
                                                    indication of the
                                                    extent of the
                                                    [BANK]'s involvement
                                                    in each of them;
                                                   (4) The processes in
                                                    place to monitor
                                                    changes in the
                                                    credit and market
                                                    risk of
                                                    securitization
                                                    exposures including
                                                    how those processes
                                                    differ for
                                                    resecuritization
                                                    exposures;
                                                   (5) The [BANK]'s
                                                    policy for
                                                    mitigating the
                                                    credit risk retained
                                                    through
                                                    securitization and
                                                    resecuritization
                                                    exposures; and
                                                   (6) The risk-based
                                                    capital approaches
                                                    that the [BANK]
                                                    follows for its
                                                    securitization
                                                    exposures including
                                                    the type of
                                                    securitization
                                                    exposure to which
                                                    each approach
                                                    applies.
                                (b)..............  A list of:
                                                   (1) The type of
                                                    securitization SPEs
                                                    that the [BANK], as
                                                    sponsor, uses to
                                                    securitize third-
                                                    party exposures. The
                                                    [BANK] must indicate
                                                    whether it has
                                                    exposure to these
                                                    SPEs, either on- or
                                                    off-balance sheet;
                                                    and
                                                   (2) Affiliated
                                                    entities:
                                                   (i) That the [BANK]
                                                    manages or advises;
                                                    and
                                                   (ii) That invest
                                                    either in the
                                                    securitization
                                                    exposures that the
                                                    [BANK] has
                                                    securitized or in
                                                    securitization SPEs
                                                    that the [BANK]
                                                    sponsors.\3\
                                (c)..............  Summary of the
                                                    [BANK]'s accounting
                                                    policies for
                                                    securitization
                                                    activities,
                                                    including:
                                                   (1) Whether the
                                                    transactions are
                                                    treated as sales or
                                                    financings;
                                                   (2) Recognition of
                                                    gain-on-sale;
                                                   (3) Methods and key
                                                    assumptions applied
                                                    in valuing retained
                                                    or purchased
                                                    interests;
                                                   (4) Changes in
                                                    methods and key
                                                    assumptions from the
                                                    previous period for
                                                    valuing retained
                                                    interests and impact
                                                    of the changes;
                                                   (5) Treatment of
                                                    synthetic
                                                    securitizations;
                                                   (6) How exposures
                                                    intended to be
                                                    securitized are
                                                    valued and whether
                                                    they are recorded
                                                    under subpart D of
                                                    this part; and
                                                   (7) Policies for
                                                    recognizing
                                                    liabilities on the
                                                    balance sheet for
                                                    arrangements that
                                                    could require the
                                                    [BANK] to provide
                                                    financial support
                                                    for securitized
                                                    assets.

[[Page 62203]]

 
                                (d)..............  An explanation of
                                                    significant changes
                                                    to any quantitative
                                                    information since
                                                    the last reporting
                                                    period.
Quantitative Disclosures......  (e)..............  The total outstanding
                                                    exposures
                                                    securitized by the
                                                    [BANK] in
                                                    securitizations that
                                                    meet the operational
                                                    criteria provided in
                                                    Sec.   --.41
                                                    (categorized into
                                                    traditional and
                                                    synthetic
                                                    securitizations), by
                                                    exposure type,
                                                    separately for
                                                    securitizations of
                                                    third-party
                                                    exposures for which
                                                    the bank acts only
                                                    as sponsor.\4\
                                (f)..............  For exposures
                                                    securitized by the
                                                    [BANK] in
                                                    securitizations that
                                                    meet the operational
                                                    criteria in Sec.   --
                                                    .41:
                                                   (1) Amount of
                                                    securitized assets
                                                    that are impaired/
                                                    past due categorized
                                                    by exposure type;
                                                    \5\ and
                                                   (2) Losses recognized
                                                    by the [BANK] during
                                                    the current period
                                                    categorized by
                                                    exposure type.\6\
                                (g)..............  The total amount of
                                                    outstanding
                                                    exposures intended
                                                    to be securitized
                                                    categorized by
                                                    exposure type.
                                (h)..............  Aggregate amount of:
                                                   (1) On-balance sheet
                                                    securitization
                                                    exposures retained
                                                    or purchased
                                                    categorized by
                                                    exposure type; and
                                                   (2) Off-balance sheet
                                                    securitization
                                                    exposures
                                                    categorized by
                                                    exposure type.
                                (i)..............  (1) Aggregate amount
                                                    of securitization
                                                    exposures retained
                                                    or purchased and the
                                                    associated capital
                                                    requirements for
                                                    these exposures,
                                                    categorized between
                                                    securitization and
                                                    resecuritization
                                                    exposures, further
                                                    categorized into a
                                                    meaningful number of
                                                    risk weight bands
                                                    and by risk-based
                                                    capital approach
                                                    (e.g., SSFA); and
                                                   (2) Exposures that
                                                    have been deducted
                                                    entirely from tier 1
                                                    capital, CEIOs
                                                    deducted from total
                                                    capital (as
                                                    described in Sec.
                                                    --.42(a)(1), and
                                                    other exposures
                                                    deducted from total
                                                    capital should be
                                                    disclosed separately
                                                    by exposure type.
                                (j)..............  Summary of current
                                                    year's
                                                    securitization
                                                    activity, including
                                                    the amount of
                                                    exposures
                                                    securitized (by
                                                    exposure type), and
                                                    recognized gain or
                                                    loss on sale by
                                                    exposure type.
                                (k)..............  Aggregate amount of
                                                    resecuritization
                                                    exposures retained
                                                    or purchased
                                                    categorized
                                                    according to:
                                                   (1) Exposures to
                                                    which credit risk
                                                    mitigation is
                                                    applied and those
                                                    not applied; and
                                                   (2) Exposures to
                                                    guarantors
                                                    categorized
                                                    according to
                                                    guarantor
                                                    creditworthiness
                                                    categories or
                                                    guarantor name.
------------------------------------------------------------------------
\1\ The [BANK] should describe the structure of resecuritizations in
  which it participates; this description should be provided for the
  main categories of resecuritization products in which the [BANK] is
  active.
\2\ For example, these roles may include originator, investor, servicer,
  provider of credit enhancement, sponsor, liquidity provider, or swap
  provider.
\3\ Such affiliated entities may include, for example, money market
  funds, to be listed individually, and personal and private trusts, to
  be noted collectively.
\4\ ``Exposures securitized'' include underlying exposures originated by
  the bank, whether generated by them or purchased, and recognized in
  the balance sheet, from third parties, and third-party exposures
  included in sponsored transactions. Securitization transactions
  (including underlying exposures originally on the bank's balance sheet
  and underlying exposures acquired by the bank from third-party
  entities) in which the originating bank does not retain any
  securitization exposure should be shown separately but need only be
  reported for the year of inception. Banks are required to disclose
  exposures regardless of whether there is a capital charge under this
  part.
\5\ Include credit-related other than temporary impairment (OTTI).
\6\ For example, charge-offs/allowances (if the assets remain on the
  bank's balance sheet) or credit-related OTTI of interest-only strips
  and other retained residual interests, as well as recognition of
  liabilities for probable future financial support required of the bank
  with respect to securitized assets.


 Table 9 to Sec.   --.63--Equities Not Subject to Subpart F of This Part
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative Disclosures.......  (a)..............  The general
                                                    qualitative
                                                    disclosure
                                                    requirement with
                                                    respect to equity
                                                    risk for equities
                                                    not subject to
                                                    subpart F of this
                                                    part, including:
                                                   (1) Differentiation
                                                    between holdings on
                                                    which capital gains
                                                    are expected and
                                                    those taken under
                                                    other objectives
                                                    including for
                                                    relationship and
                                                    strategic reasons;
                                                    and
                                                   (2) Discussion of
                                                    important policies
                                                    covering the
                                                    valuation of and
                                                    accounting for
                                                    equity holdings not
                                                    subject to subpart F
                                                    of this part. This
                                                    includes the
                                                    accounting
                                                    techniques and
                                                    valuation
                                                    methodologies used,
                                                    including key
                                                    assumptions and
                                                    practices affecting
                                                    valuation as well as
                                                    significant changes
                                                    in these practices.
Quantitative Disclosures......  (b)..............  Value disclosed on
                                                    the balance sheet of
                                                    investments, as well
                                                    as the fair value of
                                                    those investments;
                                                    for securities that
                                                    are publicly traded,
                                                    a comparison to
                                                    publicly-quoted
                                                    share values where
                                                    the share price is
                                                    materially different
                                                    from fair value.
                                (c)..............  The types and nature
                                                    of investments,
                                                    including the amount
                                                    that is: (1)
                                                    Publicly traded; and
                                                   (2) Non publicly
                                                    traded.
                                (d)..............  The cumulative
                                                    realized gains
                                                    (losses) arising
                                                    from sales and
                                                    liquidations in the
                                                    reporting period.

[[Page 62204]]

 
                                (e)..............  (1) Total unrealized
                                                    gains (losses).\1\
                                                   (2) Total latent
                                                    revaluation gains
                                                    (losses).\2\
                                                   (3) Any amounts of
                                                    the above included
                                                    in tier 1 or tier 2
                                                    capital.
                                (f)..............  Capital requirements
                                                    categorized by
                                                    appropriate equity
                                                    groupings,
                                                    consistent with the
                                                    [BANK]'s
                                                    methodology, as well
                                                    as the aggregate
                                                    amounts and the type
                                                    of equity
                                                    investments subject
                                                    to any supervisory
                                                    transition regarding
                                                    regulatory capital
                                                    requirements.
------------------------------------------------------------------------
\1\ Unrealized gains (losses) recognized on the balance sheet but not
  through earnings.
\2\ Unrealized gains (losses) not recognized either on the balance sheet
  or through earnings.


 Table 10 to Sec.   --.63--Interest Rate Risk for Non-Trading Activities
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative disclosures.......  (a)..............  The general
                                                    qualitative
                                                    disclosure
                                                    requirement,
                                                    including the nature
                                                    of interest rate
                                                    risk for non-trading
                                                    activities and key
                                                    assumptions,
                                                    including
                                                    assumptions
                                                    regarding loan
                                                    prepayments and
                                                    behavior of non-
                                                    maturity deposits,
                                                    and frequency of
                                                    measurement of
                                                    interest rate risk
                                                    for non-trading
                                                    activities.
Quantitative disclosures......  (b)..............  The increase
                                                    (decline) in
                                                    earnings or economic
                                                    value (or relevant
                                                    measure used by
                                                    management) for
                                                    upward and downward
                                                    rate shocks
                                                    according to
                                                    management's method
                                                    for measuring
                                                    interest rate risk
                                                    for non-trading
                                                    activities,
                                                    categorized by
                                                    currency (as
                                                    appropriate).
------------------------------------------------------------------------

Sec. Sec.  --.64 through --.99  [Reserved]

Subpart E--Risk-Weighted Assets--Internal Ratings-Based and 
Advanced Measurement Approaches


Sec.  --.100  Purpose, applicability, and principle of conservatism.

    (a) Purpose. This subpart E establishes:
    (1) Minimum qualifying criteria for [BANK]s using institution-
specific internal risk measurement and management processes for 
calculating risk-based capital requirements; and
    (2) Methodologies for such [BANK]s to calculate their total risk-
weighted assets.
    (b) Applicability. (1) This subpart applies to a [BANK] that:
    (i) Has consolidated total assets, as reported on its most recent 
year-end [REGULATORY REPORT] equal to $250 billion or more;
    (ii) Has consolidated total on-balance sheet foreign exposure on 
its most recent year-end [REGULATORY REPORT] equal to $10 billion or 
more (where total on-balance sheet foreign exposure equals total cross-
border claims less claims with a head office or guarantor located in 
another country plus redistributed guaranteed amounts to the country of 
head office or guarantor plus local country claims on local residents 
plus revaluation gains on foreign exchange and derivative products, 
calculated in accordance with the Federal Financial Institutions 
Examination Council (FFIEC) 009 Country Exposure Report);
    (iii) Is a subsidiary of a depository institution that uses the 
advanced approaches pursuant to subpart E of 12 CFR part 3 (OCC), 12 
CFR part 217 (Board), or 12 CFR part 325 (FDIC) to calculate its total 
risk-weighted assets;
    (iv) Is a subsidiary of a bank holding company or savings and loan 
holding company that uses the advanced approaches pursuant to 12 CFR 
part 217 to calculate its total risk-weighted assets; or
    (v) Elects to use this subpart to calculate its total risk-weighted 
assets.
    (2) A [BANK] that is subject to this subpart shall remain subject 
to this subpart unless the [AGENCY] determines in writing that 
application of this subpart is not appropriate in light of the [BANK]'s 
asset size, level of complexity, risk profile, or scope of operations. 
In making a determination under this paragraph (b), the [AGENCY] will 
apply notice and response procedures in the same manner and to the same 
extent as the notice and response procedures in [12 CFR 3.404 (OCC), 12 
CFR 263.202 (Board), and 12 CFR 324.5 (FDIC)].
    (3) A market risk [BANK] must exclude from its calculation of risk-
weighted assets under this subpart the risk-weighted asset amounts of 
all covered positions, as defined in subpart F of this part (except 
foreign exchange positions that are not trading positions, over-the-
counter derivative positions, cleared transactions, and unsettled 
transactions).
    (c) Principle of conservatism. Notwithstanding the requirements of 
this subpart, a [BANK] may choose not to apply a provision of this 
subpart to one or more exposures provided that:
    (1) The [BANK] can demonstrate on an ongoing basis to the 
satisfaction of the [AGENCY] that not applying the provision would, in 
all circumstances, unambiguously generate a risk-based capital 
requirement for each such exposure greater than that which would 
otherwise be required under this subpart;
    (2) The [BANK] appropriately manages the risk of each such 
exposure;
    (3) The [BANK] notifies the [AGENCY] in writing prior to applying 
this principle to each such exposure; and
    (4) The exposures to which the [BANK] applies this principle are 
not, in the aggregate, material to the [BANK].


Sec.  --.101  Definitions.

    (a) Terms that are set forth in Sec.  --.2 and used in this subpart 
have the definitions assigned thereto in Sec.  --.2.
    (b) For the purposes of this subpart, the following terms are 
defined as follows:
    Advanced internal ratings-based (IRB) systems means an advanced 
approaches [BANK]'s internal risk rating and segmentation system; risk 
parameter quantification system; data management and maintenance 
system; and control, oversight, and validation system for credit risk 
of wholesale and retail exposures.
    Advanced systems means an advanced approaches [BANK]'s advanced IRB 
systems, operational risk management processes, operational risk data 
and assessment systems, operational risk quantification systems, and, 
to the extent used by the [BANK], the internal models methodology, 
advanced CVA approach, double default excessive correlation detection 
process, and internal models approach (IMA) for equity exposures.
    Backtesting means the comparison of a [BANK]'s internal estimates 
with actual outcomes during a sample period

[[Page 62205]]

not used in model development. In this context, backtesting is one form 
of out-of-sample testing.
    Benchmarking means the comparison of a [BANK]'s internal estimates 
with relevant internal and external data or with estimates based on 
other estimation techniques.
    Bond option contract means a bond option, bond future, or any other 
instrument linked to a bond that gives rise to similar counterparty 
credit risk.
    Business environment and internal control factors means the 
indicators of a [BANK]'s operational risk profile that reflect a 
current and forward-looking assessment of the [BANK]'s underlying 
business risk factors and internal control environment.
    Credit default swap (CDS) means a financial contract executed under 
standard industry documentation that allows one party (the protection 
purchaser) to transfer the credit risk of one or more exposures 
(reference exposure(s)) to another party (the protection provider) for 
a certain period of time.
    Credit valuation adjustment (CVA) means the fair value adjustment 
to reflect counterparty credit risk in valuation of OTC derivative 
contracts.
    Default--For the purposes of calculating capital requirements under 
this subpart:
    (1) Retail. (i) A retail exposure of a [BANK] is in default if:
    (A) The exposure is 180 days past due, in the case of a residential 
mortgage exposure or revolving exposure;
    (B) The exposure is 120 days past due, in the case of retail 
exposures that are not residential mortgage exposures or revolving 
exposures; or
    (C) The [BANK] has taken a full or partial charge-off, write-down 
of principal, or material negative fair value adjustment of principal 
on the exposure for credit-related reasons.
    (ii) Notwithstanding paragraph (1)(i) of this definition, for a 
retail exposure held by a non-U.S. subsidiary of the [BANK] that is 
subject to an internal ratings-based approach to capital adequacy 
consistent with the Basel Committee on Banking Supervision's 
``International Convergence of Capital Measurement and Capital 
Standards: A Revised Framework'' in a non-U.S. jurisdiction, the [BANK] 
may elect to use the definition of default that is used in that 
jurisdiction, provided that the [BANK] has obtained prior approval from 
the [AGENCY] to use the definition of default in that jurisdiction.
    (iii) A retail exposure in default remains in default until the 
[BANK] has reasonable assurance of repayment and performance for all 
contractual principal and interest payments on the exposure.
    (2) Wholesale. (i) A [BANK]'s wholesale obligor is in default if:
    (A) The [BANK] determines that the obligor is unlikely to pay its 
credit obligations to the [BANK] in full, without recourse by the 
[BANK] to actions such as realizing collateral (if held); or
    (B) The obligor is past due more than 90 days on any material 
credit obligation(s) to the [BANK].\25\
---------------------------------------------------------------------------

    \25\ Overdrafts are past due once the obligor has breached an 
advised limit or been advised of a limit smaller than the current 
outstanding balance.
---------------------------------------------------------------------------

    (ii) An obligor in default remains in default until the [BANK] has 
reasonable assurance of repayment and performance for all contractual 
principal and interest payments on all exposures of the [BANK] to the 
obligor (other than exposures that have been fully written-down or 
charged-off).
    Dependence means a measure of the association among operational 
losses across and within units of measure.
    Economic downturn conditions means, with respect to an exposure 
held by the [BANK], those conditions in which the aggregate default 
rates for that exposure's wholesale or retail exposure subcategory (or 
subdivision of such subcategory selected by the [BANK]) in the 
exposure's national jurisdiction (or subdivision of such jurisdiction 
selected by the [BANK]) are significantly higher than average.
    Effective maturity (M) of a wholesale exposure means:
    (1) For wholesale exposures other than repo-style transactions, 
eligible margin loans, and OTC derivative contracts described in 
paragraph (2) or (3) of this definition:
    (i) The weighted-average remaining maturity (measured in years, 
whole or fractional) of the expected contractual cash flows from the 
exposure, using the undiscounted amounts of the cash flows as weights; 
or
    (ii) The nominal remaining maturity (measured in years, whole or 
fractional) of the exposure.
    (2) For repo-style transactions, eligible margin loans, and OTC 
derivative contracts subject to a qualifying master netting agreement 
for which the [BANK] does not apply the internal models approach in 
section 132(d), the weighted-average remaining maturity (measured in 
years, whole or fractional) of the individual transactions subject to 
the qualifying master netting agreement, with the weight of each 
individual transaction set equal to the notional amount of the 
transaction.
    (3) For repo-style transactions, eligible margin loans, and OTC 
derivative contracts for which the [BANK] applies the internal models 
approach in Sec.  --.132(d), the value determined in Sec.  
--.132(d)(4).
    Eligible double default guarantor, with respect to a guarantee or 
credit derivative obtained by a [BANK], means:
    (1) U.S.-based entities. A depository institution, a bank holding 
company, a savings and loan holding company, or a securities broker or 
dealer registered with the SEC under the Securities Exchange Act, if at 
the time the guarantee is issued or anytime thereafter, has issued and 
outstanding an unsecured debt security without credit enhancement that 
is investment grade.
    (2) Non-U.S.-based entities. A foreign bank, or a non-U.S.-based 
securities firm if the [BANK] demonstrates that the guarantor is 
subject to consolidated supervision and regulation comparable to that 
imposed on U.S. depository institutions, or securities broker-dealers) 
if at the time the guarantee is issued or anytime thereafter, has 
issued and outstanding an unsecured debt security without credit 
enhancement that is investment grade.
    Eligible operational risk offsets means amounts, not to exceed 
expected operational loss, that:
    (1) Are generated by internal business practices to absorb highly 
predictable and reasonably stable operational losses, including 
reserves calculated consistent with GAAP; and
    (2) Are available to cover expected operational losses with a high 
degree of certainty over a one-year horizon.
    Eligible purchased wholesale exposure means a purchased wholesale 
exposure that:
    (1) The [BANK] or securitization SPE purchased from an unaffiliated 
seller and did not directly or indirectly originate;
    (2) Was generated on an arm's-length basis between the seller and 
the obligor (intercompany accounts receivable and receivables subject 
to contra-accounts between firms that buy and sell to each other do not 
satisfy this criterion);
    (3) Provides the [BANK] or securitization SPE with a claim on all 
proceeds from the exposure or a pro rata interest in the proceeds from 
the exposure;
    (4) Has an M of less than one year; and
    (5) When consolidated by obligor, does not represent a concentrated 
exposure relative to the portfolio of purchased wholesale exposures.

[[Page 62206]]

    Expected exposure (EE) means the expected value of the probability 
distribution of non-negative credit risk exposures to a counterparty at 
any specified future date before the maturity date of the longest term 
transaction in the netting set. Any negative fair values in the 
probability distribution of fair values to a counterparty at a 
specified future date are set to zero to convert the probability 
distribution of fair values to the probability distribution of credit 
risk exposures.
    Expected operational loss (EOL) means the expected value of the 
distribution of potential aggregate operational losses, as generated by 
the [BANK]'s operational risk quantification system using a one-year 
horizon.
    Expected positive exposure (EPE) means the weighted average over 
time of expected (non-negative) exposures to a counterparty where the 
weights are the proportion of the time interval that an individual 
expected exposure represents. When calculating risk-based capital 
requirements, the average is taken over a one-year horizon.
    Exposure at default (EAD) means:
    (1) For the on-balance sheet component of a wholesale exposure or 
segment of retail exposures (other than an OTC derivative contract, a 
repo-style transaction or eligible margin loan for which the [BANK] 
determines EAD under Sec.  --.132, a cleared transaction, or default 
fund contribution), EAD means the [BANK]'s carrying value (including 
net accrued but unpaid interest and fees) for the exposure or segment 
less any allocated transfer risk reserve for the exposure or segment.
    (2) For the off-balance sheet component of a wholesale exposure or 
segment of retail exposures (other than an OTC derivative contract, a 
repo-style transaction or eligible margin loan for which the [BANK] 
determines EAD under Sec.  --.132, cleared transaction, or default fund 
contribution) in the form of a loan commitment, line of credit, trade-
related letter of credit, or transaction-related contingency, EAD means 
the [BANK]'s best estimate of net additions to the outstanding amount 
owed the [BANK], including estimated future additional draws of 
principal and accrued but unpaid interest and fees, that are likely to 
occur over a one-year horizon assuming the wholesale exposure or the 
retail exposures in the segment were to go into default. This estimate 
of net additions must reflect what would be expected during economic 
downturn conditions. For the purposes of this definition:
    (i) Trade-related letters of credit are short-term, self-
liquidating instruments that are used to finance the movement of goods 
and are collateralized by the underlying goods.
    (ii) Transaction-related contingencies relate to a particular 
transaction and include, among other things, performance bonds and 
performance-based letters of credit.
    (3) For the off-balance sheet component of a wholesale exposure or 
segment of retail exposures (other than an OTC derivative contract, a 
repo-style transaction, or eligible margin loan for which the [BANK] 
determines EAD under Sec.  --.132, cleared transaction, or default fund 
contribution) in the form of anything other than a loan commitment, 
line of credit, trade-related letter of credit, or transaction-related 
contingency, EAD means the notional amount of the exposure or segment.
    (4) EAD for OTC derivative contracts is calculated as described in 
Sec.  --.132. A [BANK] also may determine EAD for repo-style 
transactions and eligible margin loans as described in Sec.  --.132.
    Exposure category means any of the wholesale, retail, 
securitization, or equity exposure categories.
    External operational loss event data means, with respect to a 
[BANK], gross operational loss amounts, dates, recoveries, and relevant 
causal information for operational loss events occurring at 
organizations other than the [BANK].
    IMM exposure means a repo-style transaction, eligible margin loan, 
or OTC derivative for which a [BANK] calculates its EAD using the 
internal models methodology of Sec.  --.132(d).
    Internal operational loss event data means, with respect to a 
[BANK], gross operational loss amounts, dates, recoveries, and relevant 
causal information for operational loss events occurring at the [BANK].
    Loss given default (LGD) means:
    (1) For a wholesale exposure, the greatest of:
    (i) Zero;
    (ii) The [BANK]'s empirically based best estimate of the long-run 
default-weighted average economic loss, per dollar of EAD, the [BANK] 
would expect to incur if the obligor (or a typical obligor in the loss 
severity grade assigned by the [BANK] to the exposure) were to default 
within a one-year horizon over a mix of economic conditions, including 
economic downturn conditions; or
    (iii) The [BANK]'s empirically based best estimate of the economic 
loss, per dollar of EAD, the [BANK] would expect to incur if the 
obligor (or a typical obligor in the loss severity grade assigned by 
the [BANK] to the exposure) were to default within a one-year horizon 
during economic downturn conditions.
    (2) For a segment of retail exposures, the greatest of:
    (i) Zero;
    (ii) The [BANK]'s empirically based best estimate of the long-run 
default-weighted average economic loss, per dollar of EAD, the [BANK] 
would expect to incur if the exposures in the segment were to default 
within a one-year horizon over a mix of economic conditions, including 
economic downturn conditions; or
    (iii) The [BANK]'s empirically based best estimate of the economic 
loss, per dollar of EAD, the [BANK] would expect to incur if the 
exposures in the segment were to default within a one-year horizon 
during economic downturn conditions.
    (3) The economic loss on an exposure in the event of default is all 
material credit-related losses on the exposure (including accrued but 
unpaid interest or fees, losses on the sale of collateral, direct 
workout costs, and an appropriate allocation of indirect workout 
costs). Where positive or negative cash flows on a wholesale exposure 
to a defaulted obligor or a defaulted retail exposure (including 
proceeds from the sale of collateral, workout costs, additional 
extensions of credit to facilitate repayment of the exposure, and draw-
downs of unused credit lines) occur after the date of default, the 
economic loss must reflect the net present value of cash flows as of 
the default date using a discount rate appropriate to the risk of the 
defaulted exposure.
    Obligor means the legal entity or natural person contractually 
obligated on a wholesale exposure, except that a [BANK] may treat the 
following exposures as having separate obligors:
    (1) Exposures to the same legal entity or natural person 
denominated in different currencies;
    (2)(i) An income-producing real estate exposure for which all or 
substantially all of the repayment of the exposure is reliant on the 
cash flows of the real estate serving as collateral for the exposure; 
the [BANK], in economic substance, does not have recourse to the 
borrower beyond the real estate collateral; and no cross-default or 
cross-acceleration clauses are in place other than clauses obtained 
solely out of an abundance of caution; and
    (ii) Other credit exposures to the same legal entity or natural 
person; and
    (3)(i) A wholesale exposure authorized under section 364 of the 
U.S. Bankruptcy Code (11 U.S.C. 364) to a legal entity or natural 
person who is a debtor-in-possession for purposes of Chapter 11 of the 
Bankruptcy Code; and

[[Page 62207]]

    (ii) Other credit exposures to the same legal entity or natural 
person.
    Operational loss means a loss (excluding insurance or tax effects) 
resulting from an operational loss event. Operational loss includes all 
expenses associated with an operational loss event except for 
opportunity costs, forgone revenue, and costs related to risk 
management and control enhancements implemented to prevent future 
operational losses.
    Operational loss event means an event that results in loss and is 
associated with any of the following seven operational loss event type 
categories:
    (1) Internal fraud, which means the operational loss event type 
category that comprises operational losses resulting from an act 
involving at least one internal party of a type intended to defraud, 
misappropriate property, or circumvent regulations, the law, or company 
policy excluding diversity- and discrimination-type events.
    (2) External fraud, which means the operational loss event type 
category that comprises operational losses resulting from an act by a 
third party of a type intended to defraud, misappropriate property, or 
circumvent the law. Retail credit card losses arising from non-
contractual, third-party-initiated fraud (for example, identity theft) 
are external fraud operational losses. All other third-party-initiated 
credit losses are to be treated as credit risk losses.
    (3) Employment practices and workplace safety, which means the 
operational loss event type category that comprises operational losses 
resulting from an act inconsistent with employment, health, or safety 
laws or agreements, payment of personal injury claims, or payment 
arising from diversity- and discrimination-type events.
    (4) Clients, products, and business practices, which means the 
operational loss event type category that comprises operational losses 
resulting from the nature or design of a product or from an 
unintentional or negligent failure to meet a professional obligation to 
specific clients (including fiduciary and suitability requirements).
    (5) Damage to physical assets, which means the operational loss 
event type category that comprises operational losses resulting from 
the loss of or damage to physical assets from natural disaster or other 
events.
    (6) Business disruption and system failures, which means the 
operational loss event type category that comprises operational losses 
resulting from disruption of business or system failures.
    (7) Execution, delivery, and process management, which means the 
operational loss event type category that comprises operational losses 
resulting from failed transaction processing or process management or 
losses arising from relations with trade counterparties and vendors.
    Operational risk means the risk of loss resulting from inadequate 
or failed internal processes, people, and systems or from external 
events (including legal risk but excluding strategic and reputational 
risk).
    Operational risk exposure means the 99.9th percentile of the 
distribution of potential aggregate operational losses, as generated by 
the [BANK]'s operational risk quantification system over a one-year 
horizon (and not incorporating eligible operational risk offsets or 
qualifying operational risk mitigants).
    Other retail exposure means an exposure (other than a 
securitization exposure, an equity exposure, a residential mortgage 
exposure, a pre-sold construction loan, a qualifying revolving 
exposure, or the residual value portion of a lease exposure) that is 
managed as part of a segment of exposures with homogeneous risk 
characteristics, not on an individual-exposure basis, and is either:
    (1) An exposure to an individual for non-business purposes; or
    (2) An exposure to an individual or company for business purposes 
if the [BANK]'s consolidated business credit exposure to the individual 
or company is $1 million or less.
    Probability of default (PD) means:
    (1) For a wholesale exposure to a non-defaulted obligor, the 
[BANK]'s empirically based best estimate of the long-run average one-
year default rate for the rating grade assigned by the [BANK] to the 
obligor, capturing the average default experience for obligors in the 
rating grade over a mix of economic conditions (including economic 
downturn conditions) sufficient to provide a reasonable estimate of the 
average one-year default rate over the economic cycle for the rating 
grade.
    (2) For a segment of non-defaulted retail exposures, the [BANK]'s 
empirically based best estimate of the long-run average one-year 
default rate for the exposures in the segment, capturing the average 
default experience for exposures in the segment over a mix of economic 
conditions (including economic downturn conditions) sufficient to 
provide a reasonable estimate of the average one-year default rate over 
the economic cycle for the segment.
    (3) For a wholesale exposure to a defaulted obligor or segment of 
defaulted retail exposures, 100 percent.
    Qualifying cross-product master netting agreement means a 
qualifying master netting agreement that provides for termination and 
close-out netting across multiple types of financial transactions or 
qualifying master netting agreements in the event of a counterparty's 
default, provided that the underlying financial transactions are OTC 
derivative contracts, eligible margin loans, or repo-style 
transactions. In order to treat an agreement as a qualifying cross-
product master netting agreement for purposes of this subpart, a [BANK] 
must comply with the requirements of Sec.  --.3(c) of this part with 
respect to that agreement.
    Qualifying revolving exposure (QRE) means an exposure (other than a 
securitization exposure or equity exposure) to an individual that is 
managed as part of a segment of exposures with homogeneous risk 
characteristics, not on an individual-exposure basis, and:
    (1) Is revolving (that is, the amount outstanding fluctuates, 
determined largely by a borrower's decision to borrow and repay up to a 
pre-established maximum amount, except for an outstanding amount that 
the borrower is required to pay in full every month);
    (2) Is unsecured and unconditionally cancelable by the [BANK] to 
the fullest extent permitted by Federal law; and
    (3)(i) Has a maximum contractual exposure amount (drawn plus 
undrawn) of up to $100,000; or
    (ii) With respect to a product with an outstanding amount that the 
borrower is required to pay in full every month, the total outstanding 
amount does not in practice exceed $100,000.
    (4) A segment of exposures that contains one or more exposures that 
fails to meet paragraph (3)(ii) of this definition must be treated as a 
segment of other retail exposures for the 24 month period following the 
month in which the total outstanding amount of one or more exposures 
individually exceeds $100,000.
    Retail exposure means a residential mortgage exposure, a qualifying 
revolving exposure, or an other retail exposure.
    Retail exposure subcategory means the residential mortgage 
exposure, qualifying revolving exposure, or other retail exposure 
subcategory.
    Risk parameter means a variable used in determining risk-based 
capital requirements for wholesale and retail exposures, specifically 
probability of default (PD), loss given default (LGD),

[[Page 62208]]

exposure at default (EAD), or effective maturity (M).
    Scenario analysis means a systematic process of obtaining expert 
opinions from business managers and risk management experts to derive 
reasoned assessments of the likelihood and loss impact of plausible 
high-severity operational losses. Scenario analysis may include the 
well-reasoned evaluation and use of external operational loss event 
data, adjusted as appropriate to ensure relevance to a [BANK]'s 
operational risk profile and control structure.
    Total wholesale and retail risk-weighted assets means the sum of:
    (1) Risk-weighted assets for wholesale exposures that are not IMM 
exposures, cleared transactions, or default fund contributions to non-
defaulted obligors and segments of non-defaulted retail exposures;
    (2) Risk-weighted assets for wholesale exposures to defaulted 
obligors and segments of defaulted retail exposures;
    (3) Risk-weighted assets for assets not defined by an exposure 
category;
    (4) Risk-weighted assets for non-material portfolios of exposures;
    (5) Risk-weighted assets for IMM exposures (as determined in Sec.  
--.132(d));
    (6) Risk-weighted assets for cleared transactions and risk-weighted 
assets for default fund contributions (as determined in Sec.  --.133); 
and
    (7) Risk-weighted assets for unsettled transactions (as determined 
in Sec.  --.136).
    Unexpected operational loss (UOL) means the difference between the 
[BANK]'s operational risk exposure and the [BANK]'s expected 
operational loss.
    Unit of measure means the level (for example, organizational unit 
or operational loss event type) at which the [BANK]'s operational risk 
quantification system generates a separate distribution of potential 
operational losses.
    Wholesale exposure means a credit exposure to a company, natural 
person, sovereign, or governmental entity (other than a securitization 
exposure, retail exposure, pre-sold construction loan, or equity 
exposure).
    Wholesale exposure subcategory means the HVCRE or non-HVCRE 
wholesale exposure subcategory.

Qualification


Sec.  --.121  Qualification process.

    (a) Timing. (1) A [BANK] that is described in Sec.  --.100(b)(1)(i) 
through (iv) must adopt a written implementation plan no later than six 
months after the date the [BANK] meets a criterion in that section. The 
implementation plan must incorporate an explicit start date no later 
than 36 months after the date the [BANK] meets at least one criterion 
under Sec.  --.100(b)(1)(i) through (iv). The [AGENCY] may extend the 
start date.
    (2) A [BANK] that elects to be subject to this appendix under Sec.  
--.100(b)(1)(v) must adopt a written implementation plan.
    (b) Implementation plan. (1) The [BANK]'s implementation plan must 
address in detail how the [BANK] complies, or plans to comply, with the 
qualification requirements in Sec.  --.122. The [BANK] also must 
maintain a comprehensive and sound planning and governance process to 
oversee the implementation efforts described in the plan. At a minimum, 
the plan must:
    (i) Comprehensively address the qualification requirements in Sec.  
--.122 for the [BANK] and each consolidated subsidiary (U.S. and 
foreign-based) of the [BANK] with respect to all portfolios and 
exposures of the [BANK] and each of its consolidated subsidiaries;
    (ii) Justify and support any proposed temporary or permanent 
exclusion of business lines, portfolios, or exposures from the 
application of the advanced approaches in this subpart (which business 
lines, portfolios, and exposures must be, in the aggregate, immaterial 
to the [BANK]);
    (iii) Include the [BANK]'s self-assessment of:
    (A) The [BANK]'s current status in meeting the qualification 
requirements in Sec.  --.122; and
    (B) The consistency of the [BANK]'s current practices with the 
[AGENCY]'s supervisory guidance on the qualification requirements;
    (iv) Based on the [BANK]'s self-assessment, identify and describe 
the areas in which the [BANK] proposes to undertake additional work to 
comply with the qualification requirements in Sec.  --.122 or to 
improve the consistency of the [BANK]'s current practices with the 
[AGENCY]'s supervisory guidance on the qualification requirements (gap 
analysis);
    (v) Describe what specific actions the [BANK] will take to address 
the areas identified in the gap analysis required by paragraph 
(b)(1)(iv) of this section;
    (vi) Identify objective, measurable milestones, including delivery 
dates and a date when the [BANK]'s implementation of the methodologies 
described in this subpart will be fully operational;
    (vii) Describe resources that have been budgeted and are available 
to implement the plan; and
    (viii) Receive approval of the [BANK]'s board of directors.
    (2) The [BANK] must submit the implementation plan, together with a 
copy of the minutes of the board of directors' approval, to the 
[AGENCY] at least 60 days before the [BANK] proposes to begin its 
parallel run, unless the [AGENCY] waives prior notice.
    (c) Parallel run. Before determining its risk-weighted assets under 
this subpart and following adoption of the implementation plan, the 
[BANK] must conduct a satisfactory parallel run. A satisfactory 
parallel run is a period of no less than four consecutive calendar 
quarters during which the [BANK] complies with the qualification 
requirements in Sec.  --.122 to the satisfaction of the [AGENCY]. 
During the parallel run, the [BANK] must report to the [AGENCY] on a 
calendar quarterly basis its risk-based capital ratios determined in 
accordance with Sec.  --.10(b)(1) through (3) and Sec.  --10.(c)(1) 
through (3). During this period, the [BANK]'s minimum risk-based 
capital ratios are determined as set forth in subpart D of this part.
    (d) Approval to calculate risk-based capital requirements under 
this subpart. The [AGENCY] will notify the [BANK] of the date that the 
[BANK] must begin to use this subpart for purposes of Sec.  --.10 if 
the [AGENCY] determines that:
    (1) The [BANK] fully complies with all the qualification 
requirements in Sec.  --.122;
    (2) The [BANK] has conducted a satisfactory parallel run under 
paragraph (c) of this section; and
    (3) The [BANK] has an adequate process to ensure ongoing compliance 
with the qualification requirements in Sec.  --.122.


Sec.  --.122  Qualification requirements.

    (a) Process and systems requirements. (1) A [BANK] must have a 
rigorous process for assessing its overall capital adequacy in relation 
to its risk profile and a comprehensive strategy for maintaining an 
appropriate level of capital.
    (2) The systems and processes used by a [BANK] for risk-based 
capital purposes under this subpart must be consistent with the 
[BANK]'s internal risk management processes and management information 
reporting systems.
    (3) Each [BANK] must have an appropriate infrastructure with risk 
measurement and management processes that meet the qualification 
requirements of this section and are appropriate given the [BANK]'s 
size and level of complexity. Regardless of whether the systems and 
models that generate the risk parameters necessary

[[Page 62209]]

for calculating a [BANK]'s risk-based capital requirements are located 
at any affiliate of the [BANK], the [BANK] itself must ensure that the 
risk parameters and reference data used to determine its risk-based 
capital requirements are representative of its own credit risk and 
operational risk exposures.
    (b) Risk rating and segmentation systems for wholesale and retail 
exposures. (1) A [BANK] must have an internal risk rating and 
segmentation system that accurately and reliably differentiates among 
degrees of credit risk for the [BANK]'s wholesale and retail exposures.
    (2) For wholesale exposures:
    (i) A [BANK] must have an internal risk rating system that 
accurately and reliably assigns each obligor to a single rating grade 
(reflecting the obligor's likelihood of default). A [BANK] may elect, 
however, not to assign to a rating grade an obligor to whom the [BANK] 
extends credit based solely on the financial strength of a guarantor, 
provided that all of the [BANK]'s exposures to the obligor are fully 
covered by eligible guarantees, the [BANK] applies the PD substitution 
approach in Sec.  --.134(c)(1) to all exposures to that obligor, and 
the [BANK] immediately assigns the obligor to a rating grade if a 
guarantee can no longer be recognized under this part. The [BANK]'s 
wholesale obligor rating system must have at least seven discrete 
rating grades for non-defaulted obligors and at least one rating grade 
for defaulted obligors.
    (ii) Unless the [BANK] has chosen to directly assign LGD estimates 
to each wholesale exposure, the [BANK] must have an internal risk 
rating system that accurately and reliably assigns each wholesale 
exposure to a loss severity rating grade (reflecting the [BANK]'s 
estimate of the LGD of the exposure). A [BANK] employing loss severity 
rating grades must have a sufficiently granular loss severity grading 
system to avoid grouping together exposures with widely ranging LGDs.
    (3) For retail exposures, a [BANK] must have an internal system 
that groups retail exposures into the appropriate retail exposure 
subcategory, groups the retail exposures in each retail exposure 
subcategory into separate segments with homogeneous risk 
characteristics, and assigns accurate and reliable PD and LGD estimates 
for each segment on a consistent basis. The [BANK]'s system must 
identify and group in separate segments by subcategories exposures 
identified in Sec.  --.131(c)(2)(ii) and (iii).
    (4) The [BANK]'s internal risk rating policy for wholesale 
exposures must describe the [BANK]'s rating philosophy (that is, must 
describe how wholesale obligor rating assignments are affected by the 
[BANK]'s choice of the range of economic, business, and industry 
conditions that are considered in the obligor rating process).
    (5) The [BANK]'s internal risk rating system for wholesale 
exposures must provide for the review and update (as appropriate) of 
each obligor rating and (if applicable) each loss severity rating 
whenever the [BANK] receives new material information, but no less 
frequently than annually. The [BANK]'s retail exposure segmentation 
system must provide for the review and update (as appropriate) of 
assignments of retail exposures to segments whenever the [BANK] 
receives new material information, but generally no less frequently 
than quarterly.
    (c) Quantification of risk parameters for wholesale and retail 
exposures. (1) The [BANK] must have a comprehensive risk parameter 
quantification process that produces accurate, timely, and reliable 
estimates of the risk parameters for the [BANK]'s wholesale and retail 
exposures.
    (2) Data used to estimate the risk parameters must be relevant to 
the [BANK]'s actual wholesale and retail exposures, and of sufficient 
quality to support the determination of risk-based capital requirements 
for the exposures.
    (3) The [BANK]'s risk parameter quantification process must produce 
appropriately conservative risk parameter estimates where the [BANK] 
has limited relevant data, and any adjustments that are part of the 
quantification process must not result in a pattern of bias toward 
lower risk parameter estimates.
    (4) The [BANK]'s risk parameter estimation process should not rely 
on the possibility of U.S. government financial assistance, except for 
the financial assistance that the U.S. government has a legally binding 
commitment to provide.
    (5) Where the [BANK]'s quantifications of LGD directly or 
indirectly incorporate estimates of the effectiveness of its credit 
risk management practices in reducing its exposure to troubled obligors 
prior to default, the [BANK] must support such estimates with empirical 
analysis showing that the estimates are consistent with its historical 
experience in dealing with such exposures during economic downturn 
conditions.
    (6) PD estimates for wholesale obligors and retail segments must be 
based on at least five years of default data. LGD estimates for 
wholesale exposures must be based on at least seven years of loss 
severity data, and LGD estimates for retail segments must be based on 
at least five years of loss severity data. EAD estimates for wholesale 
exposures must be based on at least seven years of exposure amount 
data, and EAD estimates for retail segments must be based on at least 
five years of exposure amount data.
    (7) Default, loss severity, and exposure amount data must include 
periods of economic downturn conditions, or the [BANK] must adjust its 
estimates of risk parameters to compensate for the lack of data from 
periods of economic downturn conditions.
    (8) The [BANK]'s PD, LGD, and EAD estimates must be based on the 
definition of default in Sec.  --.101.
    (9) The [BANK] must review and update (as appropriate) its risk 
parameters and its risk parameter quantification process at least 
annually.
    (10) The [BANK] must, at least annually, conduct a comprehensive 
review and analysis of reference data to determine relevance of 
reference data to the [BANK]'s exposures, quality of reference data to 
support PD, LGD, and EAD estimates, and consistency of reference data 
to the definition of default in Sec.  --.101.
    (d) Counterparty credit risk model. A [BANK] must obtain the prior 
written approval of the [AGENCY] under Sec.  --.132 to use the internal 
models methodology for counterparty credit risk and the advanced CVA 
approach for the CVA capital requirement.
    (e) Double default treatment. A [BANK] must obtain the prior 
written approval of the [AGENCY] under Sec.  --.135 to use the double 
default treatment.
    (f) Equity exposures model. A [BANK] must obtain the prior written 
approval of the [AGENCY] under Sec.  --.153 to use the internal models 
approach for equity exposures.
    (g) Operational risk. (1) Operational risk management processes. A 
[BANK] must:
    (i) Have an operational risk management function that:
    (A) Is independent of business line management; and
    (B) Is responsible for designing, implementing, and overseeing the 
[BANK]'s operational risk data and assessment systems, operational risk 
quantification systems, and related processes;
    (ii) Have and document a process (which must capture business 
environment and internal control factors affecting the [BANK]'s 
operational risk

[[Page 62210]]

profile) to identify, measure, monitor, and control operational risk in 
the [BANK]'s products, activities, processes, and systems; andk
    (iii) Report operational risk exposures, operational loss events, 
and other relevant operational risk information to business unit 
management, senior management, and the board of directors (or a 
designated committee of the board).
    (2) Operational risk data and assessment systems. A [BANK] must 
have operational risk data and assessment systems that capture 
operational risks to which the [BANK] is exposed. The [BANK]'s 
operational risk data and assessment systems must:
    (i) Be structured in a manner consistent with the [BANK]'s current 
business activities, risk profile, technological processes, and risk 
management processes; and
    (ii) Include credible, transparent, systematic, and verifiable 
processes that incorporate the following elements on an ongoing basis:
    (A) Internal operational loss event data. The [BANK] must have a 
systematic process for capturing and using internal operational loss 
event data in its operational risk data and assessment systems.
    (1) The [BANK]'s operational risk data and assessment systems must 
include a historical observation period of at least five years for 
internal operational loss event data (or such shorter period approved 
by the [AGENCY] to address transitional situations, such as integrating 
a new business line).
    (2) The [BANK] must be able to map its internal operational loss 
event data into the seven operational loss event type categories.
    (3) The [BANK] may refrain from collecting internal operational 
loss event data for individual operational losses below established 
dollar threshold amounts if the [BANK] can demonstrate to the 
satisfaction of the [AGENCY] that the thresholds are reasonable, do not 
exclude important internal operational loss event data, and permit the 
[BANK] to capture substantially all the dollar value of the [BANK]'s 
operational losses.
    (B) External operational loss event data. The [BANK] must have a 
systematic process for determining its methodologies for incorporating 
external operational loss event data into its operational risk data and 
assessment systems.
    (C) Scenario analysis. The [BANK] must have a systematic process 
for determining its methodologies for incorporating scenario analysis 
into its operational risk data and assessment systems.
    (D) Business environment and internal control factors. The [BANK] 
must incorporate business environment and internal control factors into 
its operational risk data and assessment systems. The [BANK] must also 
periodically compare the results of its prior business environment and 
internal control factor assessments against its actual operational 
losses incurred in the intervening period.
    (3) Operational risk quantification systems. (i) The [BANK]'s 
operational risk quantification systems:
    (A) Must generate estimates of the [BANK]'s operational risk 
exposure using its operational risk data and assessment systems;
    (B) Must employ a unit of measure that is appropriate for the 
[BANK]'s range of business activities and the variety of operational 
loss events to which it is exposed, and that does not combine business 
activities or operational loss events with demonstrably different risk 
profiles within the same loss distribution;
    (C) Must include a credible, transparent, systematic, and 
verifiable approach for weighting each of the four elements, described 
in paragraph (g)(2)(ii) of this section, that a [BANK] is required to 
incorporate into its operational risk data and assessment systems;
    (D) May use internal estimates of dependence among operational 
losses across and within units of measure if the [BANK] can demonstrate 
to the satisfaction of the [AGENCY] that its process for estimating 
dependence is sound, robust to a variety of scenarios, and implemented 
with integrity, and allows for uncertainty surrounding the estimates. 
If the [BANK] has not made such a demonstration, it must sum 
operational risk exposure estimates across units of measure to 
calculate its total operational risk exposure; and
    (E) Must be reviewed and updated (as appropriate) whenever the 
[BANK] becomes aware of information that may have a material effect on 
the [BANK]'s estimate of operational risk exposure, but the review and 
update must occur no less frequently than annually.
    (ii) With the prior written approval of the [AGENCY], a [BANK] may 
generate an estimate of its operational risk exposure using an 
alternative approach to that specified in paragraph (g)(3)(i) of this 
section. A [BANK] proposing to use such an alternative operational risk 
quantification system must submit a proposal to the [AGENCY]. In 
determining whether to approve a [BANK]'s proposal to use an 
alternative operational risk quantification system, the [AGENCY] will 
consider the following principles:
    (A) Use of the alternative operational risk quantification system 
will be allowed only on an exception basis, considering the size, 
complexity, and risk profile of the [BANK];
    (B) The [BANK] must demonstrate that its estimate of its 
operational risk exposure generated under the alternative operational 
risk quantification system is appropriate and can be supported 
empirically; and
    (C) A [BANK] must not use an allocation of operational risk capital 
requirements that includes entities other than depository institutions 
or the benefits of diversification across entities.
    (h) Data management and maintenance. (1) A [BANK] must have data 
management and maintenance systems that adequately support all aspects 
of its advanced systems and the timely and accurate reporting of risk-
based capital requirements.
    (2) A [BANK] must retain data using an electronic format that 
allows timely retrieval of data for analysis, validation, reporting, 
and disclosure purposes.
    (3) A [BANK] must retain sufficient data elements related to key 
risk drivers to permit adequate monitoring, validation, and refinement 
of its advanced systems.
    (i) Control, oversight, and validation mechanisms. (1) The [BANK]'s 
senior management must ensure that all components of the [BANK]'s 
advanced systems function effectively and comply with the qualification 
requirements in this section.
    (2) The [BANK]'s board of directors (or a designated committee of 
the board) must at least annually review the effectiveness of, and 
approve, the [BANK]'s advanced systems.
    (3) A [BANK] must have an effective system of controls and 
oversight that:
    (i) Ensures ongoing compliance with the qualification requirements 
in this section;
    (ii) Maintains the integrity, reliability, and accuracy of the 
[BANK]'s advanced systems; and
    (iii) Includes adequate governance and project management 
processes.
    (4) The [BANK] must validate, on an ongoing basis, its advanced 
systems. The [BANK]'s validation process must be independent of the 
advanced systems' development, implementation, and operation, or the 
validation process must be subjected to an independent review of its 
adequacy and effectiveness. Validation must include:
    (i) An evaluation of the conceptual soundness of (including 
developmental

[[Page 62211]]

evidence supporting) the advanced systems;
    (ii) An ongoing monitoring process that includes verification of 
processes and benchmarking; and
    (iii) An outcomes analysis process that includes backtesting.
    (5) The [BANK] must have an internal audit function independent of 
business-line management that at least annually assesses the 
effectiveness of the controls supporting the [BANK]'s advanced systems 
and reports its findings to the [BANK]'s board of directors (or a 
committee thereof).
    (6) The [BANK] must periodically stress test its advanced systems. 
The stress testing must include a consideration of how economic cycles, 
especially downturns, affect risk-based capital requirements (including 
migration across rating grades and segments and the credit risk 
mitigation benefits of double default treatment).
    (j) Documentation. The [BANK] must adequately document all material 
aspects of its advanced systems.


Sec.  --.123  Ongoing qualification.

    (a) Changes to advanced systems. A [BANK] must meet all the 
qualification requirements in Sec.  --.122 on an ongoing basis. A 
[BANK] must notify the [AGENCY] when the [BANK] makes any change to an 
advanced system that would result in a material change in the [BANK]'s 
advanced approaches total risk-weighted asset amount for an exposure 
type or when the [BANK] makes any significant change to its modeling 
assumptions.
    (b) Failure to comply with qualification requirements. (1) If the 
[AGENCY] determines that a [BANK] that uses this subpart and that has 
conducted a satisfactory parallel run fails to comply with the 
qualification requirements in Sec.  --.122, the [AGENCY] will notify 
the [BANK] in writing of the [BANK]'s failure to comply.
    (2) The [BANK] must establish and submit a plan satisfactory to the 
[AGENCY] to return to compliance with the qualification requirements.
    (3) In addition, if the [AGENCY] determines that the [BANK]'s 
advanced approaches total risk-weighted assets are not commensurate 
with the [BANK]'s credit, market, operational, or other risks, the 
[AGENCY] may require such a [BANK] to calculate its advanced approaches 
total risk-weighted assets with any modifications provided by the 
[AGENCY].


Sec.  --.124  Merger and acquisition transitional arrangements.

    (a) Mergers and acquisitions of companies without advanced systems. 
If a [BANK] merges with or acquires a company that does not calculate 
its risk-based capital requirements using advanced systems, the [BANK] 
may use subpart D of this part to determine the risk-weighted asset 
amounts for the merged or acquired company's exposures for up to 24 
months after the calendar quarter during which the merger or 
acquisition consummates. The [AGENCY] may extend this transition period 
for up to an additional 12 months. Within 90 days of consummating the 
merger or acquisition, the [BANK] must submit to the [AGENCY] an 
implementation plan for using its advanced systems for the acquired 
company. During the period in which subpart D of this part applies to 
the merged or acquired company, any ALLL, net of allocated transfer 
risk reserves established pursuant to 12 U.S.C. 3904, associated with 
the merged or acquired company's exposures may be included in the 
acquiring [BANK]'s tier 2 capital up to 1.25 percent of the acquired 
company's risk-weighted assets. All general allowances of the merged or 
acquired company must be excluded from the [BANK]'s eligible credit 
reserves. In addition, the risk-weighted assets of the merged or 
acquired company are not included in the [BANK]'s credit-risk-weighted 
assets but are included in total risk-weighted assets. If a [BANK] 
relies on this paragraph (a), the [BANK] must disclose publicly the 
amounts of risk-weighted assets and qualifying capital calculated under 
this subpart for the acquiring [BANK] and under subpart D of this part 
for the acquired company.
    (b) Mergers and acquisitions of companies with advanced systems. 
(1) If a [BANK] merges with or acquires a company that calculates its 
risk-based capital requirements using advanced systems, the [BANK] may 
use the acquired company's advanced systems to determine total risk-
weighted assets for the merged or acquired company's exposures for up 
to 24 months after the calendar quarter during which the acquisition or 
merger consummates. The [AGENCY] may extend this transition period for 
up to an additional 12 months. Within 90 days of consummating the 
merger or acquisition, the [BANK] must submit to the [AGENCY] an 
implementation plan for using its advanced systems for the merged or 
acquired company.
    (2) If the acquiring [BANK] is not subject to the advanced 
approaches in this subpart at the time of acquisition or merger, during 
the period when subpart D of this part applies to the acquiring [BANK], 
the ALLL associated with the exposures of the merged or acquired 
company may not be directly included in tier 2 capital. Rather, any 
excess eligible credit reserves associated with the merged or acquired 
company's exposures may be included in the [BANK]'s tier 2 capital up 
to 0.6 percent of the credit-risk-weighted assets associated with those 
exposures.


Sec. Sec.  --.125 through --.130  [Reserved]

Risk-Weighted Assets for General Credit Risk


Sec.  --.131  Mechanics for calculating total wholesale and retail 
risk-weighted assets.

    (a) Overview. A [BANK] must calculate its total wholesale and 
retail risk-weighted asset amount in four distinct phases:
    (1) Phase 1--categorization of exposures;
    (2) Phase 2--assignment of wholesale obligors and exposures to 
rating grades and segmentation of retail exposures;
    (3) Phase 3--assignment of risk parameters to wholesale exposures 
and segments of retail exposures; and
    (4) Phase 4--calculation of risk-weighted asset amounts.
    (b) Phase 1--Categorization. The [BANK] must determine which of its 
exposures are wholesale exposures, retail exposures, securitization 
exposures, or equity exposures. The [BANK] must categorize each retail 
exposure as a residential mortgage exposure, a QRE, or an other retail 
exposure. The [BANK] must identify which wholesale exposures are HVCRE 
exposures, sovereign exposures, OTC derivative contracts, repo-style 
transactions, eligible margin loans, eligible purchased wholesale 
exposures, cleared transactions, default fund contributions, unsettled 
transactions to which Sec.  --.136 applies, and eligible guarantees or 
eligible credit derivatives that are used as credit risk mitigants. The 
[BANK] must identify any on-balance sheet asset that does not meet the 
definition of a wholesale, retail, equity, or securitization exposure, 
as well as any non-material portfolio of exposures described in 
paragraph (e)(4) of this section.
    (c) Phase 2--Assignment of wholesale obligors and exposures to 
rating grades and retail exposures to segments--(1) Assignment of 
wholesale obligors and exposures to rating grades.
    (i) The [BANK] must assign each obligor of a wholesale exposure to 
a single obligor rating grade and must assign each wholesale exposure 
to which it does not directly assign an LGD estimate to a loss severity 
rating grade.
    (ii) The [BANK] must identify which of its wholesale obligors are 
in default.

[[Page 62212]]

    (2) Segmentation of retail exposures. (i) The [BANK] must group the 
retail exposures in each retail subcategory into segments that have 
homogeneous risk characteristics.
    (ii) The [BANK] must identify which of its retail exposures are in 
default. The [BANK] must segment defaulted retail exposures separately 
from non-defaulted retail exposures.
    (iii) If the [BANK] determines the EAD for eligible margin loans 
using the approach in Sec.  --.132(b), the [BANK] must identify which 
of its retail exposures are eligible margin loans for which the [BANK] 
uses this EAD approach and must segment such eligible margin loans 
separately from other retail exposures.
    (3) Eligible purchased wholesale exposures. A [BANK] may group its 
eligible purchased wholesale exposures into segments that have 
homogeneous risk characteristics. A [BANK] must use the wholesale 
exposure formula in Table 1 of this section to determine the risk-based 
capital requirement for each segment of eligible purchased wholesale 
exposures.
    (d) Phase 3--Assignment of risk parameters to wholesale exposures 
and segments of retail exposures. (1) Quantification process. Subject 
to the limitations in this paragraph (d), the [BANK] must:
    (i) Associate a PD with each wholesale obligor rating grade;
    (ii) Associate an LGD with each wholesale loss severity rating 
grade or assign an LGD to each wholesale exposure;
    (iii) Assign an EAD and M to each wholesale exposure; and
    (iv) Assign a PD, LGD, and EAD to each segment of retail exposures.
    (2) Floor on PD assignment. The PD for each wholesale obligor or 
retail segment may not be less than 0.03 percent, except for exposures 
to or directly and unconditionally guaranteed by a sovereign entity, 
the Bank for International Settlements, the International Monetary 
Fund, the European Commission, the European Central Bank, or a 
multilateral development bank, to which the [BANK] assigns a rating 
grade associated with a PD of less than 0.03 percent.
    (3) Floor on LGD estimation. The LGD for each segment of 
residential mortgage exposures may not be less than 10 percent, except 
for segments of residential mortgage exposures for which all or 
substantially all of the principal of each exposure is either:
    (i) Directly and unconditionally guaranteed by the full faith and 
credit of a sovereign entity; or
    (ii) Guaranteed by a contingent obligation of the U.S. government 
or its agencies, the enforceability of which is dependent upon some 
affirmative action on the part of the beneficiary of the guarantee or a 
third party (for example, meeting servicing requirements).
    (4) Eligible purchased wholesale exposures. A [BANK] must assign a 
PD, LGD, EAD, and M to each segment of eligible purchased wholesale 
exposures. If the [BANK] can estimate ECL (but not PD or LGD) for a 
segment of eligible purchased wholesale exposures, the [BANK] must 
assume that the LGD of the segment equals 100 percent and that the PD 
of the segment equals ECL divided by EAD. The estimated ECL must be 
calculated for the exposures without regard to any assumption of 
recourse or guarantees from the seller or other parties.
    (5) Credit risk mitigation: credit derivatives, guarantees, and 
collateral. (i) A [BANK] may take into account the risk reducing 
effects of eligible guarantees and eligible credit derivatives in 
support of a wholesale exposure by applying the PD substitution or LGD 
adjustment treatment to the exposure as provided in Sec.  --.134 or, if 
applicable, applying double default treatment to the exposure as 
provided in Sec.  --.135. A [BANK] may decide separately for each 
wholesale exposure that qualifies for the double default treatment 
under Sec.  --.135 whether to apply the double default treatment or to 
use the PD substitution or LGD adjustment treatment without recognizing 
double default effects.
    (ii) A [BANK] may take into account the risk reducing effects of 
guarantees and credit derivatives in support of retail exposures in a 
segment when quantifying the PD and LGD of the segment.
    (iii) Except as provided in paragraph (d)(6) of this section, a 
[BANK] may take into account the risk reducing effects of collateral in 
support of a wholesale exposure when quantifying the LGD of the 
exposure, and may take into account the risk reducing effects of 
collateral in support of retail exposures when quantifying the PD and 
LGD of the segment.
    (6) EAD for OTC derivative contracts, repo-style transactions, and 
eligible margin loans. A [BANK] must calculate its EAD for an OTC 
derivative contract as provided in Sec.  --.132 (c) and (d). A [BANK] 
may take into account the risk-reducing effects of financial collateral 
in support of a repo-style transaction or eligible margin loan and of 
any collateral in support of a repo-style transaction that is included 
in the [BANK]'s VaR-based measure under subpart F of this part through 
an adjustment to EAD as provided in Sec.  --.132(b) and (d). A [BANK] 
that takes collateral into account through such an adjustment to EAD 
under Sec.  --.132 may not reflect such collateral in LGD.
    (7) Effective maturity. An exposure's M must be no greater than 
five years and no less than one year, except that an exposure's M must 
be no less than one day if the exposure is a trade related letter of 
credit, or if the exposure has an original maturity of less than one 
year and is not part of a [BANK]'s ongoing financing of the obligor. An 
exposure is not part of a [BANK]'s ongoing financing of the obligor if 
the [BANK]:
    (i) Has a legal and practical ability not to renew or roll over the 
exposure in the event of credit deterioration of the obligor;
    (ii) Makes an independent credit decision at the inception of the 
exposure and at every renewal or roll over; and
    (iii) Has no substantial commercial incentive to continue its 
credit relationship with the obligor in the event of credit 
deterioration of the obligor.
    (8) EAD for exposures to certain central counterparties. A [BANK] 
may attribute an EAD of zero to exposures that arise from the 
settlement of cash transactions (such as equities, fixed income, spot 
foreign exchange, and spot commodities) with a central counterparty 
where there is no assumption of ongoing counterparty credit risk by the 
central counterparty after settlement of the trade and associated 
default fund contributions.
    (e) Phase 4--Calculation of risk-weighted assets--(1) Non-defaulted 
exposures. (i) A [BANK] must calculate the dollar risk-based capital 
requirement for each of its wholesale exposures to a non-defaulted 
obligor (except for eligible guarantees and eligible credit derivatives 
that hedge another wholesale exposure, IMM exposures, cleared 
transactions, default fund contributions, unsettled transactions, and 
exposures to which the [BANK] applies the double default treatment in 
Sec.  --.135) and segments of non-defaulted retail exposures by 
inserting the assigned risk parameters for the wholesale obligor and 
exposure or retail segment into the appropriate risk-based capital 
formula specified in Table 1 and multiplying the output of the formula 
(K) by the EAD of the exposure or segment. Alternatively, a [BANK] may 
apply a 300 percent risk weight to the EAD of an eligible margin loan 
if the [BANK] is not able to meet the [AGENCY]'s requirements for 
estimation of PD and LGD for the margin loan.

