77446 Federal Register / Vol. 71, No. 247 / Tuesday, December 26, 2006 / Proposed Rules 

DEPARTMENT OF THE TREASURY 

Office of the Comptroller of the 

Currency 

12 CFR Part 3 

[Docket No. 06–15] 

RIN 1557–AC95 

FEDERAL RESERVE SYSTEM 

12 CFR Parts 208 and 225 

[Regulations H and Y; Docket No. R–1238] 

FEDERAL DEPOSIT INSURANCE 

CORPORATION 

12 CFR Part 325 

RIN 3064–AC96 

DEPARTMENT OF THE TREASURY 

Office of Thrift Supervision 

12 CFR Part 567 

[No. 2006–49] 

RIN 1550–AB98 

Risk-Based Capital Guidelines; Capital 

Adequacy Guidelines; Capital 

Maintenance: Domestic Capital 

Modifications 

AGENCIES: Office of the Comptroller of 

the Currency, Treasury; Board of 

Governors of the Federal Reserve 

System; Federal Deposit Insurance 

Corporation; and Office of Thrift 

Supervision, Treasury. 

ACTION: Joint notice of proposed 

rulemaking. 

SUMMARY: The Office of the Comptroller 

of the Currency (OCC), Board of 

Governors of the Federal Reserve 

System (Board), Federal Deposit 

Insurance Corporation (FDIC), and 

Office of Thrift Supervision (OTS) 

(collectively, the Agencies) are 

proposing revisions to the existing riskbased capital framework that would 

enhance its risk sensitivity without 

unduly increasing regulatory burden. 

These changes would apply to banks, 

bank holding companies, and savings 

associations (banking organizations). A 

banking organization would be able to 

elect to adopt these proposed revisions 

or remain subject to the Agencies’ 

existing risk-based capital rules, unless 

it uses the Advanced Capital Adequacy 

Framework proposed in the notice of 

proposed rulemaking published on 

September 25, 2006 (Basel II NPR). 

In this notice of proposed rulemaking 

(NPR or Basel IA), the Agencies are 

proposing to expand the number of risk 

weight categories, allow the use of 

external credit ratings to risk weight 

certain exposures, expand the range of 

recognized collateral and eligible 

guarantors, use loan-to-value ratios to 

risk weight most residential mortgages, 

increase the credit conversion factor for 

certain commitments with an original 

maturity of one year or less, assess a 

charge for early amortizations in 

securitizations of revolving exposures, 

and remove the 50 percent limit on the 

risk weight for certain derivative 

transactions. A banking organization 

would have to apply all the proposed 

changes if it chose to use these 

revisions. 

Finally, in Section III of this NPR, the 

Agencies seek further comment on 

possible alternatives for implementing 

the ‘‘International Convergence of 

Capital Measurement and Capital 

Standards: A Revised Framework’’ 

(Basel II) in the United States as 

proposed in the Basel II NPR. 

DATES: Comments on this joint notice of 

proposed rulemaking must be received 

by March 26, 2007. 

ADDRESSES: Comments should be 

directed to: 

OCC: You should include OCC and 

Docket Number 06–15 in your comment. 

You may submit comments by any of 

the following methods: 

• Federal eRulemaking Portal: http:// 

www.regulations.gov. Follow the 

instructions for submitting comments. 

• OCC Web Site: http:// 

www.occ.treas.gov. Click on ‘‘Contact 

the OCC,’’ scroll down and click on 

‘‘Comments on Proposed Regulations.’’ 

• E-mail address: 

regs.comments@occ.treas.gov. 

• Fax: (202) 874–4448. 

• Mail: Office of the Comptroller of 

the Currency, 250 E Street, SW., Mail 

Stop 1–5, Washington, DC 20219. 

• Hand Delivery/Courier: 250 E 

Street, SW., Attn: Public Information 

Room, Mail Stop 1–5, Washington, DC 

20219. 

Instructions: All submissions received 

must include the Agency name (OCC) 

and docket number or Regulatory 

Information Number (RIN) for this 

notice of proposed rulemaking. In 

general, OCC will enter all comments 

received into the docket without 

change, including any business or 

personal information that you provide. 

You may review comments and other 

related materials by any of the following 

methods: 

• Viewing Comments Personally: You 

may personally inspect and photocopy 

comments at the OCC’s Public 

Information Room, 250 E Street, SW., 

Washington, DC. You can make an 

appointment to inspect comments by 

calling (202) 874–5043. 