[[Page 62213]]

[GRAPHIC] [TIFF OMITTED] TR11OC13.028


[[Page 62214]]


[GRAPHIC] [TIFF OMITTED] TR11OC13.029

    (ii) The sum of all the dollar risk-based capital requirements for 
each wholesale exposure to a non-defaulted obligor and segment of non-
defaulted retail exposures calculated in paragraph (e)(1)(i) of this 
section and in Sec.  --.135(e) equals the total dollar risk-based 
capital requirement for those exposures and segments.
    (iii) The aggregate risk-weighted asset amount for wholesale 
exposures to non-defaulted obligors and segments of non-defaulted 
retail exposures equals the total dollar risk-based capital requirement 
in paragraph (e)(1)(ii) of this section multiplied by 12.5.
    (2) Wholesale exposures to defaulted obligors and segments of 
defaulted retail exposures--(i) Not covered by an eligible U.S. 
government guarantee: The dollar risk-based capital requirement for 
each wholesale exposure not covered by an eligible guarantee from the 
U.S. government to a defaulted obligor and each segment of defaulted 
retail exposures not covered by an eligible guarantee from the U.S. 
government equals 0.08 multiplied by the EAD of the exposure or 
segment.
    (ii) Covered by an eligible U.S. government guarantee: The dollar 
risk-based capital requirement for each wholesale exposure to a 
defaulted obligor covered by an eligible guarantee from the U.S. 
government and each segment of defaulted retail exposures covered by an 
eligible guarantee from the U.S. government equals the sum of:
    (A) The sum of the EAD of the portion of each wholesale exposure to 
a defaulted obligor covered by an eligible guarantee from the U.S. 
government plus the EAD of the portion of each segment of defaulted 
retail exposures that is covered by an eligible guarantee from the U.S. 
government and the resulting sum is multiplied by 0.016, and
    (B) The sum of the EAD of the portion of each wholesale exposure to 
a defaulted obligor not covered by an eligible guarantee from the U.S. 
government plus the EAD of the portion of each segment of defaulted 
retail exposures that is not covered by an eligible guarantee from the 
U.S. government and the resulting sum is multiplied by 0.08.
    (iii) The sum of all the dollar risk-based capital requirements for 
each wholesale exposure to a defaulted obligor and each segment of 
defaulted retail exposures calculated in paragraph

[[Page 62215]]

(e)(2)(i) of this section plus the dollar risk-based capital 
requirements each wholesale exposure to a defaulted obligor and for 
each segment of defaulted retail exposures calculated in paragraph 
(e)(2)(ii) of this section equals the total dollar risk-based capital 
requirement for those exposures and segments.
    (iv) The aggregate risk-weighted asset amount for wholesale 
exposures to defaulted obligors and segments of defaulted retail 
exposures equals the total dollar risk-based capital requirement 
calculated in paragraph (e)(2)(iii) of this section multiplied by 12.5.
    (3) Assets not included in a defined exposure category. (i) A 
[BANK] may assign a risk-weighted asset amount of zero to cash owned 
and held in all offices of the [BANK] or in transit and for gold 
bullion held in the [BANK]'s own vaults, or held in another [BANK]'s 
vaults on an allocated basis, to the extent the gold bullion assets are 
offset by gold bullion liabilities.
    (ii) A [BANK] must assign a risk-weighted asset amount equal to 20 
percent of the carrying value of cash items in the process of 
collection.
    (iii) A [BANK] must assign a risk-weighted asset amount equal to 50 
percent of the carrying value to a pre-sold construction loan unless 
the purchase contract is cancelled, in which case a [BANK] must assign 
a risk-weighted asset amount equal to a 100 percent of the carrying 
value of the pre-sold construction loan.
    (iv) The risk-weighted asset amount for the residual value of a 
retail lease exposure equals such residual value.
    (v) The risk-weighted asset amount for DTAs arising from temporary 
differences that the [BANK] could realize through net operating loss 
carrybacks equals the carrying value, netted in accordance with Sec.  
--.22.
    (vi) The risk-weighted asset amount for MSAs, DTAs arising from 
temporary timing differences that the [BANK] could not realize through 
net operating loss carrybacks, and significant investments in the 
capital of unconsolidated financial institutions in the form of common 
stock that are not deducted pursuant to Sec.  --.22(a)(7) equals the 
amount not subject to deduction multiplied by 250 percent.
    (vii) The risk-weighted asset amount for any other on-balance-sheet 
asset that does not meet the definition of a wholesale, retail, 
securitization, IMM, or equity exposure, cleared transaction, or 
default fund contribution and is not subject to deduction under Sec.  
--.22(a), (c), or (d) equals the carrying value of the asset.
    (4) Non-material portfolios of exposures. The risk-weighted asset 
amount of a portfolio of exposures for which the [BANK] has 
demonstrated to the [AGENCY]'s satisfaction that the portfolio (when 
combined with all other portfolios of exposures that the [BANK] seeks 
to treat under this paragraph (e)) is not material to the [BANK] is the 
sum of the carrying values of on-balance sheet exposures plus the 
notional amounts of off-balance sheet exposures in the portfolio. For 
purposes of this paragraph (e)(4), the notional amount of an OTC 
derivative contract that is not a credit derivative is the EAD of the 
derivative as calculated in Sec.  --.132.


Sec.  --.132  Counterparty credit risk of repo-style transactions, 
eligible margin loans, and OTC derivative contracts.

    (a) Methodologies for collateral recognition. (1) Instead of an LGD 
estimation methodology, a [BANK] may use the following methodologies to 
recognize the benefits of financial collateral in mitigating the 
counterparty credit risk of repo-style transactions, eligible margin 
loans, collateralized OTC derivative contracts and single product 
netting sets of such transactions, and to recognize the benefits of any 
collateral in mitigating the counterparty credit risk of repo-style 
transactions that are included in a [BANK]'s VaR-based measure under 
subpart F of this part:
    (i) The collateral haircut approach set forth in paragraph (b)(2) 
of this section;
    (ii) The internal models methodology set forth in paragraph (d) of 
this section; and
    (iii) For single product netting sets of repo-style transactions 
and eligible margin loans, the simple VaR methodology set forth in 
paragraph (b)(3) of this section.
    (2) A [BANK] may use any combination of the three methodologies for 
collateral recognition; however, it must use the same methodology for 
transactions in the same category.
    (3) A [BANK] must use the methodology in paragraph (c) of this 
section, or with prior written approval of the [AGENCY], the internal 
model methodology in paragraph (d) of this section, to calculate EAD 
for an OTC derivative contract or a set of OTC derivative contracts 
subject to a qualifying master netting agreement. To estimate EAD for 
qualifying cross-product master netting agreements, a [BANK] may only 
use the internal models methodology in paragraph (d) of this section.
    (4) A [BANK] must also use the methodology in paragraph (e) of this 
section to calculate the risk-weighted asset amounts for CVA for OTC 
derivatives.
    (b) EAD for eligible margin loans and repo-style transactions--(1) 
General. A [BANK] may recognize the credit risk mitigation benefits of 
financial collateral that secures an eligible margin loan, repo-style 
transaction, or single-product netting set of such transactions by 
factoring the collateral into its LGD estimates for the exposure. 
Alternatively, a [BANK] may estimate an unsecured LGD for the exposure, 
as well as for any repo-style transaction that is included in the 
[BANK]'s VaR-based measure under subpart F of this part, and determine 
the EAD of the exposure using:
    (i) The collateral haircut approach described in paragraph (b)(2) 
of this section;
    (ii) For netting sets only, the simple VaR methodology described in 
paragraph (b)(3) of this section; or
    (iii) The internal models methodology described in paragraph (d) of 
this section.
    (2) Collateral haircut approach--(i) EAD equation. A [BANK] may 
determine EAD for an eligible margin loan, repo-style transaction, or 
netting set by setting EAD equal to max

{0, [([Sigma]E - [Sigma]C) + [Sigma](Es x Hs) + 
[Sigma](Efx x Hfx)]{time} ,

where:

(A) [Sigma]E equals the value of the exposure (the sum of the 
current fair values of all instruments, gold, and cash the [BANK] 
has lent, sold subject to repurchase, or posted as collateral to the 
counterparty under the transaction (or netting set));
(B) [Sigma]C equals the value of the collateral (the sum of the 
current fair values of all instruments, gold, and cash the [BANK] 
has borrowed, purchased subject to resale, or taken as collateral 
from the counterparty under the transaction (or netting set));
(C) Es equals the absolute value of the net position in a 
given instrument or in gold (where the net position in a given 
instrument or in gold equals the sum of the current fair values of 
the instrument or gold the [BANK] has lent, sold subject to 
repurchase, or posted as collateral to the counterparty minus the 
sum of the current fair values of that same instrument or gold the 
[BANK] has borrowed, purchased subject to resale, or taken as 
collateral from the counterparty);
(D) Hs equals the market price volatility haircut 
appropriate to the instrument or gold referenced in Es;
(E) Efx equals the absolute value of the net position of 
instruments and cash in a currency that is different from the 
settlement currency (where the net position in a given currency 
equals the sum of the current fair values of any instruments or cash 
in the currency the [BANK] has lent, sold subject to

[[Page 62216]]

repurchase, or posted as collateral to the counterparty minus the 
sum of the current fair values of any instruments or cash in the 
currency the [BANK] has borrowed, purchased subject to resale, or 
taken as collateral from the counterparty); and
(F) Hfx equals the haircut appropriate to the mismatch 
between the currency referenced in Efx and the settlement 
currency.

    (ii) Standard supervisory haircuts. (A) Under the standard 
supervisory haircuts approach:
    (1) A [BANK] must use the haircuts for market price volatility 
(Hs) in Table 1 to Sec.  --.132, as adjusted in certain 
circumstances as provided in paragraphs (b)(2)(ii)(A)(3) and (4) of 
this section;

                                  Table 1 to Sec.   --.132-- Standard Supervisory Market Price Volatility Haircuts \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                               Haircut (in percent) assigned based on:
                                                           ------------------------------------------------------------------------------   Investment
                                                             Sovereign issuers risk  weight under    Non-sovereign issuers risk  weight        grade
                     Residual maturity                          this section \2\  (in percent)        under this section  (in percent)    securitization
                                                           ------------------------------------------------------------------------------ exposures  (in
                                                                Zero       20 or 50       100           20           50          100         percent)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Less than or equal to 1 year..............................          0.5          1.0         15.0          1.0          2.0          4.0            4.0
Greater than 1 year and less than or equal to 5 years.....          2.0          3.0         15.0          4.0          6.0          8.0           12.0
Greater than 5 years......................................          4.0          6.0         15.0          8.0         12.0         16.0           24.0
--------------------------------------------------------------------------------------------------------------------------------------------------------
Main index equities (including convertible bonds) and gold.........................15.0..........
--------------------------------------------------------------------------------------------------------------------------------------------------------
Other publicly traded equities (including convertible bonds).......................25.0..........
--------------------------------------------------------------------------------------------------------------------------------------------------------
Mutual funds...................................................Highest haircut applicable to any security in
                                                                        which the fund can invest.
--------------------------------------------------------------------------------------------------------------------------------------------------------
Cash collateral held...............................................................Zero..........
--------------------------------------------------------------------------------------------------------------------------------------------------------
Other exposure types...............................................................25.0 .........
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ The market price volatility haircuts in Table 1 to Sec.   --.132 are based on a 10 business-day holding period.
\2\ Includes a foreign PSE that receives a zero percent risk weight.

    (2) For currency mismatches, a [BANK] must use a haircut for 
foreign exchange rate volatility (Hfx) of 8 percent, as 
adjusted in certain circumstances as provided in paragraphs 
(b)(2)(ii)(A)(3) and (4) of this section.
    (3) For repo-style transactions, a [BANK] may multiply the 
supervisory haircuts provided in paragraphs (b)(2)(ii)(A)(1) and (2) of 
this section by the square root of \1/2\ (which equals 0.707107).
    (4) A [BANK] must adjust the supervisory haircuts upward on the 
basis of a holding period longer than ten business days (for eligible 
margin loans) or five business days (for repo-style transactions) where 
the following conditions apply. If the number of trades in a netting 
set exceeds 5,000 at any time during a quarter, a [BANK] must adjust 
the supervisory haircuts upward on the basis of a holding period of 
twenty business days for the following quarter (except when a [BANK] is 
calculating EAD for a cleared transaction under Sec.  --.133). If a 
netting set contains one or more trades involving illiquid collateral 
or an OTC derivative that cannot be easily replaced, a [BANK] must 
adjust the supervisory haircuts upward on the basis of a holding period 
of twenty business days. If over the two previous quarters more than 
two margin disputes on a netting set have occurred that lasted more 
than the holding period, then the [BANK] must adjust the supervisory 
haircuts upward for that netting set on the basis of a holding period 
that is at least two times the minimum holding period for that netting 
set. A [BANK] must adjust the standard supervisory haircuts upward 
using the following formula:
[GRAPHIC] [TIFF OMITTED] TR11OC13.030

(i) TM equals a holding period of longer than 10 business 
days for eligible margin loans and derivative contracts or longer 
than 5 business days for repo-style transactions;
(ii) Hs equals the standard supervisory haircut; and
(iii) Ts equals 10 business days for eligible margin 
loans and derivative contracts or 5 business days for repo-style 
transactions.


    (5) If the instrument a [BANK] has lent, sold subject to 
repurchase, or posted as collateral does not meet the definition of 
financial collateral, the [BANK] must use a 25.0 percent haircut for 
market price volatility (Hs).
    (iii) Own internal estimates for haircuts. With the prior written 
approval of the [AGENCY], a [BANK] may calculate haircuts 
(Hs and Hfx) using its own internal estimates of 
the volatilities of market prices and foreign exchange rates.
    (A) To receive [AGENCY] approval to use its own internal estimates, 
a [BANK] must satisfy the following minimum quantitative standards:
    (1) A [BANK] must use a 99th percentile one-tailed confidence 
interval.
    (2) The minimum holding period for a repo-style transaction is five 
business days and for an eligible margin loan is ten business days 
except for transactions or netting sets for which paragraph 
(b)(2)(iii)(A)(3) of this section applies. When a [BANK] calculates an 
own-estimates haircut on a TN-day holding period, which is 
different from the minimum holding period for the transaction type, the 
applicable haircut (HM) is calculated using the following 
square root of time formula:
[GRAPHIC] [TIFF OMITTED] TR11OC13.031

(i) TM equals 5 for repo-style transactions and 10 for 
eligible margin loans;
(ii) TN equals the holding period used by the [BANK] to 
derive HN; and
(iii) HN equals the haircut based on the holding period 
TN


[[Page 62217]]


    (3) If the number of trades in a netting set exceeds 5,000 at any 
time during a quarter, a [BANK] must calculate the haircut using a 
minimum holding period of twenty business days for the following 
quarter (except when a [BANK] is calculating EAD for a cleared 
transaction under Sec.  --.133). If a netting set contains one or more 
trades involving illiquid collateral or an OTC derivative that cannot 
be easily replaced, a [BANK] must calculate the haircut using a minimum 
holding period of twenty business days. If over the two previous 
quarters more than two margin disputes on a netting set have occurred 
that lasted more than the holding period, then the [BANK] must 
calculate the haircut for transactions in that netting set on the basis 
of a holding period that is at least two times the minimum holding 
period for that netting set.
    (4) A [BANK] is required to calculate its own internal estimates 
with inputs calibrated to historical data from a continuous 12-month 
period that reflects a period of significant financial stress 
appropriate to the security or category of securities.
    (5) A [BANK] must have policies and procedures that describe how it 
determines the period of significant financial stress used to calculate 
the [BANK]'s own internal estimates for haircuts under this section and 
must be able to provide empirical support for the period used. The 
[BANK] must obtain the prior approval of the [AGENCY] for, and notify 
the [AGENCY] if the [BANK] makes any material changes to, these 
policies and procedures.
    (6) Nothing in this section prevents the [AGENCY] from requiring a 
[BANK] to use a different period of significant financial stress in the 
calculation of own internal estimates for haircuts.
    (7) A [BANK] must update its data sets and calculate haircuts no 
less frequently than quarterly and must also reassess data sets and 
haircuts whenever market prices change materially.
    (B) With respect to debt securities that are investment grade, a 
[BANK] may calculate haircuts for categories of securities. For a 
category of securities, the [BANK] must calculate the haircut on the 
basis of internal volatility estimates for securities in that category 
that are representative of the securities in that category that the 
[BANK] has lent, sold subject to repurchase, posted as collateral, 
borrowed, purchased subject to resale, or taken as collateral. In 
determining relevant categories, the [BANK] must at a minimum take into 
account:
    (1) The type of issuer of the security;
    (2) The credit quality of the security;
    (3) The maturity of the security; and
    (4) The interest rate sensitivity of the security.
    (C) With respect to debt securities that are not investment grade 
and equity securities, a [BANK] must calculate a separate haircut for 
each individual security.
    (D) Where an exposure or collateral (whether in the form of cash or 
securities) is denominated in a currency that differs from the 
settlement currency, the [BANK] must calculate a separate currency 
mismatch haircut for its net position in each mismatched currency based 
on estimated volatilities of foreign exchange rates between the 
mismatched currency and the settlement currency.
    (E) A [BANK]'s own estimates of market price and foreign exchange 
rate volatilities may not take into account the correlations among 
securities and foreign exchange rates on either the exposure or 
collateral side of a transaction (or netting set) or the correlations 
among securities and foreign exchange rates between the exposure and 
collateral sides of the transaction (or netting set).
    (3) Simple VaR methodology. With the prior written approval of the 
[AGENCY], a [BANK] may estimate EAD for a netting set using a VaR model 
that meets the requirements in paragraph (b)(3)(iii) of this section. 
In such event, the [BANK] must set EAD equal to max {0, [([Sigma]E - 
[Sigma]C) + PFE]{time} , where:
    (i) [Sigma]E equals the value of the exposure (the sum of the 
current fair values of all instruments, gold, and cash the [BANK] has 
lent, sold subject to repurchase, or posted as collateral to the 
counterparty under the netting set);
    (ii) [Sigma]C equals the value of the collateral (the sum of the 
current fair values of all instruments, gold, and cash the [BANK] has 
borrowed, purchased subject to resale, or taken as collateral from the 
counterparty under the netting set); and
    (iii) PFE (potential future exposure) equals the [BANK]'s 
empirically based best estimate of the 99th percentile, one-tailed 
confidence interval for an increase in the value of ([Sigma]E - 
[Sigma]C) over a five-business-day holding period for repo-style 
transactions, or over a ten-business-day holding period for eligible 
margin loans except for netting sets for which paragraph (b)(3)(iv) of 
this section applies using a minimum one-year historical observation 
period of price data representing the instruments that the [BANK] has 
lent, sold subject to repurchase, posted as collateral, borrowed, 
purchased subject to resale, or taken as collateral. The [BANK] must 
validate its VaR model by establishing and maintaining a rigorous and 
regular backtesting regime.
    (iv) If the number of trades in a netting set exceeds 5,000 at any 
time during a quarter, a [BANK] must use a twenty-business-day holding 
period for the following quarter (except when a [BANK] is calculating 
EAD for a cleared transaction under Sec.  --.133). If a netting set 
contains one or more trades involving illiquid collateral, a [BANK] 
must use a twenty-business-day holding period. If over the two previous 
quarters more than two margin disputes on a netting set have occurred 
that lasted more than the holding period, then the [BANK] must set its 
PFE for that netting set equal to an estimate over a holding period 
that is at least two times the minimum holding period for that netting 
set.
    (c) EAD for OTC derivative contracts--(1) OTC derivative contracts 
not subject to a qualifying master netting agreement. A [BANK] must 
determine the EAD for an OTC derivative contract that is not subject to 
a qualifying master netting agreement using the current exposure 
methodology in paragraph (c)(5) of this section or using the internal 
models methodology described in paragraph (d) of this section.
    (2) OTC derivative contracts subject to a qualifying master netting 
agreement. A [BANK] must determine the EAD for multiple OTC derivative 
contracts that are subject to a qualifying master netting agreement 
using the current exposure methodology in paragraph (c)(6) of this 
section or using the internal models methodology described in paragraph 
(d) of this section.
    (3) Credit derivatives. Notwithstanding paragraphs (c)(1) and 
(c)(2) of this section:
    (i) A [BANK] that purchases a credit derivative that is recognized 
under Sec.  --.134 or Sec.  --.135 as a credit risk mitigant for an 
exposure that is not a covered position under subpart F of this part is 
not required to calculate a separate counterparty credit risk capital 
requirement under this section so long as the [BANK] does so 
consistently for all such credit derivatives and either includes or 
excludes all such credit derivatives that are subject to a master 
netting agreement from any measure used to determine counterparty 
credit risk exposure to all relevant counterparties for risk-based 
capital purposes.
    (ii) A [BANK] that is the protection provider in a credit 
derivative must treat the credit derivative as a wholesale exposure to 
the reference obligor and is not required to calculate a counterparty 
credit risk capital requirement for the

[[Page 62218]]

credit derivative under this section, so long as it does so 
consistently for all such credit derivatives and either includes all or 
excludes all such credit derivatives that are subject to a master 
netting agreement from any measure used to determine counterparty 
credit risk exposure to all relevant counterparties for risk-based 
capital purposes (unless the [BANK] is treating the credit derivative 
as a covered position under subpart F of this part, in which case the 
[BANK] must calculate a supplemental counterparty credit risk capital 
requirement under this section).
    (4) Equity derivatives. A [BANK] must treat an equity derivative 
contract as an equity exposure and compute a risk-weighted asset amount 
for the equity derivative contract under Sec. Sec.  --.151---.155 
(unless the [BANK] is treating the contract as a covered position under 
subpart F of this part). In addition, if the [BANK] is treating the 
contract as a covered position under subpart F of this part, and under 
certain other circumstances described in Sec.  --.155, the [BANK] must 
also calculate a risk-based capital requirement for the counterparty 
credit risk of an equity derivative contract under this section.
    (5) Single OTC derivative contract. Except as modified by paragraph 
(c)(7) of this section, the EAD for a single OTC derivative contract 
that is not subject to a qualifying master netting agreement is equal 
to the sum of the [BANK]'s current credit exposure and potential future 
credit exposure (PFE) on the derivative contract.
    (i) Current credit exposure. The current credit exposure for a 
single OTC derivative contract is the greater of the mark-to-fair value 
of the derivative contract or zero; and
    (ii) PFE. The PFE for a single OTC derivative contract, including 
an OTC derivative contract with a negative mark-to-fair value, is 
calculated by multiplying the notional principal amount of the 
derivative contract by the appropriate conversion factor in Table 2 to 
Sec.  --.132. For purposes of calculating either the PFE under 
paragraph (c)(5) of this section or the gross PFE under paragraph 
(c)(6) of this section for exchange rate contracts and other similar 
contracts in which the notional principal amount is equivalent to the 
cash flows, the notional principal amount is the net receipts to each 
party falling due on each value date in each currency. For any OTC 
derivative contract that does not fall within one of the specified 
categories in Table 2 to Sec.  --.132, the PFE must be calculated using 
the ``other'' conversion factors. A [BANK] must use an OTC derivative 
contract's effective notional principal amount (that is, its apparent 
or stated notional principal amount multiplied by any multiplier in the 
OTC derivative contract) rather than its apparent or stated notional 
principal amount in calculating PFE. PFE of the protection provider of 
a credit derivative is capped at the net present value of the amount of 
unpaid premiums.

                                   Table 2 to Sec.   --.132--Conversion Factor Matrix for OTC Derivative Contracts \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                              Credit       Credit (non-
                                                              Foreign      (investment-     investment-                      Precious
         Remaining maturity \2\            Interest rate   exchange rate       grade           grade          Equity          metals           Other
                                                             and gold        reference       reference                     (except gold)
                                                                            asset) \3\        asset)
--------------------------------------------------------------------------------------------------------------------------------------------------------
One year or less........................            0.00            0.01            0.05            0.10            0.06            0.07            0.10
Over one to five years..................           0.005            0.05            0.05            0.10            0.08            0.07            0.12
Over five years.........................           0.015           0.075            0.05            0.10            0.10            0.08            0.15
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ For an OTC derivative contract with multiple exchanges of principal, the conversion factor is multiplied by the number of remaining payments in the
  derivative contract.
\2\ For an OTC derivative contract that is structured such that on specified dates any outstanding exposure is settled and the terms are reset so that
  the fair value of the contract is zero, the remaining maturity equals the time until the next reset date. For an interest rate derivative contract
  with a remaining maturity of greater than one year that meets these criteria, the minimum conversion factor is 0.005.
\3\ A [BANK] must use the column labeled ``Credit (investment-grade reference asset)'' for a credit derivative whose reference asset is an outstanding
  unsecured long-term debt security without credit enhancement that is investment grade. A [BANK] must use the column labeled ``Credit (non-investment-
  grade reference asset)'' for all other credit derivatives.

    (6) Multiple OTC derivative contracts subject to a qualifying 
master netting agreement. Except as modified by paragraph (c)(7) of 
this section, the EAD for multiple OTC derivative contracts subject to 
a qualifying master netting agreement is equal to the sum of the net 
current credit exposure and the adjusted sum of the PFE exposure for 
all OTC derivative contracts subject to the qualifying master netting 
agreement.
    (i) Net current credit exposure. The net current credit exposure is 
the greater of:
    (A) The net sum of all positive and negative fair values of the 
individual OTC derivative contracts subject to the qualifying master 
netting agreement; or
    (B) Zero; and
    (ii) Adjusted sum of the PFE. The adjusted sum of the PFE, 
Anet, is calculated as

Anet = (0.4 x Agross) + (0.6 x NGR x 
Agross),

where:

(A) Agross = the gross PFE (that is, the sum of the PFE 
amounts (as determined under paragraph (c)(5)(ii) of this section) 
for each individual derivative contract subject to the qualifying 
master netting agreement); and
(B) NGR = the net to gross ratio (that is, the ratio of the net 
current credit exposure to the gross current credit exposure). In 
calculating the NGR, the gross current credit exposure equals the 
sum of the positive current credit exposures (as determined under 
paragraph (c)(6)(i) of this section) of all individual derivative 
contracts subject to the qualifying master netting agreement.

    (7) Collateralized OTC derivative contracts. A [BANK] may recognize 
the credit risk mitigation benefits of financial collateral that 
secures an OTC derivative contract or single-product netting set of OTC 
derivatives by factoring the collateral into its LGD estimates for the 
contract or netting set. Alternatively, a [BANK] may recognize the 
credit risk mitigation benefits of financial collateral that secures 
such a contract or netting set that is marked-to-market on a daily 
basis and subject to a daily margin maintenance requirement by 
estimating an unsecured LGD for the contract or netting set and 
adjusting the EAD calculated under paragraph (c)(5) or (c)(6) of this 
section using the collateral haircut approach in paragraph (b)(2) of 
this section. The [BANK] must substitute the EAD calculated under 
paragraph (c)(5) or (c)(6) of this section for [sum]E in the equation 
in paragraph (b)(2)(i) of this section and must use a ten-business day 
minimum holding period (TM = 10) unless a longer holding 
period is required by paragraph (b)(2)(iii)(A)(3) of this section.

[[Page 62219]]

    (8) Clearing member [BANK]'s EAD. A clearing member [BANK]'s EAD 
for an OTC derivative contract or netting set of OTC derivative 
contracts where the [BANK] is either acting as a financial intermediary 
and enters into an offsetting transaction with a QCCP or where the 
[BANK] provides a guarantee to the QCCP on the performance of the 
client equals the exposure amount calculated according to paragraph 
(c)(5) or (6) of this section multiplied by the scaling factor 0.71. If 
the [BANK] determines that a longer period is appropriate, it must use 
a larger scaling factor to adjust for a longer holding period as 
follows:
[GRAPHIC] [TIFF OMITTED] TR11OC13.032


where

H = the holding period greater than five days. Additionally, the 
[AGENCY] may require the [BANK] to set a longer holding period if 
the [AGENCY] determines that a longer period is appropriate due to 
the nature, structure, or characteristics of the transaction or is 
commensurate with the risks associated with the transaction.

    (d) Internal models methodology. (1)(i) With prior written approval 
from the [AGENCY], a [BANK] may use the internal models methodology in 
this paragraph (d) to determine EAD for counterparty credit risk for 
derivative contracts (collateralized or uncollateralized) and single-
product netting sets thereof, for eligible margin loans and single-
product netting sets thereof, and for repo-style transactions and 
single-product netting sets thereof.
    (ii) A [BANK] that uses the internal models methodology for a 
particular transaction type (derivative contracts, eligible margin 
loans, or repo-style transactions) must use the internal models 
methodology for all transactions of that transaction type. A [BANK] may 
choose to use the internal models methodology for one or two of these 
three types of exposures and not the other types.
    (iii) A [BANK] may also use the internal models methodology for 
derivative contracts, eligible margin loans, and repo-style 
transactions subject to a qualifying cross-product netting agreement 
if:
    (A) The [BANK] effectively integrates the risk mitigating effects 
of cross-product netting into its risk management and other information 
technology systems; and
    (B) The [BANK] obtains the prior written approval of the [AGENCY].
    (iv) A [BANK] that uses the internal models methodology for a 
transaction type must receive approval from the [AGENCY] to cease using 
the methodology for that transaction type or to make a material change 
to its internal model.
    (2) Risk-weighted assets using IMM. Under the IMM, a [BANK] uses an 
internal model to estimate the expected exposure (EE) for a netting set 
and then calculates EAD based on that EE. A [BANK] must calculate two 
EEs and two EADs (one stressed and one unstressed) for each netting set 
as follows:
    (i) EADunstressed is calculated using an EE estimate 
based on the most recent data meeting the requirements of paragraph 
(d)(3)(vii) of this section;
    (ii) EADstressed is calculated using an EE estimate 
based on a historical period that includes a period of stress to the 
credit default spreads of the [BANK]'s counterparties according to 
paragraph (d)(3)(viii) of this section;
    (iii) The [BANK] must use its internal model's probability 
distribution for changes in the fair value of a netting set that are 
attributable to changes in market variables to determine EE; and
    (iv) Under the internal models methodology, EAD = Max (0, [alpha] x 
effective EPE - CVA), or, subject to the prior written approval of 
[AGENCY] as provided in paragraph (d)(10) of this section, a more 
conservative measure of EAD.
    (A) CVA equals the credit valuation adjustment that the [BANK] has 
recognized in its balance sheet valuation of any OTC derivative 
contracts in the netting set. For purposes of this paragraph (d), CVA 
does not include any adjustments to common equity tier 1 capital 
attributable to changes in the fair value of the [BANK]'s liabilities 
that are due to changes in its own credit risk since the inception of 
the transaction with the counterparty.
[GRAPHIC] [TIFF OMITTED] TR11OC13.033

    (C) [alpha] = 1.4 except as provided in paragraph (d)(5) of this 
section, or when the [AGENCY] has determined that the [BANK] must set 
[alpha] higher based on the [BANK]'s specific characteristics of

[[Page 62220]]

counterparty credit risk or model performance.
    (v) A [BANK] may include financial collateral currently posted by 
the counterparty as collateral (but may not include other forms of 
collateral) when calculating EE.
    (vi) If a [BANK] hedges some or all of the counterparty credit risk 
associated with a netting set using an eligible credit derivative, the 
[BANK] may take the reduction in exposure to the counterparty into 
account when estimating EE. If the [BANK] recognizes this reduction in 
exposure to the counterparty in its estimate of EE, it must also use 
its internal model to estimate a separate EAD for the [BANK]'s exposure 
to the protection provider of the credit derivative.
    (3) Prior approval relating to EAD calculation. To obtain [AGENCY] 
approval to calculate the distributions of exposures upon which the EAD 
calculation is based, the [BANK] must demonstrate to the satisfaction 
of the [AGENCY] that it has been using for at least one year an 
internal model that broadly meets the following minimum standards, with 
which the [BANK] must maintain compliance:
    (i) The model must have the systems capability to estimate the 
expected exposure to the counterparty on a daily basis (but is not 
expected to estimate or report expected exposure on a daily basis);
    (ii) The model must estimate expected exposure at enough future 
dates to reflect accurately all the future cash flows of contracts in 
the netting set;
    (iii) The model must account for the possible non-normality of the 
exposure distribution, where appropriate;
    (iv) The [BANK] must measure, monitor, and control current 
counterparty exposure and the exposure to the counterparty over the 
whole life of all contracts in the netting set;
    (v) The [BANK] must be able to measure and manage current exposures 
gross and net of collateral held, where appropriate. The [BANK] must 
estimate expected exposures for OTC derivative contracts both with and 
without the effect of collateral agreements;
    (vi) The [BANK] must have procedures to identify, monitor, and 
control wrong-way risk throughout the life of an exposure. The 
procedures must include stress testing and scenario analysis;
    (vii) The model must use current market data to compute current 
exposures. The [BANK] must estimate model parameters using historical 
data from the most recent three-year period and update the data 
quarterly or more frequently if market conditions warrant. The [BANK] 
should consider using model parameters based on forward-looking 
measures, where appropriate;
    (viii) When estimating model parameters based on a stress period, 
the [BANK] must use at least three years of historical data that 
include a period of stress to the credit default spreads of the 
[BANK]'s counterparties. The [BANK] must review the data set and update 
the data as necessary, particularly for any material changes in its 
counterparties. The [BANK] must demonstrate, at least quarterly, and 
maintain documentation of such demonstration, that the stress period 
coincides with increased CDS or other credit spreads of the [BANK]'s 
counterparties. The [BANK] must have procedures to evaluate the 
effectiveness of its stress calibration that include a process for 
using benchmark portfolios that are vulnerable to the same risk factors 
as the [BANK]'s portfolio. The [AGENCY] may require the [BANK] to 
modify its stress calibration to better reflect actual historic losses 
of the portfolio;
    (ix) A [BANK] must subject its internal model to an initial 
validation and annual model review process. The model review should 
consider whether the inputs and risk factors, as well as the model 
outputs, are appropriate. As part of the model review process, the 
[BANK] must have a backtesting program for its model that includes a 
process by which unacceptable model performance will be determined and 
remedied;
    (x) A [BANK] must have policies for the measurement, management and 
control of collateral and margin amounts; and
    (xi) A [BANK] must have a comprehensive stress testing program that 
captures all credit exposures to counterparties, and incorporates 
stress testing of principal market risk factors and creditworthiness of 
counterparties.
    (4) Calculating the maturity of exposures. (i) If the remaining 
maturity of the exposure or the longest-dated contract in the netting 
set is greater than one year, the [BANK] must set M for the exposure or 
netting set equal to the lower of five years or M(EPE), where:
[GRAPHIC] [TIFF OMITTED] TR11OC13.034

    (ii) If the remaining maturity of the exposure or the longest-dated 
contract in the netting set is one year or less, the [BANK] must set M 
for the exposure or netting set equal to one year, except as provided 
in Sec.  --.131(d)(7).
    (iii) Alternatively, a [BANK] that uses an internal model to 
calculate a one-sided credit valuation adjustment may use the effective 
credit duration estimated by the model as M(EPE) in place of the 
formula in paragraph (d)(4)(i) of this section.
    (5) Effects of collateral agreements on EAD. A [BANK] may capture 
the effect on EAD of a collateral agreement that requires receipt of 
collateral when exposure to the counterparty increases, but may not 
capture the effect on EAD of a collateral agreement that requires 
receipt of collateral when counterparty credit quality deteriorates. 
Two methods are available to capture the effect of a collateral 
agreement, as set forth in paragraphs (d)(5)(i) and (ii) of this 
section:
    (i) With prior written approval from the [AGENCY], a [BANK] may 
include the effect of a collateral agreement within its internal model 
used to

[[Page 62221]]

calculate EAD. The [BANK] may set EAD equal to the expected exposure at 
the end of the margin period of risk. The margin period of risk means, 
with respect to a netting set subject to a collateral agreement, the 
time period from the most recent exchange of collateral with a 
counterparty until the next required exchange of collateral, plus the 
period of time required to sell and realize the proceeds of the least 
liquid collateral that can be delivered under the terms of the 
collateral agreement and, where applicable, the period of time required 
to re-hedge the resulting market risk upon the default of the 
counterparty. The minimum margin period of risk is set according to 
paragraph (d)(5)(iii) of this section; or
    (ii) As an alternative to paragraph (d)(5)(i) of this section, a 
[BANK] that can model EPE without collateral agreements but cannot 
achieve the higher level of modeling sophistication to model EPE with 
collateral agreements can set effective EPE for a collateralized 
netting set equal to the lesser of:
    (A) An add-on that reflects the potential increase in exposure of 
the netting set over the margin period of risk, plus the larger of:
    (1) The current exposure of the netting set reflecting all 
collateral held or posted by the [BANK] excluding any collateral called 
or in dispute; or
    (2) The largest net exposure including all collateral held or 
posted under the margin agreement that would not trigger a collateral 
call. For purposes of this section, the add-on is computed as the 
expected increase in the netting set's exposure over the margin period 
of risk (set in accordance with paragraph (d)(5)(iii) of this section); 
or
    (B) Effective EPE without a collateral agreement plus any 
collateral the [BANK] posts to the counterparty that exceeds the 
required margin amount.
    (iii) For purposes of this part, including paragraphs (d)(5)(i) and 
(ii) of this section, the margin period of risk for a netting set 
subject to a collateral agreement is:
    (A) Five business days for repo-style transactions subject to daily 
remargining and daily marking-to-market, and ten business days for 
other transactions when liquid financial collateral is posted under a 
daily margin maintenance requirement, or
    (B) Twenty business days if the number of trades in a netting set 
exceeds 5,000 at any time during the previous quarter or contains one 
or more trades involving illiquid collateral or any derivative contract 
that cannot be easily replaced (except if the [BANK] is calculating EAD 
for a cleared transaction under Sec.  --.133). If over the two previous 
quarters more than two margin disputes on a netting set have occurred 
that lasted more than the margin period of risk, then the [BANK] must 
use a margin period of risk for that netting set that is at least two 
times the minimum margin period of risk for that netting set. If the 
periodicity of the receipt of collateral is N-days, the minimum margin 
period of risk is the minimum margin period of risk under this 
paragraph (d) plus N minus 1. This period should be extended to cover 
any impediments to prompt re-hedging of any market risk.
    (C) Five business days for an OTC derivative contract or netting 
set of OTC derivative contracts where the [BANK] is either acting as a 
financial intermediary and enters into an offsetting transaction with a 
CCP or where the [BANK] provides a guarantee to the CCP on the 
performance of the client. A [BANK] must use a longer holding period if 
the [BANK] determines that a longer period is appropriate. 
Additionally, the [AGENCY] may require the [BANK] to set a longer 
holding period if the [AGENCY] determines that a longer period is 
appropriate due to the nature, structure, or characteristics of the 
transaction or is commensurate with the risks associated with the 
transaction.
    (6) Own estimate of alpha. With prior written approval of the 
[AGENCY], a [BANK] may calculate alpha as the ratio of economic capital 
from a full simulation of counterparty exposure across counterparties 
that incorporates a joint simulation of market and credit risk factors 
(numerator) and economic capital based on EPE (denominator), subject to 
a floor of 1.2. For purposes of this calculation, economic capital is 
the unexpected losses for all counterparty credit risks measured at a 
99.9 percent confidence level over a one-year horizon. To receive 
approval, the [BANK] must meet the following minimum standards to the 
satisfaction of the [AGENCY]:
    (i) The [BANK]'s own estimate of alpha must capture in the 
numerator the effects of:
    (A) The material sources of stochastic dependency of distributions 
of fair values of transactions or portfolios of transactions across 
counterparties;
    (B) Volatilities and correlations of market risk factors used in 
the joint simulation, which must be related to the credit risk factor 
used in the simulation to reflect potential increases in volatility or 
correlation in an economic downturn, where appropriate; and
    (C) The granularity of exposures (that is, the effect of a 
concentration in the proportion of each counterparty's exposure that is 
driven by a particular risk factor).
    (ii) The [BANK] must assess the potential model uncertainty in its 
estimates of alpha.
    (iii) The [BANK] must calculate the numerator and denominator of 
alpha in a consistent fashion with respect to modeling methodology, 
parameter specifications, and portfolio composition.
    (iv) The [BANK] must review and adjust as appropriate its estimates 
of the numerator and denominator of alpha on at least a quarterly basis 
and more frequently when the composition of the portfolio varies over 
time.
    (7) Risk-based capital requirements for transactions with specific 
wrong-way risk. A [BANK] must determine if a repo-style transaction, 
eligible margin loan, bond option, or equity derivative contract or 
purchased credit derivative to which the [BANK] applies the internal 
models methodology under this paragraph (d) has specific wrong-way 
risk. If a transaction has specific wrong-way risk, the [BANK] must 
treat the transaction as its own netting set and exclude it from the 
model described in Sec.  --.132(d)(2) and instead calculate the risk-
based capital requirement for the transaction as follows:
    (i) For an equity derivative contract, by multiplying:
    (A) K, calculated using the appropriate risk-based capital formula 
specified in Table 1 of Sec.  --.131 using the PD of the counterparty 
and LGD equal to 100 percent, by
    (B) The maximum amount the [BANK] could lose on the equity 
derivative.
    (ii) For a purchased credit derivative by multiplying:
    (A) K, calculated using the appropriate risk-based capital formula 
specified in Table 1 of Sec.  --.131 using the PD of the counterparty 
and LGD equal to 100 percent, by
    (B) The fair value of the reference asset of the credit derivative.
    (iii) For a bond option, by multiplying:
    (A) K, calculated using the appropriate risk-based capital formula 
specified in Table 1 of Sec.  --.131 using the PD of the counterparty 
and LGD equal to 100 percent, by
    (B) The smaller of the notional amount of the underlying reference 
asset and the maximum potential loss under the bond option contract.
    (iv) For a repo-style transaction or eligible margin loan by 
multiplying:
    (A) K, calculated using the appropriate risk-based capital formula 
specified in Table 1 of Sec.  --.131 using the

[[Page 62222]]

PD of the counterparty and LGD equal to 100 percent, by
    (B) The EAD of the transaction determined according to the EAD 
equation in Sec.  --.131(b)(2), substituting the estimated value of the 
collateral assuming a default of the counterparty for the value of the 
collateral in [Sigma]c of the equation.
    (8) Risk-weighted asset amount for IMM exposures with specific 
wrong-way risk. The aggregate risk-weighted asset amount for IMM 
exposures with specific wrong-way risk is the sum of a [BANK]'s risk-
based capital requirement for purchased credit derivatives that are not 
bond options with specific wrong-way risk as calculated under paragraph 
(d)(7)(ii) of this section, a [BANK]'s risk-based capital requirement 
for equity derivatives with specific wrong-way risk as calculated under 
paragraph (d)(7)(i) of this section, a [BANK]'s risk-based capital 
requirement for bond options with specific wrong-way risk as calculated 
under paragraph (d)(7)(iii) of this section, and a [BANK]'s risk-based 
capital requirement for repo-style transactions and eligible margin 
loans with specific wrong-way risk as calculated under paragraph 
(d)(7)(iv) of this section, multiplied by 12.5.
    (9) Risk-weighted assets for IMM exposures. (i) The [BANK] must 
insert the assigned risk parameters for each counterparty and netting 
set into the appropriate formula specified in Table 1 of Sec.  --.131 
and multiply the output of the formula by the EADunstressed 
of the netting set to obtain the unstressed capital requirement for 
each netting set. A [BANK] that uses an advanced CVA approach that 
captures migrations in credit spreads under paragraph (e)(3) of this 
section must set the maturity adjustment (b) in the formula equal to 
zero. The sum of the unstressed capital requirement calculated for each 
netting set equals Kunstressed.
    (ii) The [BANK] must insert the assigned risk parameters for each 
wholesale obligor and netting set into the appropriate formula 
specified in Table 1 of Sec.  --.131 and multiply the output of the 
formula by the EADstressed of the netting set to obtain the 
stressed capital requirement for each netting set. A [BANK] that uses 
an advanced CVA approach that captures migrations in credit spreads 
under paragraph (e)(3) of this section must set the maturity adjustment 
(b) in the formula equal to zero. The sum of the stressed capital 
requirement calculated for each netting set equals 
Kstressed.
    (iii) The [BANK]'s dollar risk-based capital requirement under the 
internal models methodology equals the larger of Kunstressed 
and Kstressed. A [BANK]'s risk-weighted assets amount for 
IMM exposures is equal to the capital requirement multiplied by 12.5, 
plus risk-weighted assets for IMM exposures with specific wrong-way 
risk in paragraph (d)(8) of this section and those in paragraph (d)(10) 
of this section.
    (10) Other measures of counterparty exposure. (i) With prior 
written approval of the [AGENCY], a [BANK] may set EAD equal to a 
measure of counterparty credit risk exposure, such as peak EAD, that is 
more conservative than an alpha of 1.4 (or higher under the terms of 
paragraph (d)(7)(iv)(C) of this section) times the larger of 
EPEunstressed and EPEstressed for every 
counterparty whose EAD will be measured under the alternative measure 
of counterparty exposure. The [BANK] must demonstrate the conservatism 
of the measure of counterparty credit risk exposure used for EAD. With 
respect to paragraph (d)(10)(i) of this section:
    (A) For material portfolios of new OTC derivative products, the 
[BANK] may assume that the current exposure methodology in paragraphs 
(c)(5) and (c)(6) of this section meets the conservatism requirement of 
this section for a period not to exceed 180 days.
    (B) For immaterial portfolios of OTC derivative contracts, the 
[BANK] generally may assume that the current exposure methodology in 
paragraphs (c)(5) and (c)(6) of this section meets the conservatism 
requirement of this section.
    (ii) To calculate risk-weighted assets for purposes of the approach 
in paragraph (d)(10)(i) of this section, the [BANK] must insert the 
assigned risk parameters for each counterparty and netting set into the 
appropriate formula specified in Table 1 of Sec.  --.131, multiply the 
output of the formula by the EAD for the exposure as specified above, 
and multiply by 12.5.
    (e) Credit valuation adjustment (CVA) risk-weighted assets--(1) In 
general. With respect to its OTC derivative contracts, a [BANK] must 
calculate a CVA risk-weighted asset amount for its portfolio of OTC 
derivative transactions that are subject to the CVA capital requirement 
using the simple CVA approach described in paragraph (e)(5) of this 
section or, with prior written approval of the [AGENCY], the advanced 
CVA approach described in paragraph (e)(6) of this section. A [BANK] 
that receives prior [AGENCY] approval to calculate its CVA risk-
weighted asset amounts for a class of counterparties using the advanced 
CVA approach must continue to use that approach for that class of 
counterparties until it notifies the [AGENCY] in writing that the 
[BANK] expects to begin calculating its CVA risk-weighted asset amount 
using the simple CVA approach. Such notice must include an explanation 
of the [BANK]'s rationale and the date upon which the [BANK] will begin 
to calculate its CVA risk-weighted asset amount using the simple CVA 
approach.
    (2) Market risk [BANK]s. Notwithstanding the prior approval 
requirement in paragraph (e)(1) of this section, a market risk [BANK] 
may calculate its CVA risk-weighted asset amount using the advanced CVA 
approach if the [BANK] has [AGENCY] approval to:
    (i) Determine EAD for OTC derivative contracts using the internal 
models methodology described in paragraph (d) of this section; and
    (ii) Determine its specific risk add-on for debt positions issued 
by the counterparty using a specific risk model described in Sec.  
--.207(b).
    (3) Recognition of hedges. (i) A [BANK] may recognize a single name 
CDS, single name contingent CDS, any other equivalent hedging 
instrument that references the counterparty directly, and index credit 
default swaps (CDSind) as a CVA hedge under paragraph 
(e)(5)(ii) of this section or paragraph (e)(6) of this section, 
provided that the position is managed as a CVA hedge in accordance with 
the [BANK]'s hedging policies.
    (ii) A [BANK] shall not recognize as a CVA hedge any tranched or 
n^th-to-default credit derivative.
    (4) Total CVA risk-weighted assets. Total CVA risk-weighted assets 
is the CVA capital requirement, KCVA, calculated for a 
[BANK]'s entire portfolio of OTC derivative counterparties that are 
subject to the CVA capital requirement, multiplied by 12.5.
    (5) Simple CVA approach. (i) Under the simple CVA approach, the CVA 
capital requirement, KCVA, is calculated according to the 
following formula:

[[Page 62223]]

[GRAPHIC] [TIFF OMITTED] TR11OC13.035

(A) wi = the weight applicable to counterparty i under Table 3 to 
Sec.  --.132;
(B) Mi = the EAD-weighted average of the effective maturity of each 
netting set with counterparty i (where each netting set's effective 
maturity can be no less than one year.)
(C) EADitotal = the sum of the EAD for all netting sets of OTC 
derivative contracts with counterparty i calculated using the 
current exposure methodology described in paragraph (c) of this 
section or the internal models methodology described in paragraph 
(d) of this section. When the [BANK] calculates EAD under paragraph 
(c) of this section, such EAD may be adjusted for purposes of 
calculating EADitotal by multiplying EAD by (1-exp(-0.05 x Mi))/
(0.05 x Mi), where ``exp'' is the exponential function. When the 
[BANK] calculates EAD under paragraph (d) of this section, EADitotal 
equals EADunstressed.
(D) Mihedge = the notional weighted average maturity of the hedge 
instrument.
(E) Bi = the sum of the notional amounts of any purchased single 
name CDS referencing counterparty i that is used to hedge CVA risk 
to counterparty i multiplied by (1-exp(-0.05 x Mihedge))/(0.05 x 
Mihedge).
(F) Mind = the maturity of the CDSind or the 
notional weighted average maturity of any CDSind 
purchased to hedge CVA risk of counterparty i.
(G) Bind = the notional amount of one or more CDSind 
purchased to hedge CVA risk for counterparty i multiplied by (1-
exp(-0.05 x Mind))/(0.05 x Mind)
(H) wind = the weight applicable to the CDSind based on 
the average weight of the underlying reference names that comprise 
the index under Table 3 to Sec.  --.132.

    (ii) The [BANK] may treat the notional amount of the index 
attributable to a counterparty as a single name hedge of counterparty i 
(Bi,) when calculating KCVA, and subtract the notional 
amount of Bi from the notional amount of the CDSind. A 
[BANK] must treat the CDSind hedge with the notional amount 
reduced by Bi as a CVA hedge.

       Table 3 to Sec.   --.132--Assignment of Counterparty Weight
------------------------------------------------------------------------
                                                          Weight wi  (in
                Internal PD  (in percent)                    percent)
------------------------------------------------------------------------
0.00-0.07...............................................            0.70
>0.070-0.15.............................................            0.80
>0.15-0.40..............................................            1.00
>0.40-2.00..............................................            2.00
>2.00-6.00..............................................            3.00
>6.00...................................................           10.00
------------------------------------------------------------------------

    (6) Advanced CVA approach. (i) A [BANK] may use the VaR model that 
it uses to determine specific risk under Sec.  --.207(b) or another VaR 
model that meets the quantitative requirements of Sec.  --.205(b) and 
Sec.  --.207(b)(1) to calculate its CVA capital requirement for a 
counterparty by modeling the impact of changes in the counterparties' 
credit spreads, together with any recognized CVA hedges, on the CVA for 
the counterparties, subject to the following requirements:
    (A) The VaR model must incorporate only changes in the 
counterparties' credit spreads, not changes in other risk factors. The 
VaR model does not need to capture jump-to-default risk;
    (B) A [BANK] that qualifies to use the advanced CVA approach must 
include in that approach any immaterial OTC derivative portfolios for 
which it uses the current exposure methodology in paragraph (c) of this 
section according to paragraph (e)(6)(viii) of this section; and
    (C) A [BANK] must have the systems capability to calculate the CVA 
capital requirement for a counterparty on a daily basis (but is not 
required to calculate the CVA capital requirement on a daily basis).
    (ii) Under the advanced CVA approach, the CVA capital requirement, 
KCVA, is calculated according to the following formulas:

[[Page 62224]]

[GRAPHIC] [TIFF OMITTED] TR11OC13.037

Where

(A) ti = the time of the i-th revaluation time bucket starting from 
t0 = 0.
(B) tT = the longest contractual maturity across the OTC derivative 
contracts with the counterparty.
(C) si = the CDS spread for the counterparty at tenor ti used to 
calculate the CVA for the counterparty. If a CDS spread is not 
available, the [BANK] must use a proxy spread based on the credit 
quality, industry and region of the counterparty.
(D) LGDMKT = the loss given default of the counterparty based on the 
spread of a publicly traded debt instrument of the counterparty, or, 
where a publicly traded debt instrument spread is not available, a 
proxy spread based on the credit quality, industry, and region of 
the counterparty. Where no market information and no reliable proxy 
based on the credit quality, industry, and region of the 
counterparty are available to determine LGDMKT, a [BANK] 
may use a conservative estimate when determining LGDMKT, 
subject to approval by the [AGENCY].
(E) EEi = the sum of the expected exposures for all netting sets 
with the counterparty at revaluation time ti, calculated according 
to paragraphs (e)(6)(iv)(A) and (e)(6)(v)(A) of this section.
(F) Di = the risk-free discount factor at time ti, where D0 = 1.
(G) Exp is the exponential function.
(H) The subscript j refers either to a stressed or an unstressed 
calibration as described in paragraphs (e)(6)(iv) and (v) of this 
section.

    (iii) Notwithstanding paragraphs (e)(6)(i) and (e)(6)(ii) of this 
section, a [BANK] must use the formulas in paragraphs (e)(6)(iii)(A) or 
(e)(6)(iii)(B) of this section to calculate credit spread sensitivities 
if its VaR model is not based on full repricing.
    (A) If the VaR model is based on credit spread sensitivities for 
specific tenors, the [BANK] must calculate each credit spread 
sensitivity according to the following formula:
[GRAPHIC] [TIFF OMITTED] TR11OC13.039


[[Page 62225]]


    (iv) To calculate the CVAUnstressed measure for purposes 
of paragraph (e)(6)(ii) of this section, the [BANK] must:
    (A) Use the EEi calculated using the calibration of 
paragraph (d)(3)(vii) of this section, except as provided in Sec.  
--.132(e)(6)(vi), and
    (B) Use the historical observation period required under Sec.  
--.205(b)(2).
    (v) To calculate the CVAStressed measure for purposes of 
paragraph (e)(6)(ii) of this section, the [BANK] must:
    (A) Use the EEi calculated using the stress calibration 
in paragraph (d)(3)(viii) of this section except as provided in 
paragraph (e)(6)(vi) of this section.
    (B) Calibrate VaR model inputs to historical data from the most 
severe twelve-month stress period contained within the three-year 
stress period used to calculate EEi. The [AGENCY] may 
require a [BANK] to use a different period of significant financial 
stress in the calculation of the CVAStressed measure.
    (vi) If a [BANK] captures the effect of a collateral agreement on 
EAD using the method described in paragraph (d)(5)(ii) of this section, 
for purposes of paragraph (e)(6)(ii) of this section, the [BANK] must 
calculate EEi using the method in paragraph (d)(5)(ii) of 
this section and keep that EE constant with the maturity equal to the 
maximum of:
    (A) Half of the longest maturity of a transaction in the netting 
set, and
    (B) The notional weighted average maturity of all transactions in 
the netting set.
    (vii) For purposes of paragraph (e)(6) of this section, the 
[BANK]'s VaR model must capture the basis between the spreads of any 
CDSind that is used as the hedging instrument and the hedged 
counterparty exposure over various time periods, including benign and 
stressed environments. If the VaR model does not capture that basis, 
the [BANK] must reflect only 50 percent of the notional amount of the 
CDSind hedge in the VaR model.
    (viii) If a [BANK] uses the current exposure methodology described 
in paragraphs (c)(5) and (c)(6) of this section to calculate the EAD 
for any immaterial portfolios of OTC derivative contracts, the [BANK] 
must use that EAD as a constant EE in the formula for the calculation 
of CVA with the maturity equal to the maximum of:
    (A) Half of the longest maturity of a transaction in the netting 
set, and
    (B) The notional weighted average maturity of all transactions in 
the netting set.


Sec.  --.133  Cleared transactions.

    (a) General requirements. (1) A [BANK] that is a clearing member 
client must use the methodologies described in paragraph (b) of this 
section to calculate risk-weighted assets for a cleared transaction.
    (2) A [BANK] that is a clearing member must use the methodologies 
described in paragraph (c) of this section to calculate its risk-
weighted assets for cleared transactions and paragraph (d) of this 
section to calculate its risk-weighted assets for its default fund 
contribution to a CCP.
    (b) Clearing member client [BANK]s--(1) Risk-weighted assets for 
cleared transactions. (i) To determine the risk-weighted asset amount 
for a cleared transaction, a [BANK] that is a clearing member client 
must multiply the trade exposure amount for the cleared transaction, 
calculated in accordance with paragraph (b)(2) of this section, by the 
risk weight appropriate for the cleared transaction, determined in 
accordance with paragraph (b)(3) of this section.
    (ii) A clearing member client [BANK]'s total risk-weighted assets 
for cleared transactions is the sum of the risk-weighted asset amounts 
for all of its cleared transactions.
    (2) Trade exposure amount. (i) For a cleared transaction that is a 
derivative contract or a netting set of derivative contracts, trade 
exposure amount equals the EAD for the derivative contract or netting 
set of derivative contracts calculated using the methodology used to 
calculate EAD for OTC derivative contracts set forth in Sec.  --.132(c) 
or (d), plus the fair value of the collateral posted by the clearing 
member client [BANK] and held by the CCP or a clearing member in a 
manner that is not bankruptcy remote. When the [BANK] calculates EAD 
for the cleared transaction using the methodology in Sec.  --.132(d), 
EAD equals EADunstressed.
    (ii) For a cleared transaction that is a repo-style transaction or 
netting set of repo-style transactions, trade exposure amount equals 
the EAD for the repo-style transaction calculated using the methodology 
set forth in Sec.  --.132(b)(2), (b)(3), or (d), plus the fair value of 
the collateral posted by the clearing member client [BANK] and held by 
the CCP or a clearing member in a manner that is not bankruptcy remote. 
When the [BANK] calculates EAD for the cleared transaction under Sec.  
--.132(d), EAD equals EADunstressed.
    (3) Cleared transaction risk weights. (i) For a cleared transaction 
with a QCCP, a clearing member client [BANK] must apply a risk weight 
of:
    (A) 2 percent if the collateral posted by the [BANK] to the QCCP or 
clearing member is subject to an arrangement that prevents any loss to 
the clearing member client [BANK] due to the joint default or a 
concurrent insolvency, liquidation, or receivership proceeding of the 
clearing member and any other clearing member clients of the clearing 
member; and the clearing member client [BANK] has conducted sufficient 
legal review to conclude with a well-founded basis (and maintains 
sufficient written documentation of that legal review) that in the 
event of a legal challenge (including one resulting from an event of 
default or from liquidation, insolvency or receivership proceedings) 
the relevant court and administrative authorities would find the 
arrangements to be legal, valid, binding and enforceable under the law 
of the relevant jurisdictions.
    (B) 4 percent, if the requirements of Sec.  --.132(b)(3)(i)(A) are 
not met.
    (ii) For a cleared transaction with a CCP that is not a QCCP, a 
clearing member client [BANK] must apply the risk weight applicable to 
the CCP under Sec.  --.32.
    (4) Collateral. (i) Notwithstanding any other requirement of this 
section, collateral posted by a clearing member client [BANK] that is 
held by a custodian (in its capacity as custodian) in a manner that is 
bankruptcy remote from the CCP, the custodian, clearing member, and 
other clearing member clients of the clearing member, is not subject to 
a capital requirement under this section.
    (ii) A clearing member client [BANK] must calculate a risk-weighted 
asset amount for any collateral provided to a CCP, clearing member or a 
custodian in connection with a cleared transaction in accordance with 
requirements under Sec.  --.131.
    (c) Clearing member [BANK]--(1) Risk-weighted assets for cleared 
transactions. (i) To determine the risk-weighted asset amount for a 
cleared transaction, a clearing member [BANK] must multiply the trade 
exposure amount for the cleared transaction, calculated in accordance 
with paragraph (c)(2) of this section by the risk weight appropriate 
for the cleared transaction, determined in accordance with paragraph 
(c)(3) of this section.
    (ii) A clearing member [BANK]'s total risk-weighted assets for 
cleared transactions is the sum of the risk-weighted asset amounts for 
all of its cleared transactions.
    (2) Trade exposure amount. A clearing member [BANK] must calculate 
its trade exposure amount for a cleared transaction as follows:

[[Page 62226]]

    (i) For a cleared transaction that is a derivative contract or a 
netting set of derivative contracts, trade exposure amount equals the 
EAD calculated using the methodology used to calculate EAD for OTC 
derivative contracts set forth in Sec.  --.132(c) or Sec.  --.132(d), 
plus the fair value of the collateral posted by the clearing member 
[BANK] and held by the CCP in a manner that is not bankruptcy remote. 
When the clearing member [BANK] calculates EAD for the cleared 
transaction using the methodology in Sec.  --.132(d), EAD equals 
EADunstressed.
    (ii) For a cleared transaction that is a repo-style transaction or 
netting set of repo-style transactions, trade exposure amount equals 
the EAD calculated under Sec. Sec.  --.132(b)(2), (b)(3), or (d), plus 
the fair value of the collateral posted by the clearing member [BANK] 
and held by the CCP in a manner that is not bankruptcy remote. When the 
clearing member [BANK] calculates EAD for the cleared transaction under 
Sec.  --.132(d), EAD equals EADunstressed.
    (3) Cleared transaction risk weights. (i) A clearing member [BANK] 
must apply a risk weight of 2 percent to the trade exposure amount for 
a cleared transaction with a QCCP.
    (ii) For a cleared transaction with a CCP that is not a QCCP, a 
clearing member [BANK] must apply the risk weight applicable to the CCP 
according to Sec.  --.32.
    (4) Collateral. (i) Notwithstanding any other requirement of this 
section, collateral posted by a clearing member [BANK] that is held by 
a custodian in a manner that is bankruptcy remote from the CCP is not 
subject to a capital requirement under this section.
    (ii) A clearing member [BANK] must calculate a risk-weighted asset 
amount for any collateral provided to a CCP, clearing member or a 
custodian in connection with a cleared transaction in accordance with 
requirements under Sec.  --.131
    (d) Default fund contributions--(1) General requirement. A clearing 
member [BANK] must determine the risk-weighted asset amount for a 
default fund contribution to a CCP at least quarterly, or more 
frequently if, in the opinion of the [BANK] or the [AGENCY], there is a 
material change in the financial condition of the CCP.
    (2) Risk-weighted asset amount for default fund contributions to 
non-qualifying CCPs. A clearing member [BANK]'s risk-weighted asset 
amount for default fund contributions to CCPs that are not QCCPs equals 
the sum of such default fund contributions multiplied by 1,250 percent 
or an amount determined by the [AGENCY], based on factors such as size, 
structure and membership characteristics of the CCP and riskiness of 
its transactions, in cases where such default fund contributions may be 
unlimited.
    (3) Risk-weighted asset amount for default fund contributions to 
QCCPs. A clearing member [BANK]'s risk-weighted asset amount for 
default fund contributions to QCCPs equals the sum of its capital 
requirement, KCM for each QCCP, as calculated under the 
methodology set forth in paragraph (d)(3)(i) of this section (Method 
1), multiplied by 1,250 percent or paragraph (d)(3)(iv) of this section 
(Method 2).
    (i) Method 1. The hypothetical capital requirement of a QCCP 
(KCCP) equals:
[GRAPHIC] [TIFF OMITTED] TR11OC13.042

Where

    (A) EBRMi = the EAD for each transaction cleared through 
the QCCP by clearing member i, calculated using the methodology used to 
calculate EAD for OTC derivative contracts set forth in Sec.  
--.132(c)(5) and Sec.  --.132.(c)(6) or the methodology used to 
calculate EAD for repo-style transactions set forth in Sec.  
--.132(b)(2) for repo-style transactions, provided that:
    (1) For purposes of this section, when calculating the EAD, the 
[BANK] may replace the formula provided in Sec.  --.132(c)(6)(ii) with 
the following formula:
    Anet = (0.15 x Agross) + (0.85 x NGR x 
Agross); and
    (2) For option derivative contracts that are cleared transactions, 
the PFE described in Sec.  --.132(c)(5) must be adjusted by multiplying 
the notional principal amount of the derivative contract by the 
appropriate conversion factor in Table 2 to Sec.  --.132 and the 
absolute value of the option's delta, that is, the ratio of the change 
in the value of the derivative contract to the corresponding change in 
the price of the underlying asset.
    (3) For repo-style transactions, when applying Sec.  --.132(b)(2), 
the [BANK] must use the methodology in Sec.  --.132(b)(2)(ii).
    (B) VMi = any collateral posted by clearing member i to 
the QCCP that it is entitled to receive from the QCCP but has not yet 
received, and any collateral that the QCCP has actually received from 
clearing member i;
    (C) IMi = the collateral posted as initial margin by 
clearing member i to the QCCP;
    (D) DFi = the funded portion of clearing member i's 
default fund contribution that will be applied to reduce the QCCP's 
loss upon a default by clearing member i; and
    (E) RW = 20 percent, except when the [AGENCY] has determined that a 
higher risk weight is more appropriate based on the specific 
characteristics of the QCCP and its clearing members; and
    (F) Where a QCCP has provided its KCCP, a [BANK] must 
rely on such disclosed figure instead of calculating KCCP 
under this paragraph (d), unless the [BANK] determines that a more 
conservative figure is appropriate based on the nature, structure, or 
characteristics of the QCCP.
    (ii) For a [BANK] that is a clearing member of a QCCP with a 
default fund supported by funded commitments, KCM equals:

[[Page 62227]]

[GRAPHIC] [TIFF OMITTED] TR11OC13.043


[[Page 62228]]


[GRAPHIC] [TIFF OMITTED] TR11OC13.044

Where:

(A) DFi = the [BANK]'s unfunded commitment to the default 
fund;
(B) DFCM = the total of all clearing members' unfunded 
commitments to the default fund; and
(C) K*CM as defined in paragraph (d)(3)(ii) of this section.
(D) For a [BANK] that is a clearing member of a QCCP with a default 
fund supported by unfunded commitments and that is unable to 
calculate KCM using the methodology described above in 
this paragraph (d)(3)(iii), KCM equals:
[GRAPHIC] [TIFF OMITTED] TR11OC13.046

Where:

(1) IMi = the [BANK]'s initial margin posted to the QCCP;
(2) IMCM = the total of initial margin posted to the 
QCCP; and
(3) K*CM as defined above in this paragraph (d)(3)(iii).

    (iv) Method 2. A clearing member [BANK]'s risk-weighted asset 
amount for its default fund contribution to a QCCP, RWADF, 
equals:

    RWADF = Min {12.5 * DF; 0.18 * TE{time} 

Where:

(A) TE = the [BANK]'s trade exposure amount to the QCCP calculated 
according to section 133(c)(2);
(B) DF = the funded portion of the [BANK]'s default fund 
contribution to the QCCP.

    (v) Total risk-weighted assets for default fund contributions. 
Total risk-weighted assets for default fund contributions is the sum of 
a clearing member [BANK]'s risk-weighted assets for all of its default 
fund contributions to all CCPs of which the [BANK] is a clearing 
member.

[[Page 62229]]

Sec.  --.134  Guarantees and credit derivatives: PD substitution and 
LGD adjustment approaches.

    (a) Scope. (1) This section applies to wholesale exposures for 
which:
    (i) Credit risk is fully covered by an eligible guarantee or 
eligible credit derivative; or
    (ii) Credit risk is covered on a pro rata basis (that is, on a 
basis in which the [BANK] and the protection provider share losses 
proportionately) by an eligible guarantee or eligible credit 
derivative.
    (2) Wholesale exposures on which there is a tranching of credit 
risk (reflecting at least two different levels of seniority) are 
securitization exposures subject to Sec.  --.141 through Sec.  --.145.
    (3) A [BANK] may elect to recognize the credit risk mitigation 
benefits of an eligible guarantee or eligible credit derivative 
covering an exposure described in paragraph (a)(1) of this section by 
using the PD substitution approach or the LGD adjustment approach in 
paragraph (c) of this section or, if the transaction qualifies, using 
the double default treatment in Sec.  --.135. A [BANK]'s PD and LGD for 
the hedged exposure may not be lower than the PD and LGD floors 
described in Sec.  --.131(d)(2) and (d)(3).
    (4) If multiple eligible guarantees or eligible credit derivatives 
cover a single exposure described in paragraph (a)(1) of this section, 
a [BANK] may treat the hedged exposure as multiple separate exposures 
each covered by a single eligible guarantee or eligible credit 
derivative and may calculate a separate risk-based capital requirement 
for each separate exposure as described in paragraph (a)(3) of this 
section.
    (5) If a single eligible guarantee or eligible credit derivative 
covers multiple hedged wholesale exposures described in paragraph 
(a)(1) of this section, a [BANK] must treat each hedged exposure as 
covered by a separate eligible guarantee or eligible credit derivative 
and must calculate a separate risk-based capital requirement for each 
exposure as described in paragraph (a)(3) of this section.
    (6) A [BANK] must use the same risk parameters for calculating ECL 
as it uses for calculating the risk-based capital requirement for the 
exposure.
    (b) Rules of recognition. (1) A [BANK] may only recognize the 
credit risk mitigation benefits of eligible guarantees and eligible 
credit derivatives.
    (2) A [BANK] may only recognize the credit risk mitigation benefits 
of an eligible credit derivative to hedge an exposure that is different 
from the credit derivative's reference exposure used for determining 
the derivative's cash settlement value, deliverable obligation, or 
occurrence of a credit event if:
    (i) The reference exposure ranks pari passu (that is, equally) with 
or is junior to the hedged exposure; and
    (ii) The reference exposure and the hedged exposure are exposures 
to the same legal entity, and legally enforceable cross-default or 
cross-acceleration clauses are in place to assure payments under the 
credit derivative are triggered when the obligor fails to pay under the 
terms of the hedged exposure.
    (c) Risk parameters for hedged exposures--(1) PD substitution 
approach--(i) Full coverage. If an eligible guarantee or eligible 
credit derivative meets the conditions in paragraphs (a) and (b) of 
this section and the protection amount (P) of the guarantee or credit 
derivative is greater than or equal to the EAD of the hedged exposure, 
a [BANK] may recognize the guarantee or credit derivative in 
determining the [BANK]'s risk-based capital requirement for the hedged 
exposure by substituting the PD associated with the rating grade of the 
protection provider for the PD associated with the rating grade of the 
obligor in the risk-based capital formula applicable to the guarantee 
or credit derivative in Table 1 of Sec.  --.131 and using the 
appropriate LGD as described in paragraph (c)(1)(iii) of this section. 
If the [BANK] determines that full substitution of the protection 
provider's PD leads to an inappropriate degree of risk mitigation, the 
[BANK] may substitute a higher PD than that of the protection provider.
    (ii) Partial coverage. If an eligible guarantee or eligible credit 
derivative meets the conditions in paragraphs (a) and (b) of this 
section and P of the guarantee or credit derivative is less than the 
EAD of the hedged exposure, the [BANK] must treat the hedged exposure 
as two separate exposures (protected and unprotected) in order to 
recognize the credit risk mitigation benefit of the guarantee or credit 
derivative.
    (A) The [BANK] must calculate its risk-based capital requirement 
for the protected exposure under Sec.  --.131, where PD is the 
protection provider's PD, LGD is determined under paragraph (c)(1)(iii) 
of this section, and EAD is P. If the [BANK] determines that full 
substitution leads to an inappropriate degree of risk mitigation, the 
[BANK] may use a higher PD than that of the protection provider.
    (B) The [BANK] must calculate its risk-based capital requirement 
for the unprotected exposure under Sec.  --.131, where PD is the 
obligor's PD, LGD is the hedged exposure's LGD (not adjusted to reflect 
the guarantee or credit derivative), and EAD is the EAD of the original 
hedged exposure minus P.
    (C) The treatment in paragraph (c)(1)(ii) of this section is 
applicable when the credit risk of a wholesale exposure is covered on a 
partial pro rata basis or when an adjustment is made to the effective 
notional amount of the guarantee or credit derivative under paragraphs 
(d), (e), or (f) of this section.
    (iii) LGD of hedged exposures. The LGD of a hedged exposure under 
the PD substitution approach is equal to:
    (A) The lower of the LGD of the hedged exposure (not adjusted to 
reflect the guarantee or credit derivative) and the LGD of the 
guarantee or credit derivative, if the guarantee or credit derivative 
provides the [BANK] with the option to receive immediate payout upon 
triggering the protection; or
    (B) The LGD of the guarantee or credit derivative, if the guarantee 
or credit derivative does not provide the [BANK] with the option to 
receive immediate payout upon triggering the protection.
    (2) LGD adjustment approach. (i) Full coverage. If an eligible 
guarantee or eligible credit derivative meets the conditions in 
paragraphs (a) and (b) of this section and the protection amount (P) of 
the guarantee or credit derivative is greater than or equal to the EAD 
of the hedged exposure, the [BANK]'s risk-based capital requirement for 
the hedged exposure is the greater of:
    (A) The risk-based capital requirement for the exposure as 
calculated under Sec.  --.131, with the LGD of the exposure adjusted to 
reflect the guarantee or credit derivative; or
    (B) The risk-based capital requirement for a direct exposure to the 
protection provider as calculated under Sec.  --.131, using the PD for 
the protection provider, the LGD for the guarantee or credit 
derivative, and an EAD equal to the EAD of the hedged exposure.
    (ii) Partial coverage. If an eligible guarantee or eligible credit 
derivative meets the conditions in paragraphs (a) and (b) of this 
section and the protection amount (P) of the guarantee or credit 
derivative is less than the EAD of the hedged exposure, the [BANK] must 
treat the hedged exposure as two separate exposures (protected and 
unprotected) in order to recognize the credit risk mitigation benefit 
of the guarantee or credit derivative.
    (A) The [BANK]'s risk-based capital requirement for the protected 
exposure would be the greater of:
    (1) The risk-based capital requirement for the protected exposure 
as calculated under Sec.  --.131, with the LGD of the exposure adjusted 
to reflect the

[[Page 62230]]

guarantee or credit derivative and EAD set equal to P; or
    (2) The risk-based capital requirement for a direct exposure to the 
guarantor as calculated under Sec.  --.131, using the PD for the 
protection provider, the LGD for the guarantee or credit derivative, 
and an EAD set equal to P.
    (B) The [BANK] must calculate its risk-based capital requirement 
for the unprotected exposure under Sec.  --.131, where PD is the 
obligor's PD, LGD is the hedged exposure's LGD (not adjusted to reflect 
the guarantee or credit derivative), and EAD is the EAD of the original 
hedged exposure minus P.
    (3) M of hedged exposures. For purposes of this paragraph (c), the 
M of the hedged exposure is the same as the M of the exposure if it 
were unhedged.
    (d) Maturity mismatch. (1) A [BANK] that recognizes an eligible 
guarantee or eligible credit derivative in determining its risk-based 
capital requirement for a hedged exposure must adjust the effective 
notional amount of the credit risk mitigant to reflect any maturity 
mismatch between the hedged exposure and the credit risk mitigant.
    (2) A maturity mismatch occurs when the residual maturity of a 
credit risk mitigant is less than that of the hedged exposure(s).
    (3) The residual maturity of a hedged exposure is the longest 
possible remaining time before the obligor is scheduled to fulfil its 
obligation on the exposure. If a credit risk mitigant has embedded 
options that may reduce its term, the [BANK] (protection purchaser) 
must use the shortest possible residual maturity for the credit risk 
mitigant. If a call is at the discretion of the protection provider, 
the residual maturity of the credit risk mitigant is at the first call 
date. If the call is at the discretion of the [BANK] (protection 
purchaser), but the terms of the arrangement at origination of the 
credit risk mitigant contain a positive incentive for the [BANK] to 
call the transaction before contractual maturity, the remaining time to 
the first call date is the residual maturity of the credit risk 
mitigant.\26\
---------------------------------------------------------------------------

    \26\ For example, where there is a step-up in cost in 
conjunction with a call feature or where the effective cost of 
protection increases over time even if credit quality remains the 
same or improves, the residual maturity of the credit risk mitigant 
will be the remaining time to the first call.
---------------------------------------------------------------------------

    (4) A credit risk mitigant with a maturity mismatch may be 
recognized only if its original maturity is greater than or equal to 
one year and its residual maturity is greater than three months.
    (5) When a maturity mismatch exists, the [BANK] must apply the 
following adjustment to the effective notional amount of the credit 
risk mitigant:

Pm = E x (t - 0.25)/(T - 0.25),

where:

(i) Pm = effective notional amount of the credit risk 
mitigant, adjusted for maturity mismatch;
(ii) E = effective notional amount of the credit risk mitigant;
(iii) t = the lesser of T or the residual maturity of the credit 
risk mitigant, expressed in years; and
(iv) T = the lesser of five or the residual maturity of the hedged 
exposure, expressed in years.

    (e) Credit derivatives without restructuring as a credit event. If 
a [BANK] recognizes an eligible credit derivative that does not include 
as a credit event a restructuring of the hedged exposure involving 
forgiveness or postponement of principal, interest, or fees that 
results in a credit loss event (that is, a charge-off, specific 
provision, or other similar debit to the profit and loss account), the 
[BANK] must apply the following adjustment to the effective notional 
amount of the credit derivative:

Pr = Pm x 0.60,

where:

(1) Pr = effective notional amount of the credit risk 
mitigant, adjusted for lack of restructuring event (and maturity 
mismatch, if applicable); and
(2) Pm = effective notional amount of the credit risk 
mitigant adjusted for maturity mismatch (if applicable).

    (f) Currency mismatch. (1) If a [BANK] recognizes an eligible 
guarantee or eligible credit derivative that is denominated in a 
currency different from that in which the hedged exposure is 
denominated, the [BANK] must apply the following formula to the 
effective notional amount of the guarantee or credit derivative:

Pc = Pr x (1 - HFX),

where:

(i) Pc = effective notional amount of the credit risk 
mitigant, adjusted for currency mismatch (and maturity mismatch and 
lack of restructuring event, if applicable);
(ii) Pr = effective notional amount of the credit risk 
mitigant (adjusted for maturity mismatch and lack of restructuring 
event, if applicable); and
(iii) HFX = haircut appropriate for the currency mismatch 
between the credit risk mitigant and the hedged exposure.

    (2) A [BANK] must set HFX equal to 8 percent unless it 
qualifies for the use of and uses its own internal estimates of foreign 
exchange volatility based on a ten-business-day holding period and 
daily marking-to-market and remargining. A [BANK] qualifies for the use 
of its own internal estimates of foreign exchange volatility if it 
qualifies for:
    (i) The own-estimates haircuts in Sec.  --.132(b)(2)(iii);
    (ii) The simple VaR methodology in Sec.  --.132(b)(3); or
    (iii) The internal models methodology in Sec.  --.132(d).
    (3) A [BANK] must adjust HFX calculated in paragraph 
(f)(2) of this section upward if the [BANK] revalues the guarantee or 
credit derivative less frequently than once every ten business days 
using the square root of time formula provided in Sec.  
--.132(b)(2)(iii)(A)(2).


Sec.  --.135  Guarantees and credit derivatives: double default 
treatment.

    (a) Eligibility and operational criteria for double default 
treatment. A [BANK] may recognize the credit risk mitigation benefits 
of a guarantee or credit derivative covering an exposure described in 
Sec.  --.134(a)(1) by applying the double default treatment in this 
section if all the following criteria are satisfied:
    (1) The hedged exposure is fully covered or covered on a pro rata 
basis by:
    (i) An eligible guarantee issued by an eligible double default 
guarantor; or
    (ii) An eligible credit derivative that meets the requirements of 
Sec.  --.134(b)(2) and that is issued by an eligible double default 
guarantor.
    (2) The guarantee or credit derivative is:
    (i) An uncollateralized guarantee or uncollateralized credit 
derivative (for example, a credit default swap) that provides 
protection with respect to a single reference obligor; or
    (ii) An n^th-to-default credit derivative (subject to the 
requirements of Sec.  --.142(m).
    (3) The hedged exposure is a wholesale exposure (other than a 
sovereign exposure).
    (4) The obligor of the hedged exposure is not:
    (i) An eligible double default guarantor or an affiliate of an 
eligible double default guarantor; or
    (ii) An affiliate of the guarantor.
    (5) The [BANK] does not recognize any credit risk mitigation 
benefits of the guarantee or credit derivative for the hedged exposure 
other than through application of the double default treatment as 
provided in this section.
    (6) The [BANK] has implemented a process (which has received the 
prior, written approval of the [AGENCY]) to detect excessive 
correlation between the creditworthiness of the obligor of the hedged 
exposure and the protection provider. If excessive correlation is 
present, the [BANK] may not use the double default treatment for the 
hedged exposure.

[[Page 62231]]

    (b) Full coverage. If a transaction meets the criteria in paragraph 
(a) of this section and the protection amount (P) of the guarantee or 
credit derivative is at least equal to the EAD of the hedged exposure, 
the [BANK] may determine its risk-weighted asset amount for the hedged 
exposure under paragraph (e) of this section.
    (c) Partial coverage. If a transaction meets the criteria in 
paragraph (a) of this section and the protection amount (P) of the 
guarantee or credit derivative is less than the EAD of the hedged 
exposure, the [BANK] must treat the hedged exposure as two separate 
exposures (protected and unprotected) in order to recognize double 
default treatment on the protected portion of the exposure:
    (1) For the protected exposure, the [BANK] must set EAD equal to P 
and calculate its risk-weighted asset amount as provided in paragraph 
(e) of this section; and
    (2) For the unprotected exposure, the [BANK] must set EAD equal to 
the EAD of the original exposure minus P and then calculate its risk-
weighted asset amount as provided in Sec.  --.131.
    (d) Mismatches. For any hedged exposure to which a [BANK] applies 
double default treatment under this part, the [BANK] must make 
applicable adjustments to the protection amount as required in Sec.  
--.134(d), (e), and (f).
    (e) The double default dollar risk-based capital requirement. The 
dollar risk-based capital requirement for a hedged exposure to which a 
[BANK] has applied double default treatment is KDD 
multiplied by the EAD of the exposure. KDD is calculated 
according to the following formula:

KDD = Ko x (0.15 + 160 x PDg),

Where:
(1)
[GRAPHIC] [TIFF OMITTED] TR11OC13.048

(2) PDg = PD of the protection provider.
(3) PDo = PD of the obligor of the hedged exposure.
(4) LGDg =
(i) The lower of the LGD of the hedged exposure (not adjusted to 
reflect the guarantee or credit derivative) and the LGD of the 
guarantee or credit derivative, if the guarantee or credit 
derivative provides the [BANK] with the option to receive immediate 
payout on triggering the protection; or
(ii) The LGD of the guarantee or credit derivative, if the guarantee 
or credit derivative does not provide the [BANK] with the option to 
receive immediate payout on triggering the protection; and
(5) [rho]os (asset value correlation of the obligor) is 
calculated according to the appropriate formula for (R) provided in 
Table 1 in Sec.  --.131, with PD equal to PDo.
(6) b (maturity adjustment coefficient) is calculated according to 
the formula for b provided in Table 1 in Sec.  --.131, with PD equal 
to the lesser of PDo and PDg; and
(7) M (maturity) is the effective maturity of the guarantee or 
credit derivative, which may not be less than one year or greater 
than five years.

Sec.  --.136  Unsettled transactions.

    (a) Definitions. For purposes of this section:
    (1) Delivery-versus-payment (DvP) transaction means a securities or 
commodities transaction in which the buyer is obligated to make payment 
only if the seller has made delivery of the securities or commodities 
and the seller is obligated to deliver the securities or commodities 
only if the buyer has made payment.
    (2) Payment-versus-payment (PvP) transaction means a foreign 
exchange transaction in which each counterparty is obligated to make a 
final transfer of one or more currencies only if the other counterparty 
has made a final transfer of one or more currencies.
    (3) A transaction has a normal settlement period if the contractual 
settlement period for the transaction is equal to or less than the 
market standard for the instrument underlying the transaction and equal 
to or less than five business days.
    (4) The positive current exposure of a [BANK] for a transaction is 
the difference between the transaction value at the agreed settlement 
price and the current market price of the transaction, if the 
difference results in a credit exposure of the [BANK] to the 
counterparty.
    (b) Scope. This section applies to all transactions involving 
securities, foreign exchange instruments, and commodities that have a 
risk of delayed settlement or delivery. This section does not apply to:
    (1) Cleared transactions that are subject to daily marking-to-
market and daily receipt and payment of variation margin;
    (2) Repo-style transactions, including unsettled repo-style 
transactions (which are addressed in Sec. Sec.  --.131 and 132);
    (3) One-way cash payments on OTC derivative contracts (which are 
addressed in Sec. Sec.  --. 131 and 132); or
    (4) Transactions with a contractual settlement period that is 
longer than the normal settlement period (which are treated as OTC 
derivative contracts and addressed in Sec. Sec.  --.131 and 132).
    (c) System-wide failures. In the case of a system-wide failure of a 
settlement or clearing system, or a central counterparty, the [AGENCY] 
may waive risk-based capital requirements for unsettled and failed 
transactions until the situation is rectified.
    (d) Delivery-versus-payment (DvP) and payment-versus-payment (PvP) 
transactions. A [BANK] must hold risk-based capital against any DvP or 
PvP transaction with a normal settlement period if the [BANK]'s 
counterparty has not made delivery or payment within five business days 
after the settlement date. The [BANK] must determine its risk-weighted 
asset amount for such a transaction by multiplying the positive current 
exposure of the transaction for the [BANK] by the appropriate risk 
weight in Table 1 to Sec.  --.136.

    Table 1 to Sec.   --.136--Risk Weights for Unsettled DvP and PvP
                              Transactions
------------------------------------------------------------------------
                                                          Risk weight to
                                                           be applied to
  Number of business days after contractual settlement       positive
                          date                                current
                                                           exposure (in
                                                             percent)
------------------------------------------------------------------------
From 5 to 15............................................             100
From 16 to 30...........................................             625
From 31 to 45...........................................           937.5
46 or more..............................................           1,250
------------------------------------------------------------------------

    (e) Non-DvP/non-PvP (non-delivery-versus-payment/non-payment-
versus-payment) transactions. (1) A [BANK] must hold risk-based capital 
against any non-DvP/non-PvP transaction with a normal settlement period 
if the [BANK] has delivered cash, securities, commodities, or 
currencies to its counterparty but has not received its corresponding 
deliverables by the end of the same business day. The [BANK] must 
continue to hold risk-based capital against the transaction until the 
[BANK] has received its corresponding deliverables.

[[Page 62232]]

    (2) From the business day after the [BANK] has made its delivery 
until five business days after the counterparty delivery is due, the 
[BANK] must calculate its risk-based capital requirement for the 
transaction by treating the current fair value of the deliverables owed 
to the [BANK] as a wholesale exposure.
    (i) A [BANK] may use a 45 percent LGD for the transaction rather 
than estimating LGD for the transaction provided the [BANK] uses the 45 
percent LGD for all transactions described in Sec.  --.135(e)(1) and 
(e)(2).
    (ii) A [BANK] may use a 100 percent risk weight for the transaction 
provided the [BANK] uses this risk weight for all transactions 
described in Sec. Sec.  --.135(e)(1) and (e)(2).
    (3) If the [BANK] has not received its deliverables by the fifth 
business day after the counterparty delivery was due, the [BANK] must 
apply a 1,250 percent risk weight to the current fair value of the 
deliverables owed to the [BANK].
    (f) Total risk-weighted assets for unsettled transactions. Total 
risk-weighted assets for unsettled transactions is the sum of the risk-
weighted asset amounts of all DvP, PvP, and non-DvP/non-PvP 
transactions.


Sec. Sec.  --.137 through --.140  [Reserved]

Risk-Weighted Assets for Securitization Exposures


Sec.  --.141  Operational criteria for recognizing the transfer of 
risk.

    (a) Operational criteria for traditional securitizations. A [BANK] 
that transfers exposures it has originated or purchased to a 
securitization SPE or other third party in connection with a 
traditional securitization may exclude the exposures from the 
calculation of its risk-weighted assets only if each of the conditions 
in this paragraph (a) is satisfied. A [BANK] that meets these 
conditions must hold risk-based capital against any securitization 
exposures it retains in connection with the securitization. A [BANK] 
that fails to meet these conditions must hold risk-based capital 
against the transferred exposures as if they had not been securitized 
and must deduct from common equity tier 1 capital any after-tax gain-
on-sale resulting from the transaction. The conditions are:
    (1) The exposures are not reported on the [BANK]'s consolidated 
balance sheet under GAAP;
    (2) The [BANK] has transferred to one or more third parties credit 
risk associated with the underlying exposures;
    (3) Any clean-up calls relating to the securitization are eligible 
clean-up calls; and
    (4) The securitization does not:
    (i) Include one or more underlying exposures in which the borrower 
is permitted to vary the drawn amount within an agreed limit under a 
line of credit; and
    (ii) Contain an early amortization provision.
    (b) Operational criteria for synthetic securitizations. For 
synthetic securitizations, a [BANK] may recognize for risk-based 
capital purposes under this subpart the use of a credit risk mitigant 
to hedge underlying exposures only if each of the conditions in this 
paragraph (b) is satisfied. A [BANK] that meets these conditions must 
hold risk-based capital against any credit risk of the exposures it 
retains in connection with the synthetic securitization. A [BANK] that 
fails to meet these conditions or chooses not to recognize the credit 
risk mitigant for purposes of this section must hold risk-based capital 
under this subpart against the underlying exposures as if they had not 
been synthetically securitized. The conditions are:
    (1) The credit risk mitigant is:
    (i) Financial collateral; or
    (ii) A guarantee that meets all of the requirements of an eligible 
guarantee in Sec.  --.2 except for paragraph (3) of the definition; or
    (iii) A credit derivative that meets all of the requirements of an 
eligible credit derivative except for paragraph (3) of the definition 
of eligible guarantee in Sec.  --.2.
    (2) The [BANK] transfers credit risk associated with the underlying 
exposures to third parties, and the terms and conditions in the credit 
risk mitigants employed do not include provisions that:
    (i) Allow for the termination of the credit protection due to 
deterioration in the credit quality of the underlying exposures;
    (ii) Require the [BANK] to alter or replace the underlying 
exposures to improve the credit quality of the underlying exposures;
    (iii) Increase the [BANK]'s cost of credit protection in response 
to deterioration in the credit quality of the underlying exposures;
    (iv) Increase the yield payable to parties other than the [BANK] in 
response to a deterioration in the credit quality of the underlying 
exposures; or
    (v) Provide for increases in a retained first loss position or 
credit enhancement provided by the [BANK] after the inception of the 
securitization;
    (3) The [BANK] obtains a well-reasoned opinion from legal counsel 
that confirms the enforceability of the credit risk mitigant in all 
relevant jurisdictions; and
    (4) Any clean-up calls relating to the securitization are eligible 
clean-up calls.
    (c) Due diligence requirements for securitization exposures. (1) 
Except for exposures that are deducted from common equity tier 1 
capital and exposures subject to Sec.  --.142(k), if a [BANK] is unable 
to demonstrate to the satisfaction of the [AGENCY] a comprehensive 
understanding of the features of a securitization exposure that would 
materially affect the performance of the exposure, the [BANK] must 
assign a 1,250 percent risk weight to the securitization exposure. The 
[BANK]'s analysis must be commensurate with the complexity of the 
securitization exposure and the materiality of the position in relation 
to regulatory capital according to this part.
    (2) A [BANK] must demonstrate its comprehensive understanding of a 
securitization exposure under paragraph (c)(1) of this section, for 
each securitization exposure by:
    (i) Conducting an analysis of the risk characteristics of a 
securitization exposure prior to acquiring the exposure and document 
such analysis within three business days after acquiring the exposure, 
considering:
    (A) Structural features of the securitization that would materially 
impact the performance of the exposure, for example, the contractual 
cash flow waterfall, waterfall-related triggers, credit enhancements, 
liquidity enhancements, fair value triggers, the performance of 
organizations that service the position, and deal-specific definitions 
of default;
    (B) Relevant information regarding the performance of the 
underlying credit exposure(s), for example, the percentage of loans 30, 
60, and 90 days past due; default rates; prepayment rates; loans in 
foreclosure; property types; occupancy; average credit score or other 
measures of creditworthiness; average loan-to-value ratio; and industry 
and geographic diversification data on the underlying exposure(s);
    (C) Relevant market data of the securitization, for example, bid-
ask spreads, most recent sales price and historical price volatility, 
trading volume, implied market rating, and size, depth and 
concentration level of the market for the securitization; and
    (D) For resecuritization exposures, performance information on the 
underlying securitization exposures, for example, the issuer name and 
credit quality, and the characteristics and

[[Page 62233]]

performance of the exposures underlying the securitization exposures; 
and
    (ii) On an on-going basis (no less frequently than quarterly), 
evaluating, reviewing, and updating as appropriate the analysis 
required under this section for each securitization exposure.


Sec.  --.142  Risk-weighted assets for securitization exposures.

    (a) Hierarchy of approaches. Except as provided elsewhere in this 
section and in Sec.  --.141:
    (1) A [BANK] must deduct from common equity tier 1 capital any 
after-tax gain-on-sale resulting from a securitization and must apply a 
1,250 percent risk weight to the portion of any CEIO that does not 
constitute after tax gain-on-sale;
    (2) If a securitization exposure does not require deduction or a 
1,250 percent risk weight under paragraph (a)(1) of this section, the 
[BANK] must apply the supervisory formula approach in Sec.  --.143 to 
the exposure if the [BANK] and the exposure qualify for the supervisory 
formula approach according to Sec.  --.143(a);
    (3) If a securitization exposure does not require deduction or a 
1,250 percent risk weight under paragraph (a)(1) of this section and 
does not qualify for the supervisory formula approach, the [BANK] may 
apply the simplified supervisory formula approach under Sec.  --.144;
    (4) If a securitization exposure does not require deduction or a 
1,250 percent risk weight under paragraph (a)(1) of this section, does 
not qualify for the supervisory formula approach in Sec.  --.143, and 
the [BANK] does not apply the simplified supervisory formula approach 
in Sec.  --.144, the [BANK] must apply a 1,250 percent risk weight to 
the exposure; and
    (5) If a securitization exposure is a derivative contract (other 
than protection provided by a [BANK] in the form of a credit 
derivative) that has a first priority claim on the cash flows from the 
underlying exposures (notwithstanding amounts due under interest rate 
or currency derivative contracts, fees due, or other similar payments), 
a [BANK] may choose to set the risk-weighted asset amount of the 
exposure equal to the amount of the exposure as determined in paragraph 
(e) of this section rather than apply the hierarchy of approaches 
described in paragraphs (a)(1) through (4) of this section.
    (b) Total risk-weighted assets for securitization exposures. A 
[BANK]'s total risk-weighted assets for securitization exposures is 
equal to the sum of its risk-weighted assets calculated using 
Sec. Sec.  --.141 through 146.
    (c) Deductions. A [BANK] may calculate any deduction from common 
equity tier 1 capital for a securitization exposure net of any DTLs 
associated with the securitization exposure.
    (d) Maximum risk-based capital requirement. Except as provided in 
Sec.  --.141(c), unless one or more underlying exposures does not meet 
the definition of a wholesale, retail, securitization, or equity 
exposure, the total risk-based capital requirement for all 
securitization exposures held by a single [BANK] associated with a 
single securitization (excluding any risk-based capital requirements 
that relate to the [BANK]'s gain-on-sale or CEIOs associated with the 
securitization) may not exceed the sum of:
    (1) The [BANK]'s total risk-based capital requirement for the 
underlying exposures calculated under this subpart as if the [BANK] 
directly held the underlying exposures; and
    (2) The total ECL of the underlying exposures calculated under this 
subpart.
    (e) Exposure amount of a securitization exposure. (1) The exposure 
amount of an on-balance sheet securitization exposure that is not a 
repo-style transaction, eligible margin loan, OTC derivative contract, 
or cleared transaction is the [BANK]'s carrying value.
    (2) Except as provided in paragraph (m) of this section, the 
exposure amount of an off-balance sheet securitization exposure that is 
not an OTC derivative contract (other than a credit derivative), repo-
style transaction, eligible margin loan, or cleared transaction (other 
than a credit derivative) is the notional amount of the exposure. For 
an off-balance-sheet securitization exposure to an ABCP program, such 
as an eligible ABCP liquidity facility, the notional amount may be 
reduced to the maximum potential amount that the [BANK] could be 
required to fund given the ABCP program's current underlying assets 
(calculated without regard to the current credit quality of those 
assets).
    (3) The exposure amount of a securitization exposure that is a 
repo-style transaction, eligible margin loan, or OTC derivative 
contract (other than a credit derivative) or cleared transaction (other 
than a credit derivative) is the EAD of the exposure as calculated in 
Sec.  --.132 or Sec.  --.133.
    (f) Overlapping exposures. If a [BANK] has multiple securitization 
exposures that provide duplicative coverage of the underlying exposures 
of a securitization (such as when a [BANK] provides a program-wide 
credit enhancement and multiple pool-specific liquidity facilities to 
an ABCP program), the [BANK] is not required to hold duplicative risk-
based capital against the overlapping position. Instead, the [BANK] may 
assign to the overlapping securitization exposure the applicable risk-
based capital treatment under this subpart that results in the highest 
risk-based capital requirement.
    (g) Securitizations of non-IRB exposures. Except as provided in 
Sec.  --.141(c), if a [BANK] has a securitization exposure where any 
underlying exposure is not a wholesale exposure, retail exposure, 
securitization exposure, or equity exposure, the [BANK]:
    (1) Must deduct from common equity tier 1 capital any after-tax 
gain-on-sale resulting from the securitization and apply a 1,250 
percent risk weight to the portion of any CEIO that does not constitute 
gain-on-sale, if the [BANK] is an originating [BANK];
    (2) May apply the simplified supervisory formula approach in Sec.  
--.144 to the exposure, if the securitization exposure does not require 
deduction or a 1,250 percent risk weight under paragraph (g)(1) of this 
section;
    (3) Must assign a 1,250 percent risk weight to the exposure if the 
securitization exposure does not require deduction or a 1,250 percent 
risk weight under paragraph (g)(1) of this section, does not qualify 
for the supervisory formula approach in Sec.  --.143, and the [BANK] 
does not apply the simplified supervisory formula approach in Sec.  
--.144 to the exposure.
    (h) Implicit support. If a [BANK] provides support to a 
securitization in excess of the [BANK]'s contractual obligation to 
provide credit support to the securitization (implicit support):
    (1) The [BANK] must calculate a risk-weighted asset amount for 
underlying exposures associated with the securitization as if the 
exposures had not been securitized and must deduct from common equity 
tier 1 capital any after-tax gain-on-sale resulting from the 
securitization; and
    (2) The [BANK] must disclose publicly:
    (i) That it has provided implicit support to the securitization; 
and
    (ii) The regulatory capital impact to the [BANK] of providing such 
implicit support.
    (i) Undrawn portion of a servicer cash advance facility. (1) 
Notwithstanding any other provision of this subpart, a [BANK] that is a 
servicer under an eligible servicer cash advance facility is not 
required to hold risk-based capital against potential future cash 
advance payments that it may be required to

[[Page 62234]]

provide under the contract governing the facility.
    (2) For a [BANK] that acts as a servicer, the exposure amount for a 
servicer cash advance facility that is not an eligible servicer cash 
advance facility is equal to the amount of all potential future cash 
advance payments that the [BANK] may be contractually required to 
provide during the subsequent 12 month period under the contract 
governing the facility.
    (j) Interest-only mortgage-backed securities. Regardless of any 
other provisions in this part, the risk weight for a non-credit-
enhancing interest-only mortgage-backed security may not be less than 
100 percent.
    (k) Small-business loans and leases on personal property 
transferred with recourse. (1) Notwithstanding any other provisions of 
this subpart E, a [BANK] that has transferred small-business loans and 
leases on personal property (small-business obligations) with recourse 
must include in risk-weighted assets only the contractual amount of 
retained recourse if all the following conditions are met:
    (i) The transaction is a sale under GAAP.
    (ii) The [BANK] establishes and maintains, pursuant to GAAP, a non-
capital reserve sufficient to meet the [BANK]'s reasonably estimated 
liability under the recourse arrangement.
    (iii) The loans and leases are to businesses that meet the criteria 
for a small-business concern established by the Small Business 
Administration under section 3(a) of the Small Business Act (15 U.S.C. 
632 et seq.); and
    (iv) The [BANK] is well-capitalized, as defined in [12 CFR 6.4 
(OCC); 12 CFR 208.43 (Board)]. For purposes of determining whether a 
[BANK] is well capitalized for purposes of this paragraph (k), the 
[BANK]'s capital ratios must be calculated without regard to the 
capital treatment for transfers of small-business obligations with 
recourse specified in paragraph (k)(1) of this section.
    (2) The total outstanding amount of recourse retained by a [BANK] 
on transfers of small-business obligations subject to paragraph (k)(1) 
of this section cannot exceed 15 percent of the [BANK]'s total capital.
    (3) If a [BANK] ceases to be well capitalized or exceeds the 15 
percent capital limitation in paragraph (k)(2) of this section, the 
preferential capital treatment specified in paragraph (k)(1) of this 
section will continue to apply to any transfers of small-business 
obligations with recourse that occurred during the time that the [BANK] 
was well capitalized and did not exceed the capital limit.
    (4) The risk-based capital ratios of a [BANK] must be calculated 
without regard to the capital treatment for transfers of small-business 
obligations with recourse specified in paragraph (k)(1) of this 
section.
    (l) Nth-to-default credit derivatives--(1) Protection provider. A 
[BANK] must determine a risk weight using the supervisory formula 
approach (SFA) pursuant to Sec.  --.143 or the simplified supervisory 
formula approach (SSFA) pursuant to Sec.  --.144 for an nth-to-default 
credit derivative in accordance with this paragraph (l). In the case of 
credit protection sold, a [BANK] must determine its exposure in the 
n^th-to-default credit derivative as the largest notional 
amount of all the underlying exposures.
    (2) For purposes of determining the risk weight for an 
n^th-to-default credit derivative using the SFA or the SSFA, 
the [BANK] must calculate the attachment point and detachment point of 
its exposure as follows:
    (i) The attachment point (parameter A) is the ratio of the sum of 
the notional amounts of all underlying exposures that are subordinated 
to the [BANK]'s exposure to the total notional amount of all underlying 
exposures. For purposes of the SSFA, parameter A is expressed as a 
decimal value between zero and one. For purposes of using the SFA to 
calculate the risk weight for its exposure in an n^th-to-
default credit derivative, parameter A must be set equal to the credit 
enhancement level (L) input to the SFA formula. In the case of a first-
to-default credit derivative, there are no underlying exposures that 
are subordinated to the [BANK]'s exposure. In the case of a second-or-
subsequent-to-default credit derivative, the smallest (n-1) risk-
weighted asset amounts of the underlying exposure(s) are subordinated 
to the [BANK]'s exposure.
    (ii) The detachment point (parameter D) equals the sum of parameter 
A plus the ratio of the notional amount of the [BANK]'s exposure in the 
n^th-to-default credit derivative to the total notional 
amount of all underlying exposures. For purposes of the SSFA, parameter 
W is expressed as a decimal value between zero and one. For purposes of 
the SFA, parameter D must be set to equal L plus the thickness of 
tranche T input to the SFA formula.
    (3) A [BANK] that does not use the SFA or the SSFA to determine a 
risk weight for its exposure in an n^th-to-default credit 
derivative must assign a risk weight of 1,250 percent to the exposure.
    (4) Protection purchaser--(i) First-to-default credit derivatives. 
A [BANK] that obtains credit protection on a group of underlying 
exposures through a first-to-default credit derivative that meets the 
rules of recognition of Sec.  --.134(b) must determine its risk-based 
capital requirement under this subpart for the underlying exposures as 
if the [BANK] synthetically securitized the underlying exposure with 
the lowest risk-based capital requirement and had obtained no credit 
risk mitigant on the other underlying exposures. A [BANK] must 
calculate a risk-based capital requirement for counterparty credit risk 
according to Sec.  --.132 for a first-to-default credit derivative that 
does not meet the rules of recognition of Sec.  --.134(b).
    (ii) Second-or-subsequent-to-default credit derivatives. (A) A 
[BANK] that obtains credit protection on a group of underlying 
exposures through a n^th-to-default credit derivative that 
meets the rules of recognition of Sec.  --.134(b) (other than a first-
to-default credit derivative) may recognize the credit risk mitigation 
benefits of the derivative only if:
    (1) The [BANK] also has obtained credit protection on the same 
underlying exposures in the form of first-through-(n-1)-to-default 
credit derivatives; or
    (2) If n-1 of the underlying exposures have already defaulted.
    (B) If a [BANK] satisfies the requirements of paragraph 
(l)(3)(ii)(A) of this section, the [BANK] must determine its risk-based 
capital requirement for the underlying exposures as if the bank had 
only synthetically securitized the underlying exposure with the 
n^th smallest risk-based capital requirement and had obtained 
no credit risk mitigant on the other underlying exposures.
    (C) A [BANK] must calculate a risk-based capital requirement for 
counterparty credit risk according to Sec.  --.132 for a 
n^th-to-default credit derivative that does not meet the 
rules of recognition of Sec.  --.134(b).
    (m) Guarantees and credit derivatives other than nth-to-default 
credit derivatives--(1) Protection provider. For a guarantee or credit 
derivative (other than an n^th-to-default credit derivative) 
provided by a [BANK] that covers the full amount or a pro rata share of 
a securitization exposure's principal and interest, the [BANK] must 
risk weight the guarantee or credit derivative as if it holds the 
portion of the reference exposure covered by the guarantee or credit 
derivative.
    (2) Protection purchaser. (i) A [BANK] that purchases an OTC credit 
derivative (other than an n^th-to-default credit derivative) 
that is recognized under

[[Page 62235]]

Sec.  --.145 as a credit risk mitigant (including via recognized 
collateral) is not required to compute a separate counterparty credit 
risk capital requirement under Sec.  --.131 in accordance with Sec.  
--.132(c)(3).
    (ii) If a [BANK] cannot, or chooses not to, recognize a purchased 
credit derivative as a credit risk mitigant under Sec.  --.145, the 
[BANK] must determine the exposure amount of the credit derivative 
under Sec.  --.132(c).
    (A) If the [BANK] purchases credit protection from a counterparty 
that is not a securitization SPE, the [BANK] must determine the risk 
weight for the exposure according Sec.  --.131.
    (B) If the [BANK] purchases the credit protection from a 
counterparty that is a securitization SPE, the [BANK] must determine 
the risk weight for the exposure according to this section, including 
paragraph (a)(5) of this section for a credit derivative that has a 
first priority claim on the cash flows from the underlying exposures of 
the securitization SPE (notwithstanding amounts due under interest rate 
or currency derivative contracts, fees due, or other similar payments.


Sec.  --.143  Supervisory formula approach (SFA).

    (a) Eligibility requirements. A [BANK] must use the SFA to 
determine its risk-weighted asset amount for a securitization exposure 
if the [BANK] can calculate on an ongoing basis each of the SFA 
parameters in paragraph (e) of this section.
    (b) Mechanics. The risk-weighted asset amount for a securitization 
exposure equals its SFA risk-based capital requirement as calculated 
under paragraph (c) and (d) of this section, multiplied by 12.5.
    (c) The SFA risk-based capital requirement. (1) If KIRB 
is greater than or equal to L + T, an exposure's SFA risk-based capital 
requirement equals the exposure amount.
    (2) If KIRB is less than or equal to L, an exposure's 
SFA risk-based capital requirement is UE multiplied by TP multiplied by 
the greater of:
    (i) F [middot] T (where F is 0.016 for all securitization 
exposures); or
    (ii) S[L + T]-S[L].
    (3) If KIRB is greater than L and less than L + T, the 
[BANK] must apply a 1,250 percent risk weight to an amount equal to UE 
[middot] TP (KIRB-L), and the exposure's SFA risk-based 
capital requirement is UE multiplied by TP multiplied by the greater 
of:
    (i) F [middot] (T-(KIRB-L)) (where F is 0.016 for all 
other securitization exposures); or
    (ii) S[L + T]-S[KIRB].
    (d) The supervisory formula:

[[Page 62236]]

[GRAPHIC] [TIFF OMITTED] TR11OC13.049

    (e) SFA parameters. For purposes of the calculations in paragraphs 
(c) and (d) of this section:
    (1) Amount of the underlying exposures (UE). UE is the EAD of any 
underlying exposures that are wholesale and retail exposures (including 
the amount of any funded spread accounts, cash collateral accounts, and 
other similar funded credit enhancements) plus the amount of any 
underlying exposures that are securitization exposures (as defined in 
Sec.  --.142(e)) plus the adjusted carrying value of any underlying 
exposures that are equity exposures (as defined in Sec.  --.151(b)).
    (2) Tranche percentage (TP). TP is the ratio of the amount of the 
[BANK]'s securitization exposure to the amount of the tranche that 
contains the securitization exposure.
    (3) Capital requirement on underlying exposures (KIRB). (i) 
KIRB is the ratio of:
    (A) The sum of the risk-based capital requirements for the 
underlying exposures plus the expected credit losses of the underlying 
exposures (as determined under this subpart E as if the underlying 
exposures were directly held by the [BANK]); to
    (B) UE.
    (ii) The calculation of KIRB must reflect the effects of 
any credit risk mitigant applied to the underlying exposures (either to 
an individual underlying exposure, to a group of underlying exposures, 
or to all of the underlying exposures).
    (iii) All assets related to the securitization are treated as 
underlying exposures, including assets in a reserve account (such as a 
cash collateral account).
    (4) Credit enhancement level (L). (i) L is the ratio of:
    (A) The amount of all securitization exposures subordinated to the 
tranche

[[Page 62237]]

that contains the [BANK]'s securitization exposure; to
    (B) UE.
    (ii) A [BANK] must determine L before considering the effects of 
any tranche-specific credit enhancements.
    (iii) Any gain-on-sale or CEIO associated with the securitization 
may not be included in L.
    (iv) Any reserve account funded by accumulated cash flows from the 
underlying exposures that is subordinated to the tranche that contains 
the [BANK]'s securitization exposure may be included in the numerator 
and denominator of L to the extent cash has accumulated in the account. 
Unfunded reserve accounts (that is, reserve accounts that are to be 
funded from future cash flows from the underlying exposures) may not be 
included in the calculation of L.
    (v) In some cases, the purchase price of receivables will reflect a 
discount that provides credit enhancement (for example, first loss 
protection) for all or certain tranches of the securitization. When 
this arises, L should be calculated inclusive of this discount if the 
discount provides credit enhancement for the securitization exposure.
    (5) Thickness of tranche (T). T is the ratio of:
    (i) The amount of the tranche that contains the [BANK]'s 
securitization exposure; to
    (ii) UE.
    (6) Effective number of exposures (N). (i) Unless the [BANK] elects 
to use the formula provided in paragraph (f) of this section,
[GRAPHIC] [TIFF OMITTED] TR11OC13.050


where EADi represents the EAD associated with the ith 
instrument in the underlying exposures.

    (ii) Multiple exposures to one obligor must be treated as a single 
underlying exposure.
    (iii) In the case of a resecuritization, the [BANK] must treat each 
underlying exposure as a single underlying exposure and must not look 
through to the originally securitized underlying exposures.
    (7) Exposure-weighted average loss given default (EWALGD). EWALGD 
is calculated as:
[GRAPHIC] [TIFF OMITTED] TR11OC13.051


where LGDi represents the average LGD associated with all 
exposures to the ith obligor. In the case of a resecuritization, an 
LGD of 100 percent must be assumed for the underlying exposures that 
are themselves securitization exposures.

    (f) Simplified method for computing N and EWALGD. (1) If all 
underlying exposures of a securitization are retail exposures, a [BANK] 
may apply the SFA using the following simplifications:
    (i) h = 0; and
    (ii) v = 0.
    (2) Under the conditions in Sec. Sec.  .--143(f)(3) and (f)(4), a 
[BANK] may employ a simplified method for calculating N and EWALGD.
    (3) If C1 is no more than 0.03, a [BANK] may set EWALGD 
= 0.50 if none of the underlying exposures is a securitization 
exposure, or may set EWALGD = 1 if one or more of the underlying 
exposures is a securitization exposure, and may set N equal to the 
following amount:

[GRAPHIC] [TIFF OMITTED] TR11OC13.052

where:

(i) Cm is the ratio of the sum of the amounts of the `m' 
largest underlying exposures to UE; and
(ii) The level of m is to be selected by the [BANK].

    (4) Alternatively, if only C1 is available and 
C1 is no more than 0.03, the [BANK] may set EWALGD = 0.50 if 
none of the underlying exposures is a securitization exposure, or may 
set EWALGD = 1 if one or more of the underlying exposures is a 
securitization exposure and may set N = 1/C1.


Sec.  --.144  Simplified supervisory formula approach (SSFA).

    (a) General requirements for the SSFA. To use the SSFA to determine 
the risk weight for a securitization exposure, a [BANK] must have data 
that enables it to assign accurately the parameters described in 
paragraph (b) of this section. Data used to assign the parameters 
described in paragraph (b) of this section must be the most currently 
available data; if the contracts governing the underlying exposures of 
the securitization require payments on a monthly or quarterly basis, 
the data used to assign the parameters described in paragraph (b) of 
this section must be no more than 91 calendar days old. A [BANK] that 
does not have the appropriate data to assign the parameters described 
in paragraph (b) of this section must assign a risk weight of 1,250 
percent to the exposure.
    (b) SSFA parameters. To calculate the risk weight for a 
securitization exposure using the SSFA, a [BANK] must have accurate 
information on the following five inputs to the SSFA calculation:
    (1) KG is the weighted-average (with unpaid principal 
used as the weight for each exposure) total capital requirement of the 
underlying exposures calculated using subpart D of this part. 
KG is expressed as a decimal value between zero and one 
(that is, an average risk weight of 100 percent represents a value of 
KG equal to 0.08).
    (2) Parameter W is expressed as a decimal value between zero and 
one. Parameter W is the ratio of the sum of the dollar amounts of any 
underlying exposures of the securitization that meet any of the 
criteria as set forth in paragraphs (b)(2)(i) through (vi) of this 
section to the balance, measured in dollars, of underlying exposures:
    (i) Ninety days or more past due;
    (ii) Subject to a bankruptcy or insolvency proceeding;
    (iii) In the process of foreclosure;
    (iv) Held as real estate owned;
    (v) Has contractually deferred payments for 90 days or more, other 
than principal or interest payments deferred on:
    (A) Federally-guaranteed student loans, in accordance with the 
terms of those guarantee programs; or
    (B) Consumer loans, including non-federally-guaranteed student 
loans, provided that such payments are deferred pursuant to provisions 
included in the contract at the time funds are disbursed that provide 
for period(s) of deferral that are not initiated based on changes in 
the creditworthiness of the borrower; or
    (vi) Is in default.
    (3) Parameter A is the attachment point for the exposure, which 
represents the threshold at which credit losses will first be allocated 
to the exposure. Except

[[Page 62238]]

as provided in section 142(l) for n^th-to-default credit 
derivatives, parameter A equals the ratio of the current dollar amount 
of underlying exposures that are subordinated to the exposure of the 
[BANK] to the current dollar amount of underlying exposures. Any 
reserve account funded by the accumulated cash flows from the 
underlying exposures that is subordinated to the [BANK]'s 
securitization exposure may be included in the calculation of parameter 
A to the extent that cash is present in the account. Parameter A is 
expressed as a decimal value between zero and one.
    (4) Parameter D is the detachment point for the exposure, which 
represents the threshold at which credit losses of principal allocated 
to the exposure would result in a total loss of principal. Except as 
provided in section 142(l) for n^th-to-default credit 
derivatives, parameter D equals parameter A plus the ratio of the 
current dollar amount of the securitization exposures that are pari 
passu with the exposure (that is, have equal seniority with respect to 
credit risk) to the current dollar amount of the underlying exposures. 
Parameter D is expressed as a decimal value between zero and one.
    (5) A supervisory calibration parameter, p, is equal to 0.5 for 
securitization exposures that are not resecuritization exposures and 
equal to 1.5 for resecuritization exposures.
    (c) Mechanics of the SSFA. KG and W are used to 
calculate KA, the augmented value of KG, which 
reflects the observed credit quality of the underlying exposures. 
KA is defined in paragraph (d) of this section. The values 
of parameters A and D, relative to KA determine the risk 
weight assigned to a securitization exposure as described in paragraph 
(d) of this section. The risk weight assigned to a securitization 
exposure, or portion of a securitization exposure, as appropriate, is 
the larger of the risk weight determined in accordance with this 
paragraph (c), paragraph (d) of this section, and a risk weight of 20 
percent.
    (1) When the detachment point, parameter D, for a securitization 
exposure is less than or equal to KA, the exposure must be 
assigned a risk weight of 1,250 percent;
    (2) When the attachment point, parameter A, for a securitization 
exposure is greater than or equal to KA, the [BANK] must 
calculate the risk weight in accordance with paragraph (d) of this 
section;
    (3) When A is less than KA and D is greater than 
KA, the risk weight is a weighted-average of 1,250 percent 
and 1,250 percent times KSSFA calculated in accordance with 
paragraph (d) of this section. For the purpose of this weighted-average 
calculation:

[[Page 62239]]

[GRAPHIC] [TIFF OMITTED] TR11OC13.053

Sec.  --.145  Recognition of credit risk mitigants for securitization 
exposures.

    (a) General. An originating [BANK] that has obtained a credit risk 
mitigant to hedge its securitization exposure to a synthetic or 
traditional securitization that satisfies the operational criteria in 
Sec.  --.141 may recognize the credit risk mitigant, but only as 
provided in this section. An investing [BANK] that has obtained a 
credit risk mitigant to hedge a securitization exposure may recognize 
the credit risk mitigant, but only as provided in this section.
    (b) Collateral. (1) Rules of recognition. A [BANK] may recognize 
financial collateral in determining the [BANK]'s risk-weighted asset 
amount for a securitization exposure (other than a repo-style 
transaction, an eligible margin loan, or an OTC derivative contract for 
which the [BANK] has reflected collateral in its determination of 
exposure amount under Sec.  --.132) as follows. The [BANK]'s risk-
weighted asset amount for the collateralized securitization exposure is 
equal to the risk-weighted asset amount for the securitization exposure 
as calculated under the SSFA in Sec.  --.144 or under the SFA in Sec.  
--.143 multiplied by the ratio of adjusted exposure amount (SE*) to 
original exposure amount (SE),

Where:

(i) SE* = max {0, [SE-C x (1-Hs-Hfx)]{time} ;
(ii) SE = the amount of the securitization exposure calculated under 
Sec.  --.142(e);
(iii) C = the current fair value of the collateral;
(iv) Hs = the haircut appropriate to the collateral type; 
and
(v) Hfx = the haircut appropriate for any currency 
mismatch between the collateral and the exposure.