• Viewing Comments Electronically: 

You may request e-mail or CD–ROM 

copies of comments that the OCC has 

received by contacting the OCC’s Public 

Information Room at 

regs.comments@occ.treas.gov. 

• Docket: You may also request 

available background documents and 

project summaries using the methods 

described above. 

Board: You may submit comments, 

identified by Docket No. R–1238, by any 

of the following methods: 

• Agency Web Site: http:// 

www.federalreserve.gov. Follow the 

instructions for submitting comments at 

http://www.federalreserve.gov/ 

generalinfo/foia/ProposedRegs.cfm. 

• Federal eRulemaking Portal: http:// 

www.regulations.gov. Follow the 

instructions for submitting comments. 

• E-mail: 

regs.comments@federalreserve.gov. 

Include docket number in the subject 

line of the message. 

• FAX: (202) 452–3819 or (202) 452– 

3102. 

• Mail: Jennifer J. Johnson, Secretary, 

Board of Governors of the Federal 

Reserve System, 20th Street and 

Constitution Avenue, NW., Washington, 

DC 20551. 

All public comments are available 

from the Board’s Web site at http:// 

www.federalreserve.gov/generalinfo/ 

foia/ProposedRegs.cfm as submitted, 

unless modified for technical reasons. 

Accordingly, your comments will not be 

edited to remove any identifying or 

contact information. Public comments 

may also be viewed electronically or in 

paper form in Room MP–500 of the 

Board’s Martin Building (20th and C 

Street, NW.) between 9 a.m. and 5 p.m. 

on weekdays. 

FDIC: You may submit by any of the 

following methods: 

• Federal eRulemaking Portal: http:// 

www.regulations.gov. Follow the 

instructions for submitting comments. 

• Agency Web site: http:// 

www.FDIC.gov/regulations/laws/ 

federal/propose.html 

• Mail: Robert E. Feldman, Executive 

Secretary, Attention: Comments/Legal 

ESS, Federal Deposit Insurance 

Corporation, 550 17th Street, NW., 

Washington, DC 20429. 

• Hand Delivered/Courier: The guard 

station at the rear of the 550 17th Street 

Building (located on F Street), on 

business days between 7 a.m. and 5 p.m. 

• E-mail: comments@FDIC.gov. 

• Public Inspection: Comments may 

be inspected and photocopied in the 

FDIC Public Information Center, Room 


sroberts on PROD1PC70 with PROPOSALS
Federal Register / Vol. 71, No. 247 / Tuesday, December 26, 2006 / Proposed Rules 77447 

1 12 CFR part 3, appendix A (OCC); 12 CFR parts 

208 and 225, appendix A (Board); 12 CFR part 325, 

appendix A (FDIC); and 12 CFR part 567 (OTS). The 

risk-based capital rules generally do not apply to 

bank holding companies with less than $500 

million in assets. 71 FR 9897 (Februray 28, 2006). 

2The Basel Committee on Banking Supervision 

was established in 1974 by central banks and 

governmental authorities with bank supervisory 

responsibilities. Current member countries are 

Belgium, Canada, France, Germany, Italy, Japan, 

Luxembourg, the Netherlands, Spain, Sweden, 

Switzerland, the United Kingdom, and the United 

States. 

3The complete text for Basel II as amended in 

November 2005 is available on the Bank for 

International Settlements Web site at http:// 

www.bis.org/publ/bcbs118.htm. 

E–1002, 3502 Fairfax Drive, Arlington, 

VA 22226, between 9 a.m. and 5 p.m. 

on business days. 

Instructions: Submissions received 

must include the Agency name and title 

for this notice. Comments received will 

be posted without change to http:// 

www.FDIC.gov/regulations/laws/ 

federal/propose.html, including any 

personal information provided. 

OTS: You may submit comments, 

identified by No. 2006–49, by any of the 

following methods: 

• Federal eRulemaking Portal: http:// 

www.regulations.gov. Follow the 

instructions for submitting comments. 

• E-mail address: 

regs.comments@ots.treas.gov. Please 

include No. 2006–49 in the subject line 

of the message and include your name 

and telephone number in the message. 

• Fax: (202) 906–6518. 

• Mail: Regulation Comments, Chief 

Counsel’s Office, Office of Thrift 

Supervision, 1700 G Street, NW., 

Washington, DC 20552, Attention: No. 

2006–49. 