[[Page 62240]]

[GRAPHIC] [TIFF OMITTED] TR11OC13.054

    (3) Standard supervisory haircuts. Unless a [BANK] qualifies for 
use of and uses own-estimates haircuts in paragraph (b)(4) of this 
section:
    (i) A [BANK] must use the collateral type haircuts (Hs) 
in Table 1 to Sec.  --.132 of this subpart;
    (ii) A [BANK] must use a currency mismatch haircut (Hfx) 
of 8 percent if the exposure and the collateral are denominated in 
different currencies;
    (iii) A [BANK] must multiply the supervisory haircuts obtained in 
paragraphs (b)(3)(i) and (ii) of this section by the square root of 6.5 
(which equals 2.549510); and
    (iv) A [BANK] must adjust the supervisory haircuts upward on the 
basis of a holding period longer than 65 business days where and as 
appropriate to take into account the illiquidity of the collateral.
    (4) Own estimates for haircuts. With the prior written approval of 
the [AGENCY], a [BANK] may calculate haircuts using its own internal 
estimates of market price volatility and foreign exchange volatility, 
subject to Sec.  --.132(b)(2)(iii). The minimum holding period 
(TM) for securitization exposures is 65 business days.
    (c) Guarantees and credit derivatives--(1) Limitations on 
recognition. A [BANK] may only recognize an eligible guarantee or 
eligible credit derivative provided by an eligible guarantor in 
determining the [BANK]'s risk-weighted asset amount for a 
securitization exposure.
    (2) ECL for securitization exposures. When a [BANK] recognizes an 
eligible guarantee or eligible credit derivative provided by an 
eligible guarantor in determining the [BANK]'s risk-weighted asset 
amount for a securitization exposure, the [BANK] must also:
    (i) Calculate ECL for the protected portion of the exposure using 
the same risk parameters that it uses for calculating the risk-weighted 
asset amount of the exposure as described in paragraph (c)(3) of this 
section; and
    (ii) Add the exposure's ECL to the [BANK]'s total ECL.
    (3) Rules of recognition. A [BANK] may recognize an eligible 
guarantee or eligible credit derivative provided by an eligible 
guarantor in determining the [BANK]'s risk-weighted asset amount for 
the securitization exposure as follows:
    (i) Full coverage. If the protection amount of the eligible 
guarantee or eligible credit derivative equals or exceeds the amount of 
the securitization exposure, the [BANK] may set the risk-weighted asset 
amount for the securitization exposure equal to the risk-weighted asset 
amount for a direct exposure to the eligible guarantor (as determined 
in the wholesale risk weight function described in Sec.  --.131), using 
the [BANK]'s PD for the guarantor, the [BANK]'s LGD for the guarantee 
or credit derivative, and an EAD equal to the amount of the 
securitization exposure (as determined in Sec.  --.142(e)).
    (ii) Partial coverage. If the protection amount of the eligible 
guarantee or eligible credit derivative is less than the amount of the 
securitization exposure, the [BANK] may set the risk-weighted asset 
amount for the securitization exposure equal to the sum of:
    (A) Covered portion. The risk-weighted asset amount for a direct 
exposure to the eligible guarantor (as determined in the wholesale risk 
weight function described in Sec.  --.131), using the [BANK]'s PD for 
the guarantor, the [BANK]'s LGD for the guarantee or credit derivative, 
and an EAD equal to the protection amount of the credit risk mitigant; 
and
    (B) Uncovered portion. (1) 1.0 minus the ratio of the protection 
amount of the eligible guarantee or eligible credit derivative to the 
amount of the securitization exposure); multiplied by
    (2) The risk-weighted asset amount for the securitization exposure 
without the credit risk mitigant (as determined in Sec. Sec.  --.142 
through 146).
    (4) Mismatches. The [BANK] must make applicable adjustments to the 
protection amount as required in Sec.  --.134(d), (e), and (f) for any 
hedged securitization exposure and any more senior securitization 
exposure that benefits from the hedge. In the context of a synthetic 
securitization, when an eligible guarantee or eligible credit 
derivative covers multiple hedged exposures that have different 
residual maturities, the [BANK] must use the longest residual maturity 
of any of the hedged exposures as the residual maturity of all the 
hedged exposures.


Sec. Sec.  --.146 through --.150  [Reserved]

Risk-Weighted Assets for Equity Exposures


Sec.  --.151  Introduction and exposure measurement.

    (a) General. (1) To calculate its risk-weighted asset amounts for 
equity exposures that are not equity exposures to investment funds, a 
[BANK] may apply either the Simple Risk Weight Approach (SRWA) in Sec.  
--.152 or, if it qualifies to do so, the Internal Models Approach (IMA) 
in Sec.  --.153. A [BANK] must use the look-through approaches provided 
in Sec.  --.154 to calculate its risk-weighted asset amounts for equity 
exposures to investment funds.
    (2) A [BANK] must treat an investment in a separate account (as 
defined in Sec.  --.2), as if it were an equity exposure to an 
investment fund as provided in Sec.  --.154.
    (3) Stable value protection. (i) Stable value protection means a 
contract where the provider of the contract is obligated to pay:
    (A) The policy owner of a separate account an amount equal to the 
shortfall between the fair value and cost basis of the separate account 
when the policy owner of the separate account surrenders the policy, or
    (B) The beneficiary of the contract an amount equal to the 
shortfall between the fair value and book value of a specified 
portfolio of assets.
    (ii) A [BANK] that purchases stable value protection on its 
investment in a separate account must treat the portion of the carrying 
value of its investment in the separate account attributable to the 
stable value protection as an exposure to the provider of the 
protection and the remaining portion of the carrying value of its 
separate account as an equity exposure to an investment fund.

[[Page 62241]]

    (iii) A [BANK] that provides stable value protection must treat the 
exposure as an equity derivative with an adjusted carrying value 
determined as the sum of Sec.  --.151(b)(1) and (2).
    (b) Adjusted carrying value. For purposes of this subpart, the 
adjusted carrying value of an equity exposure is:
    (1) For the on-balance sheet component of an equity exposure, the 
[BANK]'s carrying value of the exposure;
    (2) For the off-balance sheet component of an equity exposure, the 
effective notional principal amount of the exposure, the size of which 
is equivalent to a hypothetical on-balance sheet position in the 
underlying equity instrument that would evidence the same change in 
fair value (measured in dollars) for a given small change in the price 
of the underlying equity instrument, minus the adjusted carrying value 
of the on-balance sheet component of the exposure as calculated in 
paragraph (b)(1) of this section.
    (3) For unfunded equity commitments that are unconditional, the 
effective notional principal amount is the notional amount of the 
commitment. For unfunded equity commitments that are conditional, the 
effective notional principal amount is the [BANK]'s best estimate of 
the amount that would be funded under economic downturn conditions.


Sec.  --.152  Simple risk weight approach (SRWA).

    (a) General. Under the SRWA, a [BANK]'s aggregate risk-weighted 
asset amount for its equity exposures is equal to the sum of the risk-
weighted asset amounts for each of the [BANK]'s individual equity 
exposures (other than equity exposures to an investment fund) as 
determined in this section and the risk-weighted asset amounts for each 
of the [BANK]'s individual equity exposures to an investment fund as 
determined in Sec.  --.154.
    (b) SRWA computation for individual equity exposures. A [BANK] must 
determine the risk-weighted asset amount for an individual equity 
exposure (other than an equity exposure to an investment fund) by 
multiplying the adjusted carrying value of the equity exposure or the 
effective portion and ineffective portion of a hedge pair (as defined 
in paragraph (c) of this section) by the lowest applicable risk weight 
in this section.
    (1) Zero percent risk weight equity exposures. An equity exposure 
to an entity whose credit exposures are exempt from the 0.03 percent PD 
floor in Sec.  --.131(d)(2) is assigned a zero percent risk weight.
    (2) 20 percent risk weight equity exposures. An equity exposure to 
a Federal Home Loan Bank or the Federal Agricultural Mortgage 
Corporation (Farmer Mac) is assigned a 20 percent risk weight.
    (3) 100 percent risk weight equity exposures. The following equity 
exposures are assigned a 100 percent risk weight:
    (i) Community development equity exposures. An equity exposure that 
qualifies as a community development investment under section 24 
(Eleventh) of the National Bank Act, excluding equity exposures to an 
unconsolidated small business investment company and equity exposures 
held through a consolidated small business investment company described 
in section 302 of the Small Business Investment Act.
    (ii) Effective portion of hedge pairs. The effective portion of a 
hedge pair.
    (iii) Non-significant equity exposures. Equity exposures, excluding 
significant investments in the capital of an unconsolidated institution 
in the form of common stock and exposures to an investment firm that 
would meet the definition of a traditional securitization were it not 
for the [AGENCY]'s application of paragraph (8) of that definition in 
Sec.  --.2 and has greater than immaterial leverage, to the extent that 
the aggregate adjusted carrying value of the exposures does not exceed 
10 percent of the [BANK]'s total capital.
    (A) To compute the aggregate adjusted carrying value of a [BANK]'s 
equity exposures for purposes of this section, the [BANK] may exclude 
equity exposures described in paragraphs (b)(1), (b)(2), (b)(3)(i), and 
(b)(3)(ii) of this section, the equity exposure in a hedge pair with 
the smaller adjusted carrying value, and a proportion of each equity 
exposure to an investment fund equal to the proportion of the assets of 
the investment fund that are not equity exposures or that meet the 
criterion of paragraph (b)(3)(i) of this section. If a [BANK] does not 
know the actual holdings of the investment fund, the [BANK] may 
calculate the proportion of the assets of the fund that are not equity 
exposures based on the terms of the prospectus, partnership agreement, 
or similar contract that defines the fund's permissible investments. If 
the sum of the investment limits for all exposure classes within the 
fund exceeds 100 percent, the [BANK] must assume for purposes of this 
section that the investment fund invests to the maximum extent possible 
in equity exposures.
    (B) When determining which of a [BANK]'s equity exposures qualifies 
for a 100 percent risk weight under this section, a [BANK] first must 
include equity exposures to unconsolidated small business investment 
companies or held through consolidated small business investment 
companies described in section 302 of the Small Business Investment 
Act, then must include publicly traded equity exposures (including 
those held indirectly through investment funds), and then must include 
non-publicly traded equity exposures (including those held indirectly 
through investment funds).
    (4) 250 percent risk weight equity exposures. Significant 
investments in the capital of unconsolidated financial institutions in 
the form of common stock that are not deducted from capital pursuant to 
Sec.  --.22(b)(4) are assigned a 250 percent risk weight.
    (5) 300 percent risk weight equity exposures. A publicly traded 
equity exposure (other than an equity exposure described in paragraph 
(b)(6) of this section and including the ineffective portion of a hedge 
pair) is assigned a 300 percent risk weight.
    (6) 400 percent risk weight equity exposures. An equity exposure 
(other than an equity exposure described in paragraph (b)(6) of this 
section) that is not publicly traded is assigned a 400 percent risk 
weight.
    (7) 600 percent risk weight equity exposures. An equity exposure to 
an investment firm that:
    (i) Would meet the definition of a traditional securitization were 
it not for the [AGENCY]'s application of paragraph (8) of that 
definition in Sec.  --.2; and
    (ii) Has greater than immaterial leverage is assigned a 600 percent 
risk weight.
    (c) Hedge transactions--(1) Hedge pair. A hedge pair is two equity 
exposures that form an effective hedge so long as each equity exposure 
is publicly traded or has a return that is primarily based on a 
publicly traded equity exposure.
    (2) Effective hedge. Two equity exposures form an effective hedge 
if the exposures either have the same remaining maturity or each has a 
remaining maturity of at least three months; the hedge relationship is 
formally documented in a prospective manner (that is, before the [BANK] 
acquires at least one of the equity exposures); the documentation 
specifies the measure of effectiveness (E) the [BANK] will use for the 
hedge relationship throughout the life of the transaction; and the 
hedge relationship

[[Page 62242]]

has an E greater than or equal to 0.8. A [BANK] must measure E at least 
quarterly and must use one of three alternative measures of E:
    (i) Under the dollar-offset method of measuring effectiveness, the 
[BANK] must determine the ratio of value change (RVC). The RVC is the 
ratio of the cumulative sum of the periodic changes in value of one 
equity exposure to the cumulative sum of the periodic changes in the 
value of the other equity exposure. If RVC is positive, the hedge is 
not effective and E equals zero. If RVC is negative and greater than or 
equal to -1 (that is, between zero and -1), then E equals the absolute 
value of RVC. If RVC is negative and less than -1, then E equals 2 plus 
RVC.
    (ii) Under the variability-reduction method of measuring 
effectiveness:
[GRAPHIC] [TIFF OMITTED] TR11OC13.055

    (iii) Under the regression method of measuring effectiveness, E 
equals the coefficient of determination of a regression in which the 
change in value of one exposure in a hedge pair is the dependent 
variable and the change in value of the other exposure in a hedge pair 
is the independent variable. However, if the estimated regression 
coefficient is positive, then the value of E is zero.
    (3) The effective portion of a hedge pair is E multiplied by the 
greater of the adjusted carrying values of the equity exposures forming 
a hedge pair.
    (4) The ineffective portion of a hedge pair is (1-E) multiplied by 
the greater of the adjusted carrying values of the equity exposures 
forming a hedge pair.


Sec.  --.153  Internal models approach (IMA).

    (a) General. A [BANK] may calculate its risk-weighted asset amount 
for equity exposures using the IMA by modeling publicly traded and non-
publicly traded equity exposures (in accordance with paragraph (c) of 
this section) or by modeling only publicly traded equity exposures (in 
accordance with paragraphs (c) and (d) of this section).
    (b) Qualifying criteria. To qualify to use the IMA to calculate 
risk-weighted assets for equity exposures, a [BANK] must receive prior 
written approval from the [AGENCY]. To receive such approval, the 
[BANK] must demonstrate to the [AGENCY]'s satisfaction that the [BANK] 
meets the following criteria:
    (1) The [BANK] must have one or more models that:
    (i) Assess the potential decline in value of its modeled equity 
exposures;
    (ii) Are commensurate with the size, complexity, and composition of 
the [BANK]'s modeled equity exposures; and
    (iii) Adequately capture both general market risk and idiosyncratic 
risk.
    (2) The [BANK]'s model must produce an estimate of potential losses 
for its modeled equity exposures that is no less than the estimate of 
potential losses produced by a VaR methodology employing a 99th 
percentile one-tailed confidence interval of the distribution of 
quarterly returns for a benchmark portfolio of equity exposures 
comparable to the [BANK]'s modeled equity exposures using a long-term 
sample period.
    (3) The number of risk factors and exposures in the sample and the 
data period used for quantification in the [BANK]'s model and 
benchmarking exercise must be sufficient to provide confidence in the 
accuracy and robustness of the [BANK]'s estimates.
    (4) The [BANK]'s model and benchmarking process must incorporate 
data that are relevant in representing the risk profile of the [BANK]'s 
modeled equity exposures, and must include data from at least one 
equity market cycle containing adverse market movements relevant to the 
risk profile of the [BANK]'s modeled equity exposures. In addition, the 
[BANK]'s benchmarking exercise must be based on daily market prices for 
the benchmark portfolio. If the [BANK]'s model uses a scenario 
methodology, the [BANK] must demonstrate that the model produces a 
conservative estimate of potential losses on the [BANK]'s modeled 
equity exposures over a relevant long-term market cycle. If the [BANK] 
employs risk factor models, the [BANK] must demonstrate through 
empirical analysis the appropriateness of the risk factors used.
    (5) The [BANK] must be able to demonstrate, using theoretical 
arguments and empirical evidence, that any proxies used in the modeling 
process are comparable to the [BANK]'s modeled equity exposures and 
that the [BANK] has made appropriate adjustments for differences. The 
[BANK] must derive any proxies for its modeled equity exposures and 
benchmark portfolio using historical market data that are relevant to 
the [BANK]'s modeled equity exposures and benchmark portfolio (or, 
where not, must use appropriately adjusted data), and such proxies must 
be robust estimates of the risk of the [BANK]'s modeled equity 
exposures.
    (c) Risk-weighted assets calculation for a [BANK] using the IMA for 
publicly traded and non-publicly traded equity exposures. If a [BANK] 
models publicly traded and non-publicly traded equity exposures, the 
[BANK]'s aggregate risk-weighted asset amount for its equity exposures 
is equal to the sum of:
    (1) The risk-weighted asset amount of each equity exposure that 
qualifies for a 0 percent, 20 percent, or 100 percent risk weight under 
Sec.  --.152(b)(1) through (b)(3)(i) (as determined under Sec.  --.152) 
and each equity exposure to an investment fund (as determined under 
Sec.  --.154); and
    (2) The greater of:

[[Page 62243]]

    (i) The estimate of potential losses on the [BANK]'s equity 
exposures (other than equity exposures referenced in paragraph (c)(1) 
of this section) generated by the [BANK]'s internal equity exposure 
model multiplied by 12.5; or
    (ii) The sum of:
    (A) 200 percent multiplied by the aggregate adjusted carrying value 
of the [BANK]'s publicly traded equity exposures that do not belong to 
a hedge pair, do not qualify for a 0 percent, 20 percent, or 100 
percent risk weight under Sec.  --.152(b)(1) through (b)(3)(i), and are 
not equity exposures to an investment fund;
    (B) 200 percent multiplied by the aggregate ineffective portion of 
all hedge pairs; and
    (C) 300 percent multiplied by the aggregate adjusted carrying value 
of the [BANK]'s equity exposures that are not publicly traded, do not 
qualify for a 0 percent, 20 percent, or 100 percent risk weight under 
Sec.  --.152(b)(1) through (b)(3)(i), and are not equity exposures to 
an investment fund.
    (d) Risk-weighted assets calculation for a [BANK] using the IMA 
only for publicly traded equity exposures. If a [BANK] models only 
publicly traded equity exposures, the [BANK]'s aggregate risk-weighted 
asset amount for its equity exposures is equal to the sum of:
    (1) The risk-weighted asset amount of each equity exposure that 
qualifies for a 0 percent, 20 percent, or 100 percent risk weight under 
Sec. Sec.  --.152(b)(1) through (b)(3)(i) (as determined under Sec.  
--.152), each equity exposure that qualifies for a 400 percent risk 
weight under Sec.  --.152(b)(5) or a 600 percent risk weight under 
Sec.  --.152(b)(6) (as determined under Sec.  --.152), and each equity 
exposure to an investment fund (as determined under Sec.  --.154); and
    (2) The greater of:
    (i) The estimate of potential losses on the [BANK]'s equity 
exposures (other than equity exposures referenced in paragraph (d)(1) 
of this section) generated by the [BANK]'s internal equity exposure 
model multiplied by 12.5; or
    (ii) The sum of:
    (A) 200 percent multiplied by the aggregate adjusted carrying value 
of the [BANK]'s publicly traded equity exposures that do not belong to 
a hedge pair, do not qualify for a 0 percent, 20 percent, or 100 
percent risk weight under Sec.  --.152(b)(1) through (b)(3)(i), and are 
not equity exposures to an investment fund; and
    (B) 200 percent multiplied by the aggregate ineffective portion of 
all hedge pairs.


Sec.  --.154  Equity exposures to investment funds.

    (a) Available approaches. (1) Unless the exposure meets the 
requirements for a community development equity exposure in Sec.  
--.152(b)(3)(i), a [BANK] must determine the risk-weighted asset amount 
of an equity exposure to an investment fund under the full look-through 
approach in paragraph (b) of this section, the simple modified look-
through approach in paragraph (c) of this section, or the alternative 
modified look-through approach in paragraph (d) of this section.
    (2) The risk-weighted asset amount of an equity exposure to an 
investment fund that meets the requirements for a community development 
equity exposure in Sec.  --.152(b)(3)(i) is its adjusted carrying 
value.
    (3) If an equity exposure to an investment fund is part of a hedge 
pair and the [BANK] does not use the full look-through approach, the 
[BANK] may use the ineffective portion of the hedge pair as determined 
under Sec.  --.152(c) as the adjusted carrying value for the equity 
exposure to the investment fund. The risk-weighted asset amount of the 
effective portion of the hedge pair is equal to its adjusted carrying 
value.
    (b) Full look-through approach. A [BANK] that is able to calculate 
a risk-weighted asset amount for its proportional ownership share of 
each exposure held by the investment fund (as calculated under this 
subpart E of this part as if the proportional ownership share of each 
exposure were held directly by the [BANK]) may either:
    (1) Set the risk-weighted asset amount of the [BANK]'s exposure to 
the fund equal to the product of:
    (i) The aggregate risk-weighted asset amounts of the exposures held 
by the fund as if they were held directly by the [BANK]; and
    (ii) The [BANK]'s proportional ownership share of the fund; or
    (2) Include the [BANK]'s proportional ownership share of each 
exposure held by the fund in the [BANK]'s IMA.
    (c) Simple modified look-through approach. Under this approach, the 
risk-weighted asset amount for a [BANK]'s equity exposure to an 
investment fund equals the adjusted carrying value of the equity 
exposure multiplied by the highest risk weight assigned according to 
subpart D of this part that applies to any exposure the fund is 
permitted to hold under its prospectus, partnership agreement, or 
similar contract that defines the fund's permissible investments 
(excluding derivative contracts that are used for hedging rather than 
speculative purposes and that do not constitute a material portion of 
the fund's exposures).
    (d) Alternative modified look-through approach. Under this 
approach, a [BANK] may assign the adjusted carrying value of an equity 
exposure to an investment fund on a pro rata basis to different risk 
weight categories assigned according to subpart D of this part based on 
the investment limits in the fund's prospectus, partnership agreement, 
or similar contract that defines the fund's permissible investments. 
The risk-weighted asset amount for the [BANK]'s equity exposure to the 
investment fund equals the sum of each portion of the adjusted carrying 
value assigned to an exposure class multiplied by the applicable risk 
weight. If the sum of the investment limits for all exposure types 
within the fund exceeds 100 percent, the [BANK] must assume that the 
fund invests to the maximum extent permitted under its investment 
limits in the exposure type with the highest risk weight under subpart 
D of this part, and continues to make investments in order of the 
exposure type with the next highest risk weight under subpart D of this 
part until the maximum total investment level is reached. If more than 
one exposure type applies to an exposure, the [BANK] must use the 
highest applicable risk weight. A [BANK] may exclude derivative 
contracts held by the fund that are used for hedging rather than for 
speculative purposes and do not constitute a material portion of the 
fund's exposures.


Sec.  --.155  Equity derivative contracts.

    (a) Under the IMA, in addition to holding risk-based capital 
against an equity derivative contract under this part, a [BANK] must 
hold risk-based capital against the counterparty credit risk in the 
equity derivative contract by also treating the equity derivative 
contract as a wholesale exposure and computing a supplemental risk-
weighted asset amount for the contract under Sec.  --.132.
    (b) Under the SRWA, a [BANK] may choose not to hold risk-based 
capital against the counterparty credit risk of equity derivative 
contracts, as long as it does so for all such contracts. Where the 
equity derivative contracts are subject to a qualified master netting 
agreement, a [BANK] using the SRWA must either include all or exclude 
all of the contracts from any measure used to determine counterparty 
credit risk exposure.

[[Page 62244]]

Sec. Sec.  --.166 through --.160  [Reserved]

Risk-Weighted Assets for Operational Risk


Sec.  --.161  Qualification requirements for incorporation of 
operational risk mitigants.

    (a) Qualification to use operational risk mitigants. A [BANK] may 
adjust its estimate of operational risk exposure to reflect qualifying 
operational risk mitigants if:
    (1) The [BANK]'s operational risk quantification system is able to 
generate an estimate of the [BANK]'s operational risk exposure (which 
does not incorporate qualifying operational risk mitigants) and an 
estimate of the [BANK]'s operational risk exposure adjusted to 
incorporate qualifying operational risk mitigants; and
    (2) The [BANK]'s methodology for incorporating the effects of 
insurance, if the [BANK] uses insurance as an operational risk 
mitigant, captures through appropriate discounts to the amount of risk 
mitigation:
    (i) The residual term of the policy, where less than one year;
    (ii) The cancellation terms of the policy, where less than one 
year;
    (iii) The policy's timeliness of payment;
    (iv) The uncertainty of payment by the provider of the policy; and
    (v) Mismatches in coverage between the policy and the hedged 
operational loss event.
    (b) Qualifying operational risk mitigants. Qualifying operational 
risk mitigants are:
    (1) Insurance that:
    (i) Is provided by an unaffiliated company that the [BANK] deems to 
have strong capacity to meet its claims payment obligations and the 
obligor rating category to which the [BANK] assigns the company is 
assigned a PD equal to or less than 10 basis points;
    (ii) Has an initial term of at least one year and a residual term 
of more than 90 days;
    (iii) Has a minimum notice period for cancellation by the provider 
of 90 days;
    (iv) Has no exclusions or limitations based upon regulatory action 
or for the receiver or liquidator of a failed depository institution; 
and
    (v) Is explicitly mapped to a potential operational loss event;
    (2) Operational risk mitigants other than insurance for which the 
[AGENCY] has given prior written approval. In evaluating an operational 
risk mitigant other than insurance, the [AGENCY] will consider whether 
the operational risk mitigant covers potential operational losses in a 
manner equivalent to holding total capital.


Sec.  --.162  Mechanics of risk-weighted asset calculation.

    (a) If a [BANK] does not qualify to use or does not have qualifying 
operational risk mitigants, the [BANK]'s dollar risk-based capital 
requirement for operational risk is its operational risk exposure minus 
eligible operational risk offsets (if any).
    (b) If a [BANK] qualifies to use operational risk mitigants and has 
qualifying operational risk mitigants, the [BANK]'s dollar risk-based 
capital requirement for operational risk is the greater of:
    (1) The [BANK]'s operational risk exposure adjusted for qualifying 
operational risk mitigants minus eligible operational risk offsets (if 
any); or
    (2) 0.8 multiplied by the difference between:
    (i) The [BANK]'s operational risk exposure; and
    (ii) Eligible operational risk offsets (if any).
    (c) The [BANK]'s risk-weighted asset amount for operational risk 
equals the [BANK]'s dollar risk-based capital requirement for 
operational risk determined under sections 162(a) or (b) multiplied by 
12.5.


Sec. Sec.  --.163 through --.170  [Reserved]

Disclosures


Sec.  --.171  Purpose and scope.

    Sec. Sec.  --.171 through --.173 establish public disclosure 
requirements related to the capital requirements of a [BANK] that is an 
advanced approaches [BANK].


Sec.  --.172  Disclosure requirements.

    (a) A [BANK] that is an advanced approaches [BANK] that has 
completed the parallel run process and that has received notification 
from the [AGENCY] pursuant to section 121(d) of subpart E of this part 
must publicly disclose each quarter its total and tier 1 risk-based 
capital ratios and their components as calculated under this subpart 
(that is, common equity tier 1 capital, additional tier 1 capital, tier 
2 capital, total qualifying capital, and total risk-weighted assets).
    (b) A [BANK] that is an advanced approaches [BANK] that has 
completed the parallel run process and that has received notification 
from the [AGENCY] pursuant to section 121(d) of subpart E of this part 
must comply with paragraph (c) of this section unless it is a 
consolidated subsidiary of a bank holding company, savings and loan 
holding company, or depository institution that is subject to these 
disclosure requirements or a subsidiary of a non-U.S. banking 
organization that is subject to comparable public disclosure 
requirements in its home jurisdiction.
    (c)(1) A [BANK] described in paragraph (b) of this section must 
provide timely public disclosures each calendar quarter of the 
information in the applicable tables in Sec.  --.173. If a significant 
change occurs, such that the most recent reported amounts are no longer 
reflective of the [BANK]'s capital adequacy and risk profile, then a 
brief discussion of this change and its likely impact must be disclosed 
as soon as practicable thereafter. Qualitative disclosures that 
typically do not change each quarter (for example, a general summary of 
the [BANK]'s risk management objectives and policies, reporting system, 
and definitions) may be disclosed annually after the end of the fourth 
calendar quarter, provided that any significant changes to these are 
disclosed in the interim. Management may provide all of the disclosures 
required by this subpart in one place on the [BANK]'s public Web site 
or may provide the disclosures in more than one public financial report 
or other regulatory reports, provided that the [BANK] publicly provides 
a summary table specifically indicating the location(s) of all such 
disclosures.
    (2) A [BANK] described in paragraph (b) of this section must have a 
formal disclosure policy approved by the board of directors that 
addresses its approach for determining the disclosures it makes. The 
policy must address the associated internal controls and disclosure 
controls and procedures. The board of directors and senior management 
are responsible for establishing and maintaining an effective internal 
control structure over financial reporting, including the disclosures 
required by this subpart, and must ensure that appropriate review of 
the disclosures takes place. One or more senior officers of the [BANK] 
must attest that the disclosures meet the requirements of this subpart.
    (3) If a [BANK] described in paragraph (b) of this section believes 
that disclosure of specific commercial or financial information would 
prejudice seriously its position by making public information that is 
either proprietary or confidential in nature, the [BANK] is not 
required to disclose those specific items, but must disclose more 
general information about the subject matter of the requirement, 
together with the fact that, and the reason why, the specific items of 
information have not been disclosed.

[[Page 62245]]

Sec.  --.173  Disclosures by certain advanced approaches [BANK]s.

    (a) Except as provided in Sec.  --.172(b), a [BANK] described in 
Sec.  --.172(b) must make the disclosures described in Tables 1 through 
12 to Sec.  --.173. The [BANK] must make these disclosures publicly 
available for each of the last three years (that is, twelve quarters) 
or such shorter period beginning on January 1, 2014.

             Table 1 to Sec.   --.173--Scope of Application
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative disclosures.......  (a)..............  The name of the top
                                                    corporate entity in
                                                    the group to which
                                                    subpart E of this
                                                    part applies.
                                (b)..............  A brief description
                                                    of the differences
                                                    in the basis for
                                                    consolidating
                                                    entities\1\ for
                                                    accounting and
                                                    regulatory purposes,
                                                    with a description
                                                    of those entities:
                                                   (1) That are fully
                                                    consolidated;
                                                   (2) That are
                                                    deconsolidated and
                                                    deducted from total
                                                    capital;
                                                   (3) For which the
                                                    total capital
                                                    requirement is
                                                    deducted; and
                                                   (4) That are neither
                                                    consolidated nor
                                                    deducted (for
                                                    example, where the
                                                    investment in the
                                                    entity is assigned a
                                                    risk weight in
                                                    accordance with this
                                                    subpart).
                                (c)..............  Any restrictions, or
                                                    other major
                                                    impediments, on
                                                    transfer of funds or
                                                    total capital within
                                                    the group.
Quantitative disclosures......  (d)..............  The aggregate amount
                                                    of surplus capital
                                                    of insurance
                                                    subsidiaries
                                                    included in the
                                                    total capital of the
                                                    consolidated group.
                                (e)..............  The aggregate amount
                                                    by which actual
                                                    total capital is
                                                    less than the
                                                    minimum total
                                                    capital requirement
                                                    in all subsidiaries,
                                                    with total capital
                                                    requirements and the
                                                    name(s) of the
                                                    subsidiaries with
                                                    such deficiencies.
------------------------------------------------------------------------
\1\ Such entities include securities, insurance and other financial
  subsidiaries, commercial subsidiaries (where permitted), and
  significant minority equity investments in insurance, financial and
  commercial entities.


               Table 2 to Sec.   --.173--Capital Structure
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative disclosures.......  (a)..............  Summary information
                                                    on the terms and
                                                    conditions of the
                                                    main features of all
                                                    regulatory capital
                                                    instruments.
Quantitative disclosures......  (b)..............  The amount of common
                                                    equity tier 1
                                                    capital, with
                                                    separate disclosure
                                                    of:
                                                   (1) Common stock and
                                                    related surplus;
                                                   (2) Retained
                                                    earnings;
                                                   (3) Common equity
                                                    minority interest;
                                                   (4) AOCI (net of tax)
                                                    and other reserves;
                                                    and
                                                   (5) Regulatory
                                                    adjustments and
                                                    deductions made to
                                                    common equity tier 1
                                                    capital.
                                (c)..............  The amount of tier 1
                                                    capital, with
                                                    separate disclosure
                                                    of:
                                                   (1) Additional tier 1
                                                    capital elements,
                                                    including additional
                                                    tier 1 capital
                                                    instruments and tier
                                                    1 minority interest
                                                    not included in
                                                    common equity tier 1
                                                    capital; and
                                                   (2) Regulatory
                                                    adjustments and
                                                    deductions made to
                                                    tier 1 capital.
                                (d)..............  The amount of total
                                                    capital, with
                                                    separate disclosure
                                                    of:
                                                   (1) Tier 2 capital
                                                    elements, including
                                                    tier 2 capital
                                                    instruments and
                                                    total capital
                                                    minority interest
                                                    not included in tier
                                                    1 capital; and
                                                   (2) Regulatory
                                                    adjustments and
                                                    deductions made to
                                                    total capital.
------------------------------------------------------------------------


               Table 3 to Sec.   --.173--Capital Adequacy
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative disclosures.......  (a)..............  A summary discussion
                                                    of the [BANK]'s
                                                    approach to
                                                    assessing the
                                                    adequacy of its
                                                    capital to support
                                                    current and future
                                                    activities.
Quantitative disclosures......  (b)..............  Risk-weighted assets
                                                    for credit risk
                                                    from:
                                                   (1) Wholesale
                                                    exposures;
                                                   (2) Residential
                                                    mortgage exposures;
                                                   (3) Qualifying
                                                    revolving exposures;
                                                   (4) Other retail
                                                    exposures;
                                                   (5) Securitization
                                                    exposures;
                                                   (6) Equity exposures:
                                                   (7) Equity exposures
                                                    subject to the
                                                    simple risk weight
                                                    approach; and
                                                   (8) Equity exposures
                                                    subject to the
                                                    internal models
                                                    approach.
                                (c)..............  Standardized market
                                                    risk-weighted assets
                                                    and advanced market
                                                    risk-weighted assets
                                                    as calculated under
                                                    subpart F of this
                                                    part:
                                                   (1) Standardized
                                                    approach for
                                                    specific risk; and
                                                   (2) Internal models
                                                    approach for
                                                    specific risk.
                                (d)..............  Risk-weighted assets
                                                    for operational
                                                    risk.
                                (e)..............  Common equity tier 1,
                                                    tier 1 and total
                                                    risk-based capital
                                                    ratios:
                                                   (1) For the top
                                                    consolidated group;
                                                    and
                                                   (2) For each
                                                    depository
                                                    institution
                                                    subsidiary.
                                (f)..............  Total risk-weighted
                                                    assets.
------------------------------------------------------------------------


[[Page 62246]]


   Table 4 to Sec.   --.173--Capital Conservation and Countercyclical
                             Capital Buffers
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative disclosures.......  (a)..............  The [BANK] must
                                                    publicly disclose
                                                    the geographic
                                                    breakdown of its
                                                    private sector
                                                    credit exposures
                                                    used in the
                                                    calculation of the
                                                    countercyclical
                                                    capital buffer.
Quantitative disclosures......  (b)..............  At least quarterly,
                                                    the [BANK] must
                                                    calculate and
                                                    publicly disclose
                                                    the capital
                                                    conservation buffer
                                                    and the
                                                    countercyclical
                                                    capital buffer as
                                                    described under Sec.
                                                      --.11 of subpart
                                                    B.
                                (c)..............  At least quarterly,
                                                    the [BANK] must
                                                    calculate and
                                                    publicly disclose
                                                    the buffer retained
                                                    income of the
                                                    [BANK], as described
                                                    under Sec.   --.11
                                                    of subpart B.
                                (d)..............  At least quarterly,
                                                    the [BANK] must
                                                    calculate and
                                                    publicly disclose
                                                    any limitations it
                                                    has on distributions
                                                    and discretionary
                                                    bonus payments
                                                    resulting from the
                                                    capital conservation
                                                    buffer and the
                                                    countercyclical
                                                    capital buffer
                                                    framework described
                                                    under Sec.   --.11
                                                    of subpart B,
                                                    including the
                                                    maximum payout
                                                    amount for the
                                                    quarter.
------------------------------------------------------------------------

    (b) General qualitative disclosure requirement. For each separate 
risk area described in Tables 5 through 12 to Sec.  --.173, the [BANK] 
must describe its risk management objectives and policies, including:
    (1) Strategies and processes;
    (2) The structure and organization of the relevant risk management 
function;
    (3) The scope and nature of risk reporting and/or measurement 
systems; and
    (4) Policies for hedging and/or mitigating risk and strategies and 
processes for monitoring the continuing effectiveness of hedges/
mitigants.

     Table 5 \1\ to Sec.   --.173--Credit Risk: General Disclosures
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative disclosures.......  (a)..............  The general
                                                    qualitative
                                                    disclosure
                                                    requirement with
                                                    respect to credit
                                                    risk (excluding
                                                    counterparty credit
                                                    risk disclosed in
                                                    accordance with
                                                    Table 7 to Sec.   --
                                                    .173), including:
                                                   (1) Policy for
                                                    determining past due
                                                    or delinquency
                                                    status;
                                                   (2) Policy for
                                                    placing loans on
                                                    nonaccrual;
                                                   (3) Policy for
                                                    returning loans to
                                                    accrual status;
                                                   (4) Definition of and
                                                    policy for
                                                    identifying impaired
                                                    loans (for financial
                                                    accounting
                                                    purposes).
                                                   (5) Description of
                                                    the methodology that
                                                    the entity uses to
                                                    estimate its
                                                    allowance for loan
                                                    and lease losses,
                                                    including
                                                    statistical methods
                                                    used where
                                                    applicable;
                                                   (6) Policy for
                                                    charging-off
                                                    uncollectible
                                                    amounts; and
                                                   (7) Discussion of the
                                                    [BANK]'s credit risk
                                                    management policy
Quantitative disclosures......  (b)..............  Total credit risk
                                                    exposures and
                                                    average credit risk
                                                    exposures, after
                                                    accounting offsets
                                                    in accordance with
                                                    GAAP,\2\ without
                                                    taking into account
                                                    the effects of
                                                    credit risk
                                                    mitigation
                                                    techniques (for
                                                    example, collateral
                                                    and netting not
                                                    permitted under
                                                    GAAP), over the
                                                    period categorized
                                                    by major types of
                                                    credit exposure. For
                                                    example, [BANK]s
                                                    could use categories
                                                    similar to that used
                                                    for financial
                                                    statement purposes.
                                                    Such categories
                                                    might include, for
                                                    instance:
                                                   (1) Loans, off-
                                                    balance sheet
                                                    commitments, and
                                                    other non-derivative
                                                    off-balance sheet
                                                    exposures;
                                                   (2) Debt securities;
                                                    and
                                                   (3) OTC derivatives.
                                (c)..............  Geographic \3\
                                                    distribution of
                                                    exposures,
                                                    categorized in
                                                    significant areas by
                                                    major types of
                                                    credit exposure.
                                (d)..............  Industry or
                                                    counterparty type
                                                    distribution of
                                                    exposures,
                                                    categorized by major
                                                    types of credit
                                                    exposure.
                                (e)..............  By major industry or
                                                    counterparty type:
                                                   (1) Amount of
                                                    impaired loans for
                                                    which there was a
                                                    related allowance
                                                    under GAAP;
                                                   (2) Amount of
                                                    impaired loans for
                                                    which there was no
                                                    related allowance
                                                    under GAAP;
                                                   (3) Amount of loans
                                                    past due 90 days and
                                                    on nonaccrual;
                                                   (4) Amount of loans
                                                    past due 90 days and
                                                    still accruing; \4\
                                                   (5) The balance in
                                                    the allowance for
                                                    loan and lease
                                                    losses at the end of
                                                    each period,
                                                    disaggregated on the
                                                    basis of the
                                                    entity's impairment
                                                    method. To
                                                    disaggregate the
                                                    information required
                                                    on the basis of
                                                    impairment
                                                    methodology, an
                                                    entity shall
                                                    separately disclose
                                                    the amounts based on
                                                    the requirements in
                                                    GAAP; and
                                                   (6) Charge-offs
                                                    during the period.
                                (f)..............  Amount of impaired
                                                    loans and, if
                                                    available, the
                                                    amount of past due
                                                    loans categorized by
                                                    significant
                                                    geographic areas
                                                    including, if
                                                    practical, the
                                                    amounts of
                                                    allowances related
                                                    to each geographical
                                                    area,\5\ further
                                                    categorized as
                                                    required by GAAP.
                                (g)..............  Reconciliation of
                                                    changes in ALLL.\6\

[[Page 62247]]

 
                                (h)..............  Remaining contractual
                                                    maturity breakdown
                                                    (for example, one
                                                    year or less) of the
                                                    whole portfolio,
                                                    categorized by
                                                    credit exposure.
------------------------------------------------------------------------
\1\ Table 5 to Sec.   --.173 does not cover equity exposures, which
  should be reported in Table 9.
\2\ See, for example, ASC Topic 815-10 and 210-20 as they may be amended
  from time to time.
\3\ Geographical areas may comprise individual countries, groups of
  countries, or regions within countries. A [BANK] might choose to
  define the geographical areas based on the way the company's portfolio
  is geographically managed. The criteria used to allocate the loans to
  geographical areas must be specified.
\4\ A [BANK] is encouraged also to provide an analysis of the aging of
  past-due loans.
\5\ The portion of the general allowance that is not allocated to a
  geographical area should be disclosed separately.
\6\ The reconciliation should include the following: A description of
  the allowance; the opening balance of the allowance; charge-offs taken
  against the allowance during the period; amounts provided (or
  reversed) for estimated probable loan losses during the period; any
  other adjustments (for example, exchange rate differences, business
  combinations, acquisitions and disposals of subsidiaries), including
  transfers between allowances; and the closing balance of the
  allowance. Charge-offs and recoveries that have been recorded directly
  to the income statement should be disclosed separately.


    Table 6 to Sec.   --.173--Credit Risk: Disclosures for Portfolios
               Subject to IRB Risk-Based Capital Formulas
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative disclosures.......  (a)..............  Explanation and
                                                    review of the:
                                                   (1) Structure of
                                                    internal rating
                                                    systems and relation
                                                    between internal and
                                                    external ratings;
                                                   (2) Use of risk
                                                    parameter estimates
                                                    other than for
                                                    regulatory capital
                                                    purposes;
                                                   (3) Process for
                                                    managing and
                                                    recognizing credit
                                                    risk mitigation (see
                                                    Table 8 to Sec.   --
                                                    .173); and
                                                   (4) Control
                                                    mechanisms for the
                                                    rating system,
                                                    including discussion
                                                    of independence,
                                                    accountability, and
                                                    rating systems
                                                    review.
                                (b)..............  Description of the
                                                    internal ratings
                                                    process, provided
                                                    separately for the
                                                    following:
                                                   (1) Wholesale
                                                    category;
                                                   (2) Retail
                                                    subcategories;
                                                   (i) Residential
                                                    mortgage exposures;
                                                   (ii) Qualifying
                                                    revolving exposures;
                                                    and
                                                   (iii) Other retail
                                                    exposures.
                                                   For each category and
                                                    subcategory above
                                                    the description
                                                    should include:
                                                   (A) The types of
                                                    exposure included in
                                                    the category/
                                                    subcategories; and
                                                   (B) The definitions,
                                                    methods and data for
                                                    estimation and
                                                    validation of PD,
                                                    LGD, and EAD,
                                                    including
                                                    assumptions employed
                                                    in the derivation of
                                                    these variables.\1\
Quantitative disclosures: risk  (c)..............  (1) For wholesale
 assessment.                                        exposures, present
                                                    the following
                                                    information across a
                                                    sufficient number of
                                                    PD grades (including
                                                    default) to allow
                                                    for a meaningful
                                                    differentiation of
                                                    credit risk: \2\
                                                   (i) Total EAD; \3\
                                                   (ii) Exposure-
                                                    weighted average LGD
                                                    (percentage);
                                                   (iii) Exposure-
                                                    weighted average
                                                    risk weight; and
                                                   (iv) Amount of
                                                    undrawn commitments
                                                    and exposure-
                                                    weighted average EAD
                                                    including average
                                                    drawdowns prior to
                                                    default for
                                                    wholesale exposures.
                                                   (2) For each retail
                                                    subcategory, present
                                                    the disclosures
                                                    outlined above
                                                    across a sufficient
                                                    number of segments
                                                    to allow for a
                                                    meaningful
                                                    differentiation of
                                                    credit risk.
Quantitative disclosures:       (d)..............  Actual losses in the
 historical results.                                preceding period for
                                                    each category and
                                                    subcategory and how
                                                    this differs from
                                                    past experience. A
                                                    discussion of the
                                                    factors that
                                                    impacted the loss
                                                    experience in the
                                                    preceding period--
                                                    for example, has the
                                                    [BANK] experienced
                                                    higher than average
                                                    default rates, loss
                                                    rates or EADs.
                                (e)..............  The [BANK]'s
                                                    estimates compared
                                                    against actual
                                                    outcomes over a
                                                    longer period.\4\ At
                                                    a minimum, this
                                                    should include
                                                    information on
                                                    estimates of losses
                                                    against actual
                                                    losses in the
                                                    wholesale category
                                                    and each retail
                                                    subcategory over a
                                                    period sufficient to
                                                    allow for a
                                                    meaningful
                                                    assessment of the
                                                    performance of the
                                                    internal rating
                                                    processes for each
                                                    category/
                                                    subcategory.\5\
                                                    Where appropriate,
                                                    the [BANK] should
                                                    further decompose
                                                    this to provide
                                                    analysis of PD, LGD,
                                                    and EAD outcomes
                                                    against estimates
                                                    provided in the
                                                    quantitative risk
                                                    assessment
                                                    disclosures
                                                    above.\6\
------------------------------------------------------------------------
\1\ This disclosure item does not require a detailed description of the
  model in full--it should provide the reader with a broad overview of
  the model approach, describing definitions of the variables and
  methods for estimating and validating those variables set out in the
  quantitative risk disclosures below. This should be done for each of
  the four category/subcategories. The [BANK] must disclose any
  significant differences in approach to estimating these variables
  within each category/subcategories.
\2\ The PD, LGD and EAD disclosures in Table 6 (c) to Sec.   --.173
  should reflect the effects of collateral, qualifying master netting
  agreements, eligible guarantees and eligible credit derivatives as
  defined under this part. Disclosure of each PD grade should include
  the exposure-weighted average PD for each grade. Where a [BANK]
  aggregates PD grades for the purposes of disclosure, this should be a
  representative breakdown of the distribution of PD grades used for
  regulatory capital purposes.
\3\ Outstanding loans and EAD on undrawn commitments can be presented on
  a combined basis for these disclosures.
\4\ These disclosures are a way of further informing the reader about
  the reliability of the information provided in the ``quantitative
  disclosures: Risk assessment'' over the long run. The disclosures are
  requirements from year-end 2010; in the meantime, early adoption is
  encouraged. The phased implementation is to allow a [BANK] sufficient
  time to build up a longer run of data that will make these disclosures
  meaningful.

[[Page 62248]]

 
\5\ This disclosure item is not intended to be prescriptive about the
  period used for this assessment. Upon implementation, it is expected
  that a [BANK] would provide these disclosures for as long a set of
  data as possible--for example, if a [BANK] has 10 years of data, it
  might choose to disclose the average default rates for each PD grade
  over that 10-year period. Annual amounts need not be disclosed.
\6\ A [BANK] must provide this further decomposition where it will allow
  users greater insight into the reliability of the estimates provided
  in the ``quantitative disclosures: Risk assessment.'' In particular,
  it must provide this information where there are material differences
  between its estimates of PD, LGD or EAD compared to actual outcomes
  over the long run. The [BANK] must also provide explanations for such
  differences.


  Table 7 to Sec.   --.173--General Disclosure for Counterparty Credit
 Risk of OTC Derivative Contracts, Repo-Style Transactions, and Eligible
                              Margin Loans
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative Disclosures.......  (a)..............  The general
                                                    qualitative
                                                    disclosure
                                                    requirement with
                                                    respect to OTC
                                                    derivatives,
                                                    eligible margin
                                                    loans, and repo-
                                                    style transactions,
                                                    including:
                                                   (1) Discussion of
                                                    methodology used to
                                                    assign economic
                                                    capital and credit
                                                    limits for
                                                    counterparty credit
                                                    exposures;
                                                   (2) Discussion of
                                                    policies for
                                                    securing collateral,
                                                    valuing and managing
                                                    collateral, and
                                                    establishing credit
                                                    reserves;
                                                   (3) Discussion of the
                                                    primary types of
                                                    collateral taken;
                                                   (4) Discussion of
                                                    policies with
                                                    respect to wrong-way
                                                    risk exposures; and
                                                   (5) Discussion of the
                                                    impact of the amount
                                                    of collateral the
                                                    [BANK] would have to
                                                    provide if the
                                                    [BANK] were to
                                                    receive a credit
                                                    rating downgrade.
Quantitative Disclosures......  (b)..............  Gross positive fair
                                                    value of contracts,
                                                    netting benefits,
                                                    netted current
                                                    credit exposure,
                                                    collateral held
                                                    (including type, for
                                                    example, cash,
                                                    government
                                                    securities), and net
                                                    unsecured credit
                                                    exposure.\1\ Also
                                                    report measures for
                                                    EAD used for
                                                    regulatory capital
                                                    for these
                                                    transactions, the
                                                    notional value of
                                                    credit derivative
                                                    hedges purchased for
                                                    counterparty credit
                                                    risk protection,
                                                    and, for [BANK]s not
                                                    using the internal
                                                    models methodology
                                                    in Sec.   --.132(d)
                                                    , the distribution
                                                    of current credit
                                                    exposure by types of
                                                    credit exposure.\2\
                                (c)..............  Notional amount of
                                                    purchased and sold
                                                    credit derivatives,
                                                    segregated between
                                                    use for the [BANK]'s
                                                    own credit portfolio
                                                    and for its
                                                    intermediation
                                                    activities,
                                                    including the
                                                    distribution of the
                                                    credit derivative
                                                    products used,
                                                    categorized further
                                                    by protection bought
                                                    and sold within each
                                                    product group.
                                (d)..............  The estimate of alpha
                                                    if the [BANK] has
                                                    received supervisory
                                                    approval to estimate
                                                    alpha.
------------------------------------------------------------------------
\1\ Net unsecured credit exposure is the credit exposure after
  considering the benefits from legally enforceable netting agreements
  and collateral arrangements, without taking into account haircuts for
  price volatility, liquidity, etc.
\2\ This may include interest rate derivative contracts, foreign
  exchange derivative contracts, equity derivative contracts, credit
  derivatives, commodity or other derivative contracts, repo-style
  transactions, and eligible margin loans.


          Table 8 To Sec.   --.173--Credit Risk Mitigation 1 2
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative disclosures.......  (a)..............  The general
                                                    qualitative
                                                    disclosure
                                                    requirement with
                                                    respect to credit
                                                    risk mitigation,
                                                    including:
                                                   (1) Policies and
                                                    processes for, and
                                                    an indication of the
                                                    extent to which the
                                                    [BANK] uses, on- or
                                                    off-balance sheet
                                                    netting;
                                                   (2) Policies and
                                                    processes for
                                                    collateral valuation
                                                    and management;
                                                   (3) A description of
                                                    the main types of
                                                    collateral taken by
                                                    the [BANK];
                                                   (4) The main types of
                                                    guarantors/credit
                                                    derivative
                                                    counterparties and
                                                    their
                                                    creditworthiness;
                                                    and
                                                   (5) Information about
                                                    (market or credit)
                                                    risk concentrations
                                                    within the
                                                    mitigation taken.
Quantitative disclosures......  (b)..............  For each separately
                                                    disclosed portfolio,
                                                    the total exposure
                                                    (after, where
                                                    applicable, on- or
                                                    off-balance sheet
                                                    netting) that is
                                                    covered by
                                                    guarantees/credit
                                                    derivatives.
------------------------------------------------------------------------
\1\ At a minimum, a [BANK] must provide the disclosures in Table 8 in
  relation to credit risk mitigation that has been recognized for the
  purposes of reducing capital requirements under this subpart. Where
  relevant, [BANK]s are encouraged to give further information about
  mitigants that have not been recognized for that purpose.
\2\ Credit derivatives and other credit mitigation that are treated for
  the purposes of this subpart as synthetic securitization exposures
  should be excluded from the credit risk mitigation disclosures (in
  Table 8 to Sec.   --.173) and included within those relating to
  securitization (in Table 9 to Sec.   --.173).


                Table 9 to Sec.   --.173--Securitization
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative disclosures.......  (a)..............  The general
                                                    qualitative
                                                    disclosure
                                                    requirement with
                                                    respect to
                                                    securitization
                                                    (including synthetic
                                                    securitizations),
                                                    including a
                                                    discussion of:
                                                   (1) The [BANK]'s
                                                    objectives for
                                                    securitizing assets,
                                                    including the extent
                                                    to which these
                                                    activities transfer
                                                    credit risk of the
                                                    underlying exposures
                                                    away from the [BANK]
                                                    to other entities
                                                    and including the
                                                    type of risks
                                                    assumed and retained
                                                    with
                                                    resecuritization
                                                    activity; \1\
                                                   (2) The nature of the
                                                    risks (e.g.
                                                    liquidity risk)
                                                    inherent in the
                                                    securitized assets;
                                                   (3) The roles played
                                                    by the [BANK] in the
                                                    securitization
                                                    process \2\ and an
                                                    indication of the
                                                    extent of the
                                                    [BANK]'s involvement
                                                    in each of them;

[[Page 62249]]

 
                                                   (4) The processes in
                                                    place to monitor
                                                    changes in the
                                                    credit and market
                                                    risk of
                                                    securitization
                                                    exposures including
                                                    how those processes
                                                    differ for
                                                    resecuritization
                                                    exposures;
                                                   (5) The [BANK]'s
                                                    policy for
                                                    mitigating the
                                                    credit risk retained
                                                    through
                                                    securitization and
                                                    resecuritization
                                                    exposures; and
                                                   (6) The risk-based
                                                    capital approaches
                                                    that the [BANK]
                                                    follows for its
                                                    securitization
                                                    exposures including
                                                    the type of
                                                    securitization
                                                    exposure to which
                                                    each approach
                                                    applies.
                                (b)..............  A list of:
                                                   (1) The type of
                                                    securitization SPEs
                                                    that the [BANK], as
                                                    sponsor, uses to
                                                    securitize third-
                                                    party exposures. The
                                                    [BANK] must indicate
                                                    whether it has
                                                    exposure to these
                                                    SPEs, either on- or
                                                    off- balance sheet;
                                                    and
                                                   (2) Affiliated
                                                    entities:
                                                   (i) That the [BANK]
                                                    manages or advises;
                                                    and
                                                   (ii) That invest
                                                    either in the
                                                    securitization
                                                    exposures that the
                                                    [BANK] has
                                                    securitized or in
                                                    securitization SPEs
                                                    that the [BANK]
                                                    sponsors.\3\
                                (c)..............  Summary of the
                                                    [BANK]'s accounting
                                                    policies for
                                                    securitization
                                                    activities,
                                                    including:
                                                   (1) Whether the
                                                    transactions are
                                                    treated as sales or
                                                    financings;
                                                   (2) Recognition of
                                                    gain-on-sale;
                                                   (3) Methods and key
                                                    assumptions and
                                                    inputs applied in
                                                    valuing retained or
                                                    purchased interests;
                                                   (4) Changes in
                                                    methods and key
                                                    assumptions and
                                                    inputs from the
                                                    previous period for
                                                    valuing retained
                                                    interests and impact
                                                    of the changes;
                                                   (5) Treatment of
                                                    synthetic
                                                    securitizations;
                                                   (6) How exposures
                                                    intended to be
                                                    securitized are
                                                    valued and whether
                                                    they are recorded
                                                    under subpart E of
                                                    this part; and
                                                   (7) Policies for
                                                    recognizing
                                                    liabilities on the
                                                    balance sheet for
                                                    arrangements that
                                                    could require the
                                                    [BANK] to provide
                                                    financial support
                                                    for securitized
                                                    assets.
                                (d)..............  An explanation of
                                                    significant changes
                                                    to any of the
                                                    quantitative
                                                    information set
                                                    forth below since
                                                    the last reporting
                                                    period.
Quantitative disclosures......  (e)..............  The total outstanding
                                                    exposures
                                                    securitized \4\ by
                                                    the [BANK] in
                                                    securitizations that
                                                    meet the operational
                                                    criteria in Sec.   --
                                                    .141 (categorized
                                                    into traditional/
                                                    synthetic), by
                                                    underlying exposure
                                                    type \5\ separately
                                                    for securitizations
                                                    of third-party
                                                    exposures for which
                                                    the bank acts only
                                                    as sponsor.
                                (f)..............  For exposures
                                                    securitized by the
                                                    [BANK] in
                                                    securitizations that
                                                    meet the operational
                                                    criteria in Sec.   --
                                                    .141:
                                                   (1) Amount of
                                                    securitized assets
                                                    that are impaired
                                                    \6\/past due
                                                    categorized by
                                                    exposure type; and
                                                   (2) Losses recognized
                                                    by the [BANK] during
                                                    the current period
                                                    categorized by
                                                    exposure type.\7\
                                (g)..............  The total amount of
                                                    outstanding
                                                    exposures intended
                                                    to be securitized
                                                    categorized by
                                                    exposure type.
                                (h)..............  Aggregate amount of:
                                                   (1) On-balance sheet
                                                    securitization
                                                    exposures retained
                                                    or purchased
                                                    categorized by
                                                    exposure type; and
                                                   (2) Off-balance sheet
                                                    securitization
                                                    exposures
                                                    categorized by
                                                    exposure type.
                                (i)..............  (1) Aggregate amount
                                                    of securitization
                                                    exposures retained
                                                    or purchased and the
                                                    associated capital
                                                    requirements for
                                                    these exposures,
                                                    categorized between
                                                    securitization and
                                                    resecuritization
                                                    exposures, further
                                                    categorized into a
                                                    meaningful number of
                                                    risk weight bands
                                                    and by risk-based
                                                    capital approach
                                                    (e.g. SA, SFA, or
                                                    SSFA).
                                                   (2) Exposures that
                                                    have been deducted
                                                    entirely from tier 1
                                                    capital, CEIOs
                                                    deducted from total
                                                    capital (as
                                                    described in Sec.
                                                    --.42(a)(1), and
                                                    other exposures
                                                    deducted from total
                                                    capital should be
                                                    disclosed separately
                                                    by exposure type.
                                (j)..............  Summary of current
                                                    year's
                                                    securitization
                                                    activity, including
                                                    the amount of
                                                    exposures
                                                    securitized (by
                                                    exposure type), and
                                                    recognized gain or
                                                    loss on sale by
                                                    asset type.
                                (k)..............  Aggregate amount of
                                                    resecuritization
                                                    exposures retained
                                                    or purchased
                                                    categorized
                                                    according to:
                                                   (1) Exposures to
                                                    which credit risk
                                                    mitigation is
                                                    applied and those
                                                    not applied; and
                                                   (2) Exposures to
                                                    guarantors
                                                    categorized
                                                    according to
                                                    guarantor
                                                    creditworthiness
                                                    categories or
                                                    guarantor name.
------------------------------------------------------------------------
\1\ The [BANK] must describe the structure of resecuritizations in which
  it participates; this description must be provided for the main
  categories of resecuritization products in which the [BANK] is active.
\2\ For example, these roles would include originator, investor,
  servicer, provider of credit enhancement, sponsor, liquidity provider,
  or swap provider.
\3\ For example, money market mutual funds should be listed
  individually, and personal and private trusts, should be noted
  collectively.

[[Page 62250]]

 
\4\ ``Exposures securitized'' include underlying exposures originated by
  the bank, whether generated by them or purchased, and recognized in
  the balance sheet, from third parties, and third-party exposures
  included in sponsored transactions. Securitization transactions
  (including underlying exposures originally on the bank's balance sheet
  and underlying exposures acquired by the bank from third-party
  entities) in which the originating bank does not retain any
  securitization exposure should be shown separately but need only be
  reported for the year of inception.
\5\ A [BANK] is required to disclose exposures regardless of whether
  there is a capital charge under this part.
\6\ A [BANK] must include credit-related other than temporary impairment
  (OTTI).
\7\ For example, charge-offs/allowances (if the assets remain on the
  bank's balance sheet) or credit-related OTTI of I/O strips and other
  retained residual interests, as well as recognition of liabilities for
  probable future financial support required of the bank with respect to
  securitized assets.