• Hand Delivery/Courier: Guard’s 

Desk, East Lobby Entrance, 1700 G 

Street, NW., from 9 a.m. to 4 p.m. on 

business days, Attention: Regulation 

Comments, Chief Counsel’s Office, 

Attention: No. 2006–49. 

Instructions: All submissions received 

must include the Agency name and 

docket number or Regulatory 

Information Number (RIN) for this 

rulemaking. All comments received will 

be posted without change to the OTS 

Internet Site at http://www.ots.treas.gov/ 

pagehtml.cfm?catNumber=67&an=1, 

including any personal information 

provided. 

Docket: For access to the docket to 

read background documents or 

comments received, go to http:// 

www.ots.treas.gov/

pagehtml.cfm?catNumber=67&an=1. In 

addition, you may inspect comments at 

the Public Reading Room, 1700 G Street, 

NW., by appointment. To make an 

appointment for access, call (202) 906–

5922, send an e-mail to 

public.info@ots.treas.gov, or send a 

facsimile transmission to (202) 906–

7755. (Prior notice identifying the 

materials you will be requesting will 

assist us in serving you.) We schedule 

appointments on business days between 

10 a.m. and 4 p.m. In most cases, 

appointments will be available the next 

business day following the date we 

receive a request. 

FOR FURTHER INFORMATION CONTACT: 

OCC: Nancy Hunt, Risk Expert, (202) 

874–4923; or Kristin Bogue, Risk Expert, 

(202) 874–5411, Capital Policy Division; 

Ron Shimabukuro, Special Counsel, or 

Carl Kaminski, Attorney, Legislative and 

Regulatory Activities Division, (202) 

874–5090; Office of the Comptroller of 

the Currency, 250 E Street, SW., 

Washington, DC 20219. 

Board: Thomas R. Boemio, Senior 

Project Manager, Policy, (202) 452–

2982; Barbara Bouchard, Deputy 

Associate Director, (202) 452–3072; 

William Tiernay, Supervisory Financial 

Analyst (202) 872–7579; or Juan C. 

Climent, Supervisory Financial Analyst, 

(202) 872–7526, Division of Banking 

Supervision and Regulation; or Mark E. 

Van Der Weide, Senior Counsel, (202) 

452–2263, Legal Division. For the 

hearing impaired only, 

Telecommunication Device for the Deaf 

(TDD), (202) 263–4869. 

FDIC: Karl R. Reitz, Capital Markets 

Specialist, (202) 898–3857, or Bobby R. 

Bean, Chief, Policy Section Capital 

Markets Branch, (202) 898–3575, 

Division of Supervision and Consumer 

Protection; or Benjamin W. McDonough, 

Attorney, (202) 898–7411, or Michael B. 

Phillips, Counsel, (202) 898–3581, 

Supervision and Legislation Branch, 

Legal Division, Federal Deposit 

Insurance Corporation, 550 17th Street, 

NW., Washington, DC 20429. 

OTS: Teresa Scott, Senior Project 

Manager, Supervision Policy (202) 906–

6478; or Karen Osterloh, Special 

Counsel, Regulation and Legislation 

Division, Chief Counsel’s Office, (202) 

906–6639; Office of Thrift Supervision, 

1700 G Street, NW., Washington, DC 

20552. 

SUPPLEMENTARY INFORMATION: 

I. Background 

In 1989, the Office of the Comptroller 

of the Currency (OCC), Board of 

Governors of the Federal Reserve 

System (Board), Federal Deposit 

Insurance Corporation (FDIC), and 

Office of Thrift Supervision (OTS) 

(collectively, the Agencies) 

implemented a risk-based capital 

framework for U.S. banking 

organizations.1 The Agencies based the 

framework on the ‘‘International 

Convergence of Capital Measurement 

and Capital Standards’’ (Basel I), 

published by the Basel Committee on 

Banking Supervision (Basel Committee) 

in 1988.2 Basel I addressed certain 

weaknesses in the various regulatory 

capital regimes that were in force in 

most of the world’s major banking 

jurisdictions. In the United States, the 

Basel I-based framework established a 

uniform regulatory capital system that 

captured some of the risks not otherwise 

captured by the regulatory capital to 

total assets ratio, provided some modest 

differentiation of regulatory capital 

based on broadly defined risk-weight 

categories, and encouraged banking 

organizations to strengthen their capital 

positions. 

Consistent with Basel I, the Agencies’

existing risk-based capital rules 

generally assign each credit exposure to 

one of five broad categories of credit 

risk, which allows for only limited 

differentiation in the assessment of 

credit risk for most exposures. Since the 

implementation of Basel I-based capital 

rules, the Agencies have made 

numerous revisions to these rules in 

response to changes in financial market 

practices and accounting standards as 

well as to implement legislative 

mandates and address safety and 

soundness issues. Over time, these 

revisions have modestly increased the 

degree of risk sensitivity of the 

Agencies’ risk-based capital rules. The 

Agencies and the industry generally 

agree that the existing risk-based capital 

rules could be modified to better reflect 

the risks present in many banking 

organizations’ portfolios without 

imposing undue regulatory burden. In 

recent years, however, the Agencies 

have limited modifications to the 

existing risk-based capital rules while 

international efforts to create a new riskbased capital framework were in 

process. 

In June 2004, the Basel Committee 

introduced a new, more risk-sensitive 

capital adequacy framework, 

‘‘International Convergence of Capital 

Measurement and Capital Standards: A 

Revised Framework’’ (Basel II).3 Basel II 

is designed to promote improved risk 

measurement and management 

processes and better align minimum 

capital requirements with risk. For 

credit risk, Basel II includes three 

approaches for regulatory capital: 

Standardized, foundation internal 

ratings-based, and advanced internal 

ratings-based. For operational risk, Basel 

II also includes three methodologies: 


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77448 Federal Register / Vol. 71, No. 247 / Tuesday, December 26, 2006 / Proposed Rules 

4As stated in its preamble, the Base II ANPR was 

based on the consultative document ‘‘The New 

Basel Capital Accord’’ that was published by the 

Basel Committee on April 29, 2003. The Basel II 

ANPR anticipated the issuance of a final revised 

accord. See 68 FR 45900 (August 4, 2003). 

5 71 FR 55380 (September 25, 2006). The Basel II 

NPR would add new appendices to the Agencies’

existing capital regulations. These new appendices 

would be found at 12 CFR Part 3, Appendix C 

(OCC); 12 CFR Part 208, Appendix F and 12 CFR 

Part 225, Appendix F (FRB); 12 CFR Part 325, 

Appendix D (FDIC); and 12 CFR part 566, subpart 

A (OTS). 

6 ‘‘Summary Findings of the Fourth Quantitative 

Impact Study,’’ Joint Agency press release, February 

24, 2006. 7 70 FR 61068 (October 20, 2005). 

Basic indicator, standardized, and 

advanced measurement. 

In August 2003, the Agencies issued 

an advance notice of proposed 

rulemaking (Basel II ANPR), which 

explained how the Agencies might 

implement Basel II in the United 

States.4 On September 25, 2006, the 

Agencies issued a notice of proposed 

rulemaking that provides the industry 

with a more definitive proposal for 

implementing Basel II in the United 

States (Basel II NPR).5

The Basel II NPR identifies two types 

of U.S. banking organizations that 

would use the Basel II rules: Those for 

which application of the rules would be 

mandatory (core banks), and those that 

might voluntarily apply the rules (optin banks) (collectively referred to as 

Basel II banking organizations). In 

general, the Basel II NPR defines a core 

bank as a banking organization that has 

consolidated total assets of $250 billion 

or more, has consolidated on-balance 

sheet foreign exposure of $10 billion or 

more, or is a subsidiary of a Basel II 

banking organization. The Basel II NPR 

presents the advanced internal ratingsbased approach for credit risk and the 

advanced measurement approach for 

operational risk. However, the Agencies 

did seek comment in the Basel II NPR 

on whether U.S. banking organizations 

subject to the advanced approaches in 

the proposed rule (that is, core banks 

and opt-in banks) should be permitted 

to use other credit and operational risk 

approaches provided for in Basel II. The 

Agencies are seeking further comment 

on possible alternatives for Basel II 

banking organizations in Section III of 

this NPR. 

The complexity and cost associated 

with implementing Basel II in the 

United States effectively limit its 

application to those banking 

organizations that are able to take 

advantage of economies of scale and 

absorb the costs associated with the 

enhanced risk management practices 

required of Basel II banking 

organizations. Thus, the implementation 

of Basel II would create a bifurcated 

regulatory capital framework in the 

United States: One set of rules for Basel 

II banking organizations, and another for 

banking organizations that do not use 

the proposed Basel II capital rules (nonBasel II banking organizations). 