               Table 10 to Sec.   --.173--Operational Risk
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative disclosures.......  (a)..............  The general
                                                    qualitative
                                                    disclosure
                                                    requirement for
                                                    operational risk.
                                (b)..............  Description of the
                                                    AMA, including a
                                                    discussion of
                                                    relevant internal
                                                    and external factors
                                                    considered in the
                                                    [BANK]'s measurement
                                                    approach.
                                (c)..............  A description of the
                                                    use of insurance for
                                                    the purpose of
                                                    mitigating
                                                    operational risk.
------------------------------------------------------------------------


  Table 11 to Sec.   --.173--Equities Not Subject to Subpart F of This
                                  Part
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative disclosures.......  (a)..............  The general
                                                    qualitative
                                                    disclosure
                                                    requirement with
                                                    respect to the
                                                    equity risk of
                                                    equity holdings not
                                                    subject to subpart F
                                                    of this part,
                                                    including:
                                                   (1) Differentiation
                                                    between holdings on
                                                    which capital gains
                                                    are expected and
                                                    those held for other
                                                    objectives,
                                                    including for
                                                    relationship and
                                                    strategic reasons;
                                                    and
                                                   (2) Discussion of
                                                    important policies
                                                    covering the
                                                    valuation of and
                                                    accounting for
                                                    equity holdings not
                                                    subject to subpart F
                                                    of this part. This
                                                    includes the
                                                    accounting
                                                    methodology and
                                                    valuation
                                                    methodologies used,
                                                    including key
                                                    assumptions and
                                                    practices affecting
                                                    valuation as well as
                                                    significant changes
                                                    in these practices.
Quantitative disclosures......  (b)..............  Carrying value on the
                                                    balance sheet of
                                                    equity investments,
                                                    as well as the fair
                                                    value of those
                                                    investments.
                                (c)..............  The types and nature
                                                    of investments,
                                                    including the amount
                                                    that is:
                                                   (1) Publicly traded;
                                                    and
                                                   (2) Non-publicly
                                                    traded.
                                (d)..............  The cumulative
                                                    realized gains
                                                    (losses) arising
                                                    from sales and
                                                    liquidations in the
                                                    reporting period.
                                (e)..............  (1) Total unrealized
                                                    gains (losses) \1\
                                                   (2) Total latent
                                                    revaluation gains
                                                    (losses) \2\
                                                   (3) Any amounts of
                                                    the above included
                                                    in tier 1 and/or
                                                    tier 2 capital.
                                (f)..............  Capital requirements
                                                    categorized by
                                                    appropriate equity
                                                    groupings,
                                                    consistent with the
                                                    [BANK]'s
                                                    methodology, as well
                                                    as the aggregate
                                                    amounts and the type
                                                    of equity
                                                    investments subject
                                                    to any supervisory
                                                    transition regarding
                                                    total capital
                                                    requirements.\3\
------------------------------------------------------------------------
\1\ Unrealized gains (losses) recognized in the balance sheet but not
  through earnings.
\2\ Unrealized gains (losses) not recognized either in the balance sheet
  or through earnings.
\3\ This disclosure must include a breakdown of equities that are
  subject to the 0 percent, 20 percent, 100 percent, 300 percent, 400
  percent, and 600 percent risk weights, as applicable.


Table 12 to Sec.   --.173--Interest Rate Risk for Non-Trading Activities
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Qualitative disclosures.......  (a)..............  The general
                                                    qualitative
                                                    disclosure
                                                    requirement,
                                                    including the nature
                                                    of interest rate
                                                    risk for non-trading
                                                    activities and key
                                                    assumptions,
                                                    including
                                                    assumptions
                                                    regarding loan
                                                    prepayments and
                                                    behavior of non-
                                                    maturity deposits,
                                                    and frequency of
                                                    measurement of
                                                    interest rate risk
                                                    for non-trading
                                                    activities.
Quantitative disclosures......  (b)..............  The increase
                                                    (decline) in
                                                    earnings or economic
                                                    value (or relevant
                                                    measure used by
                                                    management) for
                                                    upward and downward
                                                    rate shocks
                                                    according to
                                                    management's method
                                                    for measuring
                                                    interest rate risk
                                                    for non-trading
                                                    activities,
                                                    categorized by
                                                    currency (as
                                                    appropriate).
------------------------------------------------------------------------

Sec. Sec. --.174 through --.200  [Reserved]

Subpart F--Risk-Weighted Assets--Market Risk


Sec.  --.201  Purpose, applicability, and reservation of authority.

    (a) Purpose. This subpart F establishes risk-based capital 
requirements for [BANK]s with significant exposure to market risk, 
provides methods for these [BANK]s to calculate their standardized 
measure for market risk and, if applicable, advanced measure for market 
risk, and establishes public disclosure requirements.
    (b) Applicability. (1) This subpart F applies to any [BANK] with 
aggregate trading assets and trading liabilities (as reported in the 
[BANK]'s most recent quarterly [regulatory report]), equal to:
    (i) 10 percent or more of quarter-end total assets as reported on 
the most recent quarterly [Call Report or FR Y-9C]; or
    (ii) $1 billion or more.
    (2) The [AGENCY] may apply this subpart to any [BANK] if the 
[AGENCY] deems it necessary or appropriate because of the level of 
market risk of the [BANK] or to ensure safe and sound banking 
practices.
    (3) The [AGENCY] may exclude a [BANK] that meets the criteria of

[[Page 62251]]

paragraph (b)(1) of this section from application of this subpart if 
the [AGENCY] determines that the exclusion is appropriate based on the 
level of market risk of the [BANK] and is consistent with safe and 
sound banking practices.
    (c) Reservation of authority (1) The [AGENCY] may require a [BANK] 
to hold an amount of capital greater than otherwise required under this 
subpart if the [AGENCY] determines that the [BANK]'s capital 
requirement for market risk as calculated under this subpart is not 
commensurate with the market risk of the [BANK]'s covered positions. In 
making determinations under paragraphs (c)(1) through (c)(3) of this 
section, the [AGENCY] will apply notice and response procedures 
generally in the same manner as the notice and response procedures set 
forth in [12 CFR 3.404, 12 CFR 263.202, 12 CFR 324.5(c)].
    (2) If the [AGENCY] determines that the risk-based capital 
requirement calculated under this subpart by the [BANK] for one or more 
covered positions or portfolios of covered positions is not 
commensurate with the risks associated with those positions or 
portfolios, the [AGENCY] may require the [BANK] to assign a different 
risk-based capital requirement to the positions or portfolios that more 
accurately reflects the risk of the positions or portfolios.
    (3) The [AGENCY] may also require a [BANK] to calculate risk-based 
capital requirements for specific positions or portfolios under this 
subpart, or under subpart D or subpart E of this part, as appropriate, 
to more accurately reflect the risks of the positions.
    (4) Nothing in this subpart limits the authority of the [AGENCY] 
under any other provision of law or regulation to take supervisory or 
enforcement action, including action to address unsafe or unsound 
practices or conditions, deficient capital levels, or violations of 
law.


Sec.  --.202  Definitions.

    (a) Terms set forth in Sec.  --.2 and used in this subpart have the 
definitions assigned thereto in Sec.  --.2.
    (b) For the purposes of this subpart, the following terms are 
defined as follows:
    Backtesting means the comparison of a [BANK]'s internal estimates 
with actual outcomes during a sample period not used in model 
development. For purposes of this subpart, backtesting is one form of 
out-of-sample testing.
    Commodity position means a position for which price risk arises 
from changes in the price of a commodity.
    Corporate debt position means a debt position that is an exposure 
to a company that is not a sovereign entity, the Bank for International 
Settlements, the European Central Bank, the European Commission, the 
International Monetary Fund, a multilateral development bank, a 
depository institution, a foreign bank, a credit union, a public sector 
entity, a GSE, or a securitization.
    Correlation trading position means:
    (1) A securitization position for which all or substantially all of 
the value of the underlying exposures is based on the credit quality of 
a single company for which a two-way market exists, or on commonly 
traded indices based on such exposures for which a two-way market 
exists on the indices; or
    (2) A position that is not a securitization position and that 
hedges a position described in paragraph (1) of this definition; and
    (3) A correlation trading position does not include:
    (i) A resecuritization position;
    (ii) A derivative of a securitization position that does not 
provide a pro rata share in the proceeds of a securitization tranche; 
or
    (iii) A securitization position for which the underlying assets or 
reference exposures are retail exposures, residential mortgage 
exposures, or commercial mortgage exposures.
    Covered position means the following positions:
    (1) A trading asset or trading liability (whether on- or off-
balance sheet),\27\ as reported on [REGULATORY REPORT], that meets the 
following conditions:
---------------------------------------------------------------------------

    \27\ Securities subject to repurchase and lending agreements are 
included as if they are still owned by the lender.
---------------------------------------------------------------------------

    (i) The position is a trading position or hedges another covered 
position; \28\ and
---------------------------------------------------------------------------

    \28\ A position that hedges a trading position must be within 
the scope of the bank's hedging strategy as described in paragraph 
(a)(2) of section 203 of this subpart.
---------------------------------------------------------------------------

    (ii) The position is free of any restrictive covenants on its 
tradability or the [BANK] is able to hedge the material risk elements 
of the position in a two-way market;
    (2) A foreign exchange or commodity position, regardless of whether 
the position is a trading asset or trading liability (excluding any 
structural foreign currency positions that the [BANK] chooses to 
exclude with prior supervisory approval); and
    (3) Notwithstanding paragraphs (1) and (2) of this definition, a 
covered position does not include:
    (i) An intangible asset, including any servicing asset;
    (ii) Any hedge of a trading position that the [AGENCY] determines 
to be outside the scope of the [BANK]'s hedging strategy required in 
paragraph (a)(2) of Sec.  --.203;
    (iii) Any position that, in form or substance, acts as a liquidity 
facility that provides support to asset-backed commercial paper;
    (iv) A credit derivative the [BANK] recognizes as a guarantee for 
risk-weighted asset amount calculation purposes under subpart D or 
subpart E of this part;
    (v) Any position that is recognized as a credit valuation 
adjustment hedge under Sec.  --.132(e)(5) or Sec.  --.132(e)(6), except 
as provided in Sec.  --.132(e)(6)(vii);
    (vi) Any equity position that is not publicly traded, other than a 
derivative that references a publicly traded equity and other than a 
position in an investment company as defined in and registered with the 
SEC under the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.), 
provided that all the underlying equities held by the investment 
company are publicly traded;
    (vii) Any equity position that is not publicly traded, other than a 
derivative that references a publicly traded equity and other than a 
position in an entity not domiciled in the United States (or a 
political subdivision thereof) that is supervised and regulated in a 
manner similar to entities described in paragraph (3)(vi) of this 
definition;
    (viii) Any position a [BANK] holds with the intent to securitize; 
or
    (ix) Any direct real estate holding.
    Debt position means a covered position that is not a securitization 
position or a correlation trading position and that has a value that 
reacts primarily to changes in interest rates or credit spreads.
    Default by a sovereign entity has the same meaning as the term 
sovereign default under Sec.  --.2.
    Equity position means a covered position that is not a 
securitization position or a correlation trading position and that has 
a value that reacts primarily to changes in equity prices.
    Event risk means the risk of loss on equity or hybrid equity 
positions as a result of a financial event, such as the announcement or 
occurrence of a company merger, acquisition, spin-off, or dissolution.
    Foreign exchange position means a position for which price risk 
arises from changes in foreign exchange rates.
    General market risk means the risk of loss that could result from 
broad market movements, such as changes in the general level of 
interest rates, credit

[[Page 62252]]

spreads, equity prices, foreign exchange rates, or commodity prices.
    Hedge means a position or positions that offset all, or 
substantially all, of one or more material risk factors of another 
position.
    Idiosyncratic risk means the risk of loss in the value of a 
position that arises from changes in risk factors unique to that 
position.
    Incremental risk means the default risk and credit migration risk 
of a position. Default risk means the risk of loss on a position that 
could result from the failure of an obligor to make timely payments of 
principal or interest on its debt obligation, and the risk of loss that 
could result from bankruptcy, insolvency, or similar proceeding. Credit 
migration risk means the price risk that arises from significant 
changes in the underlying credit quality of the position.
    Market risk means the risk of loss on a position that could result 
from movements in market prices.
    Resecuritization position means a covered position that is:
    (1) An on- or off-balance sheet exposure to a resecuritization; or
    (2) An exposure that directly or indirectly references a 
resecuritization exposure in paragraph (1) of this definition.
    Securitization means a transaction in which:
    (1) All or a portion of the credit risk of one or more underlying 
exposures is transferred to one or more third parties;
    (2) The credit risk associated with the underlying exposures has 
been separated into at least two tranches that reflect different levels 
of seniority;
    (3) Performance of the securitization exposures depends upon the 
performance of the underlying exposures;
    (4) All or substantially all of the underlying exposures are 
financial exposures (such as loans, commitments, credit derivatives, 
guarantees, receivables, asset-backed securities, mortgage-backed 
securities, other debt securities, or equity securities);
    (5) For non-synthetic securitizations, the underlying exposures are 
not owned by an operating company;
    (6) The underlying exposures are not owned by a small business 
investment company described in section 302 of the Small Business 
Investment Act;
    (7) The underlying exposures are not owned by a firm an investment 
in which qualifies as a community development investment under section 
24(Eleventh) of the National Bank Act;
    (8) The [AGENCY] may determine that a transaction in which the 
underlying exposures are owned by an investment firm that exercises 
substantially unfettered control over the size and composition of its 
assets, liabilities, and off-balance sheet exposures is not a 
securitization based on the transaction's leverage, risk profile, or 
economic substance;
    (9) The [AGENCY] may deem an exposure to a transaction that meets 
the definition of a securitization, notwithstanding paragraph (5), (6), 
or (7) of this definition, to be a securitization based on the 
transaction's leverage, risk profile, or economic substance; and
    (10) The transaction is not:
    (i) An investment fund;
    (ii) A collective investment fund (as defined in [12 CFR 208.34 
(Board), 12 CFR 9.18 (OCC)]);
    (iii) An employee benefit plan as defined in paragraphs (3) and 
(32) of section 3 of ERISA, a ``governmental plan'' (as defined in 29 
U.S.C. 1002(32)) that complies with the tax deferral qualification 
requirements provided in the Internal Revenue Code, or any similar 
employee benefit plan established under the laws of a foreign 
jurisdiction; or
    (iv) Registered with the SEC under the Investment Company Act of 
1940 (15 U.S.C. 80a-1 et seq.) or foreign equivalents thereof.
    Securitization position means a covered position that is:
    (1) An on-balance sheet or off-balance sheet credit exposure 
(including credit-enhancing representations and warranties) that arises 
from a securitization (including a resecuritization); or
    (2) An exposure that directly or indirectly references a 
securitization exposure described in paragraph (1) of this definition.
    Sovereign debt position means a direct exposure to a sovereign 
entity.
    Specific risk means the risk of loss on a position that could 
result from factors other than broad market movements and includes 
event risk, default risk, and idiosyncratic risk.
    Structural position in a foreign currency means a position that is 
not a trading position and that is:
    (1) Subordinated debt, equity, or minority interest in a 
consolidated subsidiary that is denominated in a foreign currency;
    (2) Capital assigned to foreign branches that is denominated in a 
foreign currency;
    (3) A position related to an unconsolidated subsidiary or another 
item that is denominated in a foreign currency and that is deducted 
from the [BANK]'s tier 1 or tier 2 capital; or
    (4) A position designed to hedge a [BANK]'s capital ratios or 
earnings against the effect on paragraphs (1), (2), or (3) of this 
definition of adverse exchange rate movements.
    Term repo-style transaction means a repo-style transaction that has 
an original maturity in excess of one business day.
    Trading position means a position that is held by the [BANK] for 
the purpose of short-term resale or with the intent of benefiting from 
actual or expected short-term price movements, or to lock in arbitrage 
profits.
    Two-way market means a market where there are independent bona fide 
offers to buy and sell so that a price reasonably related to the last 
sales price or current bona fide competitive bid and offer quotations 
can be determined within one day and settled at that price within a 
relatively short time frame conforming to trade custom.
    Value-at-Risk (VaR) means the estimate of the maximum amount that 
the value of one or more positions could decline due to market price or 
rate movements during a fixed holding period within a stated confidence 
interval.


Sec.  --.203  Requirements for application of this subpart F.

    (a) Trading positions--(1) Identification of trading positions. A 
[BANK] must have clearly defined policies and procedures for 
determining which of its trading assets and trading liabilities are 
trading positions and which of its trading positions are correlation 
trading positions. These policies and procedures must take into 
account:
    (i) The extent to which a position, or a hedge of its material 
risks, can be marked-to-market daily by reference to a two-way market; 
and
    (ii) Possible impairments to the liquidity of a position or its 
hedge.
    (2) Trading and hedging strategies. A [BANK] must have clearly 
defined trading and hedging strategies for its trading positions that 
are approved by senior management of the [BANK].
    (i) The trading strategy must articulate the expected holding 
period of, and the market risk associated with, each portfolio of 
trading positions.
    (ii) The hedging strategy must articulate for each portfolio of 
trading positions the level of market risk the [BANK] is willing to 
accept and must detail the instruments, techniques, and strategies the 
[BANK] will use to hedge the risk of the portfolio.
    (b) Management of covered positions--(1) Active management. A 
[BANK] must have clearly defined policies and procedures for actively 
managing all covered positions. At a

[[Page 62253]]

minimum, these policies and procedures must require:
    (i) Marking positions to market or to model on a daily basis;
    (ii) Daily assessment of the [BANK]'s ability to hedge position and 
portfolio risks, and of the extent of market liquidity;
    (iii) Establishment and daily monitoring of limits on positions by 
a risk control unit independent of the trading business unit;
    (iv) Daily monitoring by senior management of information described 
in paragraphs (b)(1)(i) through (b)(1)(iii) of this section;
    (v) At least annual reassessment of established limits on positions 
by senior management; and
    (vi) At least annual assessments by qualified personnel of the 
quality of market inputs to the valuation process, the soundness of key 
assumptions, the reliability of parameter estimation in pricing models, 
and the stability and accuracy of model calibration under alternative 
market scenarios.
    (2) Valuation of covered positions. The [BANK] must have a process 
for prudent valuation of its covered positions that includes policies 
and procedures on the valuation of positions, marking positions to 
market or to model, independent price verification, and valuation 
adjustments or reserves. The valuation process must consider, as 
appropriate, unearned credit spreads, close-out costs, early 
termination costs, investing and funding costs, liquidity, and model 
risk.
    (c) Requirements for internal models. (1) A [BANK] must obtain the 
prior written approval of the [AGENCY] before using any internal model 
to calculate its risk-based capital requirement under this subpart.
    (2) A [BANK] must meet all of the requirements of this section on 
an ongoing basis. The [BANK] must promptly notify the [AGENCY] when:
    (i) The [BANK] plans to extend the use of a model that the [AGENCY] 
has approved under this subpart to an additional business line or 
product type;
    (ii) The [BANK] makes any change to an internal model approved by 
the [AGENCY] under this subpart that would result in a material change 
in the [BANK]'s risk-weighted asset amount for a portfolio of covered 
positions; or
    (iii) The [BANK] makes any material change to its modeling 
assumptions.
    (3) The [AGENCY] may rescind its approval of the use of any 
internal model (in whole or in part) or of the determination of the 
approach under Sec.  --.209(a)(2)(ii) for a [BANK]'s modeled 
correlation trading positions and determine an appropriate capital 
requirement for the covered positions to which the model would apply, 
if the [AGENCY] determines that the model no longer complies with this 
subpart or fails to reflect accurately the risks of the [BANK]'s 
covered positions.
    (4) The [BANK] must periodically, but no less frequently than 
annually, review its internal models in light of developments in 
financial markets and modeling technologies, and enhance those models 
as appropriate to ensure that they continue to meet the [AGENCY]'s 
standards for model approval and employ risk measurement methodologies 
that are most appropriate for the [BANK]'s covered positions.
    (5) The [BANK] must incorporate its internal models into its risk 
management process and integrate the internal models used for 
calculating its VaR-based measure into its daily risk management 
process.
    (6) The level of sophistication of a [BANK]'s internal models must 
be commensurate with the complexity and amount of its covered 
positions. A [BANK]'s internal models may use any of the generally 
accepted approaches, including but not limited to variance-covariance 
models, historical simulations, or Monte Carlo simulations, to measure 
market risk.
    (7) The [BANK]'s internal models must properly measure all the 
material risks in the covered positions to which they are applied.
    (8) The [BANK]'s internal models must conservatively assess the 
risks arising from less liquid positions and positions with limited 
price transparency under realistic market scenarios.
    (9) The [BANK] must have a rigorous and well-defined process for 
re-estimating, re-evaluating, and updating its internal models to 
ensure continued applicability and relevance.
    (10) If a [BANK] uses internal models to measure specific risk, the 
internal models must also satisfy the requirements in paragraph (b)(1) 
of Sec.  --.207.
    (d) Control, oversight, and validation mechanisms. (1) The [BANK] 
must have a risk control unit that reports directly to senior 
management and is independent from the business trading units.
    (2) The [BANK] must validate its internal models initially and on 
an ongoing basis. The [BANK]'s validation process must be independent 
of the internal models' development, implementation, and operation, or 
the validation process must be subjected to an independent review of 
its adequacy and effectiveness. Validation must include:
    (i) An evaluation of the conceptual soundness of (including 
developmental evidence supporting) the internal models;
    (ii) An ongoing monitoring process that includes verification of 
processes and the comparison of the [BANK]'s model outputs with 
relevant internal and external data sources or estimation techniques; 
and
    (iii) An outcomes analysis process that includes backtesting. For 
internal models used to calculate the VaR-based measure, this process 
must include a comparison of the changes in the [BANK]'s portfolio 
value that would have occurred were end-of-day positions to remain 
unchanged (therefore, excluding fees, commissions, reserves, net 
interest income, and intraday trading) with VaR-based measures during a 
sample period not used in model development.
    (3) The [BANK] must stress test the market risk of its covered 
positions at a frequency appropriate to each portfolio, and in no case 
less frequently than quarterly. The stress tests must take into account 
concentration risk (including but not limited to concentrations in 
single issuers, industries, sectors, or markets), illiquidity under 
stressed market conditions, and risks arising from the [BANK]'s trading 
activities that may not be adequately captured in its internal models.
    (4) The [BANK] must have an internal audit function independent of 
business-line management that at least annually assesses the 
effectiveness of the controls supporting the [BANK]'s market risk 
measurement systems, including the activities of the business trading 
units and independent risk control unit, compliance with policies and 
procedures, and calculation of the [BANK]'s measures for market risk 
under this subpart. At least annually, the internal audit function must 
report its findings to the [BANK]'s board of directors (or a committee 
thereof).
    (e) Internal assessment of capital adequacy. The [BANK] must have a 
rigorous process for assessing its overall capital adequacy in relation 
to its market risk. The assessment must take into account risks that 
may not be captured fully in the VaR-based measure, including 
concentration and liquidity risk under stressed market conditions.
    (f) Documentation. The [BANK] must adequately document all material 
aspects of its internal models, management and valuation of covered 
positions, control, oversight, validation and review processes and 
results, and internal assessment of capital adequacy.

[[Page 62254]]

Sec.  --.204  Measure for market risk.

    (a) General requirement. (1) A [BANK] must calculate its 
standardized measure for market risk by following the steps described 
in paragraph (a)(2) of this section. An advanced approaches [BANK] also 
must calculate an advanced measure for market risk by following the 
steps in paragraph (a)(2) of this section.
    (2) Measure for market risk. A [BANK] must calculate the 
standardized measure for market risk, which equals the sum of the VaR-
based capital requirement, stressed VaR-based capital requirement, 
specific risk add-ons, incremental risk capital requirement, 
comprehensive risk capital requirement, and capital requirement for de 
minimis exposures all as defined under this paragraph (a)(2), (except, 
that the [BANK] may not use the SFA in section 210(b)(2)(vii)(B) of 
this subpart for purposes of this calculation)[, plus any additional 
capital requirement established by the [AGENCY]]. An advanced 
approaches [BANK] that has completed the parallel run process and that 
has received notifications from the [AGENCY] pursuant to Sec.  
--.121(d) also must calculate the advanced measure for market risk, 
which equals the sum of the VaR-based capital requirement, stressed 
VaR-based capital requirement, specific risk add-ons, incremental risk 
capital requirement, comprehensive risk capital requirement, and 
capital requirement for de minimis exposures as defined under this 
paragraph (a)(2) [, plus any additional capital requirement established 
by the [AGENCY]].
    (i) VaR-based capital requirement. A [BANK]'s VaR-based capital 
requirement equals the greater of:
    (A) The previous day's VaR-based measure as calculated under Sec.  
--.205; or
    (B) The average of the daily VaR-based measures as calculated under 
Sec.  --.205 for each of the preceding 60 business days multiplied by 
three, except as provided in paragraph (b) of this section.
    (ii) Stressed VaR-based capital requirement. A [BANK]'s stressed 
VaR-based capital requirement equals the greater of:
    (A) The most recent stressed VaR-based measure as calculated under 
Sec.  --.206; or
    (B) The average of the stressed VaR-based measures as calculated 
under Sec.  --.206 for each of the preceding 12 weeks multiplied by 
three, except as provided in paragraph (b) of this section.
    (iii) Specific risk add-ons. A [BANK]'s specific risk add-ons equal 
any specific risk add-ons that are required under Sec.  --.207 and are 
calculated in accordance with Sec.  --.210.
    (iv) Incremental risk capital requirement. A [BANK]'s incremental 
risk capital requirement equals any incremental risk capital 
requirement as calculated under section 208 of this subpart.
    (v) Comprehensive risk capital requirement. A [BANK]'s 
comprehensive risk capital requirement equals any comprehensive risk 
capital requirement as calculated under section 209 of this subpart.
    (vi) Capital requirement for de minimis exposures. A [BANK]'s 
capital requirement for de minimis exposures equals:
    (A) The absolute value of the fair value of those de minimis 
exposures that are not captured in the [BANK]'s VaR-based measure or 
under paragraph (a)(2)(vi)(B) of this section; and
    (B) With the prior written approval of the [AGENCY], the capital 
requirement for any de minimis exposures using alternative techniques 
that appropriately measure the market risk associated with those 
exposures.
    (b) Backtesting. A [BANK] must compare each of its most recent 250 
business days' trading losses (excluding fees, commissions, reserves, 
net interest income, and intraday trading) with the corresponding daily 
VaR-based measures calibrated to a one-day holding period and at a one-
tail, 99.0 percent confidence level. A [BANK] must begin backtesting as 
required by this paragraph (b) no later than one year after the later 
of January 1, 2014 and the date on which the [BANK] becomes subject to 
this subpart. In the interim, consistent with safety and soundness 
principles, a [BANK] subject to this subpart as of January 1, 2014 
should continue to follow backtesting procedures in accordance with the 
[AGENCY]'s supervisory expectations.
    (1) Once each quarter, the [BANK] must identify the number of 
exceptions (that is, the number of business days for which the actual 
daily net trading loss, if any, exceeds the corresponding daily VaR-
based measure) that have occurred over the preceding 250 business days.
    (2) A [BANK] must use the multiplication factor in Table 1 to Sec.  
--.204 that corresponds to the number of exceptions identified in 
paragraph (b)(1) of this section to determine its VaR-based capital 
requirement for market risk under paragraph (a)(2)(i) of this section 
and to determine its stressed VaR-based capital requirement for market 
risk under paragraph (a)(2)(ii) of this section until it obtains the 
next quarter's backtesting results, unless the [AGENCY] notifies the 
[BANK] in writing that a different adjustment or other action is 
appropriate.

  Table 1 to Sec.   --.204--Multiplication Factors Based on Results of
                               Backtesting
------------------------------------------------------------------------
                                                          Multiplication
                  Number of exceptions                        factor
------------------------------------------------------------------------
4 or fewer..............................................            3.00
5.......................................................            3.40
6.......................................................            3.50
7.......................................................            3.65
8.......................................................            3.75
9.......................................................            3.85
10 or more..............................................            4.00
------------------------------------------------------------------------

Sec.  --.205  VaR-based measure.

    (a) General requirement. A [BANK] must use one or more internal 
models to calculate daily a VaR-based measure of the general market 
risk of all covered positions. The daily VaR-based measure also may 
reflect the [BANK]'s specific risk for one or more portfolios of debt 
and equity positions, if the internal models meet the requirements of 
paragraph (b)(1) of Sec.  --.207. The daily VaR-based measure must also 
reflect the [BANK]'s specific risk for any portfolio of correlation 
trading positions that is modeled under Sec.  --.209. A [BANK] may 
elect to include term repo-style transactions in its VaR-based measure, 
provided that the [BANK] includes all such term repo-style transactions 
consistently over time.
    (1) The [BANK]'s internal models for calculating its VaR-based 
measure must use risk factors sufficient to measure the market risk 
inherent in all covered positions. The market risk categories must 
include, as appropriate, interest rate risk, credit spread risk, equity 
price risk, foreign exchange risk, and commodity price risk. For 
material positions in the major currencies and markets, modeling 
techniques must incorporate enough segments of the yield curve--in no 
case less than six--to capture differences in volatility and less than 
perfect correlation of rates along the yield curve.
    (2) The VaR-based measure may incorporate empirical correlations 
within and across risk categories, provided the [BANK] validates and 
demonstrates the reasonableness of its process for measuring 
correlations. If the VaR-based measure does not incorporate empirical 
correlations across risk categories, the [BANK] must add the separate 
measures from its internal models used to calculate the VaR-based 
measure for the appropriate market risk categories (interest rate risk, 
credit spread risk, equity price risk, foreign exchange rate risk, and/
or

[[Page 62255]]

commodity price risk) to determine its aggregate VaR-based measure.
    (3) The VaR-based measure must include the risks arising from the 
nonlinear price characteristics of options positions or positions with 
embedded optionality and the sensitivity of the fair value of the 
positions to changes in the volatility of the underlying rates, prices, 
or other material risk factors. A [BANK] with a large or complex 
options portfolio must measure the volatility of options positions or 
positions with embedded optionality by different maturities and/or 
strike prices, where material.
    (4) The [BANK] must be able to justify to the satisfaction of the 
[AGENCY] the omission of any risk factors from the calculation of its 
VaR-based measure that the [BANK] uses in its pricing models.
    (5) The [BANK] must demonstrate to the satisfaction of the [AGENCY] 
the appropriateness of any proxies used to capture the risks of the 
[BANK]'s actual positions for which such proxies are used.
    (b) Quantitative requirements for VaR-based measure. (1) The VaR-
based measure must be calculated on a daily basis using a one-tail, 
99.0 percent confidence level, and a holding period equivalent to a 10-
business-day movement in underlying risk factors, such as rates, 
spreads, and prices. To calculate VaR-based measures using a 10-
business-day holding period, the [BANK] may calculate 10-business-day 
measures directly or may convert VaR-based measures using holding 
periods other than 10 business days to the equivalent of a 10-business-
day holding period. A [BANK] that converts its VaR-based measure in 
such a manner must be able to justify the reasonableness of its 
approach to the satisfaction of the [AGENCY].
    (2) The VaR-based measure must be based on a historical observation 
period of at least one year. Data used to determine the VaR-based 
measure must be relevant to the [BANK]'s actual exposures and of 
sufficient quality to support the calculation of risk-based capital 
requirements. The [BANK] must update data sets at least monthly or more 
frequently as changes in market conditions or portfolio composition 
warrant. For a [BANK] that uses a weighting scheme or other method for 
the historical observation period, the [BANK] must either:
    (i) Use an effective observation period of at least one year in 
which the average time lag of the observations is at least six months; 
or
    (ii) Demonstrate to the [AGENCY] that its weighting scheme is more 
effective than a weighting scheme with an average time lag of at least 
six months representing the volatility of the [BANK]'s trading 
portfolio over a full business cycle. A [BANK] using this option must 
update its data more frequently than monthly and in a manner 
appropriate for the type of weighting scheme.
    (c) A [BANK] must divide its portfolio into a number of significant 
subportfolios approved by the [AGENCY] for subportfolio backtesting 
purposes. These subportfolios must be sufficient to allow the [BANK] 
and the [AGENCY] to assess the adequacy of the VaR model at the risk 
factor level; the [AGENCY] will evaluate the appropriateness of these 
subportfolios relative to the value and composition of the [BANK]'s 
covered positions. The [BANK] must retain and make available to the 
[AGENCY] the following information for each subportfolio for each 
business day over the previous two years (500 business days), with no 
more than a 60-day lag:
    (1) A daily VaR-based measure for the subportfolio calibrated to a 
one-tail, 99.0 percent confidence level;
    (2) The daily profit or loss for the subportfolio (that is, the net 
change in price of the positions held in the portfolio at the end of 
the previous business day); and
    (3) The p-value of the profit or loss on each day (that is, the 
probability of observing a profit that is less than, or a loss that is 
greater than, the amount reported for purposes of paragraph (c)(2) of 
this section based on the model used to calculate the VaR-based measure 
described in paragraph (c)(1) of this section).


Sec.  --.206  Stressed VaR-based measure.

    (a) General requirement. At least weekly, a [BANK] must use the 
same internal model(s) used to calculate its VaR-based measure to 
calculate a stressed VaR-based measure.
    (b) Quantitative requirements for stressed VaR-based measure. (1) A 
[BANK] must calculate a stressed VaR-based measure for its covered 
positions using the same model(s) used to calculate the VaR-based 
measure, subject to the same confidence level and holding period 
applicable to the VaR-based measure under Sec.  --.205, but with model 
inputs calibrated to historical data from a continuous 12-month period 
that reflects a period of significant financial stress appropriate to 
the [BANK]'s current portfolio.
    (2) The stressed VaR-based measure must be calculated at least 
weekly and be no less than the [BANK]'s VaR-based measure.
    (3) A [BANK] must have policies and procedures that describe how it 
determines the period of significant financial stress used to calculate 
the [BANK]'s stressed VaR-based measure under this section and must be 
able to provide empirical support for the period used. The [BANK] must 
obtain the prior approval of the [AGENCY] for, and notify the [AGENCY] 
if the [BANK] makes any material changes to, these policies and 
procedures. The policies and procedures must address:
    (i) How the [BANK] links the period of significant financial stress 
used to calculate the stressed VaR-based measure to the composition and 
directional bias of its current portfolio; and
    (ii) The [BANK]'s process for selecting, reviewing, and updating 
the period of significant financial stress used to calculate the 
stressed VaR-based measure and for monitoring the appropriateness of 
the period to the [BANK]'s current portfolio.
    (4) Nothing in this section prevents the [AGENCY] from requiring a 
[BANK] to use a different period of significant financial stress in the 
calculation of the stressed VaR-based measure.


Sec.  --.207  Specific risk.

    (a) General requirement. A [BANK] must use one of the methods in 
this section to measure the specific risk for each of its debt, equity, 
and securitization positions with specific risk.
    (b) Modeled specific risk. A [BANK] may use models to measure the 
specific risk of covered positions as provided in paragraph (a) of 
section 205 of this subpart (therefore, excluding securitization 
positions that are not modeled under section 209 of this subpart). A 
[BANK] must use models to measure the specific risk of correlation 
trading positions that are modeled under Sec.  --.209.
    (1) Requirements for specific risk modeling. (i) If a [BANK] uses 
internal models to measure the specific risk of a portfolio, the 
internal models must:
    (A) Explain the historical price variation in the portfolio;
    (B) Be responsive to changes in market conditions;
    (C) Be robust to an adverse environment, including signaling rising 
risk in an adverse environment; and
    (D) Capture all material components of specific risk for the debt 
and equity positions in the portfolio. Specifically, the internal 
models must:
    (1) Capture event risk and idiosyncratic risk; and
    (2) Capture and demonstrate sensitivity to material differences

[[Page 62256]]

between positions that are similar but not identical and to changes in 
portfolio composition and concentrations.
    (ii) If a [BANK] calculates an incremental risk measure for a 
portfolio of debt or equity positions under section 208 of this 
subpart, the [BANK] is not required to capture default and credit 
migration risks in its internal models used to measure the specific 
risk of those portfolios.
    (2) Specific risk fully modeled for one or more portfolios. If the 
[BANK]'s VaR-based measure captures all material aspects of specific 
risk for one or more of its portfolios of debt, equity, or correlation 
trading positions, the [BANK] has no specific risk add-on for those 
portfolios for purposes of paragraph (a)(2)(iii) of Sec.  --.204.
    (c) Specific risk not modeled. (1) If the [BANK]'s VaR-based 
measure does not capture all material aspects of specific risk for a 
portfolio of debt, equity, or correlation trading positions, the [BANK] 
must calculate a specific-risk add-on for the portfolio under the 
standardized measurement method as described in Sec.  --.210.
    (2) A [BANK] must calculate a specific risk add-on under the 
standardized measurement method as described in Sec.  --.210 for all of 
its securitization positions that are not modeled under Sec.  --.209.


Sec.  --.208  Incremental risk.

    (a) General requirement. A [BANK] that measures the specific risk 
of a portfolio of debt positions under Sec.  --.207(b) using internal 
models must calculate at least weekly an incremental risk measure for 
that portfolio according to the requirements in this section. The 
incremental risk measure is the [BANK]'s measure of potential losses 
due to incremental risk over a one-year time horizon at a one-tail, 
99.9 percent confidence level, either under the assumption of a 
constant level of risk, or under the assumption of constant positions. 
With the prior approval of the [AGENCY], a [BANK] may choose to include 
portfolios of equity positions in its incremental risk model, provided 
that it consistently includes such equity positions in a manner that is 
consistent with how the [BANK] internally measures and manages the 
incremental risk of such positions at the portfolio level. If equity 
positions are included in the model, for modeling purposes default is 
considered to have occurred upon the default of any debt of the issuer 
of the equity position. A [BANK] may not include correlation trading 
positions or securitization positions in its incremental risk measure.
    (b) Requirements for incremental risk modeling. For purposes of 
calculating the incremental risk measure, the incremental risk model 
must:
    (1) Measure incremental risk over a one-year time horizon and at a 
one-tail, 99.9 percent confidence level, either under the assumption of 
a constant level of risk, or under the assumption of constant 
positions.
    (i) A constant level of risk assumption means that the [BANK] 
rebalances, or rolls over, its trading positions at the beginning of 
each liquidity horizon over the one-year horizon in a manner that 
maintains the [BANK]'s initial risk level. The [BANK] must determine 
the frequency of rebalancing in a manner consistent with the liquidity 
horizons of the positions in the portfolio. The liquidity horizon of a 
position or set of positions is the time required for a [BANK] to 
reduce its exposure to, or hedge all of its material risks of, the 
position(s) in a stressed market. The liquidity horizon for a position 
or set of positions may not be less than the shorter of three months or 
the contractual maturity of the position.
    (ii) A constant position assumption means that the [BANK] maintains 
the same set of positions throughout the one-year horizon. If a [BANK] 
uses this assumption, it must do so consistently across all portfolios.
    (iii) A [BANK]'s selection of a constant position or a constant 
risk assumption must be consistent between the [BANK]'s incremental 
risk model and its comprehensive risk model described in section 209 of 
this subpart, if applicable.
    (iv) A [BANK]'s treatment of liquidity horizons must be consistent 
between the [BANK]'s incremental risk model and its comprehensive risk 
model described in section 209, if applicable.
    (2) Recognize the impact of correlations between default and 
migration events among obligors.
    (3) Reflect the effect of issuer and market concentrations, as well 
as concentrations that can arise within and across product classes 
during stressed conditions.
    (4) Reflect netting only of long and short positions that reference 
the same financial instrument.
    (5) Reflect any material mismatch between a position and its hedge.
    (6) Recognize the effect that liquidity horizons have on dynamic 
hedging strategies. In such cases, a [BANK] must:
    (i) Choose to model the rebalancing of the hedge consistently over 
the relevant set of trading positions;
    (ii) Demonstrate that the inclusion of rebalancing results in a 
more appropriate risk measurement;
    (iii) Demonstrate that the market for the hedge is sufficiently 
liquid to permit rebalancing during periods of stress; and
    (iv) Capture in the incremental risk model any residual risks 
arising from such hedging strategies.
    (7) Reflect the nonlinear impact of options and other positions 
with material nonlinear behavior with respect to default and migration 
changes.
    (8) Maintain consistency with the [BANK]'s internal risk management 
methodologies for identifying, measuring, and managing risk.
    (c) Calculation of incremental risk capital requirement. The 
incremental risk capital requirement is the greater of:
    (1) The average of the incremental risk measures over the previous 
12 weeks; or
    (2) The most recent incremental risk measure.


Sec.  --.209  Comprehensive risk.

    (a) General requirement. (1) Subject to the prior approval of the 
[AGENCY], a [BANK] may use the method in this section to measure 
comprehensive risk, that is, all price risk, for one or more portfolios 
of correlation trading positions.
    (2) A [BANK] that measures the price risk of a portfolio of 
correlation trading positions using internal models must calculate at 
least weekly a comprehensive risk measure that captures all price risk 
according to the requirements of this section. The comprehensive risk 
measure is either:
    (i) The sum of:
    (A) The [BANK]'s modeled measure of all price risk determined 
according to the requirements in paragraph (b) of this section; and
    (B) A surcharge for the [BANK]'s modeled correlation trading 
positions equal to the total specific risk add-on for such positions as 
calculated under section 210 of this subpart multiplied by 8.0 percent; 
or
    (ii) With approval of the [AGENCY] and provided the [BANK] has met 
the requirements of this section for a period of at least one year and 
can demonstrate the effectiveness of the model through the results of 
ongoing model validation efforts including robust benchmarking, the 
greater of:
    (A) The [BANK]'s modeled measure of all price risk determined 
according to the requirements in paragraph (b) of this section; or
    (B) The total specific risk add-on that would apply to the bank's 
modeled correlation trading positions as calculated under section 210 
of this subpart multiplied by 8.0 percent.
    (b) Requirements for modeling all price risk. If a [BANK] uses an 
internal

[[Page 62257]]

model to measure the price risk of a portfolio of correlation trading 
positions:
    (1) The internal model must measure comprehensive risk over a one-
year time horizon at a one-tail, 99.9 percent confidence level, either 
under the assumption of a constant level of risk, or under the 
assumption of constant positions.
    (2) The model must capture all material price risk, including but 
not limited to the following:
    (i) The risks associated with the contractual structure of cash 
flows of the position, its issuer, and its underlying exposures;
    (ii) Credit spread risk, including nonlinear price risks;
    (iii) The volatility of implied correlations, including nonlinear 
price risks such as the cross-effect between spreads and correlations;
    (iv) Basis risk;
    (v) Recovery rate volatility as it relates to the propensity for 
recovery rates to affect tranche prices; and
    (vi) To the extent the comprehensive risk measure incorporates the 
benefits of dynamic hedging, the static nature of the hedge over the 
liquidity horizon must be recognized. In such cases, a [BANK] must:
    (A) Choose to model the rebalancing of the hedge consistently over 
the relevant set of trading positions;
    (B) Demonstrate that the inclusion of rebalancing results in a more 
appropriate risk measurement;
    (C) Demonstrate that the market for the hedge is sufficiently 
liquid to permit rebalancing during periods of stress; and
    (D) Capture in the comprehensive risk model any residual risks 
arising from such hedging strategies;
    (3) The [BANK] must use market data that are relevant in 
representing the risk profile of the [BANK]'s correlation trading 
positions in order to ensure that the [BANK] fully captures the 
material risks of the correlation trading positions in its 
comprehensive risk measure in accordance with this section; and
    (4) The [BANK] must be able to demonstrate that its model is an 
appropriate representation of comprehensive risk in light of the 
historical price variation of its correlation trading positions.
    (c) Requirements for stress testing. (1) A [BANK] must at least 
weekly apply specific, supervisory stress scenarios to its portfolio of 
correlation trading positions that capture changes in:
    (i) Default rates;
    (ii) Recovery rates;
    (iii) Credit spreads;
    (iv) Correlations of underlying exposures; and
    (v) Correlations of a correlation trading position and its hedge.
    (2) Other requirements. (i) A [BANK] must retain and make available 
to the [AGENCY] the results of the supervisory stress testing, 
including comparisons with the capital requirements generated by the 
[BANK]'s comprehensive risk model.
    (ii) A [BANK] must report to the [AGENCY] promptly any instances 
where the stress tests indicate any material deficiencies in the 
comprehensive risk model.
    (d) Calculation of comprehensive risk capital requirement. The 
comprehensive risk capital requirement is the greater of:
    (1) The average of the comprehensive risk measures over the 
previous 12 weeks; or
    (2) The most recent comprehensive risk measure.


Sec.  --.210  Standardized measurement method for specific risk

    (a) General requirement. A [BANK] must calculate a total specific 
risk add-on for each portfolio of debt and equity positions for which 
the [BANK]'s VaR-based measure does not capture all material aspects of 
specific risk and for all securitization positions that are not modeled 
under Sec.  --.209. A [BANK] must calculate each specific risk add-on 
in accordance with the requirements of this section. Notwithstanding 
any other definition or requirement in this subpart, a position that 
would have qualified as a debt position or an equity position but for 
the fact that it qualifies as a correlation trading position under 
paragraph (2) of the definition of correlation trading position in 
Sec.  --.2, shall be considered a debt position or an equity position, 
respectively, for purposes of this section 210 of this subpart.
    (1) The specific risk add-on for an individual debt or 
securitization position that represents sold credit protection is 
capped at the notional amount of the credit derivative contract. The 
specific risk add-on for an individual debt or securitization position 
that represents purchased credit protection is capped at the current 
fair value of the transaction plus the absolute value of the present 
value of all remaining payments to the protection seller under the 
transaction. This sum is equal to the value of the protection leg of 
the transaction.
    (2) For debt, equity, or securitization positions that are 
derivatives with linear payoffs, a [BANK] must assign a specific risk-
weighting factor to the fair value of the effective notional amount of 
the underlying instrument or index portfolio, except for a 
securitization position for which the [BANK] directly calculates a 
specific risk add-on using the SFA in paragraph (b)(2)(vii)(B) of this 
section. A swap must be included as an effective notional position in 
the underlying instrument or portfolio, with the receiving side treated 
as a long position and the paying side treated as a short position. For 
debt, equity, or securitization positions that are derivatives with 
nonlinear payoffs, a [BANK] must risk weight the fair value of the 
effective notional amount of the underlying instrument or portfolio 
multiplied by the derivative's delta.
    (3) For debt, equity, or securitization positions, a [BANK] may net 
long and short positions (including derivatives) in identical issues or 
identical indices. A [BANK] may also net positions in depositary 
receipts against an opposite position in an identical equity in 
different markets, provided that the [BANK] includes the costs of 
conversion.
    (4) A set of transactions consisting of either a debt position and 
its credit derivative hedge or a securitization position and its credit 
derivative hedge has a specific risk add-on of zero if:
    (i) The debt or securitization position is fully hedged by a total 
return swap (or similar instrument where there is a matching of swap 
payments and changes in fair value of the debt or securitization 
position);
    (ii) There is an exact match between the reference obligation of 
the swap and the debt or securitization position;
    (iii) There is an exact match between the currency of the swap and 
the debt or securitization position; and
    (iv) There is either an exact match between the maturity date of 
the swap and the maturity date of the debt or securitization position; 
or, in cases where a total return swap references a portfolio of 
positions with different maturity dates, the total return swap maturity 
date must match the maturity date of the underlying asset in that 
portfolio that has the latest maturity date.
    (5) The specific risk add-on for a set of transactions consisting 
of either a debt position and its credit derivative hedge or a 
securitization position and its credit derivative hedge that does not 
meet the criteria of paragraph (a)(4) of this section is equal to 20.0 
percent of the capital requirement for the side of the transaction with 
the higher specific risk add-on when:
    (i) The credit risk of the position is fully hedged by a credit 
default swap or similar instrument;
    (ii) There is an exact match between the reference obligation of 
the credit

[[Page 62258]]

derivative hedge and the debt or securitization position;
    (iii) There is an exact match between the currency of the credit 
derivative hedge and the debt or securitization position; and
    (iv) There is either an exact match between the maturity date of 
the credit derivative hedge and the maturity date of the debt or 
securitization position; or, in the case where the credit derivative 
hedge has a standard maturity date:
    (A) The maturity date of the credit derivative hedge is within 30 
business days of the maturity date of the debt or securitization 
position; or
    (B) For purchased credit protection, the maturity date of the 
credit derivative hedge is later than the maturity date of the debt or 
securitization position, but is no later than the standard maturity 
date for that instrument that immediately follows the maturity date of 
the debt or securitization position. The maturity date of the credit 
derivative hedge may not exceed the maturity date of the debt or 
securitization position by more than 90 calendar days.
    (6) The specific risk add-on for a set of transactions consisting 
of either a debt position and its credit derivative hedge or a 
securitization position and its credit derivative hedge that does not 
meet the criteria of either paragraph (a)(4) or (a)(5) of this section, 
but in which all or substantially all of the price risk has been 
hedged, is equal to the specific risk add-on for the side of the 
transaction with the higher specific risk add-on.
    (b) Debt and securitization positions. (1) The total specific risk 
add-on for a portfolio of debt or securitization positions is the sum 
of the specific risk add-ons for individual debt or securitization 
positions, as computed under this section. To determine the specific 
risk add-on for individual debt or securitization positions, a [BANK] 
must multiply the absolute value of the current fair value of each net 
long or net short debt or securitization position in the portfolio by 
the appropriate specific risk-weighting factor as set forth in 
paragraphs (b)(2)(i) through (b)(2)(vii) of this section.
    (2) For the purpose of this section, the appropriate specific risk-
weighting factors include:
    (i) Sovereign debt positions. (A) In accordance with Table 1 to 
Sec.  --.210, a [BANK] must assign a specific risk-weighting factor to 
a sovereign debt position based on the CRC applicable to the sovereign, 
and, as applicable, the remaining contractual maturity of the position, 
or if there is no CRC applicable to the sovereign, based on whether the 
sovereign entity is a member of the OECD. Notwithstanding any other 
provision in this subpart, sovereign debt positions that are backed by 
the full faith and credit of the United States are treated as having a 
CRC of 0.

 Table 1 to Sec.   --.210--Specific Risk-Weighting Factors for Sovereign
                             Debt Positions
------------------------------------------------------------------------
 
------------------------------------------------------------------------
                                       Specific risk-weighting factor
                                                (in percent)
------------------------------------------------------------------------
CRC:
    0-1..........................                   0.0
                                  --------------------------------------
    2-3..........................  Remaining                        0.25
                                    contractual
                                    maturity of 6
                                    months or less.
                                   Remaining                         1.0
                                    contractual
                                    maturity of
                                    greater than 6 and
                                    up to and
                                    including 24
                                    months.
                                   Remaining                         1.6
                                    contractual
                                    maturity exceeds
                                    24 months.
                                  ======================
    4-6..........................                   8.0
                                  ======================
    7............................                   12.0
==================================
OECD Member with No CRC..........                   0.0
==================================
Non-OECD Member with No CRC......                   8.0
==================================
Sovereign Default................                   12.0
------------------------------------------------------------------------

    (B) Notwithstanding paragraph (b)(2)(i)(A) of this section, a 
[BANK] may assign to a sovereign debt position a specific risk-
weighting factor that is lower than the applicable specific risk-
weighting factor in Table 1 to Sec.  --.210 if:
    (1) The position is denominated in the sovereign entity's currency;
    (2) The [BANK] has at least an equivalent amount of liabilities in 
that currency; and
    (3) The sovereign entity allows banks under its jurisdiction to 
assign the lower specific risk-weighting factor to the same exposures 
to the sovereign entity.
    (C) A [BANK] must assign a 12.0 percent specific risk-weighting 
factor to a sovereign debt position immediately upon determination a 
default has occurred; or if a default has occurred within the previous 
five years.
    (D) A [BANK] must assign a 0.0 percent specific risk-weighting 
factor to a sovereign debt position if the sovereign entity is a member 
of the OECD and does not have a CRC assigned to it, except as provided 
in paragraph (b)(2)(i)(C) of this section.
    (E) A [BANK] must assign an 8.0 percent specific risk-weighting 
factor to a sovereign debt position if the sovereign is not a member of 
the OECD and does not have a CRC assigned to it, except as provided in 
paragraph (b)(2)(i)(C) of this section.
    (ii) Certain supranational entity and multilateral development bank 
debt positions. A [BANK] may assign a 0.0 percent specific risk-
weighting factor to a debt position that is an exposure to the Bank for 
International Settlements, the European Central Bank, the European 
Commission, the International Monetary Fund, or an MDB.
    (iii) GSE debt positions. A [BANK] must assign a 1.6 percent 
specific risk-weighting factor to a debt position that is an exposure 
to a GSE. Notwithstanding the foregoing, a [BANK] must assign an 8.0 
percent specific risk-weighting factor to preferred stock issued by a 
GSE.
    (iv) Depository institution, foreign bank, and credit union debt 
positions. (A) Except as provided in paragraph (b)(2)(iv)(B) of this 
section, a [BANK] must assign a specific risk-weighting factor to a 
debt position that is an exposure to a depository institution, a

[[Page 62259]]

foreign bank, or a credit union, in accordance with Table 2 to Sec.  
--.210, based on the CRC that corresponds to that entity's home country 
or the OECD membership status of that entity's home country if there is 
no CRC applicable to the entity's home country, and, as applicable, the 
remaining contractual maturity of the position.

Table 2 to Sec.   --.210--Specific Risk-Weighting Factors for Depository
       Institution, Foreign Bank, and Credit Union Debt Positions
------------------------------------------------------------------------
 
------------------------------------------------------------------------
                                     Specific risk-weighting factor
                                              (in percent)
------------------------------------------------------------------------
CRC 0-2 or OECD Member with No  Remaining contractual               0.25
 CRC.                            maturity of 6 months
                                 or less.
                                Remaining contractual                1.0
                                 maturity of greater
                                 than 6 and up to and
                                 including 24 months.
                                Remaining contractual                1.6
                                 maturity exceeds 24
                                 months.
------------------------------------------------------------------------
CRC 3.........................                     8.0
------------------------------------------------------------------------
CRC 4-7.......................                    12.0
------------------------------------------------------------------------
Non-OECD Member with No CRC...                     8.0
------------------------------------------------------------------------
Sovereign Default.............                    12.0
------------------------------------------------------------------------

    (B) A [BANK] must assign a specific risk-weighting factor of 8.0 
percent to a debt position that is an exposure to a depository 
institution or a foreign bank that is includable in the depository 
institution's or foreign bank's regulatory capital and that is not 
subject to deduction as a reciprocal holding under Sec.  --.22.
    (C) A [BANK] must assign a 12.0 percent specific risk-weighting 
factor to a debt position that is an exposure to a foreign bank 
immediately upon determination that a default by the foreign bank's 
home country has occurred or if a default by the foreign bank's home 
country has occurred within the previous five years.
    (v) PSE debt positions. (A) Except as provided in paragraph 
(b)(2)(v)(B) of this section, a [BANK] must assign a specific risk-
weighting factor to a debt position that is an exposure to a PSE in 
accordance with Tables 3 and 4 to Sec.  --.210 depending on the 
position's categorization as a general obligation or revenue obligation 
based on the CRC that corresponds to the PSE's home country or the OECD 
membership status of the PSE's home country if there is no CRC 
applicable to the PSE's home country, and, as applicable, the remaining 
contractual maturity of the position, as set forth in Tables 3 and 4 of 
this section.
    (B) A [BANK] may assign a lower specific risk-weighting factor than 
would otherwise apply under Tables 3 and 4 of this section to a debt 
position that is an exposure to a foreign PSE if:
    (1) The PSE's home country allows banks under its jurisdiction to 
assign a lower specific risk-weighting factor to such position; and
    (2) The specific risk-weighting factor is not lower than the risk 
weight that corresponds to the PSE's home country in accordance with 
Tables 3 and 4 of this section.
    (C) A [BANK] must assign a 12.0 percent specific risk-weighting 
factor to a PSE debt position immediately upon determination that a 
default by the PSE's home country has occurred or if a default by the 
PSE's home country has occurred within the previous five years.

    Table 3 to Sec.   --.210--Specific Risk-Weighting Factors for PSE
                    General Obligation Debt Positions
------------------------------------------------------------------------
 
------------------------------------------------------------------------
                                    General obligation specific risk-
                                             weighting factor
                                              (in percent)
------------------------------------------------------------------------
CRC 0-2 or OECD Member with No  Remaining contractual               0.25
 CRC.                            maturity of 6 months
                                 or less.
                                Remaining contractual                1.0
                                 maturity of greater
                                 than 6 and up to and
                                 including 24 months.
                                Remaining contractual                1.6
                                 maturity exceeds 24
                                 months.
------------------------------------------------------------------------
CRC 3.........................                     8.0
------------------------------------------------------------------------
CRC 4-7.......................                    12.0
------------------------------------------------------------------------
Non-OECD Member with No CRC...                     8.0
------------------------------------------------------------------------
Sovereign Default.............                    12.0
------------------------------------------------------------------------


[[Page 62260]]


    Table 4 to Sec.   --.210--Specific Risk-Weighting Factors for PSE
                    Revenue Obligation Debt Positions
------------------------------------------------------------------------
 
------------------------------------------------------------------------
                                    Revenue obligation specific risk-
                                             weighting factor
                                              (in percent)
------------------------------------------------------------------------
CRC 0-1 or OECD Member with No  Remaining contractual               0.25
 CRC.                            maturity of 6 months
                                 or less.
                                Remaining contractual                1.0
                                 maturity of greater
                                 than 6 and up to and
                                 including 24 months.
                                Remaining contractual                1.6
                                 maturity exceeds 24
                                 months.
------------------------------------------------------------------------
CRC 2-3.......................                     8.0
------------------------------------------------------------------------
CRC 4-7.......................                    12.0
------------------------------------------------------------------------
Non-OECD Member with No CRC...                     8.0
------------------------------------------------------------------------
Sovereign Default.............                    12.0
------------------------------------------------------------------------

    (vi) Corporate debt positions. Except as otherwise provided in 
paragraph (b)(2)(vi)(B) of this section, a [BANK] must assign a 
specific risk-weighting factor to a corporate debt position in 
accordance with the investment grade methodology in paragraph 
(b)(2)(vi)(A) of this section.
    (A) Investment grade methodology. (1) For corporate debt positions 
that are exposures to entities that have issued and outstanding 
publicly traded instruments, a [BANK] must assign a specific risk-
weighting factor based on the category and remaining contractual 
maturity of the position, in accordance with Table 5 to Sec.  --.210. 
For purposes of this paragraph (b)(2)(vi)(A)(1), the [BANK] must 
determine whether the position is in the investment grade or not 
investment grade category.

 Table 5 to Sec.   --.210--Specific Risk-Weighting Factors for Corporate
          Debt Positions Under the Investment Grade Methodology
------------------------------------------------------------------------
                                                         Specific risk-
           Category              Remaining contractual  weighting factor
                                       maturity           (in percent)
------------------------------------------------------------------------
Investment Grade..............  6 months or less......              0.50
                                Greater than 6 and up               2.00
                                 to and including 24
                                 months.
                                Greater than 24 months              4.00
------------------------------------------------------------------------
Non-investment Grade..................................             12.00
------------------------------------------------------------------------

    (2) A [BANK] must assign an 8.0 percent specific risk-weighting 
factor for corporate debt positions that are exposures to entities that 
do not have publicly traded instruments outstanding.
    (B) Limitations. (1) A [BANK] must assign a specific risk-weighting 
factor of at least 8.0 percent to an interest-only mortgage-backed 
security that is not a securitization position.
    (2) A [BANK] shall not assign a corporate debt position a specific 
risk-weighting factor that is lower than the specific risk-weighting 
factor that corresponds to the CRC of the issuer's home country, if 
applicable, in table 1 of this section.
    (vii) Securitization positions. (A) General requirements. (1) A 
[BANK] that is not an advanced approaches [BANK] must assign a specific 
risk-weighting factor to a securitization position using either the 
simplified supervisory formula approach (SSFA) in paragraph 
(b)(2)(vii)(C) of this section (and Sec.  --.211) or assign a specific 
risk-weighting factor of 100 percent to the position.
    (2) A [BANK] that is an advanced approaches [BANK] must calculate a 
specific risk add-on for a securitization position in accordance with 
paragraph (b)(2)(vii)(B) of this section if the [BANK] and the 
securitization position each qualifies to use the SFA in Sec.  --.143. 
A [BANK] that is an advanced approaches [BANK] with a securitization 
position that does not qualify for the SFA under paragraph 
(b)(2)(vii)(B) of this section may assign a specific risk-weighting 
factor to the securitization position using the SSFA in accordance with 
paragraph (b)(2)(vii)(C) of this section or assign a specific risk-
weighting factor of 100 percent to the position.
    (3) A [BANK] must treat a short securitization position as if it is 
a long securitization position solely for calculation purposes when 
using the SFA in paragraph (b)(2)(vii)(B) of this section or the SSFA 
in paragraph (b)(2)(vii)(C) of this section.
    (B) SFA. To calculate the specific risk add-on for a securitization 
position using the SFA, a [BANK] that is an advanced approaches [BANK] 
must set the specific risk add-on for the position equal to the risk-
based capital requirement as calculated under Sec.  --.143.
    (C) SSFA. To use the SSFA to determine the specific risk-weighting 
factor for a securitization position, a [BANK] must calculate the 
specific risk-weighting factor in accordance with Sec.  --.211.
    (D) Nth-to-default credit derivatives. A [BANK] must determine a 
specific risk add-on using the SFA in paragraph (b)(2)(vii)(B) of this 
section, or assign a specific risk-weighting factor using the SSFA in 
paragraph (b)(2)(vii)(C) of this section to an n^th-to-
default credit derivative in accordance with this paragraph 
(b)(2)(vii)(D), regardless of whether the [BANK] is a net protection 
buyer or net protection seller. A [BANK] must determine its position in 
the n^th-to-default credit derivative as the largest notional 
amount of all the underlying exposures.
    (1) For purposes of determining the specific risk add-on using the 
SFA in paragraph (b)(2)(vii)(B) of this section or the specific risk-
weighting factor for an

[[Page 62261]]

n^th-to-default credit derivative using the SSFA in paragraph 
(b)(2)(vii)(C) of this section the [BANK] must calculate the attachment 
point and detachment point of its position as follows:
    (i) The attachment point (parameter A) is the ratio of the sum of 
the notional amounts of all underlying exposures that are subordinated 
to the [BANK]'s position to the total notional amount of all underlying 
exposures. For purposes of the SSFA, parameter A is expressed as a 
decimal value between zero and one. For purposes of using the SFA in 
paragraph (b)(2)(vii)(B) of this section to calculate the specific add-
on for its position in an n^th-to-default credit derivative, 
parameter A must be set equal to the credit enhancement level (L) input 
to the SFA formula in section 143 of this subpart. In the case of a 
first-to-default credit derivative, there are no underlying exposures 
that are subordinated to the [BANK]'s position. In the case of a 
second-or-subsequent-to-default credit derivative, the smallest (n-1) 
notional amounts of the underlying exposure(s) are subordinated to the 
[BANK]'s position.
    (ii) The detachment point (parameter D) equals the sum of parameter 
A plus the ratio of the notional amount of the [BANK]'s position in the 
n^th-to-default credit derivative to the total notional 
amount of all underlying exposures. For purposes of the SSFA, parameter 
A is expressed as a decimal value between zero and one. For purposes of 
using the SFA in paragraph (b)(2)(vii)(B) of this section to calculate 
the specific risk add-on for its position in an n^th-to-
default credit derivative, parameter D must be set to equal the L input 
plus the thickness of tranche T input to the SFA formula in Sec.  
--.143 of this subpart.
    (2) A [BANK] that does not use the SFA in paragraph (b)(2)(vii)(B) 
of this section to determine a specific risk-add on, or the SSFA in 
paragraph (b)(2)(vii)(C) of this section to determine a specific risk-
weighting factor for its position in an n^th-to-default 
credit derivative must assign a specific risk-weighting factor of 100 
percent to the position.
    (c) Modeled correlation trading positions. For purposes of 
calculating the comprehensive risk measure for modeled correlation 
trading positions under either paragraph (a)(2)(i) or (a)(2)(ii) of 
Sec.  --.209, the total specific risk add-on is the greater of:
    (1) The sum of the [BANK]'s specific risk add-ons for each net long 
correlation trading position calculated under this section; or
    (2) The sum of the [BANK]'s specific risk add-ons for each net 
short correlation trading position calculated under this section.
    (d) Non-modeled securitization positions. For securitization 
positions that are not correlation trading positions and for 
securitizations that are correlation trading positions not modeled 
under Sec.  --.209, the total specific risk add-on is the greater of:
    (1) The sum of the [BANK]'s specific risk add-ons for each net long 
securitization position calculated under this section; or
    (2) The sum of the [BANK]'s specific risk add-ons for each net 
short securitization position calculated under this section.
    (e) Equity positions. The total specific risk add-on for a 
portfolio of equity positions is the sum of the specific risk add-ons 
of the individual equity positions, as computed under this section. To 
determine the specific risk add-on of individual equity positions, a 
[BANK] must multiply the absolute value of the current fair value of 
each net long or net short equity position by the appropriate specific 
risk-weighting factor as determined under this paragraph (e):
    (1) The [BANK] must multiply the absolute value of the current fair 
value of each net long or net short equity position by a specific risk-
weighting factor of 8.0 percent. For equity positions that are index 
contracts comprising a well-diversified portfolio of equity 
instruments, the absolute value of the current fair value of each net 
long or net short position is multiplied by a specific risk-weighting 
factor of 2.0 percent.\29\
---------------------------------------------------------------------------

    \29\ A portfolio is well-diversified if it contains a large 
number of individual equity positions, with no single position 
representing a substantial portion of the portfolio's total fair 
value.
---------------------------------------------------------------------------

    (2) For equity positions arising from the following futures-related 
arbitrage strategies, a [BANK] may apply a 2.0 percent specific risk-
weighting factor to one side (long or short) of each position with the 
opposite side exempt from an additional capital requirement:
    (i) Long and short positions in exactly the same index at different 
dates or in different market centers; or
    (ii) Long and short positions in index contracts at the same date 
in different, but similar indices.
    (3) For futures contracts on main indices that are matched by 
offsetting positions in a basket of stocks comprising the index, a 
[BANK] may apply a 2.0 percent specific risk-weighting factor to the 
futures and stock basket positions (long and short), provided that such 
trades are deliberately entered into and separately controlled, and 
that the basket of stocks is comprised of stocks representing at least 
90.0 percent of the capitalization of the index. A main index refers to 
the Standard & Poor's 500 Index, the FTSE All-World Index, and any 
other index for which the [BANK] can demonstrate to the satisfaction of 
the [AGENCY] that the equities represented in the index have liquidity, 
depth of market, and size of bid-ask spreads comparable to equities in 
the Standard & Poor's 500 Index and FTSE All-World Index.
    (f) Due diligence requirements for securitization positions. (1) A 
[BANK] must demonstrate to the satisfaction of the [AGENCY] a 
comprehensive understanding of the features of a securitization 
position that would materially affect the performance of the position 
by conducting and documenting the analysis set forth in paragraph 
(f)(2) of this section. The [BANK]'s analysis must be commensurate with 
the complexity of the securitization position and the materiality of 
the position in relation to capital.
    (2) A [BANK] must demonstrate its comprehensive understanding for 
each securitization position by:
    (i) Conducting an analysis of the risk characteristics of a 
securitization position prior to acquiring the position and document 
such analysis within three business days after acquiring position, 
considering:
    (A) Structural features of the securitization that would materially 
impact the performance of the position, for example, the contractual 
cash flow waterfall, waterfall-related triggers, credit enhancements, 
liquidity enhancements, fair value triggers, the performance of 
organizations that service the position, and deal-specific definitions 
of default;
    (B) Relevant information regarding the performance of the 
underlying credit exposure(s), for example, the percentage of loans 30, 
60, and 90 days past due; default rates; prepayment rates; loans in 
foreclosure; property types; occupancy; average credit score or other 
measures of creditworthiness; average loan-to-value ratio; and industry 
and geographic diversification data on the underlying exposure(s);
    (C) Relevant market data of the securitization, for example, bid-
ask spreads, most recent sales price and historical price volatility, 
trading volume, implied market rating, and size, depth and 
concentration level of the market for the securitization; and
    (D) For resecuritization positions, performance information on the 
underlying securitization exposures, for example, the issuer name and 
credit

[[Page 62262]]

quality, and the characteristics and performance of the exposures 
underlying the securitization exposures.
    (ii) On an on-going basis (no less frequently than quarterly), 
evaluating, reviewing, and updating as appropriate the analysis 
required under paragraph (f)(1) of this section for each securitization 
position.


Sec.  --.211  Simplified supervisory formula approach (SSFA).

    (a) General requirements. To use the SSFA to determine the specific 
risk-weighting factor for a securitization position, a [BANK] must have 
data that enables it to assign accurately the parameters described in 
paragraph (b) of this section. Data used to assign the parameters 
described in paragraph (b) of this section must be the most currently 
available data; if the contracts governing the underlying exposures of 
the securitization require payments on a monthly or quarterly basis, 
the data used to assign the parameters described in paragraph (b) of 
this section must be no more than 91 calendar days old. A [BANK] that 
does not have the appropriate data to assign the parameters described 
in paragraph (b) of this section must assign a specific risk-weighting 
factor of 100 percent to the position.
    (b) SSFA parameters. To calculate the specific risk-weighting 
factor for a securitization position using the SSFA, a [BANK] must have 
accurate information on the five inputs to the SSFA calculation 
described in paragraphs (b)(1) through (b)(5) of this section.
    (1) KG is the weighted-average (with unpaid principal 
used as the weight for each exposure) total capital requirement of the 
underlying exposures calculated using subpart D. KG is 
expressed as a decimal value between zero and one (that is, an average 
risk weight of 100 percent represents a value of KG equal to 
0.08).
    (2) Parameter W is expressed as a decimal value between zero and 
one. Parameter W is the ratio of the sum of the dollar amounts of any 
underlying exposures of the securitization that meet any of the 
criteria as set forth in paragraphs (b)(2)(i) through (vi) of this 
section to the balance, measured in dollars, of underlying exposures:
    (i) Ninety days or more past due;
    (ii) Subject to a bankruptcy or insolvency proceeding;
    (iii) In the process of foreclosure;
    (iv) Held as real estate owned;
    (v) Has contractually deferred payments for 90 days or more, other 
than principal or interest payments deferred on:
    (A) Federally-guaranteed student loans, in accordance with the 
terms of those guarantee programs; or
    (B) Consumer loans, including non-federally-guaranteed student 
loans, provided that such payments are deferred pursuant to provisions 
included in the contract at the time funds are disbursed that provide 
for period(s) of deferral that are not initiated based on changes in 
the creditworthiness of the borrower; or
    (vi) Is in default.
    (3) Parameter A is the attachment point for the position, which 
represents the threshold at which credit losses will first be allocated 
to the position. Except as provided in Sec.  --.210(b)(2)(vii)(D) for 
n^th-to-default credit derivatives, parameter A equals the 
ratio of the current dollar amount of underlying exposures that are 
subordinated to the position of the [BANK] to the current dollar amount 
of underlying exposures. Any reserve account funded by the accumulated 
cash flows from the underlying exposures that is subordinated to the 
position that contains the [BANK]'s securitization exposure may be 
included in the calculation of parameter A to the extent that cash is 
present in the account. Parameter A is expressed as a decimal value 
between zero and one.
    (4) Parameter D is the detachment point for the position, which 
represents the threshold at which credit losses of principal allocated 
to the position would result in a total loss of principal. Except as 
provided in Sec.  --.210(b)(2)(vii)(D) for n^th-to-default 
credit derivatives, parameter D equals parameter A plus the ratio of 
the current dollar amount of the securitization positions that are pari 
passu with the position (that is, have equal seniority with respect to 
credit risk) to the current dollar amount of the underlying exposures. 
Parameter D is expressed as a decimal value between zero and one.
    (5) A supervisory calibration parameter, p, is equal to 0.5 for 
securitization positions that are not resecuritization positions and 
equal to 1.5 for resecuritization positions.
    (c) Mechanics of the SSFA. KG and W are used to 
calculate KA, the augmented value of KG, which 
reflects the observed credit quality of the underlying exposures. 
KA is defined in paragraph (d) of this section. The values 
of parameters A and D, relative to KA determine the specific 
risk-weighting factor assigned to a position as described in this 
paragraph (c) and paragraph (d) of this section. The specific risk-
weighting factor assigned to a securitization position, or portion of a 
position, as appropriate, is the larger of the specific risk-weighting 
factor determined in accordance with this paragraph (c), paragraph (d) 
of this section, and a specific risk-weighting factor of 1.6 percent.
    (1) When the detachment point, parameter D, for a securitization 
position is less than or equal to KA, the position must be 
assigned a specific risk-weighting factor of 100 percent.
    (2) When the attachment point, parameter A, for a securitization 
position is greater than or equal to KA, the [BANK] must 
calculate the specific risk-weighting factor in accordance with 
paragraph (d) of this section.
    (3) When A is less than KA and D is greater than 
KA, the specific risk-weighting factor is a weighted-average 
of 1.00 and KSSFA calculated under paragraphs (c)(3)(i) and 
(c)(3)(ii) of this section. For the purpose of this calculation:
    (i) The weight assigned to 1.00 equals

[[Page 62263]]

[GRAPHIC] [TIFF OMITTED] TR11OC13.057

Sec.  --.212  Market risk disclosures.

    (a) Scope. A [BANK] must comply with this section unless it is a 
consolidated subsidiary of a bank holding company or a depository 
institution that is subject to these requirements or of a non-U.S. 
banking organization that is subject to comparable public disclosure 
requirements in its home jurisdiction. A [BANK] must make timely public 
disclosures each calendar quarter. If a significant change occurs, such 
that the most recent reporting amounts are no longer reflective of the 
[BANK]'s capital adequacy and risk profile, then a brief discussion of 
this change and its likely impact must be provided as soon as 
practicable thereafter. Qualitative disclosures that typically do not 
change each quarter may be disclosed annually, provided any significant 
changes are disclosed in the interim. If a [BANK] believes that 
disclosure of specific commercial or financial information would 
prejudice seriously its position by making public certain information 
that is either proprietary or confidential in nature, the [BANK] is not 
required to disclose these specific items, but must disclose more 
general information about the subject matter of the requirement, 
together with the fact that, and the reason why, the specific items of 
information have not been disclosed. The [BANK]'s management may 
provide all of the disclosures required by this section in one place on 
the [BANK]'s public Web site or may provide the disclosures in more 
than one public financial report or other regulatory reports, provided 
that the [BANK] publicly provides a summary table specifically 
indicating the location(s) of all such disclosures.
    (b) Disclosure policy. The [BANK] must have a formal disclosure 
policy approved by the board of directors that addresses the [BANK]'s 
approach for determining its market risk disclosures. The policy must 
address the associated internal controls and disclosure controls and 
procedures. The board of directors and senior management must ensure 
that appropriate verification of the disclosures takes place and that 
effective internal controls and disclosure controls and procedures are 
maintained. One or more senior officers of the [BANK] must attest that 
the disclosures meet the requirements of this subpart, and the board of 
directors and senior management are responsible for establishing and 
maintaining an effective internal control structure over financial 
reporting, including the disclosures required by this section.

[[Page 62264]]

    (c) Quantitative disclosures. (1) For each material portfolio of 
covered positions, the [BANK] must provide timely public disclosures of 
the following information at least quarterly:
    (i) The high, low, and mean VaR-based measures over the reporting 
period and the VaR-based measure at period-end;
    (ii) The high, low, and mean stressed VaR-based measures over the 
reporting period and the stressed VaR-based measure at period-end;
    (iii) The high, low, and mean incremental risk capital requirements 
over the reporting period and the incremental risk capital requirement 
at period-end;
    (iv) The high, low, and mean comprehensive risk capital 
requirements over the reporting period and the comprehensive risk 
capital requirement at period-end, with the period-end requirement 
broken down into appropriate risk classifications (for example, default 
risk, migration risk, correlation risk);
    (v) Separate measures for interest rate risk, credit spread risk, 
equity price risk, foreign exchange risk, and commodity price risk used 
to calculate the VaR-based measure; and
    (vi) A comparison of VaR-based estimates with actual gains or 
losses experienced by the [BANK], with an analysis of important 
outliers.
    (2) In addition, the [BANK] must disclose publicly the following 
information at least quarterly:
    (i) The aggregate amount of on-balance sheet and off-balance sheet 
securitization positions by exposure type; and
    (ii) The aggregate amount of correlation trading positions.
    (d) Qualitative disclosures. For each material portfolio of covered 
positions, the [BANK] must provide timely public disclosures of the 
following information at least annually after the end of the fourth 
calendar quarter, or more frequently in the event of material changes 
for each portfolio:
    (1) The composition of material portfolios of covered positions;
    (2) The [BANK]'s valuation policies, procedures, and methodologies 
for covered positions including, for securitization positions, the 
methods and key assumptions used for valuing such positions, any 
significant changes since the last reporting period, and the impact of 
such change;
    (3) The characteristics of the internal models used for purposes of 
this subpart. For the incremental risk capital requirement and the 
comprehensive risk capital requirement, this must include:
    (i) The approach used by the [BANK] to determine liquidity 
horizons;
    (ii) The methodologies used to achieve a capital assessment that is 
consistent with the required soundness standard; and
    (iii) The specific approaches used in the validation of these 
models;
    (4) A description of the approaches used for validating and 
evaluating the accuracy of internal models and modeling processes for 
purposes of this subpart;
    (5) For each market risk category (that is, interest rate risk, 
credit spread risk, equity price risk, foreign exchange risk, and 
commodity price risk), a description of the stress tests applied to the 
positions subject to the factor;
    (6) The results of the comparison of the [BANK]'s internal 
estimates for purposes of this subpart with actual outcomes during a 
sample period not used in model development;
    (7) The soundness standard on which the [BANK]'s internal capital 
adequacy assessment under this subpart is based, including a 
description of the methodologies used to achieve a capital adequacy 
assessment that is consistent with the soundness standard;
    (8) A description of the [BANK]'s processes for monitoring changes 
in the credit and market risk of securitization positions, including 
how those processes differ for resecuritization positions; and
    (9) A description of the [BANK]'s policy governing the use of 
credit risk mitigation to mitigate the risks of securitization and 
resecuritization positions.


Sec. Sec.  --.213   through --.299 [Reserved]

Subpart G--Transition Provisions


Sec.  --.300  Transitions.

    (a) Capital conservation and countercyclical capital buffer. (1) 
From January 1, 2014 through December 31, 2015, a [BANK] is not subject 
to limits on distributions and discretionary bonus payments under Sec.  
--.11 of subpart B of this part notwithstanding the amount of its 
capital conservation buffer or any applicable countercyclical capital 
buffer amount.
    (2) Beginning January 1, 2016 through December 31, 2018 a [BANK]'s 
maximum payout ratio shall be determined as set forth in Table 1 to 
Sec.  --.300.

                                            Table 1 to Sec.   --.300
----------------------------------------------------------------------------------------------------------------
                                                                                        Maximum payout ratio (as
           Transition period                      Capital conservation buffer           a percentage of eligible
                                                                                            retained income)
----------------------------------------------------------------------------------------------------------------
Calendar year 2016....................  Greater than 0.625 percent (plus 25 percent of  No payout ratio
                                         any applicable countercyclical capital buffer   limitation applies
                                         amount).                                        under this section.
                                        Less than or equal to 0.625 percent (plus 25    60 percent.
                                         percent of any applicable countercyclical
                                         capital buffer amount), and greater than
                                         0.469 percent (plus 17.25 percent of any
                                         applicable countercyclical capital buffer
                                         amount).
                                        Less than or equal to 0.469 percent (plus       40 percent.
                                         17.25 percent of any applicable
                                         countercyclical capital buffer amount), and
                                         greater than 0.313 percent (plus 12.5 percent
                                         of any applicable countercyclical capital
                                         buffer amount).
                                        Less than or equal to 0.313 percent (plus 12.5  20 percent.
                                         percent of any applicable countercyclical
                                         capital buffer amount), and greater than
                                         0.156 percent (plus 6.25 percent of any
                                         applicable countercyclical capital buffer
                                         amount).
                                        Less than or equal to 0.156 percent (plus 6.25  0 percent.
                                         percent of any applicable countercyclical
                                         capital buffer amount).
Calendar year 2017....................  Greater than 1.25 percent (plus 50 percent of   No payout ratio
                                         any applicable countercyclical capital buffer   limitation applies
                                         amount).                                        under this section.
                                        Less than or equal to 1.25 percent (plus 50     60 percent.
                                         percent of any applicable countercyclical
                                         capital buffer amount), and greater than
                                         0.938 percent (plus 37.5 percent of any
                                         applicable countercyclical capital buffer
                                         amount).

[[Page 62265]]

 
                                        Less than or equal to 0.938 percent (plus 37.5  40 percent.
                                         percent of any applicable countercyclical
                                         capital buffer amount), and greater than
                                         0.625 percent (plus 25 percent of any
                                         applicable countercyclical capital buffer
                                         amount).
                                        Less than or equal to 0.625 percent (plus 25    20 percent.
                                         percent of any applicable countercyclical
                                         capital buffer amount), and greater than
                                         0.313 percent (plus 12.5 percent of any
                                         applicable countercyclical capital buffer
                                         amount).
                                        Less than or equal to 0.313 percent (plus 12.5  0 percent.
                                         percent of any applicable countercyclical
                                         capital buffer amount).
Calendar year 2018....................  Greater than 1.875 percent (plus 75 percent of  No payout ratio
                                         any applicable countercyclical capital buffer   limitation applies
                                         amount).                                        under this section.
                                        Less than or equal to 1.875 percent (plus 75    60 percent.
                                         percent of any applicable countercyclical
                                         capital buffer amount), and greater than
                                         1.406 percent (plus 56.25 percent of any
                                         applicable countercyclical capital buffer
                                         amount).
                                        Less than or equal to 1.406 percent (plus       40 percent.
                                         56.25 percent of any applicable
                                         countercyclical capital buffer amount), and
                                         greater than 0.938 percent (plus 37.5 percent
                                         of any applicable countercyclical capital
                                         buffer amount).
                                        Less than or equal to 0.938 percent (plus 37.5  20 percent.
                                         percent of any applicable countercyclical
                                         capital buffer amount), and greater than
                                         0.469 percent (plus 18.75 percent of any
                                         applicable countercyclical capital buffer
                                         amount).
                                        Less than or equal to 0.469 percent (plus       0 percent.
                                         18.75 percent of any applicable
                                         countercyclical capital buffer amount).
----------------------------------------------------------------------------------------------------------------

    (b) Regulatory capital adjustments and deductions. Beginning 
January 1, 2014 for an advanced approaches [BANK], and beginning 
January 1, 2015 for a [BANK] that is not an advanced approaches [BANK], 
and in each case through December 31, 2017, a [BANK] must make the 
capital adjustments and deductions in Sec.  --.22 in accordance with 
the transition requirements in this paragraph (b). Beginning January 1, 
2018, a [BANK] must make all regulatory capital adjustments and 
deductions in accordance with Sec.  --.22.
    (1) Transition deductions from common equity tier 1 capital. 
Beginning January 1, 2014 for an advanced approaches [BANK], and 
beginning January 1, 2015 for a [BANK] that is not an advanced 
approaches [BANK], and in each case through December 31, 2017, a 
[BANK], must make the deductions required under Sec.  --.22(a)(1)-(7) 
from common equity tier 1 or tier 1 capital elements in accordance with 
the percentages set forth in Table 2 and Table 3 to Sec.  --.300.
    (i) A [BANK] must deduct the following items from common equity 
tier 1 and additional tier 1 capital in accordance with the percentages 
set forth in Table 2 to Sec.  --.300: goodwill (Sec.  --.22(a)(1)), 
DTAs that arise from net operating loss and tax credit carryforwards 
(Sec.  --.22(a)(3)), a gain-on-sale in connection with a securitization 
exposure (Sec.  --.22(a)(4)), defined benefit pension fund assets 
(Sec.  --.22(a)(5)), expected credit loss that exceeds eligible credit 
reserves (for advanced approaches [BANK]s that have completed the 
parallel run process and that have received notifications from the 
[AGENCY] pursuant to Sec.  --.121(d) of subpart E) (Sec.  --.22(a)(6)), 
and financial subsidiaries (Sec.  --.22(a)(7)).

                                            Table 2 to Sec.   --.300
----------------------------------------------------------------------------------------------------------------
                                      Transition deductions   Transition deductions under Sec.   --.22(a)(3)-(6)
                                    under Sec.   --.22(a)(1) ---------------------------------------------------
                                             and (7)
         Transition period         --------------------------     Percentage of the         Percentage of the
                                        Percentage of the      deductions from common    deductions from tier 1
                                     deductions from common     equity tier 1 capital            capital
                                      equity tier 1 capital
----------------------------------------------------------------------------------------------------------------
Calendar year 2014................                      100                        20                        80
Calendar year 2015................                      100                        40                        60
Calendar year 2016................                      100                        60                        40
Calendar year 2017................                      100                        80                        20
Calendar year 2018, and thereafter                      100                       100                         0
----------------------------------------------------------------------------------------------------------------

    (ii) A [BANK] must deduct from common equity tier 1 capital any 
intangible assets other than goodwill and MSAs in accordance with the 
percentages set forth in Table 3 to Sec.  --.300.
    (iii) A [BANK] must apply a 100 percent risk-weight to the 
aggregate amount of intangible assets other than goodwill and MSAs that 
are not required to be deducted from common equity tier 1 capital under 
this section.

[[Page 62266]]



                        Table 3 to Sec.   --.300
------------------------------------------------------------------------
                                 Transition deductions under Sec.   --
      Transition period         .22(a)(2)--percentage of the deductions
                                   from common equity tier 1 capital
------------------------------------------------------------------------
Calendar year 2014..........                                         20
Calendar year 2015..........                                         40
Calendar year 2016..........                                         60
Calendar year 2017..........                                         80
Calendar year 2018, and                                             100
 thereafter.................
------------------------------------------------------------------------

    (2) Transition adjustments to common equity tier 1 capital. 
Beginning January 1, 2014 for an advanced approaches [BANK], and 
beginning January 1, 2015 for a [BANK] that is not an advanced 
approaches [BANK], and in each case through December 31, 2017, a 
[BANK], must allocate the regulatory adjustments related to changes in 
the fair value of liabilities due to changes in the [BANK]'s own credit 
risk (Sec.  --.22(b)(1)(iii)) between common equity tier 1 capital and 
tier 1 capital in accordance with the percentages set forth in Table 4 
to Sec.  --.300.
    (i) If the aggregate amount of the adjustment is positive, the 
[BANK] must allocate the deduction between common equity tier 1 and 
tier 1 capital in accordance with Table 4 to Sec.  --.300.
    (ii) If the aggregate amount of the adjustment is negative, the 
[BANK] must add back the adjustment to common equity tier 1 capital or 
to tier 1 capital, in accordance with Table 4 to Sec.  --.300.

                                            Table 4 to Sec.   --.300
----------------------------------------------------------------------------------------------------------------
                                                     Transition adjustments under Sec.   --.22(b)(2)
                                       -------------------------------------------------------------------------
           Transition period                Percentage of the adjustment
                                          applied to common equity tier 1        Percentage of the adjustment
                                                      capital                     applied to tier 1 capital
----------------------------------------------------------------------------------------------------------------
Calendar year 2014....................                                  20                                   80
Calendar year 2015....................                                  40                                   60
Calendar year 2016....................                                  60                                   40
Calendar year 2017....................                                  80                                   20
Calendar year 2018, and thereafter....                                 100                                    0
----------------------------------------------------------------------------------------------------------------

    (3) Transition adjustments to AOCI for an advanced approaches 
[BANK] and a [BANK] that has not made an AOCI opt-out election under 
Sec.  --.22(b)(2). Beginning January 1, 2014 for an advanced approaches 
[BANK], and beginning January 1, 2015 for a [BANK] that is not an 
advanced approaches [BANK] that has not made an AOCI opt-out election 
under Sec.  --.22(b)(2), and in each case through December 31, 2017, a 
[BANK] must adjust common equity tier 1 capital with respect to the 
transition AOCI adjustment amount (transition AOCI adjustment amount):
    (i) The transition AOCI adjustment amount is the aggregate amount 
of a [BANK]'s:
    (A) Unrealized gains on available-for-sale securities that are 
preferred stock classified as an equity security under GAAP or 
available-for-sale equity exposures, plus
    (B) Net unrealized gains or losses on available-for-sale securities 
that are not preferred stock classified as an equity security under 
GAAP or available-for-sale equity exposures, plus
    (C) Any amounts recorded in AOCI attributed to defined benefit 
postretirement plans resulting from the initial and subsequent 
application of the relevant GAAP standards that pertain to such plans 
(excluding, at the [BANK]'s option, the portion relating to pension 
assets deducted under section 22(a)(5)), plus
    (D) Accumulated net gains or losses on cash flow hedges related to 
items that are reported on the balance sheet at fair value included in 
AOCI, plus
    (E) Net unrealized gains or losses on held-to-maturity securities 
that are included in AOCI.
    (ii) A [BANK] must make the following adjustment to its common 
equity tier 1 capital:
    (A) If the transition AOCI adjustment amount is positive, the 
appropriate amount must be deducted from common equity tier 1 capital 
in accordance with Table 5 to Sec.  --.300.
    (B) If the transition AOCI adjustment amount is negative, the 
appropriate amount must be added back to common equity tier 1 capital 
in accordance with Table 5 to Sec.  --.300.

                        Table 5 to Sec.   --.300
------------------------------------------------------------------------
                                   Percentage of the transition AOCI
      Transition period        adjustment amount to be applied to common
                                         equity tier 1 capital
------------------------------------------------------------------------
Calendar year 2014..........                                         80
Calendar year 2015..........                                         60
Calendar year 2016..........                                         40
Calendar year 2017..........                                         20
Calendar year 2018 and                                                0
 thereafter.................
------------------------------------------------------------------------


[[Page 62267]]

    (iii) A [BANK] may include in tier 2 capital the percentage of 
unrealized gains on available-for-sale preferred stock classified as an 
equity security under GAAP and available-for-sale equity exposures as 
set forth in Table 6 to Sec.  --.300.

                        Table 6 to Sec.   --.300
------------------------------------------------------------------------
                                   Percentage of unrealized gains on
                                  available-for-sale preferred stock
                                classified as an  equity security under
      Transition period           GAAP and available-for-sale equity
                               exposures that may be included in tier 2
                                                capital
------------------------------------------------------------------------
Calendar year 2014..........                                         36
Calendar year 2015..........                                         27
Calendar year 2016..........                                         18
Calendar year 2017..........                                          9
Calendar year 2018 and                                                0
 thereafter.................
------------------------------------------------------------------------

    (4) Additional transition deductions from regulatory capital. (i) 
Beginning January 1, 2014 for an advanced approaches [BANK], and 
beginning January 1, 2015 for a [BANK] that is not an advanced 
approaches [BANK], and in each case through December 31, 2017, a 
[BANK], must use Table 7 to Sec.  --.300 to determine the amount of 
investments in capital instruments and the items subject to the 10 and 
15 percent common equity tier 1 capital deduction thresholds (Sec.  
--.22(d)) (that is, MSAs, DTAs arising from temporary differences that 
the [BANK] could not realize through net operating loss carrybacks, and 
significant investments in the capital of unconsolidated financial 
institutions in the form of common stock) that must be deducted from 
common equity tier 1 capital.
    (ii) Beginning January 1, 2014 for an advanced approaches [BANK], 
and beginning January 1, 2015 for a [BANK] that is not an advanced 
approaches [BANK], and in each case through December 31, 2017, a [BANK] 
must apply a 100 percent risk-weight to the aggregate amount of the 
items subject to the 10 and 15 percent common equity tier 1 capital 
deduction thresholds that are not deducted under this section. As set 
forth in Sec.  --.22(d)(2), beginning January 1, 2018, a [BANK] must 
apply a 250 percent risk-weight to the aggregate amount of the items 
subject to the 10 and 15 percent common equity tier 1 capital deduction 
thresholds that are not deducted from common equity tier 1 capital.

                        Table 7 to Sec.   --.300
------------------------------------------------------------------------
                              Transitions for deductions under Sec.   --
      Transition period        .22(c) and (d)--Percentage of additional
                                  deductions from regulatory capital
------------------------------------------------------------------------
Calendar year 2014..........                                         20
Calendar year 2015..........                                         40
Calendar year 2016..........                                         60
Calendar year 2017..........                                         80
Calendar year 2018 and                                              100
 thereafter.................
------------------------------------------------------------------------

    (iii) For purposes of calculating the transition deductions in this 
paragraph (b)(4) beginning January 1, 2014 for an advanced approaches 
[BANK], and beginning January 1, 2015 for a [BANK] that is not an 
advanced approaches [BANK], and in each case through December 31, 2017, 
a [BANK]'s 15 percent common equity tier 1 capital deduction threshold 
for MSAs, DTAs arising from temporary differences that the [BANK] could 
not realize through net operating loss carrybacks, and significant 
investments in the capital of unconsolidated financial institutions in 
the form of common stock is equal to 15 percent of the sum of the 
[BANK]'s common equity tier 1 elements, after regulatory adjustments 
and deductions required under Sec.  --.22(a) through (c) (transition 15 
percent common equity tier 1 capital deduction threshold).
    (iv) Beginning January 1, 2018, a [BANK] must calculate the 15 
percent common equity tier 1 capital deduction threshold in accordance 
with Sec.  --.22(d).
    (c) Non-qualifying capital instruments--(1) Depository institution 
holding companies with total consolidated assets of more than $15 
billion as of December 31, 2009 that were not mutual holding companies 
prior to May 19, 2010. The transition provisions in this paragraph 
(c)(1) apply to debt or equity instruments that do not meet the 
criteria for additional tier 1 or tier 2 capital instruments in Sec.  
--.20, but that were issued and included in tier 1 or tier 2 capital, 
respectively prior to May 19, 2010 (non-qualifying capital 
instruments), and that were issued by a depository institution holding 
company with total consolidated assets greater than or equal to $15 
billion as of December 31, 2009 that was not a mutual holding company 
prior to May 19, 2010 (2010 MHC) (depository institution holding 
company of $15 billion or more).
    (i) A depository institution holding company of $15 billion or more 
may include in tier 1 and tier 2 capital non-qualifying capital 
instruments up to the applicable percentage set forth in Table 8 to 
Sec.  --.300 of the aggregate outstanding principal amounts of non-
qualifying tier 1 and tier 2 capital instruments, respectively, that 
are outstanding as of January 1, 2014, beginning January 1, 2014, for a 
depository institution holding company of $15 billion or more that is 
an advanced approaches [BANK] that is not a savings and loan holding 
company, and beginning January 1, 2015, for all other depository 
institution holding companies of $15 billion or more.
    (ii) A depository institution holding company of $15 billion or 
more must apply the applicable percentages set forth in Table 8 to 
Sec.  --.300 separately to

[[Page 62268]]

the aggregate amounts of its tier 1 and tier 2 non-qualifying capital 
instruments.
    (iii) The amount of non-qualifying capital instruments that must be 
excluded from additional tier 1 capital in accordance with this section 
may be included in tier 2 capital without limitation, provided the 
instruments meet the criteria for tier 2 capital set forth in Sec.  
--.20(d).
    (iv) Non-qualifying capital instruments that do not meet the 
criteria for tier 2 capital set forth in Sec.  --.20(d) may be included 
in tier 2 capital as follows:
    (A) A depository institution holding company of $15 billion or more 
that is not an advanced approaches [BANK] may include non-qualifying 
capital instruments that have been phased-out of tier 1 capital in tier 
2 capital, and
    (B) During calendar years 2014 and 2015, a depository institution 
holding company of $15 billion or more that is an advanced approaches 
[BANK] may include non-qualifying capital instruments in tier 2 capital 
that have been phased out of tier 1 capital in accordance with Table 8 
to Sec.  --.300. Beginning January 1, 2016, a depository institution 
holding company of $15 billion or more that is an advanced approaches 
[BANK] may include non-qualifying capital instruments in tier 2 capital 
that have been phased out of tier 1 capital in accordance with Table 8, 
up to the applicable percentages set forth in Table 9 to Sec.  --.300.
    (2) Mergers and acquisitions. (i) A depository institution holding 
company of $15 billion or more that acquires either a depository 
institution holding company with total consolidated assets of less than 
$15 billion as of December 31, 2009 (depository institution holding 
company under $15 billion) or a depository institution holding company 
that is a 2010 MHC, may include in regulatory capital the non-
qualifying capital instruments issued by the acquired organization up 
to the applicable percentages set forth in Table 8 to Sec.  --.300.
    (ii) If a depository institution holding company under $15 billion 
acquires a depository institution holding company under $15 billion or 
a 2010 MHC, and the resulting organization has total consolidated 
assets of $15 billion or more as reported on the resulting 
organization's FR Y-9C for the period in which the transaction 
occurred, the resulting organization may include in regulatory capital 
non-qualifying instruments of the resulting organization up to the 
applicable percentages set forth in Table 8 to Sec.  --.300.

                        Table 8 to Sec.   --.300
------------------------------------------------------------------------
                                 Percentage of non-qualifying capital
                               instruments includable in additional tier
 Transition period (calendar     1 or tier 2 capital for a depository
            year)             institution holding company of $15 billion
                                                or more
------------------------------------------------------------------------
Calendar year 2014..........                                         50
Calendar year 2015..........                                         25
Calendar year 2016 and                                                0
 thereafter.................
------------------------------------------------------------------------

    (3) Depository institution holding companies under $15 billion and 
2010 MHCs. (i) Non-qualifying capital instruments issued by depository 
institution holding companies under $15 billion and 2010 MHCs prior to 
May 19, 2010 may be included in additional tier 1 or tier 2 capital if 
the instrument was included in tier 1 or tier 2 capital, respectively, 
as of January 1, 2014.
    (ii) Non-qualifying capital instruments includable in tier 1 
capital are subject to a limit of 25 percent of tier 1 capital 
elements, excluding any non-qualifying capital instruments and after 
applying all regulatory capital deductions and adjustments to tier 1 
capital.
    (iii) Non-qualifying capital instruments that are not included in 
tier 1 as a result of the limitation in paragraph (c)(3)(ii) of this 
section are includable in tier 2 capital.
    (4) Depository institutions. (i) Beginning on January 1, 2014, a 
depository institution that is an advanced approaches [BANK], and 
beginning on January 1, 2015, all other depository institutions, may 
include in regulatory capital debt or equity instruments issued prior 
to September 12, 2010 that do not meet the criteria for additional tier 
1 or tier 2 capital instruments in Sec.  --.20 but that were included 
in tier 1 or tier 2 capital respectively as of September 12, 2010 (non-
qualifying capital instruments issued prior to September 12, 2010) up 
to the percentage of the outstanding principal amount of such non-
qualifying capital instruments as of January 1, 2014 in accordance with 
Table 9 to Sec.  --.300.
    (ii) Table 9 to Sec.  --.300 applies separately to tier 1 and tier 
2 non-qualifying capital instruments.
    (iii) The amount of non-qualifying capital instruments that cannot 
be included in additional tier 1 capital under this section may be 
included in tier 2 capital without limitation, provided that the 
instruments meet the criteria for tier 2 capital instruments under 
Sec.  --.20(d).

                                            Table 9 to Sec.   --.300
----------------------------------------------------------------------------------------------------------------
                                                                       Percentage of non-qualifying capital
                 Transition period (calendar year)                   instruments includable in additional tier
                                                                                1 or tier 2 capital
---------------------------------------------------------------------------------------------------------------
Calendar year 2014................................................                                         80
Calendar year 2015................................................                                         70
Calendar year 2016................................................                                         60
Calendar year 2017................................................                                         50
Calendar year 2018................................................                                         40
Calendar year 2019................................................                                         30
Calendar year 2020................................................                                         20
Calendar year 2021................................................                                         10
Calendar year 2022 and thereafter.................................                                          0
----------------------------------------------------------------------------------------------------------------


[[Page 62269]]

    (d) Minority interest--(1) Surplus minority interest. Beginning 
January 1, 2014 for an advanced approaches [BANK], and beginning 
January 1, 2015 for a [BANK] that is not an advanced approaches [BANK], 
and in each case through December 31, 2017, a [BANK] may include in 
common equity tier 1 capital, tier 1 capital, or total capital the 
percentage of the common equity tier 1 minority interest, tier 1 
minority interest and total capital minority interest outstanding as of 
January 1, 2014 that exceeds any common equity tier 1 minority 
interest, tier 1 minority interest or total capital minority interest 
includable under Sec.  --.21 (surplus minority interest), respectively, 
as set forth in Table 10 to Sec.  --.300.
    (2) Non-qualifying minority interest. Beginning January 1, 2014 for 
an advanced approaches [BANK], and beginning January 1, 2015 for a 
[BANK] that is not an advanced approaches [BANK], and in each case 
through December 31, 2017, a [BANK] may include in tier 1 capital or 
total capital the percentage of the tier 1 minority interest and total 
capital minority interest outstanding as of January 1, 2014 that does 
not meet the criteria for additional tier 1 or tier 2 capital 
instruments in Sec.  --.20 (non-qualifying minority interest), as set 
forth in Table 10 to Sec.  --.300.

                        Table 10 to Sec.   --.300
------------------------------------------------------------------------
                              Percentage of the amount of surplus or non-
                               qualifying minority interest that can be
      Transition period        included in regulatory capital during the
                                           transition period
------------------------------------------------------------------------
Calendar year 2014..........                                         80
Calendar year 2015..........                                         60
Calendar year 2016..........                                         40
Calendar year 2017..........                                         20
Calendar year 2018 and                                                0
 thereafter.................
------------------------------------------------------------------------

    (e) Prompt corrective action. For purposes of [12 CFR Part 6 (OCC); 
12 CFR 208, subpart D (Board)], a [BANK] must calculate its capital 
measures and tangible equity ratio in accordance with the transition 
provisions in this section.
    End of Common Rule.

List of Subjects

12 CFR Part 3

    Administrative practice and procedure, Capital, National banks, 
Reporting and recordkeeping requirements, Risk.

12 CFR Part 5

    Administrative practice and procedure, National banks, Reporting 
and recordkeeping requirements, Securities.

12 CFR Part 6

    National banks.

12 CFR Part 165

    Administrative practice and procedure, Savings associations.

12 CFR Part 167

    Capital, Reporting and recordkeeping requirements, Risk, Savings 
associations.

12 CFR Part 208

    Confidential business information, Crime, Currency, Federal Reserve 
System, Mortgages, reporting and recordkeeping requirements, 
Securities.

12 CFR Part 217

    Administrative practice and procedure, Banks, Banking, Capital, 
Federal Reserve System, Holding companies, Reporting and recordkeeping 
requirements, Risk.

12 CFR Part 225

    Administrative practice and procedure, Banks, banking, Federal 
Reserve System, Holding companies, Reporting and recordkeeping 
requirements, Securities.

Adoption of Common Rule

    The adoption of the final common rules by the agencies, as modified 
by the agency-specific text, is set forth below:

DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Chapter I

Authority and Issuance

    For the reasons set forth in the common preamble and under the 
authority of 12 U.S.C. 93a and 5412(b)(2)(B), the Office of the 
Comptroller of the Currency amends part 3 of chapter I of title 12, 
Code of Federal Regulations as follows:

PART 3--CAPITAL ADEQUACY STANDARDS

0
1. The authority citation for part 3 is revised to read as follows:

    Authority:  12 U.S.C. 93a, 161, 1462, 1462a, 1463, 1464, 1818, 
1828(n), 1828 note, 1831n note, 1835, 3907, 3909, and 5412(b)(2)(B).

0
2. Revise the heading of part 3 to read as set forth above.

Subpart A [Removed]

0
3. Remove subpart A, consisting of Sec. Sec.  3.1 through 3.4.

Subpart B [Removed]

0
4. Remove subpart B, consisting of Sec. Sec.  3.5 through 3.8.

Subparts C through E [Redesignated as Subparts H through J]

0
5a. Redesignate subparts C through E as subparts H through J.
0
5b. Revise newly redesignated subparts H through J to read as follows:
Subpart H--Establishment of Minimum Capital Ratios for an Individual 
Bank or Individual Federal Savings Association
Sec.
3.401 Purpose and scope.
3.402 Applicability.
3.403 Standards for determination of appropriate individual minimum 
capital ratios.
3.404 Procedures.
3.405 Relation to other actions.

Subpart H--Establishment of Minimum Capital Ratios for an 
Individual Bank or Individual Federal Savings Association


Sec.  3.401  Purpose and scope.

    The rules and procedures specified in this subpart are applicable 
to a proceeding to establish required minimum capital ratios that would 
otherwise be applicable to a national bank or Federal savings 
association under subpart B of this part. The OCC is authorized under 
12 U.S.C. 1464(s)(2) and 3907(a)(2) to establish such minimum capital 
requirements for a national bank or Federal savings

[[Page 62270]]

association as the OCC, in its discretion, deems appropriate in light 
of the particular circumstances at that national bank or Federal 
savings association. Proceedings under this subpart also may be 
initiated to require a national bank or Federal savings association 
having capital ratios above those set forth in subpart B of this part, 
or other legal authority to continue to maintain those higher ratios.


Sec.  3.402  Applicability.

    The OCC may require higher minimum capital ratios for an individual 
national bank or Federal savings association in view of its 
circumstances. For example, higher capital ratios may be appropriate 
for:
    (a) A newly chartered national bank or Federal savings association;
    (b) A national bank or Federal savings association receiving 
special supervisory attention;
    (c) A national bank or Federal savings association that has, or is 
expected to have, losses resulting in capital inadequacy;
    (d) A national bank or Federal savings association with significant 
exposure due to the risks from concentrations of credit, certain risks 
arising from nontraditional activities, or management's overall 
inability to monitor and control financial and operating risks 
presented by concentrations of credit and nontraditional activities;
    (e) A national bank or Federal savings association with significant 
exposure to declines in the economic value of its capital due to 
changes in interest rates;
    (f) A national bank or Federal savings association with significant 
exposure due to fiduciary or operational risk;
    (g) A national bank or Federal savings association exposed to a 
high degree of asset depreciation, or a low level of liquid assets in 
relation to short term liabilities;
    (h) A national bank or Federal savings association exposed to a 
high volume of, or particularly severe, problem loans;
    (i) A national bank or Federal savings association that is growing 
rapidly, either internally or through acquisitions; or
    (j) A national bank or Federal savings association that may be 
adversely affected by the activities or condition of its holding 
company, affiliate(s), or other persons or institutions, including 
chain banking organizations, with which it has significant business 
relationships.


Sec.  3.403  Standards for determination of appropriate individual 
minimum capital ratios.

    The appropriate minimum capital ratios for an individual national 
bank or Federal savings association cannot be determined solely through 
the application of a rigid mathematical formula or wholly objective 
criteria. The decision is necessarily based in part on subjective 
judgment grounded in agency expertise. The factors to be considered in 
the determination will vary in each case and may include, for example:
    (a) The conditions or circumstances leading to the OCC's 
determination that higher minimum capital ratios are appropriate or 
necessary for the national bank or Federal savings association;
    (b) The exigency of those circumstances or potential problems;
    (c) The overall condition, management strength, and future 
prospects of the national bank or Federal savings association and, if 
applicable, its holding company and/or affiliate(s);
    (d) The national bank's or Federal savings association's liquidity, 
capital, risk asset and other ratios compared to the ratios of its peer 
group; and
    (e) The views of the national bank's or Federal savings 
association's directors and senior management.


Sec.  3.404  Procedures.

    (a) Notice. When the OCC determines that minimum capital ratios 
above those set forth in subpart B of this part or other legal 
authority are necessary or appropriate for a particular national bank 
or Federal savings association, the OCC will notify the national bank 
or Federal savings association in writing of the proposed minimum 
capital ratios and the date by which they should be reached (if 
applicable) and will provide an explanation of why the ratios proposed 
are considered necessary or appropriate for the national bank or 
Federal savings association.
    (b) Response. (1) The national bank or Federal savings association 
may respond to any or all of the items in the notice. The response 
should include any matters which the national bank or Federal savings 
association would have the OCC consider in deciding whether individual 
minimum capital ratios should be established for the national bank or 
Federal savings association, what those capital ratios should be, and, 
if applicable, when they should be achieved. The response must be in 
writing and delivered to the designated OCC official within 30 days 
after the date on which the national bank or Federal savings 
association received the notice. The OCC may shorten the time period 
when, in the opinion of the OCC, the condition of the national bank or 
Federal savings association so requires, provided that the national 
bank or Federal savings association is informed promptly of the new 
time period, or with the consent of the national bank or Federal 
savings association. In its discretion, the OCC may extend the time 
period for good cause.
    (2) Failure to respond within 30 days or such other time period as 
may be specified by the OCC shall constitute a waiver of any objections 
to the proposed minimum capital ratios or the deadline for their 
achievement.
    (c) Decision. After the close of the national bank's or Federal 
savings association's response period, the OCC will decide, based on a 
review of the national bank's or Federal savings association's response 
and other information concerning the national bank or Federal savings 
association, whether individual minimum capital ratios should be 
established for the national bank or Federal savings association and, 
if so, the ratios and the date the requirements will become effective. 
The national bank or Federal savings association will be notified of 
the decision in writing. The notice will include an explanation of the 
decision, except for a decision not to establish individual minimum 
capital requirements for the national bank or Federal savings 
association.
    (d) Submission of plan. The decision may require the national bank 
or Federal savings association to develop and submit to the OCC, within 
a time period specified, an acceptable plan to reach the minimum 
capital ratios established for the national bank or Federal savings 
association by the date required.
    (e) Change in circumstances. If, after the OCC's decision in 
paragraph (c) of this section, there is a change in the circumstances 
affecting the national bank's or Federal savings association's capital 
adequacy or its ability to reach the required minimum capital ratios by 
the specified date, the national bank or Federal savings association 
may propose to the OCC, or the OCC may propose to the national bank or 
Federal savings association, a change in the minimum capital ratios for 
the national bank or Federal savings association, the date when the 
minimums must be achieved, or the national bank's or Federal savings 
association's plan (if applicable). The OCC may decline to consider 
proposals that are not based on a significant change in circumstances 
or are repetitive or frivolous. Pending a decision on reconsideration, 
the OCC's original decision and any plan required

[[Page 62271]]

under that decision shall continue in full force and effect.


Sec.  3.405  Relation to other actions.

    In lieu of, or in addition to, the procedures in this subpart, the 
required minimum capital ratios for a national bank or Federal savings 
association may be established or revised through a written agreement 
or cease and desist proceedings under 12 U.S.C. 1818 (b) or (c) (12 CFR 
19.0 through 19.21 for national banks and 12 CFR part 109 for Federal 
savings associations) or as a condition for approval of an application.

Subpart I--Enforcement


Sec.  3.501  Remedies.

    A national bank or Federal savings association that does not have 
or maintain the minimum capital ratios applicable to it, whether 
required in subpart B of this part, in a decision pursuant to subpart H 
of this part, in a written agreement or temporary or final order under 
12 U.S.C. 1818 (b) or (c), or in a condition for approval of an 
application, or a national bank or Federal savings association that has 
failed to submit or comply with an acceptable plan to attain those 
ratios, will be subject to such administrative action or sanctions as 
the OCC considers appropriate. These sanctions may include the issuance 
of a Directive pursuant to subpart J of this part or other enforcement 
action, assessment of civil money penalties, and/or the denial, 
conditioning, or revocation of applications. A national bank's or 
Federal savings association's failure to achieve or maintain minimum 
capital ratios in subpart B of this part may also be the basis for an 
action by the Federal Deposit Insurance Corporation to terminate 
Federal deposit insurance. See 12 CFR part 308, subpart F.
Subpart J--Issuance of a Directive
Sec.
3.601 Purpose and scope.
3.602 Notice of intent to issue a directive.
3.603 Response to notice.
3.604 Decision.
3.605 Issuance of a directive.
3.606 Change in circumstances.
3.607 Relation to other administrative actions.

Subpart J--Issuance of a Directive


Sec.  3.601  Purpose and scope.

    (a) This subpart is applicable to proceedings by the OCC to issue a 
directive under 12 U.S.C. 3907(b)(2) or 12 U.S.C. 1464(s), as 
appropriate. A directive is an order issued to a national bank or 
Federal savings association that does not have or maintain capital at 
or above the minimum ratios set forth in subpart B of this part, or 
established for the national bank or Federal savings association under 
subpart H of this part, by a written agreement under 12 U.S.C. 1818(b), 
or as a condition for approval of an application. A directive may order 
the national bank or Federal savings association to:
    (1) Achieve the minimum capital ratios applicable to it by a 
specified date;
    (2) Adhere to a previously submitted plan to achieve the applicable 
capital ratios;
    (3) Submit and adhere to a plan acceptable to the OCC describing 
the means and time schedule by which the national bank or Federal 
savings association shall achieve the applicable capital ratios;
    (4) Take other action, such as reduction of assets or the rate of 
growth of assets, or restrictions on the payment of dividends, to 
achieve the applicable capital ratios; or
    (5) A combination of any of these or similar actions.
    (b) A directive issued under this rule, including a plan submitted 
under a directive, is enforceable in the same manner and to the same 
extent as an effective and outstanding cease and desist order which has 
become final as defined in 12 U.S.C. 1818(k). Violation of a directive 
may result in assessment of civil money penalties in accordance with 12 
U.S.C. 3909(d).


Sec.  3.602  Notice of intent to issue a directive.

    The OCC will notify a national bank or Federal savings association 
in writing of its intention to issue a directive. The notice will 
state:
    (a) Reasons for issuance of the directive; and
    (b) The proposed contents of the directive.


Sec.  3.603  Response to notice.

    (a) A national bank or Federal savings association may respond to 
the notice by stating why a directive should not be issued and/or by 
proposing alternative contents for the directive. The response should 
include any matters which the national bank or Federal savings 
association would have the OCC consider in deciding whether to issue a 
directive and/or what the contents of the directive should be. The 
response may include a plan for achieving the minimum capital ratios 
applicable to the national bank or Federal savings association. The 
response must be in writing and delivered to the designated OCC 
official within 30 days after the date on which the national bank or 
Federal savings association received the notice. The OCC may shorten 
the 30-day time period:
    (1) When, in the opinion of the OCC, the condition of the national 
bank or Federal savings association so requires, provided that the 
national bank or Federal savings association shall be informed promptly 
of the new time period;
    (2) With the consent of the national bank or Federal savings 
association; or
    (3) When the national bank or Federal savings association already 
has advised the OCC that it cannot or will not achieve its applicable 
minimum capital ratios.
    (b) In its discretion, the OCC may extend the time period for good 
cause.
    (c) Failure to respond within 30 days or such other time period as 
may be specified by the OCC shall constitute a waiver of any objections 
to the proposed directive.


Sec.  3.604  Decision.

    After the closing date of the national bank's or Federal savings 
association's response period, or receipt of the national bank's or 
Federal savings association's response, if earlier, the OCC will 
consider the national bank's or Federal savings association's response, 
and may seek additional information or clarification of the response. 
Thereafter, the OCC will determine whether or not to issue a directive, 
and if one is to be issued, whether it should be as originally proposed 
or in modified form.


Sec.  3.605  Issuance of a directive.

    (a) A directive will be served by delivery to the national bank or 
Federal savings association. It will include or be accompanied by a 
statement of reasons for its issuance.
    (b) A directive is effective immediately upon its receipt by the 
national bank or Federal savings association, or upon such later date 
as may be specified therein, and shall remain effective and enforceable 
until it is stayed, modified, or terminated by the OCC.


Sec.  3.606  Change in circumstances.

    Upon a change in circumstances, a national bank or Federal savings 
association may request the OCC to reconsider the terms of its 
directive or may propose changes in the plan to achieve the national 
bank's or Federal savings association's applicable minimum capital 
ratios. The OCC also may take such action on its own motion. The OCC 
may decline to consider requests or proposals that are not based on a 
significant change in circumstances or are repetitive or frivolous. 
Pending a decision on reconsideration, the

[[Page 62272]]

directive and plan shall continue in full force and effect.


Sec.  3.607  Relation to other administrative actions.

    A directive may be issued in addition to, or in lieu of, any other 
action authorized by law, including cease and desist proceedings, civil 
money penalties, or the conditioning or denial of applications. The OCC 
also may, in its discretion, take any action authorized by law, in lieu 
of a directive, in response to a national bank's or Federal savings 
association's failure to achieve or maintain the applicable minimum 
capital ratios.

0
5c. Add a new Subpart K to read as follows:

Subpart K--Interpretations


Sec.  3.701  Capital and surplus.

    For purposes of determining statutory limits that are based on the 
amount of a national bank's capital and/or surplus, the provisions of 
this section are to be used, rather than the definitions of capital 
contained in subparts A through J of this part.
    (a) Capital. The term capital as used in provisions of law relating 
to the capital of national banks shall include the amount of common 
stock outstanding and unimpaired plus the amount of perpetual preferred 
stock outstanding and unimpaired.
    (b) Capital Stock. The term capital stock as used in provisions of 
law relating to the capital stock of national banks, other than 12 
U.S.C. 101, 177, and 178 shall have the same meaning as the term 
capital set forth in paragraph (a) of this section.
    (c) Surplus. The term surplus as used in provisions of law relating 
to the surplus of national banks means the sum of paragraphs (c)(1), 
(2), (3), and (4) of this section:
    (1) Capital surplus; undivided profits; reserves for contingencies 
and other capital reserves (excluding accrued dividends on perpetual 
and limited life preferred stock); net worth certificates issued 
pursuant to 12 U.S.C. 1823(i); minority interests in consolidated 
subsidiaries; and allowances for loan and lease losses; minus 
intangible assets;
    (2) Mortgage servicing assets;
    (3) Mandatory convertible debt to the extent of 20 percent of the 
sum of paragraphs (a) and (c) (1) and (2) of this section;
    (4) Other mandatory convertible debt, limited life preferred stock 
and subordinated notes and debentures to the extent set forth in 
paragraph (f)(2) of this section.
    (d) Unimpaired surplus fund. The term unimpaired surplus fund as 
used in provisions of law relating to the unimpaired surplus fund of 
national banks shall have the same meaning as the term surplus set 
forth in paragraph (c) of this section.
    (e) Definitions. (1) Allowance for loan and lease losses means the 
balance of the valuation reserve on December 31, 1968, plus additions 
to the reserve charged to operations since that date, less losses 
charged against the allowance net of recoveries.
    (2) Capital surplus means the total of those accounts reflecting:
    (i) Amounts paid in in excess of the par or stated value of capital 
stock;
    (ii) Amounts contributed to the national bank other than for 
capital stock;
    (iii) Amounts transferred from undivided profits pursuant to 12 
U.S.C. 60; and
    (iv) Other amounts transferred from undivided profits.
    (3) Intangible assets means those purchased assets that are to be 
reported as intangible assets in accordance with the Instructions--
Consolidated Reports of Condition and Income (Call Report).
    (4) Limited life preferred stock means preferred stock which has a 
maturity or which may be redeemed at the option of the holder.
    (5) Mandatory convertible debt means subordinated debt instruments 
which unqualifiedly require the issuer to exchange either common or 
perpetual preferred stock for such instruments by a date at or before 
the maturity of the instrument. The maturity of these instruments must 
be 12 years or less. In addition, the instrument must meet the 
requirements of paragraphs (f)(1)(i) through (v) of this section for 
subordinated notes and debentures or other requirements published by 
the OCC.
    (6) Minority interest in consolidated subsidiaries means the 
portion of equity capital accounts of all consolidated subsidiaries of 
the national bank that is allocated to minority shareholders of such 
subsidiaries.
    (7) Mortgage servicing assets means the national bank-owned rights 
to service for a fee mortgage loans that are owned by others.
    (8) Perpetual preferred stock means preferred stock that does not 
have a stated maturity date and cannot be redeemed at the option of the 
holder.
    (f) Requirements and restrictions: Limited life preferred stock, 
mandatory convertible debt, and other subordinated debt--(1) 
Requirements. Issues of limited life preferred stock and subordinated 
notes and debentures (except mandatory convertible debt) shall have 
original weighted average maturities of at least five years to be 
included in the definition of surplus. In addition, a subordinated note 
or debenture must also:
    (i) Be subordinated to the claims of depositors;
    (ii) State on the instrument that it is not a deposit and is not 
insured by the FDIC;
    (iii) Be unsecured;
    (iv) Be ineligible as collateral for a loan by the issuing national 
bank;
    (v) Provide that once any scheduled payments of principal begin, 
all scheduled payments shall be made at least annually and the amount 
repaid in each year shall be no less than in the prior year; and
    (vi) Provide that no prepayment (including payment pursuant to an 
acceleration clause or redemption prior to maturity) shall be made 
without prior OCC approval unless the national bank remains an eligible 
bank, as defined in 12 CFR 5.3(g), after the prepayment.
    (2) Restrictions. The total amount of mandatory convertible debt 
not included in paragraph (c)(3) of this section, limited life 
preferred stock, and subordinated notes and debentures considered as 
surplus is limited to 50 percent of the sum of paragraphs (a) and (c) 
(1), (2) and (3) of this section.
    (3) Reservation of authority. The OCC expressly reserves the 
authority to waive the requirements and restrictions set forth in 
paragraphs (f)(1) and (2) of this section, in order to allow the 
inclusion of other limited life preferred stock, mandatory convertible 
notes and subordinated notes and debentures in the capital base of any 
national bank for capital adequacy purposes or for purposes of 
determining statutory limits. The OCC further expressly reserves the 
authority to impose more stringent conditions than those set forth in 
paragraphs (f)(1) and (2) of this section to exclude any component of 
tier 1 or tier 2 capital, in whole or in part, as part of a national 
bank's capital and surplus for any purpose.
    (g) Transitional rules. (1) Equity commitment notes approved by the 
OCC as capital and issued prior to April 15, 1985, may continue to be 
included in paragraph (c)(3) of this section. All other instruments 
approved by the OCC as capital and issued prior to April 15, 1985, are 
to be included in paragraph (c)(4) of this section.
    (2) Intangible assets (other than mortgage servicing assets) 
purchased prior to April 15, 1985, and accounted for in accordance with 
OCC instructions, may continue to be included as surplus up to 25 
percent of

[[Page 62273]]

the sum of paragraphs (a) and (c)(1) of this section.

0
6. Add subparts A through G to part 3, as set forth at the end of the 
common preamble.

Appendix C to Part 3 [Removed]

0
7. Remove appendix C.