In comments responding to the Basel 

II ANPR, Congressional testimony, and 

other industry communications, several 

banking organizations, trade 

associations, and others raised concerns 

about the competitive effects of a 

bifurcated regulatory framework on 

community and regional banking 

organizations. Among other broad 

concerns, these commenters asserted 

that implementing the Basel II capital 

regime in the United States could result 

in lower minimum regulatory capital 

requirements for Basel II banking 

organizations with respect to certain 

types of credit exposures. As a result, 

regulatory capital requirements for 

similar products could differ depending 

on the capital regime under which a 

banking organization operates. 

Community and regional banking 

organizations asserted that this would 

put them at a competitive disadvantage. 

To assist in quantifying the potential 

effects of implementing Basel II in the 

United States, the Agencies conducted a 

quantitative impact study during late 

2004 and early 2005 (QIS 4).6 QIS 4 was 

a comprehensive survey completed on a 

best efforts basis by 26 of the largest 

U.S. banking organizations using their 

own internal estimates of the key risk 

parameters driving the capital 

requirements under the Basel II 

framework. The results of the study 

suggested that the aggregate minimum 

risk-based capital requirements for the 

26 banking organizations could drop 

approximately 15.5 percent relative to 

the existing Basel I-based framework. 

The QIS 4 results also indicated 

dispersion in capital requirements 

across banking organizations and 

portfolios, which was attributed in part 

to differences in the underlying data 

and methodologies used by banking 

organizations to quantify risk and their 

overall readiness to implement a Basel 

II framework. The Basel II NPR contains 

several provisions designed to limit 

potential reductions in minimum 

regulatory capital, such as an extended 

transition period during which the 

Agencies can thoroughly review those 

Basel II systems that are subject to 

supervisory oversight. 

On October 20, 2005, the Agencies 

issued an advanced notice of proposed 

rulemaking soliciting public comment 

on possible revisions to U.S. risk-based 

capital rules that would apply to nonBasel II banking organizations (Basel IA 

ANPR).7 The proposals in this NPR are 

based on those initial conceptual 

approaches and take into consideration 

the public comments that the Agencies 

received. 

Together, the Agencies received 73 

public comments from banking, trade, 

and other organizations and individuals. 

Generally, most commenters supported 

the Agencies’ goal to make the riskbased capital rules more risk-sensitive. 

Several larger banking organizations and 

industry groups favored increased risk 

sensitivity, but argued that many of the 

proposed revisions should be optional 

so that banking organizations may 

weigh the costs and benefits of using the 

revisions. Several non-Basel II banking 

organizations and industry groups 

argued that the U.S. risk-based capital 

rules should allow banking 

organizations to use internal 

assessments of risk to determine their 

capital requirements. A few commenters 

endorsed a proposal for a four-tier 

capital framework that would apply 

different approaches to banking 

organizations based on the size and 

complexity, and the robustness of a 

banking organization’s internal ratings 

systems. The commenters’ proposal 

included an approach that would permit 

some non-Basel II banking organizations 

to use internal rating-based systems. 

One commenter suggested tying Basel 

IA capital requirements directly to the 

aggregate results for Basel II 

calculations. This commenter suggested 

that Basel IA capital charges should link 

by loan category to the average riskbased capital requirements of the Basel 

II banking organizations for that loan 

category, plus a small premium to 

recognize the substantial costs of 

implementing Basel II. 

Most smaller and midsize banking 

organizations generally requested that 

any changes to the existing capital rules 

be simple and not require large data 

gathering and monitoring expenses. A 

number of the smallest banking 

organizations said that they do not wish 

to have any changes in the capital rules 

that apply to them. They noted that they 

already hold significantly more 

regulatory capital than the Agencies’

risk-based capital rules require and, 

therefore, amending the rules would 

have little or no effect. 

This NPR makes a number of 

proposals that should improve the risk 

sensitivity of the existing risk-based 

capital rules. The Agencies, however, 

are not proposing to allow a non-Basel 

II banking organization to use internal 

risk ratings or to use its internal risk 


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Federal Register / Vol. 71, No. 247 / Tuesday, December 26, 2006 / Proposed Rules 77449 

8The Agencies’ existing capital rules, however, 

would continue to permit the use of internal ratings 

for a direct credit substitute (but not a purchased 

credit-enhancing interest-only strip) assumed in 

connection with an asset-backed commercial paper 

program sponsored by a banking organization. 12 

CFR part 3, appendix A section 4(g) (OCC); 12 CFR 

parts 208 and 225, appendix A, section III.B.3.F 

(Board); 12 CFR part 325, appendix A, section 

II.B.5(g)(1) (FDIC); and 12 CFR 567.6(b)(4) (OTS). 