0
8. Subparts A through G, as set forth at the end of the common 
preamble, are amended as follows:
0
A. Remove ``[AGENCY]'' and add ``OCC'' in its place, wherever it 
appears;
0
B. Remove ``[BANK]'' and add ``national bank or Federal savings 
association'' in its place, wherever it appears;
0
C. Remove ``[BANKS]'' and ``[BANK]s'' and add ``national banks and 
Federal savings associations'' in their places, wherever they appear;
0
D. Remove ``[BANK]'s'' and add ``national bank's or Federal savings 
association's'' in their places, wherever they appear;
0
E. Remove ``[PART]'' and add ``part'' in its place, wherever it 
appears; and
0
F. Remove ``[REGULATORY REPORT]'' and add ``Call Report'' in its place, 
wherever it appears;
0
G. Remove ``[other Federal banking agencies]'' wherever it appears and 
add ``Federal Deposit Insurance Corporation and Federal Reserve Board'' 
in its place;

0
9. In Sec.  3.1:
0
A. In paragraph (e), remove ``[12 CFR 3.404, (OCC); 12 CFR 263.202 
(Board)]'' and add ``Sec.  3.404'' in its place;
0
B. In paragraph (f)(1)(ii)(A), remove ``[12 CFR part 3, appendix A and, 
if applicable, 12 CFR part 3, subpart F (national banks), or 12 CFR 
part 167 and, if applicable, 12 CFR part 3, subpart F (Federal savings 
associations)(OCC); 12 CFR part 225, appendix A (Board)]'' and add 
``appendix A to this part and, if applicable, subpart F of this part 
(national banks), or 12 CFR part 167 and, if applicable, subpart F of 
this part (Federal savings associations)'' in its place;
0
C. In footnote 1 in paragraph (f)(1)(ii)(A), remove ``[12 CFR part 3, 
appendix A, Sec. 3 and, if applicable, 12 CFR part 3, subpart F 
(national banks), or 12 CFR part 167 and, if applicable, 12 CFR part 3, 
subpart F (Federal savings associations) (OCC);, 12 CFR parts 208 and 
225, and, if applicable, appendix E to this part (state member banks or 
bank holding companies, respectively (Board)]'' and add ``appendix A to 
this part, Sec. 3 and, if applicable, subpart F of this part (national 
banks), or 12 CFR part 167 and, if applicable, subpart F of this part 
(Federal savings associations)'' in its place;
0
D. In paragraph (f)(1)(ii)(B), remove ``[12 CFR part 3, appendix B, 
section 4(a)(3) (national banks) (OCC); 12 CFR parts 208 or 225, 
appendix E, section 4(a)(3) (state member banks or bank holding 
companies, respectively) (Board); and 12 CFR part 325, appendix C, 
section 4(a)(3) (state nonmember banks and state savings 
associations)]'' and add ``appendix B to this part, section 4(a)(3) 
(national banks)'' in its place.
0
E. In paragraph (f)(1)(ii)(C), remove ``[12 CFR part 3, appendix A, 
and, if applicable, appendix B (national banks), or 12 CFR part 167 
(Federal savings associations) (OCC)); 12 CFR parts 208 or 225, 
appendix A, and, if applicable, appendix E (state member banks or bank 
holding companies, respectively) (Board)]'' and add in its place 
``appendix A to this part, and, if applicable, appendix B to this part 
(national banks), or 12 CFR part 167 (Federal savings associations)
0
F. In footnote 2 in paragraph (f)(1)(ii)(C), remove ``[12 CFR part 3, 
appendix A, Sec. 3, appendix A, section 3 and, if applicable, 12 CFR 
part 3, appendix B (national banks), or 12 CFR part 167 (Federal 
savings associations) (OCC); 12 CFR parts 208 and 225, appendix A and, 
if applicable, appendix E (state member banks or bank holding 
companies, respectively) (Board)]'' and add ``appendix A to this part 
and, if applicable, subpart F of this part (national banks), or 12 CFR 
part 167 and, if applicable, subpart F of this part (Federal savings 
associations)'' in its place; and
0
G. Add paragraph (f)(4).
    The addition and revision read as follows:


Sec.  3.1  Purpose, applicability, reservations of authority, and 
timing.

* * * * *
    (f) * * *
    (4) No national bank or Federal savings association that is not an 
advanced approaches bank or advanced approaches savings association is 
subject to this part 3 until January 1, 2015.

0
10. Section 3.2 is amended by:
0
A. Adding definitions of ``Core capital'', ``Federal savings 
association'', and '' Tangible capital means'' in alphabetical order;
0
B. In paragraph (2)(i) of the definition of ``high volatility 
commercial real estate (HVCRE) exposure'', remove ``[12 CFR part 25 
(national bank), 12 CFR part 195 (Federal savings association) (OCC); 
12 CFR part 228 (Board)]'' and add ``12 CFR parts 25 (national banks) 
and 195 (Federal savings associations)'' in its place;
0
C. In paragraph (2)(ii) of the definition of ``high volatility 
commercial real estate (HVCRE) exposure'', remove ``[12 CFR part 
25.12(g)(3) (national banks) and 12 CFR part 195.12(g)(3) (Federal 
savings associations) (OCC); 12 CFR part 208.22(a)(3) or 228.12(g)(3) 
(Board)]'' and add ``12 CFR 25.12(g)(3) (national banks) and 12 CFR 
195.12(g)(3) (Federal savings associations)'' in its place;
0
D. In paragraph (4)(i) of the definition of ``high volatility 
commercial real estate (HVCRE) exposure'', remove ``[12 CFR part 34, 
subpart D (national banks) and 12 CFR part 160, subparts A and B 
(Federal savings associations) (OCC); 12 CFR part 208, appendix C 
(Board)]'' and add ``12 CFR part 34, subpart D (national banks) and 12 
CFR part 160, subparts A and B (Federal savings associations)'' in its 
place; and
0
E. In paragraph (10)(ii) of the definition of ``traditional 
securitization'', remove ``[12 CFR 9.18 (national bank) and 12 CFR 
151.40 (Federal saving association) (OCC); 12 CFR 208.34 (Board)]'' and 
add ``12 CFR 9.18 (national banks), 12 CFR 151.40 (Federal saving 
associations)'' in its place.
    The additions read as follows:


Sec.  3.2  Definitions.

* * * * *
    Core capital means tier 1 capital, as calculated in accordance with 
subpart B of this part.
* * * * *
    Federal savings association means an insured Federal savings 
association or an insured Federal savings bank chartered under section 
5 of the Home Owners' Loan Act of 1933.
* * * * *
    Tangible capital means the amount of core capital (tier 1 capital), 
as calculated in accordance with subpart B of this part, plus the 
amount of outstanding perpetual preferred stock (including related 
surplus) not included in tier 1 capital.
* * * * *
0
11. Section 3.10,is amended by:
0
A. Adding paragraphs (a)(6), (b)(5), and (c)(5) to read as follows;
0
B. In paragraph (d)(1), removing ``[12 CFR 3.10 (national banks), 12 
CFR 167.3(c) (Federal savings associations) and 12 CFR 208.4 (state 
member banks)]'' and adding ``this section (national banks), 12 CFR 
167.3(c) (Federal savings associations)'' in its place.
    The additions read as follows:


Sec.  3.10  Minimum capital requirements.

    (a) * * *
    (6) For Federal savings associations, a tangible capital ratio of 
1.5 percent.

[[Page 62274]]

    (b) * * *
    (5) Federal savings association tangible capital ratio. A Federal 
savings association's tangible capital ratio is the ratio of the 
Federal savings association's core capital (tier 1 capital) to average 
total assets as calculated under this subpart B. For purposes of this 
paragraph (b)(5), the term ``total assets'' means ``total assets'' as 
defined in part 6, subpart A of this chapter, subject to subpart G of 
this part.
    (c) * * *
    (5) Federal savings association tangible capital ratio. A Federal 
savings association's tangible capital ratio is the ratio of the 
Federal savings association's core capital (tier 1 capital) to average 
total assets as calculated under this subpart B. For purposes of this 
paragraph (c)(5), the term ``total assets'' means ``total assets'' as 
defined in part 6, subpart A of this chapter, subject to subpart G of 
this part.
* * * * *


Sec.  3.11  [Amended]

0
12. In Sec.  3.11, in paragraph (a)(4)(v), remove ``12 CFR part 3, 
subparts H and I; 12 CFR part 5.46, 12 CFR part 5, subpart E; 12 CFR 
part 6 (OCC); 12 CFR 225.4; 12 CFR 225.8; 12 CFR 263.202 (Board)'' and 
add ``subparts H and I of this part; 12 CFR 5.46, 12 CFR part 5, 
subpart E; 12 CFR part 6'' in its place;

0
13. Section 3.20 is amended by:
0
A. Revising paragraphs (b)(1)(v) and (c)(1)(viii);
0
B. In paragraph (c)(3), removing ``[12 CFR part 3, appendix A (national 
banks), 12 CFR 167 (Federal savings associations) (OCC); 12 CFR part 
208, appendix A, 12 CFR part 225, appendix A (Board)]'' and add 
``appendix A to this part (national banks), 12 CFR part 167 (Federal 
savings associations)'' in its place; and
0
C. In paragraph (d)(4), removing ``12 CFR part 3, appendix A, 12 CFR 
167 (OCC); 12 CFR part 208, appendix A, 12 CFR part 225, appendix A 
(Board)'' and adding ``appendix A to this part, 12 CFR part 167'' in 
its place.
    The revisions read as follows:


Sec.  3.20  Capital components and eligibility criteria for regulatory 
capital instruments.

* * * * *
    (b) * * *
    (1) * * *
    (v) Any cash dividend payments on the instrument are paid out of 
the [BANK]'s net income or retained earnings and are not subject to a 
limit imposed by the contractual terms governing the instrument.
* * * * *
    (c) * * *
    (1) * * *
    (viii) Any cash dividend payments on the instrument are paid out of 
the [BANK]'s net income or retained earnings and are not subject to a 
limit imposed by the contractual terms governing the instrument.
* * * * *

0
14. Section 3.22 is amended by adding paragraph (a)(8) to read as 
follows:


Sec.  3.22  Regulatory capital adjustments and deductions.

    (a) * * *
    (8)(i) A Federal savings association must deduct the aggregate 
amount of its outstanding investments (both equity and debt) in, and 
extensions of credit to, subsidiaries that are not includable 
subsidiaries as defined in paragraph (a)(8)(iv) of this section and may 
not consolidate the assets and liabilities of the subsidiary with those 
of the Federal savings association. Any such deductions shall be 
deducted from assets and common equity tier 1 except as provided in 
paragraphs (a)(8)(ii) and (iii) of this section.
    (ii) If a Federal savings association has any investments (both 
debt and equity) in, or extensions or credit to, one or more 
subsidiaries engaged in any activity that would not fall within the 
scope of activities in which includable subsidiaries as defined in 
paragraph (a)(8)(iv) of this section may engage, it must deduct such 
investments and extensions of credit from assets and, thus, common 
equity tier 1 in accordance with paragraph (a)(8)(i) of this section.
    (iii) If a Federal savings association holds a subsidiary (either 
directly or through a subsidiary) that is itself a domestic depository 
institution, the OCC may, in its sole discretion upon determining that 
the amount of common equity tier 1 that would be required would be 
higher if the assets and liabilities of such subsidiary were 
consolidated with those of the parent Federal savings association than 
the amount that would be required if the parent Federal savings 
association's investment were deducted pursuant to paragraphs (a)(8)(i) 
and (ii) of this section, consolidate the assets and liabilities of 
that subsidiary with those of the parent Federal savings association in 
calculating the capital adequacy of the parent Federal savings 
association, regardless of whether the subsidiary would otherwise be an 
includable subsidiary as defined in paragraph (a)(8)(iv) of this 
section.
    (iv) For purposes of this section, the term includable subsidiary 
means a subsidiary of a Federal savings association that:
    (A) Is engaged solely in activities not impermissible for a 
national bank;
    (B) Is engaged in activities not permissible for a national bank, 
but only if acting solely as agent for its customers and such agency 
position is clearly documented in the Federal savings association's 
files;
    (C) Is engaged solely in mortgage-banking activities;
    (D)(1) Is itself an insured depository institution or a company the 
sole investment of which is an insured depository institution; and
    (2) Was acquired by the parent Federal savings association prior to 
May 1, 1989; or
    (E) Was a subsidiary of any Federal savings association existing as 
a Federal savings association on August 9, 1989:
    (1) That was chartered prior to October 15, 1982, as a savings bank 
or a cooperative bank under state law; or
    (2) That acquired its principal assets from an association that was 
chartered prior to October 15, 1982, as a savings bank or a cooperative 
bank under state law.
* * * * *


Sec.  3.42  [Amended]

0
15. In Sec.  3.42(h)(1)(iv) and (h)(3), remove ``[12 CFR 6.4 (OCC); 12 
CFR 208.43 (Board)]'' and add ``12 CFR 6.4'' in its place.


Sec.  3.100  [Amended]

0
16. In Sec.  3.100(b)(2), remove ``[12 CFR 3.404 (OCC), 12 CFR 263.202 
(Board), and 12 CFR 324.5 (FDIC)]'' and add ``12 CFR 3.404'' in its 
place.


Sec.  3.142  [Amended]

0
17. Section 3.142(k)(1)(iv) is amended by removing ``[12 CFR 6.4 (OCC); 
12 CFR 208.43 (Board)]'' and by adding ``12 CFR 6.4'' in its place.


Sec.  3.201  [Amended]

0
18. In Sec.  3.201(c)(1), remove ``[12 CFR 3.404, 12 CFR 263.202, 12 
CFR 324.5(c)]'' and add ``12 CFR 3.404'' in its place.


Sec.  3.300  [Amended]

0
19. Section 3.300 is amended:
0
A. In paragraph (b)(1) introductory text, by removing ``Sec.  
--.22(a)(1)-(7)'' and adding ``Sec.  3.22(a)(1)-(8)'' in its place;
0
B. In paragraph (b)(1)(i), by removing at the end of the paragraph, 
``and financial subsidiaries (Sec.  --.22(a)(7)).'' and adding in its 
place the phrase ``and financial subsidiaries (Sec.  3.22(a)(7)), and 
nonincludable subsidiaries of a Federal savings association (Sec.  
3.22(a)(8)).''; and in Table 2 to Sec.  3.300, adding at the end of the 
heading in the second column the phrase ``and (8)'';

[[Page 62275]]

0
C. By removing and reserving paragraphs (c)(1) through (c)(3); and
0
D. In paragraph (e), by removing ``[12 CFR Part 6 (OCC); 12 CFR 208 
(Board)]'', and adding ``12 CFR part 6'' in its place.

PART 5--RULES, POLICIES, AND PROCEDURES FOR CORPORATE ACTIVITIES

0
20. The authority citation for part 5 continues to read as follows:

    Authority: 12 U.S.C. 1 et seq., 93a, 215a-2, 215a-3, 481, and 
section 5136A of the Revised Statutes (12 U.S.C. 24a).


0
21. Section 5.39 is amended by revising paragraph (h)(1) and 
republishing paragraph (h)(2) to read as follows:


Sec.  5.39  Financial subsidiaries.

* * * * *
    (h) * * *
    (1) For purposes of determining regulatory capital the national 
bank may not consolidate the assets and liabilities of a financial 
subsidiary with those of the bank and must deduct the aggregate amount 
of its outstanding equity investment, including retained earnings, in 
its financial subsidiaries from regulatory capital as provided by Sec.  
3.22(a)(7) of this chapter;
    (2) Any published financial statement of the national bank shall, 
in addition to providing information prepared in accordance with 
generally accepted accounting principles, separately present financial 
information for the bank in the manner provided in paragraph (h)(1) of 
this section;
* * * * *

0
22. Part 6 is revised to read as follows:

PART 6--PROMPT CORRECTIVE ACTION

Subpart A--Capital Categories
Sec.
6.1 Authority, purpose, scope, other supervisory authority, 
disclosure of capital categories, and transition procedures.
6.2 Definitions.
6.3 Notice of capital category.
6.4 Capital measures and capital category definition.
6.5 Capital restoration plan.
6.6 Mandatory and discretionary supervisory actions.
Subpart B--Directives To Take Prompt Corrective Action
6.20 Scope.
6.21 Notice of intent to issue a directive.
6.22 Response to notice.
6.23 Decision and issuance of a prompt corrective action directive.
6.24 Request for modification or rescission of directive.
6.25 Enforcement of directive.

    Authority: 12 U.S.C. 93a, 1831o, 5412(b)(2)(B).

Subpart A--Capital Categories


Sec.  6.1  Authority, purpose, scope, other supervisory authority, 
disclosure of capital categories, and transition procedures.

    (a) Authority. This part is issued by the Office of the Comptroller 
of the Currency (OCC) pursuant to section 38 (section 38) of the 
Federal Deposit Insurance Act (FDI Act) as added by section 131 of the 
Federal Deposit Insurance Corporation Improvement Act of 1991 (Pub. L. 
102-242, 105 Stat. 2236 (1991)) (12 U.S.C. 1831o).
    (b) Purpose. Section 38 of the FDI Act establishes a framework of 
supervisory actions for insured depository institutions that are not 
adequately capitalized. The principal purpose of this subpart is to 
define, for insured national banks and insured Federal savings 
associations, the capital measures and capital levels, and for insured 
Federal branches, comparable asset-based measures and levels, that are 
used for determining the supervisory actions authorized under section 
38 of the FDI Act. This part 6 also establishes procedures for 
submission and review of capital restoration plans and for issuance and 
review of directives and orders pursuant to section 38.
    (c) Scope. This subpart implements the provisions of section 38 of 
the FDI Act as they apply to insured national banks, insured Federal 
branches, and insured Federal savings associations. Certain of these 
provisions also apply to officers, directors, and employees of these 
insured institutions. Other provisions apply to any company that 
controls an insured national bank, insured Federal branch, or insured 
Federal savings association and to the affiliates of an insured 
national bank, insured Federal branch, or insured Federal savings 
association.
    (d) Other supervisory authority. Neither section 38 nor this part 
in any way limits the authority of the OCC under any other provision of 
law to take supervisory actions to address unsafe or unsound practices, 
deficient capital levels, violations of law, unsafe or unsound 
conditions, or other practices. Action under section 38 of the FDI Act 
and this part may be taken independently of, in conjunction with, or in 
addition to any other enforcement action available to the OCC, 
including issuance of cease and desist orders, capital directives, 
approval or denial of applications or notices, assessment of civil 
money penalties, or any other actions authorized by law.
    (e) Disclosure of capital categories. The assignment of an insured 
national bank, insured Federal branch, or insured Federal savings 
association under this subpart within a particular capital category is 
for purposes of implementing and applying the provisions of section 38. 
Unless permitted by the OCC or otherwise required by law, no national 
bank or Federal savings association may state in any advertisement or 
promotional material its capital category under this subpart or that 
the OCC or any other Federal banking agency has assigned the national 
bank or Federal savings association to a particular capital category.
    (f) Transition procedures--(1) Definitions applicable before 
January 1, 2015, for certain national banks and Federal savings 
associations. Before January 1, 2015, notwithstanding any other 
requirement in this subpart and with respect to any national bank that 
is not an advanced approaches bank and any Federal savings association 
that is not an advanced approaches Federal savings association:
    (i) The definitions of leverage ratio, tangible equity, tier 1 
capital, tier 1 risk-based capital, and total risk-based capital as 
calculated or defined under appendix A to part 3 of this chapter, 
remain in effect for purposes of this subpart; and
    (ii) The definition of total assets means quarterly average total 
assets as reported in a national bank's or Federal savings 
association's Consolidated Reports of Condition and Income (Call 
Report), minus intangible assets except mortgage servicing assets as 
provided in the definition of tangible equity. The OCC reserves the 
right to require a national bank or Federal savings association to 
compute and maintain its capital ratios on the basis of actual, rather 
than average, total assets when computing tangible equity.
    (2) Timing. On January 1, 2015 and thereafter, the calculation of 
the definitions of common equity tier 1 capital, the common equity tier 
1 risk-based capital ratio, the leverage ratio, the supplementary 
leverage ratio, tangible equity, tier 1 capital, the tier 1 risk-based 
capital ratio, total assets, total leverage exposure, the total risk-
based capital ratio, and total risk-weighted assets under this subpart 
is subject to the timing provisions at 12 CFR Sec.  3.1(f) and the 
transitions at 12 CFR part 3, subpart G.


Sec.  6.2  Definitions.

    For purposes of this subpart, except as modified in this section or 
unless the context otherwise requires, the terms used have the same 
meanings as set

[[Page 62276]]

forth in section 38 and section 3 of the FDI Act.
    Advanced approaches national bank or advanced approaches Federal 
savings association means a national bank or Federal savings 
association that is subject to subpart E of part 3 of this chapter.
    Common equity tier 1 capital means common equity tier 1 capital, as 
defined in accordance with the OCC's definition in subpart A of part 3 
of this chapter.
    Common equity tier 1 risk-based capital ratio means the ratio of 
common equity tier 1 capital to total risk-weighted assets, as 
calculated in accordance with subpart B of part 3 of this chapter, as 
applicable.
    Control. (1) Control has the same meaning assigned to it in section 
2 of the Bank Holding Company Act (12 U.S.C. 1841), and the term 
controlled shall be construed consistently with the term control.
    (2) Exclusion for fiduciary ownership. No insured depository 
institution or company controls another insured depository institution 
or company by virtue of its ownership or control of shares in a 
fiduciary capacity. Shares shall not be deemed to have been acquired in 
a fiduciary capacity if the acquiring insured depository institution or 
company has sole discretionary authority to exercise voting rights with 
respect thereto.
    (3) Exclusion for debts previously contracted. No insured 
depository institution or company controls another insured depository 
institution or company by virtue of its ownership or control of shares 
acquired in securing or collecting a debt previously contracted in good 
faith, until two years after the date of acquisition. The two-year 
period may be extended at the discretion of the appropriate Federal 
banking agency for up to three one-year periods.
    Controlling person means any person having control of an insured 
depository institution and any company controlled by that person.
    Federal savings association means an insured Federal savings 
association or an insured Federal savings bank chartered under section 
5 of the Home Owners' Loan Act of 1933.
    Leverage ratio means the ratio of tier 1 capital to average total 
consolidated assets, as calculated in accordance with subpart B of part 
3 of this chapter.\30\
---------------------------------------------------------------------------

    \30\ Before January 1, 2015, the leverage ratio of a national 
bank or Federal savings association that is not an advanced 
approaches national bank or advanced approaches Federal savings 
association is the ratio of tier 1 capital to average total 
consolidated assets, as calculated in accordance with appendix A to 
part 3 of this chapter.
---------------------------------------------------------------------------

    Management fee means any payment of money or provision of any other 
thing of value to a company or individual for the provision of 
management services or advice to the national bank or Federal savings 
association or related overhead expenses, including payments related to 
supervisory, executive, managerial, or policymaking functions, other 
than compensation to an individual in the individual's capacity as an 
officer or employee of the national bank or Federal savings 
association.
    National bank means all insured national banks and all insured 
Federal branches, except where otherwise provided in this subpart.
    Supplementary leverage ratio means the ratio of tier 1 capital to 
total leverage exposure, as calculated in accordance with subpart B of 
part 3 of this chapter.
    Tangible equity means the amount of tier 1 capital, as calculated 
in accordance with subpart B of part 3 of this chapter, plus the amount 
of outstanding perpetual preferred stock (including related surplus) 
not included in tier 1 capital.\31\
---------------------------------------------------------------------------

    \31\ Before January 1, 2015, the tangible equity of a national 
bank or Federal savings association that is not an advanced 
approaches national bank or advanced approaches Federal savings 
association is the amount of tier 1 capital elements as defined in 
appendix A to part 3 of this chapter, plus the amount of outstanding 
cumulative perpetual preferred stock (including related surplus) 
minus all intangible assets except mortgage servicing assets to the 
extent permitted in tier 1 capital, as calculated in accordance with 
appendix A to part 3 of this chapter. The OCC reserves the right to 
require a national bank or Federal savings association to compute 
and maintain its capital ratios on the basis of actual, rather than 
average, total assets when computing tangible equity.
---------------------------------------------------------------------------

    Tier 1 capital means the amount of tier 1 capital as defined in 
subpart B of part 3 of this chapter.\32\
---------------------------------------------------------------------------

    \32\ Before January 1, 2015, the tier 1 capital of a national 
bank or Federal savings association that is not an advanced 
approaches national bank or advanced approaches Federal savings 
association (as an advanced approaches national bank or advanced 
approaches Federal savings association is defined in this Sec.  6.2) 
is calculated in accordance with appendix A to part 3 of this 
chapter.
---------------------------------------------------------------------------

    Tier 1 risk-based capital ratio means the ratio of tier 1 capital 
to risk-weighted assets, as calculated in accordance with subpart B of 
part 3 of this chapter.\33\
---------------------------------------------------------------------------

    \33\ Before January 1, 2015, the tier 1 risk-based capital ratio 
of a national bank or Federal savings association that is not an 
advanced approaches national bank or advanced approaches Federal 
savings association (as an advanced approaches national bank or 
advanced approaches Federal savings association is defined in this 
Sec.  6.2) is calculated in accordance with appendix A to part 3 of 
this chapter.
---------------------------------------------------------------------------

    Total assets means quarterly average total assets as reported in a 
national bank's or Federal savings association's Consolidated Reports 
of Condition and Income (Call Report), minus any deductions as provided 
in Sec.  3.22(a), (c), and (d) of this chapter. The OCC reserves the 
right to require a national bank or Federal savings association to 
compute and maintain its capital ratios on the basis of actual, rather 
than average, total assets when computing tangible equity.\34\
---------------------------------------------------------------------------

    \34\ Before January 1, 2015, total assets means, for a national 
bank or Federal savings association that is not an advanced 
approaches national bank or advanced approaches Federal savings 
association (as an advanced approaches national bank or advanced 
approaches Federal savings association is defined in this Sec.  
6.2), quarterly average total assets as reported in a bank's or 
savings association's Call Report, minus all intangible assets 
except mortgage servicing assets to the extent permitted in tier 1 
capital, as calculated in accordance with appendix A to part 3 of 
this chapter. The OCC reserves the right to require a national bank 
or Federal savings association to compute and maintain its capital 
ratios on the basis of actual, rather than average, total assets 
when computing tangible equity.
---------------------------------------------------------------------------

    Total leverage exposure means the total leverage exposure, as 
calculated in accordance with subpart B of part 3 of this chapter.
    Total risk-based capital ratio means the ratio of total capital to 
total risk-weighted assets, as calculated in accordance with subpart B 
of part 3 of this chapter.\35\
---------------------------------------------------------------------------

    \35\ Before January 1, 2015, the total risk-based capital ratio 
of a national bank or Federal savings association that is not an 
advanced approaches national bank or advanced approaches Federal 
savings association (as an advanced approaches national bank or 
advanced approaches Federal savings association is defined in this 
Sec.  6.2) is calculated in accordance with appendix A to part 3 of 
this chapter.
---------------------------------------------------------------------------

    Total risk-weighted assets means standardized total risk-weighted 
assets, and for an advanced approaches national bank or advanced 
approaches Federal savings association also includes advanced 
approaches total risk-weighted assets, as defined in subpart B of part 
3 of this chapter.


Sec.  6.3  Notice of capital category.

    (a) Effective date of determination of capital category. A national 
bank or Federal savings association shall be deemed to be within a 
given capital category for purposes of section 38 of the FDI Act and 
this part as of the date the national bank or Federal savings 
association is notified of, or is deemed to have notice of, its capital 
category pursuant to paragraph (b) of this section.
    (b) Notice of capital category. A national bank or Federal savings 
association shall be deemed to have been notified of its capital levels 
and its capital category as of the most recent date:
    (1) A Consolidated Reports of Condition and Income (Call Report) is 
required to be filed with the OCC;

[[Page 62277]]

    (2) A final report of examination is delivered to the national bank 
or Federal savings association; or
    (3) Written notice is provided by the OCC to the national bank or 
Federal savings association of its capital category for purposes of 
section 38 of the FDI Act and this part or that the national bank's or 
Federal savings association's capital category has changed pursuant to 
paragraph (c) of this section, or Sec.  6.4(e) and with respect to 
national banks, subpart M of part 19 of this chapter, and with respect 
to Federal savings associations Sec.  165.8 of this chapter.
    (c) Adjustments to reported capital levels and capital category--
(1) Notice of adjustment by national bank or Federal savings 
association. A national bank or Federal savings association shall 
provide the OCC with written notice that an adjustment to the national 
bank's or Federal savings association's capital category may have 
occurred no later than 15 calendar days following the date that any 
material event has occurred that would cause the national bank or 
Federal savings association to be placed in a lower capital category 
from the category assigned to the national bank or Federal savings 
association for purposes of section 38 and this part on the basis of 
the national bank's or Federal savings association's most recent Call 
Report or report of examination.
    (2) Determination to change capital category. After receiving 
notice pursuant to paragraph (c)(1) of this section, the OCC shall 
determine whether to change the capital category of the national bank 
or Federal savings association and shall notify the national bank or 
Federal savings association of the OCC's determination.


Sec.  6.4  Capital measures and capital category definition.

    (a) Capital measures--(1) Capital measures applicable before 
January 1, 2015. On or before December 31, 2014, for purposes of 
section 38 and this part, the relevant capital measures for all 
national banks and Federal savings associations are:
    (i) Total Risk-Based Capital Measure: the total risk-based capital 
ratio;
    (ii) Tier 1 Risk-Based Capital Measure: the tier 1 risk-based 
capital ratio; and
    (iii) Leverage Measure: the leverage ratio.
    (2) Capital measures applicable on and after January 1, 2015. On 
January 1, 2015 and thereafter, for purposes of section 38 and this 
part, the relevant capital measures are:
    (i) Total Risk-Based Capital Measure: the total risk-based capital 
ratio;
    (ii) Tier 1 Risk-Based Capital Measure: the tier 1 risk-based 
capital ratio;
    (iii) Common Equity Tier 1 Capital Measure: the common equity tier 
1 risk-based capital ratio; and
    (iv) The Leverage Measure:
    (A) The leverage ratio; and
    (B) With respect to an advanced approaches national bank or 
advanced approaches Federal savings association, on January 1, 2018, 
and thereafter, the supplementary leverage ratio.
    (b) Capital categories applicable before January 1, 2015. On or 
before December 31, 2014, for purposes of the provisions of section 38 
and this part, a national bank or Federal savings association shall be 
deemed to be:
    (1) Well capitalized if:
    (i) Total Risk-Based Capital Measure: the national bank or Federal 
savings association has a total risk-based capital ratio of 10.0 
percent or greater;
    (ii) Tier 1 Risk-Based Capital Measure: the national bank or 
Federal savings association has a tier 1 risk-based capital ratio of 
6.0 percent or greater;
    (iii) Leverage Ratio: the national bank or Federal savings 
association has a leverage ratio of 5.0 percent or greater; and
    (iv) The national bank or Federal savings association is not 
subject to any written agreement, order or capital directive, or prompt 
corrective action directive issued by the OCC or the former OTS 
pursuant to section 8 of the FDI Act, the International Lending 
Supervision Act of 1983 (12 U.S.C. 3907), the Home Owners' Loan Act (12 
U.S.C. 1464(t)(6)(A)(ii)), or section 38 of the FDI Act, or any 
regulation thereunder, to meet and maintain a specific capital level 
for any capital measure.
    (2) Adequately capitalized if:
    (i) Total Risk-Based Capital Measure: the national bank or Federal 
savings association has a total risk-based capital ratio of 8.0 percent 
or greater;
    (ii) Tier 1 Risk-Based Capital Measure: the national bank or 
Federal savings association has a tier 1 risk-based capital ratio of 
4.0 percent or greater;
    (iii) Leverage Ratio:
    (A) The national bank or Federal savings association has a leverage 
ratio of 4.0 percent or greater; or
    (B) The national bank or Federal savings association has a leverage 
ratio of 3.0 percent or greater if the national bank or Federal savings 
association is rated composite 1 under the CAMELS rating system in the 
most recent examination of the national bank and or Federal savings 
association; and
    (iv) Does not meet the definition of a ``well capitalized'' 
national bank or Federal savings association.
    (3) Undercapitalized if:
    (i) Total Risk-Based Capital Measure: the national bank or Federal 
savings association has a total risk-based capital ratio of less than 
8.0 percent; or
    (ii) Tier 1 Risk-Based Capital Measure: the national bank or 
Federal savings association has a tier 1 risk-based capital ratio of 
less than 4.0 percent; or
    (iii) Leverage Ratio:
    (A) Except as provided in paragraph (b)(2)(iii)(B) of this section, 
the national bank or Federal savings association has a leverage ratio 
of less than 4.0 percent; or
    (B) The national bank or Federal savings association has a leverage 
ratio of less than 3.0 percent, if the national bank or Federal savings 
association is rated composite 1 under the CAMELS rating system in the 
most recent examination of the national bank or Federal savings 
association.
    (4) Significantly undercapitalized if:
    (i) Total Risk-Based Capital Measure: the national bank or Federal 
savings association has a total risk-based capital ratio of less than 
6.0 percent; or
    (ii) Tier 1 Risk-Based Capital Measure: the national bank or 
Federal savings association has a tier 1 risk-based capital ratio of 
less than 3.0 percent; or
    (iii) Leverage Ratio: the national bank or Federal savings 
association has a leverage ratio of less than 3.0 percent.
    (5) Critically undercapitalized if the national bank or Federal 
savings association has a ratio of tangible equity to total assets that 
is equal to or less than 2.0 percent.
    (c) Capital categories applicable on and after January 1, 2015. On 
January 1, 2015, and thereafter, for purposes of the provisions of 
section 38 and this part, a national bank or Federal savings 
association shall be deemed to be:
    (1) Well capitalized if:
    (i) Total Risk-Based Capital Measure: the national bank or Federal 
savings association has a total risk-based capital ratio of 10.0 
percent or greater;
    (ii) Tier 1 Risk-Based Capital Measure: the national bank or 
Federal savings association has a tier 1 risk-based capital ratio of 
8.0 percent or greater;
    (iii) Common Equity Tier 1 Capital Measure: the national bank or 
Federal savings association has a common equity tier 1 risk-based 
capital ratio of 6.5 percent or greater;
    (iv) Leverage Ratio: the national bank or Federal savings 
association has a leverage ratio of 5.0 or greater; and
    (v) The national bank or Federal savings association is not subject 
to any written agreement, order or capital directive, or prompt 
corrective action directive issued by the OCC pursuant to section 8 of 
the FDI Act, the

[[Page 62278]]

International Lending Supervision Act of 1983 (12 U.S.C. 3907), the 
Home Owners' Loan Act (12 U.S.C. 1464(t)(6)(A)(ii)), or section 38 of 
the FDI Act, or any regulation thereunder, to meet and maintain a 
specific capital level for any capital measure.
    (2) Adequately capitalized if:
    (i) Total Risk-Based Capital Measure: the national bank or Federal 
savings association has a total risk-based capital ratio of 8.0 percent 
or greater;
    (ii) Tier 1 Risk-Based Capital Measure: the national bank or 
Federal savings association has a tier 1 risk-based capital ratio of 
6.0 percent or greater;
    (iii) Common Equity Tier 1 Capital Measure: the national bank or 
Federal savings association has a common equity tier 1 risk-based 
capital ratio of 4.5 percent or greater;
    (iv) Leverage Measure:
    (A) The national bank or Federal savings association has a leverage 
ratio of 4.0 percent or greater; and
    (B) With respect to an advanced approaches national bank or 
advanced approaches Federal savings association, on January 1, 2018 and 
thereafter, the national bank or Federal savings association has an 
supplementary leverage ratio of 3.0 percent or greater; and
    (v) The national bank or Federal savings association does not meet 
the definition of a ``well capitalized'' national bank or Federal 
savings association.
    (3) Undercapitalized if:
    (i) Total Risk-Based Capital Measure: the national bank or Federal 
savings association has a total risk-based capital ratio of less than 
8.0 percent;
    (ii) Tier 1 Risk-Based Capital Measure: the national bank or 
Federal savings association has a tier 1 risk-based capital ratio of 
less than 6.0 percent;
    (iii) Common Equity Tier 1 Capital Measure: the national bank or 
Federal savings association has a common equity tier 1 risk-based 
capital ratio of less than 4.5 percent; or
    (iv) Leverage Measure:
    (A) The national bank or Federal savings association has a leverage 
ratio of less than 4.0 percent; or
    (B) With respect to an advanced approaches national bank or 
advanced approaches Federal savings association, on January 1, 2018, 
and thereafter, the national bank or Federal savings association has a 
supplementary leverage ratio of less than 3.0 percent.
    (4) Significantly undercapitalized if:
    (i) Total Risk-Based Capital Measure: the national bank or Federal 
savings association has a total risk-based capital ratio of less than 
6.0 percent;
    (ii) Tier 1 Risk-Based Capital Measure: the national bank or 
Federal savings association has a tier 1 risk-based capital ratio of 
less than 4.0 percent;
    (iii) Common Equity Tier 1 Capital Measure: the national bank or 
Federal savings association has a common equity tier 1 risk-based 
capital ratio of less than 3.0 percent; or
    (iv) Leverage Ratio: the national bank or Federal savings 
association has a leverage ratio of less than 3.0 percent.
    (5) Critically undercapitalized if the national bank or Federal 
savings association has a ratio of tangible equity to total assets that 
is equal to or less than 2.0 percent.
    (d) Capital categories for insured Federal branches. For purposes 
of the provisions of section 38 of the FDI Act and this part, an 
insured Federal branch shall be deemed to be:
    (1) Well capitalized if the insured Federal branch:
    (i) Maintains the pledge of assets required under 12 CFR 347.209; 
and
    (ii) Maintains the eligible assets prescribed under 12 CFR 347.210 
at 108 percent or more of the preceding quarter's average book value of 
the insured branch's third-party liabilities; and
    (iii) Has not received written notification from:
    (A) The OCC to increase its capital equivalency deposit pursuant to 
Sec.  28.15 of this chapter, or to comply with asset maintenance 
requirements pursuant to Sec.  28.20 of this chapter; or
    (B) The FDIC to pledge additional assets pursuant to 12 CFR 347.209 
or to maintain a higher ratio of eligible assets pursuant to 12 CFR 
347.210.
    (2) Adequately capitalized if the insured Federal branch:
    (i) Maintains the pledge of assets prescribed under 12 CFR 347.209;
    (ii) Maintains the eligible assets prescribed under 12 CFR 347.210 
at 106 percent or more of the preceding quarter's average book value of 
the insured branch's third-party liabilities; and
    (iii) Does not meet the definition of a well capitalized insured 
Federal branch.
    (3) Undercapitalized if the insured Federal branch:
    (i) Fails to maintain the pledge of assets required under 12 CFR 
347.209; or
    (ii) Fails to maintain the eligible assets prescribed under 12 CFR 
347.210 at 106 percent or more of the preceding quarter's average book 
value of the insured branch's third-party liabilities.
    (4) Significantly undercapitalized if it fails to maintain the 
eligible assets prescribed under 12 CFR 347.210 at 104 percent or more 
of the preceding quarter's average book value of the insured Federal 
branch's third-party liabilities.
    (5) Critically undercapitalized if it fails to maintain the 
eligible assets prescribed under 12 CFR 347.210 at 102 percent or more 
of the preceding quarter's average book value of the insured Federal 
branch's third-party liabilities.
    (e) Reclassification based on supervisory criteria other than 
capital. The OCC may reclassify a well capitalized national bank or 
Federal savings association as adequately capitalized and may require 
an adequately capitalized or an undercapitalized national bank or 
Federal savings association to comply with certain mandatory or 
discretionary supervisory actions as if the national bank or Federal 
savings association were in the next lower capital category (except 
that the OCC may not reclassify a significantly undercapitalized 
national bank or Federal savings association as critically 
undercapitalized) (each of these actions are hereinafter referred to 
generally as reclassifications) in the following circumstances:
    (1) Unsafe or unsound condition. The OCC has determined, after 
notice and opportunity for hearing pursuant to subpart M of part 19 of 
this chapter with respect to national banks and Sec.  165.8 of this 
chapter with respect to Federal savings associations, that the national 
bank or Federal savings association is in unsafe or unsound condition; 
or
    (2) Unsafe or unsound practice. The OCC has determined, after 
notice and opportunity for hearing pursuant to subpart M of part 19 of 
this chapter with respect to national banks and Sec.  165.8 of this 
chapter with respect to Federal savings associations, that in the most 
recent examination of the national bank or Federal savings association, 
the national bank or Federal savings association received, and has not 
corrected a less-than-satisfactory rating for any of the categories of 
asset quality, management, earnings, or liquidity.


Sec.  6.5  Capital restoration plan.

    (a) Schedule for filing plan--(1) In general. A national bank or 
Federal savings association shall file a written capital restoration 
plan with the OCC within 45 days of the date that the national bank or 
Federal savings association receives notice or is deemed to have notice 
that the national bank or Federal savings association is 
undercapitalized, significantly undercapitalized, or critically 
undercapitalized, unless the OCC notifies the national bank or Federal 
savings association in writing that the plan is to be filed within a 
different period. An adequately capitalized national bank or Federal 
savings

[[Page 62279]]

association that has been required, pursuant to Sec.  6.4 and subpart M 
of part 19 of this chapter with respect to national banks, and 
Sec. Sec.  6.4 and 165.8 of this chapter with respect to Federal 
savings associations, to comply with supervisory actions as if the 
national bank or Federal savings association were undercapitalized is 
not required to submit a capital restoration plan solely by virtue of 
the reclassification.
    (2) Additional capital restoration plans. Notwithstanding paragraph 
(a)(1) of this section, a national bank or Federal savings association 
that has already submitted and is operating under a capital restoration 
plan approved under section 38 and this subpart is not required to 
submit an additional capital restoration plan based on a revised 
calculation of its capital measures or a reclassification of the 
institution pursuant to Sec.  6.4 and subpart M of part 19 of this 
chapter with respect to national banks and Sec. Sec.  6.4 and 165.8 of 
this chapter with respect to Federal savings associations, unless the 
OCC notifies the national bank or Federal savings association that it 
must submit a new or revised capital plan. A national bank or Federal 
savings association that is notified that it must submit a new or 
revised capital restoration plan shall file the plan in writing with 
the OCC within 45 days of receiving such notice, unless the OCC 
notifies the national bank or Federal savings association in writing 
that the plan must be filed within a different period.
    (b) Contents of plan. All financial data submitted in connection 
with a capital restoration plan shall be prepared in accordance with 
the instructions provided on the Call Report, unless the OCC instructs 
otherwise. The capital restoration plan shall include all of the 
information required to be filed under section 38(e)(2) of the FDI Act. 
A national bank or Federal savings association that is required to 
submit a capital restoration plan as the result of a reclassification 
of the national bank or Federal savings association, pursuant to Sec.  
6.4 and subpart M of part 19 of this chapter with respect to national 
banks, and Sec. Sec.  6.4 and 165.8 of this chapter with respect to 
Federal savings associations, shall include a description of the steps 
the national bank or Federal savings association will take to correct 
the unsafe or unsound condition or practice. No plan shall be accepted 
unless it includes any performance guarantee described in section 
38(e)(2)(C) of that Act by each company that controls the national bank 
or Federal savings association.
    (c) Review of capital restoration plans. Within 60 days after 
receiving a capital restoration plan under this subpart, the OCC shall 
provide written notice to the national bank or Federal savings 
association of whether the plan has been approved. The OCC may extend 
the time within which notice regarding approval of a plan shall be 
provided.
    (d) Disapproval of capital restoration plan. If a capital 
restoration plan is not approved by the OCC, the national bank or 
Federal savings association shall submit a revised capital restoration 
plan within the time specified by the OCC. Upon receiving notice that 
its capital restoration plan has not been approved, any 
undercapitalized national bank or Federal savings association (as 
defined in Sec.  6.4) shall be subject to all of the provisions of 
section 38 and this part applicable to significantly undercapitalized 
institutions. These provisions shall be applicable until such time as a 
new or revised capital restoration plan submitted by the national bank 
or Federal savings association has been approved by the OCC.
    (e) Failure to submit a capital restoration plan. A national bank 
or Federal savings association that is undercapitalized (as defined in 
Sec.  6.4) and that fails to submit a written capital restoration plan 
within the period provided in this section shall, upon the expiration 
of that period, be subject to all of the provisions of section 38 and 
this part applicable to significantly undercapitalized national banks 
or Federal savings associations.
    (f) Failure to implement a capital restoration plan. Any 
undercapitalized national bank or Federal savings association that 
fails, in any material respect, to implement a capital restoration plan 
shall be subject to all of the provisions of section 38 and this part 
applicable to significantly undercapitalized national banks or Federal 
savings associations.
    (g) Amendment of capital restoration plan. A national bank or 
Federal savings association that has submitted an approved capital 
restoration plan may, after prior written notice to and approval by the 
OCC, amend the plan to reflect a change in circumstance. Until such 
time as a proposed amendment has been approved, the national bank or 
Federal savings association shall implement the capital restoration 
plan as approved prior to the proposed amendment.
    (h) Notice to FDIC. Within 45 days of the effective date of OCC 
approval of a capital restoration plan, or any amendment to a capital 
restoration plan, the OCC shall provide a copy of the plan or amendment 
to the Federal Deposit Insurance Corporation.
    (i) Performance guarantee by companies that control a national bank 
or Federal savings association--(1) Limitation on liability--(i) Amount 
limitation. The aggregate liability under the guarantee provided under 
section 38 and this subpart for all companies that control a specific 
national bank or Federal savings association that is required to submit 
a capital restoration plan under this subpart shall be limited to the 
lesser of:
    (A) An amount equal to 5.0 percent of the national bank's or 
Federal savings association's total assets at the time the national 
bank or Federal savings association was notified or deemed to have 
notice that the national bank or Federal savings association was 
undercapitalized; or
    (B) The amount necessary to restore the relevant capital measures 
of the national bank or Federal savings association to the levels 
required for the national bank or Federal savings association to be 
classified as adequately capitalized, as those capital measures and 
levels are defined at the time that the national bank or Federal 
savings association initially fails to comply with a capital 
restoration plan under this subpart.
    (ii) Limit on duration. The guarantee and limit of liability under 
section 38 and this subpart shall expire after the OCC notifies the 
national bank or Federal savings association that it has remained 
adequately capitalized for each of four consecutive calendar quarters. 
The expiration or fulfillment by a company of a guarantee of a capital 
restoration plan shall not limit the liability of the company under any 
guarantee required or provided in connection with any capital 
restoration plan filed by the same national bank or Federal savings 
association after expiration of the first guarantee.
    (iii) Collection on guarantee. Each company that controls a given 
national bank or Federal savings association shall be jointly and 
severally liable for the guarantee for such national bank or Federal 
savings association as required under section 38 and this subpart, and 
the OCC may require payment of the full amount of that guarantee from 
any or all of the companies issuing the guarantee.
    (2) Failure to provide guarantee. In the event that a national bank 
or Federal savings association that is controlled by any company 
submits a capital restoration plan that does not contain the guarantee 
required under section 38(e)(2) of the FDI Act, the national bank or 
Federal savings association shall, upon submission of the plan, be 
subject to the provisions of section 38 and this part that are 
applicable to

[[Page 62280]]

national banks or Federal savings associations that have not submitted 
an acceptable capital restoration plan.
    (3) Failure to perform guarantee. Failure by any company that 
controls a national bank or Federal savings association to perform 
fully its guarantee of any capital plan shall constitute a material 
failure to implement the plan for purposes of section 38(f) of the FDI 
Act. Upon such failure, the national bank or Federal savings 
association shall be subject to the provisions of section 38 and this 
part that are applicable to national banks or Federal savings 
associations that have failed in a material respect to implement a 
capital restoration plan.
    (j) Enforcement of capital restoration plan. The failure of a 
national bank or Federal savings association to implement, in any 
material respect, a capital restoration plan required under section 38 
and this section shall subject the national bank or Federal savings 
association to the assessment of civil money penalties pursuant to 
section 8(i)(2)(A) of the FDI Act.


Sec.  6.6  Mandatory and discretionary supervisory actions.

    (a) Mandatory supervisory actions--(1) Provisions applicable to all 
national banks and Federal savings associations. All national banks and 
Federal savings associations are subject to the restrictions contained 
in section 38(d) of the FDI Act on payment of distributions and 
management fees.
    (2) Provisions applicable to undercapitalized, significantly 
undercapitalized, and critically undercapitalized national banks or 
Federal savings associations. Immediately upon receiving notice or 
being deemed to have notice, as provided in Sec.  6.3, that the 
national bank or Federal savings association is undercapitalized, 
significantly undercapitalized, or critically undercapitalized, the 
national bank or Federal savings association shall become subject to 
the provisions of section 38 of the FDI Act:
    (i) Restricting payment of distributions and management fees 
(section 38(d));
    (ii) Requiring that the OCC monitor the condition of the national 
bank or Federal savings association (section 38(e)(1));
    (iii) Requiring submission of a capital restoration plan within the 
schedule established in this subpart (section 38(e)(2));
    (iv) Restricting the growth of the national bank's or Federal 
savings association's assets (section 38(e)(3)); and
    (v) Requiring prior approval of certain expansion proposals 
(section 38(e)(4)).
    (3) Additional provisions applicable to significantly 
undercapitalized, and critically undercapitalized national banks or 
Federal savings associations. In addition to the provisions of section 
38 of the FDI Act described in paragraph (a)(2) of this section, 
immediately upon receiving notice or being deemed to have notice, as 
provided in this subpart, that the national bank or Federal savings 
association is significantly undercapitalized, or critically 
undercapitalized, or that the national bank or Federal savings 
association is subject to the provisions applicable to institutions 
that are significantly undercapitalized because it has failed to submit 
or implement, in any material respect, an acceptable capital 
restoration plan, the national bank or Federal savings association 
shall become subject to the provisions of section 38 of the FDI Act 
that restrict compensation paid to senior executive officers of the 
institution (section 38(f)(4)).
    (4) Additional provisions applicable to critically undercapitalized 
national banks or Federal savings associations. In addition to the 
provisions of section 38 of the FDI Act described in paragraphs (a)(2) 
and (3) of this section, immediately upon receiving notice or being 
deemed to have notice, as provided in Sec.  6.3, that the national bank 
or Federal savings association is critically undercapitalized, the 
national bank or Federal savings association shall become subject to 
the provisions of section 38 of the FDI Act:
    (i) Restricting the activities of the national bank or Federal 
savings association (section 38 (h)(1)); and
    (ii) Restricting payments on subordinated debt of the national bank 
or Federal savings association (section 38 (h)(2)).
    (b) Discretionary supervisory actions. In taking any action under 
section 38 that is within the OCC's discretion to take in connection 
with a national bank or Federal savings association that is deemed to 
be undercapitalized, significantly undercapitalized, or critically 
undercapitalized, or has been reclassified as undercapitalized or 
significantly undercapitalized; an officer or director of such national 
bank or Federal savings association; or a company that controls such 
national bank or Federal savings association, the OCC shall follow the 
procedures for issuing directives under subpart B of this part and 
subpart N of part 19 of this chapter with respect to national banks and 
subpart B of this part and Sec.  165.9 of this chapter with respect to 
Federal savings associations, unless otherwise provided in section 38 
of the FDI Act or this part.

Subpart B--Directives To Take Prompt Corrective Action


Sec.  6.20  Scope.

    The rules and procedures set forth in this subpart apply to insured 
national banks, insured Federal branches, Federal savings associations, 
and senior executive officers and directors of national banks and 
Federal savings associations that are subject to the provisions of 
section 38 of the Federal Deposit Insurance Act (section 38) and 
subpart A of this part.


Sec.  6.21  Notice of intent to issue a directive.

    (a) Notice of intent to issue a directive--(1) In general. The OCC 
shall provide an undercapitalized, significantly undercapitalized, or 
critically undercapitalized national bank or Federal savings 
association prior written notice of the OCC's intention to issue a 
directive requiring such national bank, Federal savings association, or 
company to take actions or to follow proscriptions described in section 
38 that are within the OCC's discretion to require or impose under 
section 38 of the FDI Act, including section 38(e)(5), (f)(2), (f)(3), 
or (f)(5). The national bank or Federal savings association shall have 
such time to respond to a proposed directive as provided under Sec.  
6.22.
    (2) Immediate issuance of final directive. If the OCC finds it 
necessary in order to carry out the purposes of section 38 of the FDI 
Act, the OCC may, without providing the notice prescribed in paragraph 
(a)(1) of this section, issue a directive requiring a national bank or 
Federal savings association immediately to take actions or to follow 
proscriptions described in section 38 that are within the OCC's 
discretion to require or impose under section 38 of the FDI Act, 
including section 38(e)(5), (f)(2), (f)(3), or (f)(5). A national bank 
or Federal savings association that is subject to such an immediately 
effective directive may submit a written appeal of the directive to the 
OCC. Such an appeal must be received by the OCC within 14 calendar days 
of the issuance of the directive, unless the OCC permits a longer 
period. The OCC shall consider any such appeal, if filed in a timely 
matter, within 60 days of receiving the appeal. During such period of 
review, the directive shall remain in effect unless the OCC, in its 
sole discretion, stays the effectiveness of the directive.
    (b) Contents of notice. A notice of intention to issue a directive 
shall include:

[[Page 62281]]

    (1) A statement of the national bank's or Federal savings 
association's capital measures and capital levels;
    (2) A description of the restrictions, prohibitions or affirmative 
actions that the OCC proposes to impose or require;
    (3) The proposed date when such restrictions or prohibitions would 
be effective or the proposed date for completion of such affirmative 
actions; and
    (4) The date by which the national bank or Federal savings 
association subject to the directive may file with the OCC a written 
response to the notice.


Sec.  6.22  Response to notice.

    (a) Time for response. A national bank or Federal savings 
association may file a written response to a notice of intent to issue 
a directive within the time period set by the OCC. The date shall be at 
least 14 calendar days from the date of the notice unless the OCC 
determines that a shorter period is appropriate in light of the 
financial condition of the national bank or Federal savings association 
or other relevant circumstances.
    (b) Content of response. The response should include:
    (1) An explanation why the action proposed by the OCC is not an 
appropriate exercise of discretion under section 38;
    (2) Any recommended modification of the proposed directive; and
    (3) Any other relevant information, mitigating circumstances, 
documentation, or other evidence in support of the position of the 
national bank or Federal savings association regarding the proposed 
directive.
    (c) Failure to file response. Failure by a national bank or Federal 
savings association to file with the OCC, within the specified time 
period, a written response to a proposed directive shall constitute a 
waiver of the opportunity to respond and shall constitute consent to 
the issuance of the directive.


Sec.  6.23  Decision and issuance of a prompt corrective action 
directive.

    (a) OCC consideration of response. After considering the response, 
the OCC may:
    (1) Issue the directive as proposed or in modified form;
    (2) Determine not to issue the directive and so notify the national 
bank or Federal savings association; or
    (3) Seek additional information or clarification of the response 
from the national bank or Federal savings association, or any other 
relevant source.
    (b) [Reserved]


Sec.  6.24  Request for modification or rescission of directive.

    Any national bank or Federal savings association that is subject to 
a directive under this subpart may, upon a change in circumstances, 
request in writing that the OCC reconsider the terms of the directive, 
and may propose that the directive be rescinded or modified. Unless 
otherwise ordered by the OCC, the directive shall continue in place 
while such request is pending before the OCC.


Sec.  6.25  Enforcement of directive.

    (a) Judicial remedies. Whenever a national bank or Federal savings 
association fails to comply with a directive issued under section 38, 
the OCC may seek enforcement of the directive in the appropriate United 
States district court pursuant to section 8(i)(1) of the FDI Act.
    (b) Administrative remedies. Pursuant to section 8(i)(2)(A) of the 
FDI Act, the OCC may assess a civil money penalty against any national 
bank or Federal savings association that violates or otherwise fails to 
comply with any final directive issued under section 38 and against any 
institution-affiliated party who participates in such violation or 
noncompliance.
    (c) Other enforcement action. In addition to the actions described 
in paragraphs (a) and (b) of this section, the OCC may seek enforcement 
of the provisions of section 38 or this part through any other judicial 
or administrative proceeding authorized by law.

PART 165--PROMPT CORRECTIVE ACTION

0
23. The authority citation for part 165 continues to read as follows:

    Authority: 12 U.S.C. 1831o, 5412(b)(2)(B).


Sec. Sec.  165.1 through 165.7   [Removed and Reserved]

0
24. Sections 165.1 through 165.7 are removed and reserved.


Sec.  165.8  [Amended]

0
25. Section 165.8 is amended in paragraphs (a)(1)(i)(A) introductory 
text and (a)(1)(ii) by removing the phrases ``Sec.  165.4(c) of this 
part'' and ``Sec.  165.4(c)(1)'' respectively, and adding in their 
place the phrase ``12 CFR 6.4(d)''.


Sec.  165.9  [Amended]

0
26a. Section 165.9(a) is amended by removing ``section 165.7'' and 
adding in its place ``subpart B of part 6 of this chapter''.


Sec.  165.10  [Removed and Reserved]

0
26b. Section 165.10 is removed and reserved.

PART 167--CAPITAL

0
27. The authority citation for part 167 continues to read as follows:

    Authority:  12 U.S.C. 1462, 1462a, 1463, 1464, 1467a, 1828 
(note), 5412(b)(2)(B).

Appendix C to Part 167 [REMOVED]

0
28. Under the authority of 12 U.S.C. 93a and 5412(b)(2)(B), Appendix C 
to part 167 is removed.

Board of Governors of the Federal Reserve System

12 CFR CHAPTER II

Authority and Issuance

    For the reasons set forth in the common preamble, parts 208, 217, 
and 225 of chapter II of title 12 of the Code of Federal Regulations 
are amended as follows:

PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL 
RESERVE SYSTEM (REGULATION H)

0
29. The authority citation for part 208 is revised to read as follows:

    Authority:  12 U.S.C. 24, 36, 92a, 93a, 248(a), 248(c), 321-
338a, 371d, 461, 481-486, 601, 611, 1814, 1816, 1818, 1820(d)(9), 
1833(j), 1828(o), 1831, 1831o, 1831p-1, 1831r-1, 1831w, 1831x, 
1835a, 1882, 2901-2907, 3105, 3310, 3331-3351, 3905-3909, and 5371; 
15 U.S.C. 78b, 78I(b), 78l(i), 780-4(c)(5), 78q, 78q-1, and 78w, 
1681s, 1681w, 6801, and 6805; 31 U.S.C. 5318; 42 U.S.C. 4012a, 
4104a, 4104b, 4106 and 4128.

Subpart A--General Membership and Branching Requirements

0
29a. In Sec.  208.2, revise paragraph (d) to read as follows:


Sec.  208.2  Definitions.

* * * * *
    (d) Capital stock and surplus means, unless otherwise provided in 
this part, or by statute, tier 1 and tier 2 capital included in a 
member bank's risk-based capital (as defined in Sec.  217.2 of 
Regulation Q) and the balance of a member bank's allowance for loan and 
lease losses not included in its tier 2 capital for calculation of 
risk-based capital, based on the bank's most recent Report of Condition 
and Income filed under 12 U.S.C. 324.\2\
---------------------------------------------------------------------------

    \2\ Before January 1, 2015, capital stock and surplus for a 
member bank that is not an advanced approaches bank (as defined in 
Sec.  208.41) means unless otherwise provided in this part, or by 
statute, tier 1 and tier 2 capital included in a member bank's risk-
based capital (under the guidelines in appendix A of this part) and 
the balance of a member bank's allowance for loan and lease losses 
not included in its tier 2 capital for calculation of risk-based 
capital, based on the bank's most recent consolidated Report of 
Condition and Income filed under 12 U.S.C. 324.
---------------------------------------------------------------------------

* * * * *

[[Page 62282]]

Sec.  208.3  [Amended]

0
29b. In Sec.  208.3 (a), redesignate footnote 2 as footnote 3:

0
29c. Revise Sec.  208.4 to read as follows:


Sec.  208.4  Capital adequacy.

    (a) Adequacy. A member bank's capital, calculated in accordance 
with part 217, shall be at all times adequate in relation to the 
character and condition liabilities and other corporate 
responsibilities.\4\ If at any time, in light of all the circumstances, 
the bank's capital appears inadequate in relation to its assets, 
liabilities, and responsibilities, the bank shall increase the amount 
of its capital, within such period as the Board deems reasonable, to an 
amount which, in the judgment of the Board, shall be adequate.
---------------------------------------------------------------------------

    \4\ Before January 1, 2015, the capital of a member bank that is 
not an advanced approaches bank (as defined in Sec.  208.41) is 
calculated in accordance with appendices A, B, and E to this part, 
as applicable.
---------------------------------------------------------------------------

    (b) Standards for evaluating capital adequacy. Standards and 
measures, by which the Board evaluates the capital adequacy of member 
banks for risk-based capital purposes and for leverage measurement 
purposes, are located in part 217 of this chapter.\5\
---------------------------------------------------------------------------

    \5\ Before January 1, 2015, the standards and measures by which 
the Board evaluates the capital adequacy of member banks that are 
not advanced approaches banks (as defined in Sec.  208.41) for risk-
based capital purposes and for leverage measurement purposes are 
located in appendices A, B, and E to this part, as applicable.
---------------------------------------------------------------------------


Sec.  208.5  [Amended]

0
29d. In Sec.  208.5. redesignate footnotes 3 and 4 as footnotes 6 and 7 
respectively.

Subpart B--Investments and Loans


Sec.  208.21  [Amended]

0
29e. In Sec.  208.21,redesignate footnote 5 as footnote 8.

0
29f. In Sec.  208.23, revise paragraph (c) to read as follows:


Sec.  208.23  Agricultural loan loss amortization.

* * * * *
    (c) Accounting for amortization. Any bank that is permitted to 
amortize losses in accordance with paragraph (b) of this section may 
restate its capital and other relevant accounts and account for future 
authorized deferrals and authorization in accordance with the 
instructions to the FFIEC Consolidated Reports of Condition and Income. 
Any resulting increase in the capital account shall be included in 
capital pursuant to part 217 of this chapter.
* * * * *


Sec.  208.24  [Amended]

0
29g. In Sec.  208.24(a)(3), redesignate footnote 6 as footnote 9.

Subpart D--Prompt Corrective Action

0
30-31. Add paragraph (e) to Sec.  208.40 to read as follows:


Sec.  208.40  Authority, purpose, scope, other supervisory authority, 
and disclosure of capital categories.

* * * * *
    (e) Transition procedures--(1) Definitions applicable before 
January 1, 2015, for certain banks. Before January 1, 2015, 
notwithstanding any other requirement in this subpart and with respect 
to any bank that is not an advanced approaches bank:
    (i) The definitions of leverage ratio, tier 1 capital, tier 1 risk-
based capital, and total risk-based capital as calculated or defined 
under Appendix A to this part or Appendix B to this part, as 
applicable, remain in effect for purposes of this subpart;
    (ii) The definition of total assets means quarterly average total 
assets as reported in a bank's Report of Condition and Income (Call 
Report), minus all intangible assets except mortgage servicing assets 
to the extent that the Federal Reserve determines that mortgage 
servicing assets may be included in calculating the bank's tier 1 
capital. At its discretion the Federal Reserve may calculate total 
assets using a bank's period-end assets rather than quarterly average 
assets; and
    (iii) The definition of tangible equity of a member bank that is 
not an advanced approaches bank is the amount of core capital elements 
as defined in appendix A to this part, plus the amount of outstanding 
cumulative perpetual preferred stock (including related surplus) minus 
all intangible assets except mortgage servicing assets to the extent 
that the Board determines that mortgage servicing assets may be 
included in calculating the bank's tier 1 capital, as calculated in 
accordance with Appendix A to this part.
    (2) Timing. The calculation of the definitions of common equity 
tier 1 capital, the common equity tier 1 risk-based capital ratio, the 
leverage ratio, the supplementary leverage ratio, tangible equity, tier 
1 capital, the tier 1 risk-based capital ratio, total assets, total 
leverage exposure, the total risk-based capital ratio, and total risk-
weighted assets under this subpart is subject to the timing provisions 
at 12 CFR 217.1(f) and the transitions at 12 CFR part 217, subpart G.

0
32. Revise Sec.  208.41 to read as follows:


Sec.  208.41  Definitions for purposes of this subpart.

    For purposes of this subpart, except as modified in this section or 
unless the context otherwise requires, the terms used have the same 
meanings as set forth in section 38 and section 3 of the FDI Act.
    (a) Advanced approaches bank means a bank that is described in 
Sec.  217.100(b)(1) of Regulation Q (12 CFR 217.100(b)(1)).
    (b) Bank means an insured depository institution as defined in 
section 3 of the FDI Act (12 U.S.C. 1813).
    (c) Common equity tier 1 capital means the amount of capital as 
defined in Sec.  217.2 of Regulation Q (12 CFR 217.2).
    (d) Common equity tier 1 risk-based capital ratio means the ratio 
of common equity tier 1 capital to total risk-weighted assets, as 
calculated in accordance with Sec.  217.10(b)(1) or Sec.  217.10(c)(1) 
of Regulation Q (12 CFR 217.10(b)(1), 12 CFR 217.10(c)(1)), as 
applicable.
    (e) Control--(1) Control has the same meaning assigned to it in 
section 2 of the Bank Holding Company Act (12 U.S.C. 1841), and the 
term controlled shall be construed consistently with the term control.
    (2) Exclusion for fiduciary ownership. No insured depository 
institution or company controls another insured depository institution 
or company by virtue of its ownership or control of shares in a 
fiduciary capacity. Shares shall not be deemed to have been acquired in 
a fiduciary capacity if the acquiring insured depository institution or 
company has sole discretionary authority to exercise voting rights with 
respect to the shares.
    (3) Exclusion for debts previously contracted. No insured 
depository institution or company controls another insured depository 
institution or company by virtue of its ownership or control of shares 
acquired in securing or collecting a debt previously contracted in good 
faith, until two years after the date of acquisition. The two-year 
period may be extended at the discretion of the appropriate Federal 
banking agency for up to three one-year periods.
    (f) Controlling person means any person having control of an 
insured depository institution and any company controlled by that 
person.

[[Page 62283]]

    (g) Leverage ratio means the ratio of tier 1 capital to average 
total consolidated assets, as calculated in accordance with Sec.  
217.10 of Regulation Q (12 CFR 217.10).\10\
---------------------------------------------------------------------------

    \10\ Before January 1, 2015, the leverage ratio of a member bank 
that is not an advanced approaches bank is the ratio of tier 1 
capital to average total consolidated assets, as calculated in 
accordance with Appendix B to this part.
---------------------------------------------------------------------------

    (h) Management fee means any payment of money or provision of any 
other thing of value to a company or individual for the provision of 
management services or advice to the bank, or related overhead 
expenses, including payments related to supervisory, executive, 
managerial, or policy making functions, other than compensation to an 
individual in the individual's capacity as an officer or employee of 
the bank.
    (i) Supplementary leverage ratio means the ratio of tier 1 capital 
to total leverage exposure, as calculated in accordance with Sec.  
217.10 of Regulation Q (12 CFR 217.10).
    (j) Tangible equity means the amount of tier 1 capital, plus the 
amount of outstanding perpetual preferred stock (including related 
surplus) not included in tier 1 capital.\11\
---------------------------------------------------------------------------

    \11\ Before January 1, 2015, the tangible equity of a member 
bank that is not an advanced approaches bank is the amount of core 
capital elements as defined in appendix A to this part, plus the 
amount of outstanding cumulative perpetual preferred stock 
(including related surplus) minus all intangible assets except 
mortgage servicing assets to the extent that the Board determines 
that mortgage servicing assets may be included in calculating the 
bank's tier 1 capital, as calculated in accordance with Appendix A 
to this part.
---------------------------------------------------------------------------

    (k) Tier 1 capital means the amount of capital as defined in Sec.  
217.20 of Regulation Q (12 CFR 217.20).\12\
---------------------------------------------------------------------------

    \12\ Before January 1, 2015, the tier 1 capital of a member bank 
that is not an advanced approaches bank (as defined in Sec.  208.41) 
is calculated in accordance with Appendix A to this part.
---------------------------------------------------------------------------

    (l) Tier 1 risk-based capital ratio means the ratio of tier 1 
capital to total risk-weighted assets, as calculated in accordance with 
Sec.  217.10(b)(2) or Sec.  217.10(c)(2) of Regulation Q (12 CFR 
217.10(b)(2), 12 CFR 217.10(c)(2)), as applicable.\13\
---------------------------------------------------------------------------

    \13\ Before January 1, 2015, the tier 1 risk-based capital ratio 
of a member bank that is not an advanced approaches bank (as defined 
in Sec.  208.41) is calculated in accordance with Appendix A to this 
part.
---------------------------------------------------------------------------

    (m) Total assets means quarterly average total assets as reported 
in a bank's Call Report, minus items deducted from tier 1 capital. At 
its discretion the Federal Reserve may calculate total assets using a 
bank's period-end assets rather than quarterly average assets.\14\
---------------------------------------------------------------------------

    \14\ Before January 1, 2015, total assets means, for a member 
bank that is not an advanced approaches bank (as defined in Sec.  
208.41), quarterly average total assets as reported in a bank's Call 
Report, minus all intangible assets except mortgage servicing assets 
to the extent that the Federal Reserve determines that mortgage 
servicing assets may be included in calculating the bank's tier 1 
capital. At its discretion the Federal Reserve may calculate total 
assets using a bank's period-end assets rather than quarterly 
average assets.
---------------------------------------------------------------------------

    (n) Total leverage exposure means the total leverage exposure, as 
calculated in accordance with Sec.  217.11 of Regulation Q (12 CFR 
217.11).
    (o) Total risk-based capital ratio means the ratio of total capital 
to total risk-weighted assets, as calculated in accordance with Sec.  
217.10(b)(3) or Sec.  217.10(c)(3) of Regulation Q (12 CFR 
217.10(b)(3), 12 CFR 217.10(c)(3)), as applicable.\15\
---------------------------------------------------------------------------

    \15\ Before January 1, 2015, the total risk-based capital ratio 
of a member bank that is not an advanced approaches bank (as defined 
in Sec.  208.41) is calculated in accordance with appendix A to this 
part.
---------------------------------------------------------------------------

    (p) Total risk-weighted assets means standardized total risk-
weighted assets, and for an advanced approaches bank also includes 
advanced approaches total risk-weighted assets, as defined in Sec.  
217.2 of Regulation Q (12 CFR 217.2).

0
33. In Sec.  208.43, revise paragraphs (a) and (b), redesignate 
paragraph (c) as paragraph (d), and add a new paragraph (c) to read as 
follows:


Sec.  208.43  Capital measures and capital category definitions.

    (a) Capital measures. (1) Capital measures applicable before 
January 1, 2015. On or before December 31, 2014, for purposes of 
section 38 and this subpart, the relevant capital measures for all 
banks are:
    (i) Total Risk-Based Capital Measure: the total risk-based capital 
ratio;
    (ii) Tier 1 Risk-Based Capital Measure: the tier 1 risk-based 
capital ratio; and
    (iii) Leverage Measure: the leverage ratio.
    (2) Capital measures applicable after January 1, 2015. On January 
1, 2015, and thereafter, for purposes of section 38 and this subpart, 
the relevant capital measures are:
    (i) Total Risk-Based Capital Measure: The total risk-based capital 
ratio;
    (ii) Tier 1 Risk-Based Capital Measure: the tier 1 risk-based 
capital ratio;
    (iii) Common Equity Tier 1 Capital Measure: the common equity tier 
1 risk-based capital ratio; and
    (iv) Leverage Measure:
    (A) The leverage ratio, and
    (B) With respect to an advanced approaches bank, on January 1, 
2018, and thereafter, the supplementary leverage ratio.
    (b) Capital categories applicable before January 1, 2015. On or 
before December 31, 2014, for purposes of section 38 of the FDI Act and 
this subpart, a member bank is deemed to be:
    (1) ``Well capitalized'' if:
    (i) Total Risk-Based Capital Measure: the bank has a total risk-
based capital ratio of 10.0 percent or greater;
    (ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-
based capital ratio of 6.0 percent or greater;
    (iii) Leverage Measure: the bank has a leverage ratio of 5.0 
percent or greater; and
    (iv) The bank is not subject to any written agreement, order, 
capital directive, or prompt corrective action directive issued by the 
Board pursuant to section 8 of the FDI Act, the International Lending 
Supervision Act of 1983 (12 U.S.C. 3907), or section 38 of the FDI Act, 
or any regulation thereunder, to meet and maintain a specific capital 
level for any capital measure.
    (2) ``Adequately capitalized'' if:
    (i) Total Risk-Based Capital Measure: the bank has a total risk-
based capital ratio of 8.0 percent or greater;
    (ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-
based capital ratio of 4.0 percent or greater;
    (iii) Leverage Measure:
    (A) The bank has a leverage ratio of 4.0 percent or greater; or
    (B) The bank has a leverage ratio of 3.0 percent or greater if the 
bank is rated composite 1 under the CAMELS rating system in the most 
recent examination of the bank and is not experiencing or anticipating 
any significant growth; and
    (iv) Does not meet the definition of a ``well capitalized'' bank.
    (3) ``Undercapitalized'' if:
    (i) Total Risk-Based Capital Measure: the bank has a total risk-
based capital ratio of less than 8.0 percent;
    (ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-
based capital ratio of less than 4.0 percent; or
    (iii) Leverage Measure:
    (A) Except as provided in paragraph (b)(2)(iii)(B) of this section, 
the bank has a leverage ratio of less than 4.0 percent; or
    (B) The bank has a leverage ratio of less than 3.0 percent, if the 
bank is rated composite 1 under the CAMELS rating system in the most 
recent examination of the bank and is not experiencing or anticipating 
significant growth.
    (4) ``Significantly undercapitalized'' if:
    (i) Total Risk-Based Capital Measure: the bank has a total risk-
based capital ratio of less than 6.0 percent; or
    (ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-
based capital ratio of less than 3.0 percent; or
    (iii) Leverage Measure: the bank has a leverage ratio of less than 
3.0 percent.

[[Page 62284]]

    (5) ``Critically undercapitalized'' if the bank has a ratio of 
tangible equity to total assets that is equal to or less than 2.0 
percent.
    (c) Capital categories applicable to advanced approaches banks and 
to all member banks on and after January 1, 2015. On January 1, 2015, 
and thereafter, for purposes of section 38 and this subpart, a member 
bank is deemed to be:
    (1) ``Well capitalized'' if:
    (i) Total Risk-Based Capital Measure: the bank has a total risk-
based capital ratio of 10.0 percent or greater;
    (ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-
based capital ratio of 8.0 percent or greater;
    (iii) Common Equity Tier 1 Capital Measure: the bank has a common 
equity tier 1 risk-based capital ratio of 6.5 percent or greater;
    (iv) Leverage Measure: the bank has a leverage ratio of 5.0 or 
greater; and
    (v) The bank is not subject to any written agreement, order, 
capital directive, or prompt corrective action directive issued by the 
Board pursuant to section 8 of the FDI Act, the International Lending 
Supervision Act of 1983 (12 U.S.C. 3907), or section 38 of the FDI Act, 
or any regulation thereunder, to meet and maintain a specific capital 
level for any capital measure.
    (2) ``Adequately capitalized'' if:
    (i) Total Risk-Based Capital Measure: the bank has a total risk-
based capital ratio of 8.0 percent or greater;
    (ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-
based capital ratio of 6.0 percent or greater;
    (iii) Common Equity Tier 1 Capital Measure: the bank has a common 
equity tier 1 risk-based capital ratio of 4.5 percent or greater;
    (iv) Leverage Measure:
    (A) The bank has a leverage ratio of 4.0 percent or greater; and
    (B) With respect to an advanced approaches bank, on January 1, 
2018, and thereafter, the bank has a supplementary leverage ratio of 
3.0 percent or greater; and
    (v) The bank does not meet the definition of a ``well capitalized'' 
bank.
    (3) ``Undercapitalized'' if:
    (i) Total Risk-Based Capital Measure: the bank has a total risk-
based capital ratio of less than 8.0 percent;
    (ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-
based capital ratio of less than 6.0 percent;
    (iii) Common Equity Tier 1 Capital Measure: the bank has a common 
equity tier 1 risk-based capital ratio of less than 4.5 percent; or
    (iv) Leverage Measure:
    (A) The bank has a leverage ratio of less than 4.0 percent; or
    (B) With respect to an advanced approaches bank, on January 1, 
2018, and thereafter, the bank has a supplementary leverage ratio of 
less than 3.0 percent.
    (4) ``Significantly undercapitalized'' if:
    (i) Total Risk-Based Capital Measure: the bank has a total risk-
based capital ratio of less than 6.0 percent;
    (ii) Tier 1 Risk-Based Capital Measure: the bank has a tier 1 risk-
based capital ratio of less than 4.0 percent;
    (iii) Common Equity Tier 1 Capital Measure: the bank has a common 
equity tier 1 risk-based capital ratio of less than 3.0 percent; or
    (iv) Leverage Measure: the bank has a leverage ratio of less than 
3.0 percent.
    (5) ``Critically undercapitalized'' if the bank has a ratio of 
tangible equity to total assets that is equal to or less than 2.0 
percent.
* * * * *

Subpart G--Financial Subsidiaries of State Member Banks

0
34-35. In Sec.  208.73:
0
A. Revise the heading in paragraph (a).
0
B. Redesignate paragraphs (b) through (e) as paragraphs (c) through 
(f); and add new paragraph (b).
    The revision and addition read as follows:


Sec.  208.73  What additional provisions are applicable to state member 
banks with financial subsidiaries?

    (a) Capital deduction required prior to January 1, 2015, for state 
member banks that are not advanced approaches banks (as defined in 
Sec.  208.41). * * *
    (b) Capital requirements for advanced approaches banks (as defined 
in Sec.  208.41) and, after January 1, 2015, all state member banks. 
Beginning on January 1, 2014, for a state member bank that is an 
advanced approaches bank, and beginning on January 1, 2015 for all 
state member banks, a state member bank that controls or holds an 
interest in a financial subsidiary must comply with the rules set forth 
in Sec.  217.22(a)(7) of Regulation Q (12 CFR 217.22(a)(7)) in 
determining its compliance with applicable regulatory capital standards 
(including the well capitalized standard of Sec.  208.71(a)(1)).
* * * * *


Sec.  208.77  [Amended]

0
36a. In Sec.  208.77, remove and reserve paragraph (c).


Sec.  208.102  [Amended]

0
36b. In Sec.  208.102, redesignate footnote 7 as footnote 16.


Sec.  208.111  [Amended]

0
36c. In Sec.  208.111, redesignate footnotes 8 and 9 as footnotes 17 
and 18 respectively.

Appendix A to Part 208--[Removed and Reserved]

0
37. Effective January 1, 2015, appendix A to part 208 is removed and 
reserved.

Appendix B to Part 208--[Removed and Reserved]

0
38. Effective January 1, 2015, appendix B to part 208 is removed and 
reserved.

0
39. In Appendix C to part 208, under Loans In Excess of the Supervisory 
Loan-To-Value Limits, footnote 2 is revised to read as follows:

Appendix C to Part 208--Interagency Guidelines for Real Estate Lending 
Policies

* * * * *
    \2\ For advanced approaches banks (as defined in 12 CFR 208.41) 
and, after January 1, 2015, for all state member banks, the term 
``total capital'' refers to that term as defined in subpart A of 12 
CFR part 217. For insured state nonmember banks and state savings 
associations, ``total capital'' refers to that term defined in 
subpart A of 12 CFR part 324. For national banks and Federal savings 
associations, the term ``total capital'' refers to that term as 
defined in subpart A of 12 CFR part 3. Prior to January 1, 2015, for 
state member banks that are not advanced approaches banks (as 
defined in 12 CFR 208.41), the term ``total capital'' means ``total 
risk-based capital'' as defined in appendix A to 12 CFR part 208. 
For insured state non-member banks, ``total capital'' refers to that 
term described in table I of appendix A to 12 CFR part 325. For 
national banks, the term ``total capital'' is defined at 12 CFR 
3.2(e). For savings associations, the term ``total capital'' is 
defined at 12 CFR 567.5(c)
* * * * *

Appendix E to Part 208--[Removed and Reserved]

0
40. Effective January 1, 2015, appendix E to part 208 is removed and 
reserved.

Appendix F to Part 208--[Removed and Reserved]

0
41. Effective January 1, 2014, Appendix F to part 208 is removed and 
reserved.

PART 217--CAPITAL ADEQUACY OF BANK HOLDING COMPANIES, SAVINGS AND 
LOAN HOLDING COMPANIES, AND STATE MEMBER BANKS (REGULATION Q)

0
42. The authority citation for part 217 is added to read as follows:


[[Page 62285]]


    Authority: 12 U.S.C. 248(a), 321-338a, 481-486, 1462a, 1467a, 
1818, 1828, 1831n, 1831o, 1831p-l, 1831w, 1835, 1844(b), 1851, 3904, 
3906-3909, 4808, 5365, 5371.


0
43. Add Part 217 as set forth at the end of the common preamble.
0
44. Part 217 is amended as set forth below:

0
A. Remove ``[AGENCY]'' and add ``Board'' in its place wherever it 
appears.
0
B. Remove ``[BANK]'' and add ``Board-regulated institution'' in its 
place wherever it appears.
0
C. Remove ``[BANKS]'' and ``[BANK]s'' and add ``Board-regulated 
institutions'' in its place, wherever they appear;
0
D. Remove ``[BANK]'s'' and add ``Board-regulated institution's'' in 
their place, wherever they appear;
0
E. Remove ``[PART]'' and add ``part'' wherever it appears.
0
F. Remove ``[REGULATORY REPORT]'' wherever it appears and add in its 
place ``Call Report, for a state member bank, or the Consolidated 
Financial Statements for Bank Holding Companies (FR Y-9C), for a bank 
holding company or savings and loan holding company, as applicable'' in 
Sec.  --.10(b)(4) and ``Call Report, for a state member bank, or FR Y-
9C, for a bank holding company or savings and loan holding company, as 
applicable'' every time thereafter;
0
G. Remove ``[other Federal banking agencies]'' wherever it appears and 
add ``Federal Deposit Insurance Corporation and Office of the 
Comptroller of the Currency'' in its place''.

0
45. In Sec.  217.1,
0
A. Revise paragraphs (a) and (b) and (c)(1);
0
B. Redesignate paragraphs (c)(2) through (c)(4) as paragraphs (c)(3) 
through (c)(5) respectively;
0
C. Add new paragraph (c)(2);
0
D. Revise paragraphs (e) and (f)(1)(ii)(A) through (C); and
0
E. Add new paragraph (f)(4) to read as follows:


Sec.  217.1  Purpose, applicability, and reservations of authority.

    (a) Purpose. This part establishes minimum capital requirements and 
overall capital adequacy standards for entities described in paragraph 
(c)(1) of this section. This part includes methodologies for 
calculating minimum capital requirements, public disclosure 
requirements related to the capital requirements, and transition 
provisions for the application of this part.
    (b) Limitation of authority. Nothing in this part shall be read to 
limit the authority of the Board to take action under other provisions 
of law, including action to address unsafe or unsound practices or 
conditions, deficient capital levels, or violations of law or 
regulation, under section 8 of the Federal Deposit Insurance Act, 
section 8 of the Bank Holding Company Act, or section 10 of the Home 
Owners' Loan Act.
    (c) Applicability. (1) This part applies on a consolidated basis to 
every Board-regulated institution that is:
    (i) A state member bank;
    (ii) A bank holding company domiciled in the United States that is 
not subject to 12 CFR part 225, appendix C, provided that the Board may 
by order apply any or all of this part 217 to any bank holding company, 
based on the institution's size, level of complexity, risk profile, 
scope of operations, or financial condition; or
    (iii) A covered savings and loan holding company domiciled in the 
United States. For purposes of compliance with the capital adequacy 
requirements and calculations in this part, savings and loan holding 
companies that do not file the FR Y-9C should follow the instructions 
to the FR Y-9C.
    (2) Minimum capital requirements and overall capital adequacy 
standards. Each Board-regulated institution must calculate its minimum 
capital requirements and meet the overall capital adequacy standards in 
subpart B of this part.
* * * * *
    (e) Notice and response procedures. In making a determination under 
this section, the Board will apply notice and response procedures in 
the same manner and to the same extent as the notice and response 
procedures in 12 CFR 263.202.
    (f) * * *
    (1) * * *
    (ii) * * *
    (A) Calculate risk-weighted assets in accordance with the general 
risk-based capital rules under 12 CFR parts 208 or 225, appendix A, 
and, if applicable, appendix E (state member banks or bank holding 
companies, respectively) \1\ and substitute such risk-weighted assets 
for standardized total risk-weighted assets for purposes of Sec.  
217.10;
---------------------------------------------------------------------------

    \1\ For the purpose of calculating its general risk-based 
capital ratios from January 1, 2014 to December 31, 2014, an 
advanced approaches Board-regulated institution shall adjust, as 
appropriate, its risk-weighted asset measure (as that amount is 
calculated under 12 CFR parts 208 and 225, and, if applicable, 
appendix E (state member banks or bank holding companies, 
respectively) in the general risk-based capital rules) by excluding 
those assets that are deducted from its regulatory capital under 
Sec.  217.22.
---------------------------------------------------------------------------

    (B) If applicable, calculate general market risk equivalent assets 
in accordance with 12 CFR parts 208 or 225, appendix E, section 4(a)(3) 
(state member banks or bank holding companies, respectively) and 
substitute such general market risk equivalent assets for standardized 
market risk-weighted assets for purposes of Sec.  217.20(d)(3); and
    (C) Substitute the corresponding provision or provisions of 12 CFR 
parts 208 or 225, appendix A, and, if applicable, appendix E (state 
member banks or bank holding companies, respectively) for any reference 
to subpart D of this part in: Sec.  217.121(c); Sec.  217.124(a) and 
(b); Sec.  217.144(b); Sec.  217.154(c) and (d); Sec.  217.202(b) 
(definition of covered position in paragraph (b)(3)(iv)); and Sec.  
217.211(b); \2\
---------------------------------------------------------------------------

    \2\ In addition, for purposes of Sec.  217.201(c)(3), from 
January 1, 2014 to December 31, 2014, for any circumstance in which 
the Board may require a Board-regulated institution to calculate 
risk-based capital requirements for specific positions or portfolios 
under subpart D of this part, the Board will instead require the 
Board-regulated institution to make such calculations according to 
12 CFR parts 208 and 225, appendix A and, if applicable, appendix E 
(state member banks or bank holding companies, respectively).
---------------------------------------------------------------------------

* * * * *
    (4) This part shall not apply until January 1, 2015, to any Board-
regulated institution that is not an advanced approaches Board-
regulated institution or to any covered savings and loan holding 
company.

0
46. In Sec.  217.2:
0
A. Add definitions of ``Board'', ``Board-regulated institution'', 
``non-guaranteed separate account'', ``policy loan'', ``state bank'', 
and ``state member bank or member bank'' in alphabetical order;
0
B. Add paragraphs (12) and (13) to the definition of ``corporate 
exposure'';
0
C. Revise paragraphs (2)(i), (2)(ii) and (4)(i) of the definition of 
``high volatility commercial real estate (HVCRE) exposure'', paragraph 
(4) of the definition of ``pre-sold construction loan'', paragraph (1) 
of the definition of ``total leverage exposure'', and paragraph 
(10)(ii) of the definition of ``traditional securitization''.
    The additions and revisions read as follows:
* * * * *


Sec.  217.2  Definitions.

* * * * *
    Board means the Board of Governors of the Federal Reserve System.
    Board-regulated institution means a state member bank, bank holding 
company, or savings and loan holding company.
* * * * *
    Corporate exposure * * *

[[Page 62286]]

    (12) A policy loan; or
    (13) A separate account.
* * * * *
    High volatility commercial real estate (HVCRE) exposure * * *
    (2) * * *
    (i) Would qualify as an investment in community development under 
12 U.S.C. 338a or 12 U.S.C. 24 (Eleventh), as applicable, or as a 
``qualified investment'' under 12 CFR part 228, and
    (ii) Is not an ADC loan to any entity described in 12 CFR 
208.22(a)(3) or 228.12(g)(3), unless it is otherwise described in 
paragraph (1), (2)(i), (3) or (4) of this definition;
* * * * *
    (4) * * *
    (i) The loan-to-value ratio is less than or equal to the applicable 
maximum supervisory loan-to-value ratio in the Board's real estate 
lending standards at 12 CFR part 208, appendix C;
* * * * *
    Non-guaranteed separate account means a separate account where the 
insurance company:
    (1) Does not contractually guarantee either a minimum return or 
account value to the contract holder; and
    (2) Is not required to hold reserves (in the general account) 
pursuant to its contractual obligations to a policyholder.
* * * * *
    Policy loan means a loan by an insurance company to a policy holder 
pursuant to the provisions of an insurance contract that is secured by 
the cash surrender value or collateral assignment of the related policy 
or contract. A policy loan includes:
    (1) A cash loan, including a loan resulting from early payment 
benefits or accelerated payment benefits, on an insurance contract when 
the terms of contract specify that the payment is a policy loan secured 
by the policy; and
    (2) An automatic premium loan, which is a loan that is made in 
accordance with policy provisions which provide that delinquent premium 
payments are automatically paid from the cash value at the end of the 
established grace period for premium payments.
* * * * *
    Pre-sold construction loan means * * *
    (4) The purchaser has not terminated the contract; however, if the 
purchaser terminates the sales contract, the Board must immediately 
apply a 100 percent risk weight to the loan and report the revised risk 
weight in the next quarterly Call Report, for a state member bank, or 
the FR Y-9C, for a bank holding company or savings and loan holding 
company, as applicable,
* * * * *
    State bank means any bank incorporated by special law of any State, 
or organized under the general laws of any State, or of the United 
States, including a Morris Plan bank, or other incorporated banking 
institution engaged in a similar business.
    State member bank or member bank means a state bank that is a 
member of the Federal Reserve System.
* * * * *
    Total leverage exposure * * *
    (1) The balance sheet carrying value of all of the Board-regulated 
institution's on-balance sheet assets, as reported on the Call Report, 
for a state member bank, or the FR Y-9C, for a bank holding company or 
savings and loan holding company, as applicable, less amounts deducted 
from tier 1 capital under Sec.  217.22 (a), (c) and (d);
    Traditional securitization * * *
    (10) * * *
    (ii) A collective investment fund (as defined in 12 CFR 208.34);
* * * * *

0
47. In Sec.  217.10, revise paragraph (d) to read as follows:


Sec.  217.10  Minimum capital requirements.

* * * * *
    (d) Capital adequacy. (1) Notwithstanding the minimum requirements 
in this part, a Board-regulated institution must maintain capital 
commensurate with the level and nature of all risks to which the Board-
regulated institution is exposed. The supervisory evaluation of the 
Board-regulated institution's capital adequacy is based on an 
individual assessment of numerous factors, including the character and 
condition of the institution's assets and its existing and prospective 
liabilities and other corporate responsibilities.
    (2) A Board-regulated institution must have a process for assessing 
its overall capital adequacy in relation to its risk profile and a 
comprehensive strategy for maintaining an appropriate level of capital.

0
48. In Sec.  217.11, revise paragraphs (a)(2)(i) and (a)(4)(v) to read 
as follows:


Sec.  217.11  Capital conservation buffer and countercyclical capital 
buffer amount.

* * * * *
    (a) * * *
    (2) * * *
    (i) Eligible retained income. The eligible retained income of a 
Board-regulated institution is the Board-regulated institution's net 
income for the four calendar quarters preceding the current calendar 
quarter, based on the Board-regulated institution's quarterly Call 
Report, for a state member bank, or the FR Y-9C, for a bank holding 
company or savings and loan holding company, as applicable, net of any 
distributions and associated tax effects not already reflected in net 
income. Net income, as reported in the Call Report or the FR Y-9C, as 
applicable, reflects discretionary bonus payments and certain 
distributions that are expense items (and their associated tax 
effects).
* * * * *
    (4) * * *
    (v) Other limitations on distributions. Additional limitations on 
distributions may apply to a Board-regulated institution under 12 CFR 
225.4, 12 CFR 225.8, and 12 CFR 263.202.
* * * * *
0
49. In Sec.  217.20:
0
A. Revise paragraphs (b)(1)(v), (c)(1)(viii), (c)(3), and (e)(2); and
0
B. In paragraph (d)(4), remove '' [12 CFR part 3, appendix A, 12 CFR 
167 (OCC); 12 CFR part 208, appendix A, 12 CFR part 225, appendix A 
(Board)]'' and add ``12 CFR part 208, appendix A, 12 CFR part 225, 
appendix A'' in its place.
    The revisions read as follows:


Sec.  217.20  Capital components and eligibility criteria for 
regulatory capital instruments.

* * * * *
    (b) * * *
    (1) * * *
    (v) Any cash dividend payments on the instrument are paid out of 
the Board-regulated institution's net income, retained earnings, or 
surplus related to common stock, and are not subject to a limit imposed 
by the contractual terms governing the instrument. State member banks 
are subject to other legal restrictions on reductions in capital 
resulting from cash dividends, including out of the capital surplus 
account, under 12 U.S.C. 324 and 12 CFR 208.5.
* * * * *
    (c) * * *
    (1) * * *
    (viii) Any distributions on the instrument are paid out of the 
Board-regulated institution's net income, retained earnings, or surplus 
related to other additional tier 1 capital instruments. State member 
banks are subject to other legal restrictions on reductions in capital 
resulting from cash dividends, including out of the capital surplus 
account, under 12 U.S.C. 324 and 12 CFR 208.5.
* * * * *
    (3) Any and all instruments that qualified as tier 1 capital under 
the Board's general risk-based capital rules

[[Page 62287]]

under 12 CFR part 208, appendix A or 12 CFR part 225, appendix A, as 
then in effect, that were issued under the Small Business Jobs Act of 
2010 \10\ or prior to October 4, 2010, under the Emergency Economic 
Stabilization Act of 2008.\11\
---------------------------------------------------------------------------

    \10\ Public Law 111-240; 124 Stat. 2504 (2010).
    \11\ Public Law 110-343, 122 Stat. 3765 (2008).
---------------------------------------------------------------------------

* * * * *
    (e) * * *
    (2) When considering whether a Board-regulated institution may 
include a regulatory capital element in its common equity tier 1 
capital, additional tier 1 capital, or tier 2 capital, the Federal 
Reserve Board will consult with the FDIC and OCC.
* * * * *

0
50. In Sec.  217.22, revise paragraphs (a)(7), (b)(2)(ii) through 
(b)(2)(iii), and (b)(2)(iv) introductory text, add paragraph (b)(3), 
and revise paragraph (d)(1)(i) to read as follows:


Sec.  217.22  Regulatory capital adjustments and deductions.

* * * * *
    (a) * * *
    (7) Financial subsidiaries. (i) A state member bank must deduct the 
aggregate amount of its outstanding equity investment, including 
retained earnings, in its financial subsidiaries (as defined in 12 CFR 
208.77) and may not consolidate the assets and liabilities of a 
financial subsidiary with those of the state member bank.
    (ii) No other deduction is required under Sec.  217.22(c) for 
investments in the capital instruments of financial subsidiaries.
    (b) * * *
    (2) * * *
    (ii) A Board-regulated institution that is not an advanced 
approaches Board-regulated institution must make its AOCI opt-out 
election in the Call Report, for a state member bank, FR Y-9C or FR Y-
9SP, as applicable, for bank holding companies or savings and loan 
holding companies, filed by the Board-regulated institution for the 
first reporting period after the Board-regulated institution is 
required to comply with subpart A of this part as set forth in Sec.  
217.1(f).
    (iii) Each depository institution subsidiary of a Board-regulated 
institution that is not an advanced approaches Board-regulated 
institution must elect the same option as the Board-regulated 
institution pursuant to paragraph (b)(2).
    (iv) With prior notice to the Board, a Board-regulated institution 
resulting from a merger, acquisition, or purchase transaction may make 
a new AOCI opt-out election in the Call Report (for a state member 
bank), or FR Y-9C or FR Y-9SP, as applicable (for bank holding 
companies or savings and loan holding companies) filed by the resulting 
Board-regulated institution for the first reporting period after it is 
required to comply with subpart A of this part as set forth in Sec.  
217.1(f) if:
* * * * *
    (3) Regulatory capital requirement for insurance underwriting 
risks. A bank holding company or savings and loan holding company must 
deduct an amount equal to the regulatory capital requirement for 
insurance underwriting risks established by the regulator of any 
insurance underwriting activities of the company. The bank holding 
company or savings and loan holding company must take the deduction 50 
percent from tier 1 capital and 50 percent from tier 2 capital. If the 
amount deductible from tier 2 capital exceeds the Board-regulated 
institution's tier 2 capital, the Board-regulated institution must 
deduct the excess from tier 1 capital.
* * * * *
    (d) * * *
    (1) * * *
    (i) DTAs arising from temporary differences that the Board-
regulated institution could not realize through net operating loss 
carrybacks, net of any related valuation allowances and net of DTLs, in 
accordance paragraph (e) of this section. A Board-regulated institution 
is not required to deduct from the sum of its common equity tier 1 
capital elements DTAs (net of any related valuation allowances and net 
of DTLs, in accordance with Sec.  217.22(e)) arising from timing 
differences that the Board-regulated institution could realize through 
net operating loss carrybacks. The Board-regulated institution must 
risk weight these assets at 100 percent. For a state member bank that 
is a member of a consolidated group for tax purposes, the amount of 
DTAs that could be realized through net operating loss carrybacks may 
not exceed the amount that the state member bank could reasonably 
expect to have refunded by its parent holding company.
* * * * *

0
51. In Sec.  217.32, revise paragraphs (g)(1)(ii), (k) introductory 
text, (l)(1) and (l)(6) introductory text, and add new paragraph (m) to 
read as follows:


Sec.  217.32  General risk weights.

* * * * *
    (g) * * *
    (1) * * *
    (ii) Is made in accordance with prudent underwriting standards, 
including relating to the loan amount as a percent of the appraised 
value of the property; A Board-regulated institution must base all 
estimates of a property's value on an appraisal or evaluation of the 
property that satisfies subpart E of 12 CFR part 208.
* * * * *
    (k) Past due exposures. Except for an exposure to a sovereign 
entity or a residential mortgage exposure or a policy loan, if an 
exposure is 90 days or more past due or on nonaccrual:
* * * * *
    (l) Other assets. (1)(i) A bank holding company or savings and loan 
holding company must assign a zero percent risk weight to cash owned 
and held in all offices of subsidiary depository institutions or in 
transit, and to gold bullion held in a subsidiary depository 
institution's own vaults, or held in another depository institution's 
vaults on an allocated basis, to the extent the gold bullion assets are 
offset by gold bullion liabilities.
    (ii) A state member bank must assign a zero percent risk weight to 
cash owned and held in all offices of the state member bank or in 
transit; to gold bullion held in the state member bank's own vaults or 
held in another depository institution's vaults on an allocated basis, 
to the extent the gold bullion assets are offset by gold bullion 
liabilities; and to exposures that arise from the settlement of cash 
transactions (such as equities, fixed income, spot foreign exchange and 
spot commodities) with a central counterparty where there is no 
assumption of ongoing counterparty credit risk by the central 
counterparty after settlement of the trade and associated default fund 
contributions.
* * * * *
    (6) Notwithstanding the requirements of this section, a state 
member bank may assign an asset that is not included in one of the 
categories provided in this section to the risk weight category 
applicable under the capital rules applicable to bank holding companies 
and savings and loan holding companies under this part, provided that 
all of the following conditions apply:
* * * * *
    (m) Insurance assets--(1) Assets held in a separate account. (i) A 
bank holding company or savings and loan holding company must risk-
weight the individual assets held in a separate account that does not 
qualify as a non-guaranteed separate account as if the individual 
assets were held directly by the bank holding company or savings and 
loan holding company.

[[Page 62288]]

    (ii) A bank holding company or savings and loan holding company 
must assign a zero percent risk weight to an asset that is held in a 
non-guaranteed separate account.
    (2) Policy loans. A bank holding company or savings and loan 
holding company must assign a 20 percent risk weight to a policy loan.

0
52. In Sec.  217.42:
0
A. Revise paragraph (h)(1)(iv); and
0
B. In paragraph (h)(3), remove ``[12 CFR 6.4 (OCC); 12 CFR 208.43 
(Board)]'' and add ``12 CFR 208.43'' in its pace.
    The revision reads as follows:


Sec.  217.42  Risk-weighted assets for securitization exposures.

* * * * *
    (h) * * *
    (1) * * *
    (iv)(A) In the case of a state member bank, the bank is well 
capitalized, as defined in 12 CFR 208.43. For purposes of determining 
whether a state member bank is well capitalized for purposes of this 
paragraph (h), the state member bank's capital ratios must be 
calculated without regard to the capital treatment for transfers of 
small-business obligations under this paragraph (h).
    (B) In the case of a bank holding company or savings and loan 
holding company, the bank holding company or savings and loan holding 
company is well capitalized, as defined in 12 CFR 225.2. For purposes 
of determining whether a bank holding company or savings and loan 
holding company is well capitalized for purposes of this paragraph (h), 
the bank holding company or savings and loan holding company's capital 
ratios must be calculated without regard to the capital treatment for 
transfers of small-business obligations with recourse specified in 
paragraph (k)(1) of this section.
* * * * *

0
53. In Sec.  217.52, revise paragraph (b)(3)(i) to read as follows:


Sec.  217.52  Simple risk-weight approach (SRWA).

* * * * *
    (b) * * *
    (3) * * *
    (i) Community development equity exposures. (A) For state member 
banks and bank holding companies, an equity exposure that qualifies as 
a community development investment under 12 U.S.C. 24 (Eleventh), 
excluding equity exposures to an unconsolidated small business 
investment company and equity exposures held through a consolidated 
small business investment company described in section 302 of the Small 
Business Investment Act of 1958 (15 U.S.C. 682).
    (B) For savings and loan holding companies, an equity exposure that 
is designed primarily to promote community welfare, including the 
welfare of low- and moderate-income communities or families, such as by 
providing services or employment, and excluding equity exposures to an 
unconsolidated small business investment company and equity exposures 
held through a small business investment company described in section 
302 of the Small Business Investment Act of 1958 (15 U.S.C. 682).
* * * * *

0
54. In Sec.  217.100, revise paragraphs (b)(1) introductory text, 
(b)(1)(i) through (iii), and (b)(2) to read as follows:


Sec.  217.100  Purpose, applicability, and principle of conservatism.

* * * * *
    (b) Applicability. (1) This subpart applies to:
    (i) A top-tier bank holding company or savings and loan holding 
company domiciled in the United States that:
    (A) Is not a consolidated subsidiary of another bank holding 
company or savings and loan holding company that uses 12 CFR part 217, 
subpart E, to calculate its risk-based capital requirements; and
    (B) That:
    (1) Has total consolidated assets (excluding assets held by an 
insurance underwriting subsidiary), as defined on schedule HC-K of the 
FR Y-9C, equal to $250 billion or more;
    (2) Has consolidated total on-balance sheet foreign exposure at the 
most recent year-end equal to $10 billion (excluding exposures held by 
an insurance underwriting subsidiary). Total on-balance sheet foreign 
exposure equals total cross-border claims less claims with head office 
or guarantor located in another country plus redistributed guaranteed 
amounts to the country of head office or guarantor plus local country 
claims on local residents plus revaluation gains on foreign exchange 
and derivative products, calculated in accordance with the Federal 
Financial Institutions Examination Council (FFIEC) 009 Country Exposure 
Report); or
    (3) Has a subsidiary depository institution that is required, or 
has elected, to use 12 CFR part 3, subpart E (OCC), 12 CFR part 217, 
subpart E (Board), or 12 CFR part 325, subpart E (FDIC) to calculate 
its risk-based capital requirements;
    (ii) A state member bank that:
    (A) Has total consolidated assets, as reported on the most recent 
year-end Consolidated Report of Condition and Income (Call Report), 
equal to $250 billion or more;
    (B) Has consolidated total on-balance sheet foreign exposure at the 
most recent year-end equal to $10 billion or more (where total on-
balance sheet foreign exposure equals total cross-border claims less 
claims with head office or guarantor located in another country plus 
redistributed guaranteed amounts to the country of head office or 
guarantor plus local country claims on local residents plus revaluation 
gains on foreign exchange and derivative products, calculated in 
accordance with the Federal Financial Institutions Examination Council 
(FFIEC) 009 Country Exposure Report);
    (C) Is a subsidiary of a depository institution that uses 12 CFR 
part 3, subpart E (OCC), 12 CFR part 217, subpart E (Board), or 12 CFR 
part 325, subpart E (FDIC) to calculate its risk-based capital 
requirements; or
    (D) Is a subsidiary of a bank holding company or savings and loan 
holding company that uses 12 CFR part 217, subpart E, to calculate its 
risk-based capital requirements; and
    (iii) Any Board-regulated institution that elects to use this 
subpart to calculate its risk-based capital requirements.
* * * * *
    (2) A bank that is subject to this subpart shall remain subject to 
this subpart unless the Board determines in writing that application of 
this subpart is not appropriate in light of the Board-regulated 
institution's asset size, level of complexity, risk profile, or scope 
of operations. In making a determination under this paragraph (b), the 
Board will apply notice and response procedures in the same manner and 
to the same extent as the notice and response procedures in 12 CFR 
263.202.
* * * * *

0
55. In Sec.  217.121, revise paragraph (a) to read as follows:


Sec.  217.121  Qualification process.

    (a) Timing. (1) A Board-regulated institution that is described in 
Sec.  217.100(b)(1)(i) and (ii) must adopt a written implementation 
plan no later than six months after the date the Board-regulated 
institution meets a criterion in that section. The implementation plan 
must incorporate an explicit start date no later than 36 months after 
the date the Board-regulated institution meets at least one criterion 
under Sec.  217.100(b)(1)(i) and (ii). The Board may extend the start 
date.
    (2) A Board-regulated institution that elects to be subject to this 
subpart under

[[Page 62289]]

Sec.  217.101(b)(1)(iii) must adopt a written implementation plan.
* * * * *

0
56. In Sec.  217.122(g), revise paragraph (g)(3)(ii) to read as 
follows:


Sec.  217.122  Qualification requirements.

* * * * *
    (g) * * *
    (3) * * *
    (ii) With the prior written approval of the Board, a state member 
bank may generate an estimate of its operational risk exposure using an 
alternative approach to that specified in paragraph (g)(3)(i) of this 
section. A state member bank proposing to use such an alternative 
operational risk quantification system must submit a proposal to the 
Board. In determining whether to approve a state member bank's proposal 
to use an alternative operational risk quantification system, the Board 
will consider the following principles:
    (A) Use of the alternative operational risk quantification system 
will be allowed only on an exception basis, considering the size, 
complexity, and risk profile of the state member bank;
    (B) The state member bank must demonstrate that its estimate of its 
operational risk exposure generated under the alternative operational 
risk quantification system is appropriate and can be supported 
empirically; and
    (C) A state member bank must not use an allocation of operational 
risk capital requirements that includes entities other than depository 
institutions or the benefits of diversification across entities.
* * * * *

0
57. In Sec.  217.131, revise paragraph (b) and paragraphs (e)(3)(i) and 
(ii), and add a new paragraph (e)(5) to read as follows:


Sec.  217.131  Mechanics for calculating total wholesale and retail 
risk-weighted assets.

* * * * *
    (b) Phase 1--Categorization. The Board-regulated institution must 
determine which of its exposures are wholesale exposures, retail 
exposures, securitization exposures, or equity exposures. The Board-
regulated institution must categorize each retail exposure as a 
residential mortgage exposure, a QRE, or another retail exposure. The 
Board-regulated institution must identify which wholesale exposures are 
HVCRE exposures, sovereign exposures, OTC derivative contracts, repo-
style transactions, eligible margin loans, eligible purchased wholesale 
exposures, cleared transactions, default fund contributions, and 
unsettled transactions to which Sec.  217.136 applies, and eligible 
guarantees or eligible credit derivatives that are used as credit risk 
mitigants. The Board-regulated institution must identify any on-balance 
sheet asset that does not meet the definition of a wholesale, retail, 
equity, or securitization exposure, any non-material portfolio of 
exposures described in paragraph (e)(4) of this section, and for bank 
holding companies and savings and loan holding companies, any on-
balance sheet asset that is held in a non-guaranteed separate account.
* * * * *
    (e) * * *
    (3) * * *
    (i) A bank holding company or savings and loan holding company may 
assign a risk-weighted asset amount of zero to cash owned and held in 
all offices of subsidiary depository institutions or in transit; and 
for gold bullion held in a subsidiary depository institution's own 
vaults, or held in another depository institution's vaults on an 
allocated basis, to the extent the gold bullion assets are offset by 
gold bullion liabilities.
    (ii) A state member bank may assign a risk-weighted asset amount to 
cash owned and held in all offices of the state member bank or in 
transit and for gold bullion held in the state member bank's own 
vaults, or held in another depository institution's vaults on an 
allocated basis, to the extent the gold bullion assets are offset by 
gold bullion liabilities.
* * * * *
    (5) Assets held in non-guaranteed separate accounts. The risk-
weighted asset amount for an on-balance sheet asset that is held in a 
non-guaranteed separate account is zero percent of the carrying value 
of the asset.

0
58. In Sec.  217.142, revise the section heading and paragraph 
(k)(1)(iv) to read as follows:


Sec.  217.142  Risk-based capital requirement for securitization 
exposures.

* * * * *
    (k) * * *
    (1) * * *
    (iv)(A) In the case of a state member bank, the bank is well 
capitalized, as defined in section 208.43 of this chapter. For purposes 
of determining whether a state member bank is well capitalized for 
purposes of this paragraph, the state member bank's capital ratios must 
be calculated without regard to the capital treatment for transfers of 
small-business obligations with recourse specified in this paragraph 
(k)(1).
    (B) In the case of a bank holding company or savings and loan 
holding company, the bank holding company or savings and loan holding 
company is well capitalized, as defined in 12 CFR 225.2. For purposes 
of determining whether a bank holding company or savings and loan 
holding company is well capitalized for purposes of this paragraph, the 
bank holding company or savings and loan holding company's capital 
ratios must be calculated without regard to the capital treatment for 
transfers of small-business obligations with recourse specified in this 
paragraph (k)(1).
* * * * *

0
59. In Sec.  217.152, revise paragraph (b)(3)(i) to read as follows:


Sec.  217.152  Simple risk weight approach (SRWA).

* * * * *
    (b) * * *
    (3) * * *
    (i) Community development equity exposures. (A) For state member 
banks and bank holding companies, an equity exposure that qualifies as 
a community development investment under 12 U.S.C. 24 (Eleventh), 
excluding equity exposures to an unconsolidated small business 
investment company and equity exposures held through a consolidated 
small business investment company described in section 302 of the Small 
Business Investment Act of 1958 (15 U.S.C. 682).
    (B) For savings and loan holding companies, an equity exposure that 
is designed primarily to promote community welfare, including the 
welfare of low- and moderate-income communities or families, such as by 
providing services or employment, and excluding equity exposures to an 
unconsolidated small business investment company and equity exposures 
held through a small business investment company described in section 
302 of the Small Business Investment Act of 1958 (15 U.S.C. 682).
* * * * *

0
60. In Sec.  217.201:
0
A. Revise paragraph (b)(1) introductory text.
0
B. In paragraph (c)(1), remove [12 CFR 3.404, 12 CFR 263.202, 12 CFR 
325.6(c)]'' and add ``12 CFR 263.202'' in its place.
    The revision reads as follows:


Sec.  217.201  Purpose, applicability, and reservation of authority.

* * * * *
    (b) Applicability. (1) This subpart applies to any Board-regulated 
institution with aggregate trading assets

[[Page 62290]]

and trading liabilities (as reported in the Board-regulated 
institution's most recent quarterly Call Report, for a state member 
bank, or FR Y-9C, for a bank holding company or savings and loan 
holding company, as applicable, any savings and loan holding company 
that does not file the FR Y-9C should follow the instructions to the FR 
Y-9C) equal to:
* * * * *

0
61. In Sec.  217.202(b):
0
A. Revise the introductory text of paragraph (1) of the definition of 
``covered position''; and
0
B. In paragraph (10)(i) of the definition of ``securitzation'', remove 
``[12 CFR 208.34 (Board), 12 CFR 9.18 (OCC)]'' and adding in its place 
``12 CFR 208.34''.
    The revision reads as follows:


Sec.  217.202  Definitions.

* * * * *
    Covered position means the following positions:
    (1) A trading asset or trading liability (whether on- or off-
balance sheet),\27\ as reported on Schedule RC-D of the Call Report or 
Schedule HC-D of the FR Y-9C (any savings and loan holding companies 
that does not file the FR Y-9C should follow the instructions to the FR 
Y-9C), that meets the following conditions:
---------------------------------------------------------------------------

    \27\ Securities subject to repurchase and lending agreements are 
included as if they are still owned by the lender.
---------------------------------------------------------------------------

* * * * *
0
62. In Sec.  217.300, revise paragraph (c)(1), revise the heading to 
paragraph (c)(3), add introductory text to paragraph (c)(3), revise 
paragraph (e), and add new paragraph (f), to read as follows:


Sec.  217.  300 Transitions.

* * * * *
    (c) * * *
    (1) Depository institution holding companies with total 
consolidated assets of more than $15 billion as of December 31, 2009 
that were not mutual holding companies prior to May 19, 2010. The 
transition provisions in this paragraph (c)(1) apply to debt or equity 
instruments that do not meet the criteria for additional tier 1 or tier 
2 capital instruments in Sec.  217.20, but that were issued and 
included in tier 1 or tier 2 capital, respectively (or, in the case of 
a savings and loan holding company, would have been included in tier 1 
or tier 2 capital if the savings and loan holding company had been 
subject to the general risk-based capital rules under 12 CFR part 225, 
appendix A), prior to May 19, 2010 (non-qualifying capital 
instruments), and that were issued by a depository institution holding 
company with total consolidated assets greater than or equal to $15 
billion as of December 31, 2009 that was not a mutual holding company 
prior to May 19, 2010 (2010 MHC) (depository institution holding 
company of $15 billion or more).
* * * * *
    (3) Transition adjustments to AOCI. From January 1, 2014 through 
December 31, 2017, a Board-regulated institution that has not made an 
AOCI opt-out election under Sec.  217.22(b)(2) must adjust common 
equity tier 1 capital with respect to the aggregate amount of 
unrealized gains on available-for-sale preferred stock classified as an 
equity security under GAAP and available-for-sale equity exposures, 
plus net unrealized gains or losses on available-for-sale securities 
that are not preferred stock classified as equity securities under GAAP 
or equity exposures, plus any amounts recorded in AOCI attributed to 
defined benefit postretirement plans resulting from the initial and 
subsequent application of the relevant GAAP standards that pertain to 
such plans (excluding, at the Board-regulated institution's option, the 
portion relating to pension assets deducted under Sec.  217.22(a)(5)), 
plus accumulated net unrealized gains or losses on cash flow hedges 
related to items that are reported on the balance sheet at fair value 
included in AOCI, plus net unrealized gains or losses on held-to-
maturity securities that are included in AOCI (the transition AOCI 
adjustment amount) as reported on the Board-regulated institution's 
most recent Call Report, for a state member bank, or the FR Y-9C, for a 
bank holding company or savings and loan holding company, as 
applicable, as follows:
* * * * *
    (e) Prompt corrective action. For purposes of 12 CFR part 208, 
subpart D, a Board-regulated institution must calculate its capital 
measures and tangible equity ratio in accordance with the transition 
provisions in this section.
    (f) Until July 21, 2015, this part will not apply to any bank 
holding company subsidiary of a foreign banking organization that is 
currently relying on Supervision and Regulation Letter SR 01-01 issued 
by the Board (as in effect on May 19, 2010).

PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL 
(REGULATION Y)

0
63. The authority citation for part 225 continues to read as follows:

    Authority:  12 U.S.C. 1817(j)(13), 1818, 1828(o), 1831i, 1831p-
1, 1843(c)(8), 1844(b), 1972(1), 3106, 3108, 3310, 3331-3351, 3907, 
and 3909; 15 U.S.C. 1681s, 1681w, 6801 and 6805.

Subpart A--General Provisions

0
64. Effective January 1, 2015, in Sec.  225.1, remove and reserve 
paragraphs (c)(12), (c)(13) and (c)(15) to read as follows:


Sec.  225.1  Authority, purpose, and scope.

* * * * *
    (c) * * *
    (12) [Reserved]
* * * * *
    (14) [Reserved]
    (15) [Reserved]
* * * * *

0
65. In Sec.  225.2, revise paragraphs (r)(1)(i) and (ii) to read as 
follows:


Sec.  225.2  Definitions.

* * * * *
    (r) * * *
    (1) * * *
    (i) On a consolidated basis, the bank holding company maintains a 
total risk-based capital ratio of 10.0 percent or greater, as defined 
in 12 CFR 217.10; \3\
---------------------------------------------------------------------------

    \3\ Before January 1, 2015, the total risk-based capital ratio 
of a bank holding company that is not an advanced approaches bank 
holding company (as defined in 12 CFR 217.100(b)(1)) is calculated 
in accordance with appendix A to this part.
---------------------------------------------------------------------------

    (ii) On a consolidated basis, the bank holding company maintains a 
tier 1 risk-based capital ratio of 6.0 percent or greater, as defined 
in 12 CFR 217.10; \4\ and
---------------------------------------------------------------------------

    \4\ Before January 1, 2015, the tier 1 risk-based capital ratio 
of a bank holding company that is not an advanced approaches bank 
holding company (as defined in 12 CFR 217.100(b)(1)) is calculated 
in accordance with appendix A to this part.
---------------------------------------------------------------------------

* * * * *

0
66. In Sec.  225.4, revise paragraph (b)(4)(ii) to read as follows:


Sec.  225.4  Corporate practices.

* * * * *
    (b) * * *
    (4) * * *
    (ii) In determining whether a proposal constitutes an unsafe or 
unsound practice, the Board shall consider whether the bank holding 
company's financial condition, after giving effect to the proposed 
purchase or redemption, meets the financial standards applied by the 
Board under section 3 of the BHC Act, including 12 CFR part 217,\1\ and 
the Board's Policy Statement for Small

[[Page 62291]]

Bank Holding Companies (appendix C of this part).
---------------------------------------------------------------------------

    \1\ Before January 1, 2015, the Board will consider the 
financial standards at 12 CFR part 225 appendices A, C, and E for a 
bank holding company that is not an advanced approaches bank holding 
company.
---------------------------------------------------------------------------

* * * * *

Subpart B--Acquisition of Bank Securities or Assets

0
67a. In Sec.  225.12:
0
a. In paragraph (d)(3)(i)(B), redesignate footnote 1 as footnote 2;
0
b. Revise paragraph (d)(2)(iv) and add a new footnote 1 to read as 
follows:


Sec.  225.12  Transactions not requiring Board approval.

* * * * *
    (d) * * *
    (2) * * *
    (iv) Both before and after the transaction, the acquiring bank 
holding company meets the requirements of 12 CFR part 217; \1\
---------------------------------------------------------------------------

    \1\ Or before January 1, 2015, if the acquiring company, after 
giving effect to the transaction, meets the requirements of appendix 
A to this part, and the Board has not previously notified the 
acquiring company that it may not acquire assets under the exemption 
in this paragraph.
---------------------------------------------------------------------------

* * * * *


Sec.  225.14  [Amended]

0
67b. In Sec.  225.14, redesignate footnote 2 as footnote 3.


Sec.  225.17  [Amended]

0
67c. In Sec.  225.17, redesignate footnotes 3 through 5 as footnotes 4 
through 6 respectively.

Subpart C--Nonbanking Activities and Acquisitions by Bank Holding 
Companies

0
68a. In Sec.  225.22, revise paragraph (d)(8)(v) and add footnote 1 to 
read as follows:


Sec.  225.22  Exempt nonbanking activities and acquisitions.

* * * * *
    (d) * * *
    (8) * * *
    (v) The acquiring company, after giving effect to the transaction, 
meets the requirements of 12 CFR part 217, and the Board has not 
previously notified the acquiring company that it may not acquire 
assets under the exemption in this paragraph (d).\1\
---------------------------------------------------------------------------

    \1\ Before January 1, 2015, the maximum marginal tier 1 capital 
charge applicable to merchant banking investments held by a 
financial holding company that is not an advanced approaches bank 
holding company (as defined in 12 CFR 217.100(b)(1)) is calculated 
in accordance with appendix A to this part.
---------------------------------------------------------------------------

* * * * *


Sec.  225.23  [Amended]

0
68b. In Sec.  225.23, redesignate footnote 1 as footnote 2.


Sec.  225.28  [Amended]

0
68c. In Sec.  225.23, redesignate footnotes 2 through 18 as footnotes 3 
through 19 respectively.

Subpart J--Merchant Banking Investments

0
69. In Sec.  225.172, revise paragraph (b)(6)(i)(A) and add footnote 1 
to read as follows:


Sec.  225.172  What are the holding periods permitted for merchant 
banking investments?

* * * * *
    (b) * * *
    (6) * * *
    (i) * * *
    (A) Higher than the maximum marginal tier 1 capital charge 
applicable under part 217 to merchant banking investments held by that 
financial holding company; \1\ and
---------------------------------------------------------------------------

    \1\ Before January 1, 2015, the Board will consider the 
financial standards at 12 CFR part 225 appendices A, C, and E for a 
bank holding company that is not an advanced approaches bank holding 
company.
---------------------------------------------------------------------------

* * * * *

Appendix A to Part 225--Capital Adequacy Guidelines for Bank Holding 
Companies: Risk-Based Measure

0
70. Effective January 1, 2019, appendix A to part 225 is removed and 
reserved.

Appendix B to Part 225--Capital Adequacy Guidelines for Bank Holding 
Companies and State Member Banks: Leverage Measure [Removed and 
Reserved]

0
71. Appendix B to part 225 is removed and reserved.

Appendix D to Part 225--Capital Adequacy Guidelines for Bank Holding 
Companies: Tier 1 Leverage Measure

0
72. Effective January 1, 2015, appendix D to part 225 is removed and 
reserved.

Appendix E to Part 225--Capital Adequacy Guidelines for Bank Holding 
Companies: Market Risk Measure

0
73. Effective January 1, 2015, Appendix E to part 225 is removed and 
reserved.

Appendix G to Part 225--Capital Adequacy Guidelines for Bank Holding 
Companies: Internal-Ratings-Based and Advanced Measurement Approaches

0
74. Effective January 1, 2014, Appendix G to part 225 is removed and 
reserved.

    Dated: July 9, 2013.
Thomas J. Curry,
Comptroller of the Currency.
    By order of the Board of Governors of the Federal Reserve 
System, August 30, 2013.
Robert deV. Frierson,
Secretary of the Board.
[FR Doc. 2013-21653 Filed 10-10-13; 8:45 a.m.]
BILLING CODE 4810-33-P

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