9 12 CFR 3.6(b) and (c) (OCC); 12 CFR part 208, 

appendix B and 12 CFR part 225, appendix D 

(Board); 12 CFR part 325.3 (FDIC); and 12 CFR 

567.8 (OTS). 

measurement processes to calculate 

risk-based capital requirements for any 

new categories of exposures.8 The 

Agencies believe that the use of these 

internal ratings and measurement 

processes should require the systems 

controls, supervisory oversight, and 

other qualification requirements that are 

proposed in the Basel II NPR. 

The Agencies also believe that any 

proposal to tie capital requirements 

under Basel IA to the capital charges 

that would result under the proposed 

Basel II rules is premature. The 

Agencies anticipate that the Basel II 

transition phase would not be 

completed until 2011 at the earliest. The 

Agencies also have other concerns about 

the commenter’s proposal including the 

absence of a capital charge for 

operational risk; the method by which 

any premium over the Basel II charges 

would be determined; difficulties in 

defining comparable portfolios; and the 

need to periodically update capital 

requirements, which would 

significantly increase complexity and 

burden. 

II. Proposed Changes 

In considering revisions to the 

existing risk-based capital rules, the 

Agencies were guided by five broad 

principles. A revised framework must: 

(1) Promote safe and sound banking 

practices and a prudent level of 

regulatory capital; (2) maintain a 

balance between risk sensitivity and 

operational feasibility; (3) avoid undue 

regulatory burden; (4) create appropriate 

incentives for banking organizations; 

and (5) mitigate material distortions in 

the risk-based capital requirements for 

large and small banking organizations. 

The Agencies are concerned about 

potential competitive disadvantages that 

could result from capital requirements 

that differ depending on the capital 

regime under which a banking 

organization operates. By allowing nonBasel II banking organizations the 

choice of adopting all of the provisions 

in this proposal or continuing to use the 

existing risk-based capital rules, the 

proposed regulation is intended to help 

maintain the competitive position of 

these banks relative to Basel II banking 

organizations. Moreover, the proposed 

rule strives for better alignment of 

capital and risk, with capital 

requirements potentially higher for 

organizations with riskier exposures and 

lower for those with safer exposures. 

The Agencies seek to achieve these 

objectives while balancing operational 

feasibility and regulatory burden 

considerations. 

In this NPR, the Agencies are 

proposing to: 

• Allow non-Basel II banking 

organizations the choice of adopting all 

of the revisions in this proposal or 

continuing to use the existing risk-based 

capital rules. The voluntary nature of 

this proposed rule gives banking 

organizations the opportunity to weigh 

the various costs and benefits to them of 

adopting the new system. 

• Increase the number of risk weight 

categories to which credit exposures 

may be assigned. 

• Use external credit ratings to risk 

weight certain exposures. 

• Expand the range of recognized 

collateral and eligible guarantors. 

• Use loan-to-value ratios to risk 

weight most residential mortgages. 

• Increase the credit conversion factor 

for various commitments with an 

original maturity of one year or less. 

• Assess a risk-based capital charge 

for early amortizations in securitizations 

of revolving exposures. 

• Remove the 50 percent limit on the 

risk weight for certain derivative 

transactions. 

The existing risk-based capital 

requirements focus primarily on credit 

risk and do not impose explicit capital 

charges for interest rate, operational, or 

other risks. These risks, however, are 

implicitly covered by the existing riskbased capital rules. The risk-based 

capital charges proposed in this NPR 

continue the implicit coverage of risks 

other than credit risk. Moreover, the 

Agencies are not proposing revisions to 

the existing leverage ratio requirement 

(that is, the ratio of Tier 1 capital to total 

assets).9

To ensure safety and soundness, the 

Agencies intend to closely monitor the 

level of risk-based capital at those 

banking organizations that choose to opt 

in to Basel IA. Any significant decline 

in the aggregate level of risk-based 

capital for these banking organizations 

may warrant modifications to the 

proposed risk-based capital rules. 

Question 1: The Agencies welcome 

comments on all aspects of these 

proposals, especially suggestions for 

reducing the burden that may be 

associated with these proposals. The 

Agencies believe that a banking 

organization that chooses to adopt these 

proposals will generally be able to do so 

with data it currently uses as part of its 

credit approval and portfolio 

management processes. Commenters are 

particularly requested to address 

whether any of the proposed changes 

would require data that are not 

currently available as part of the 

organization’s existing credit approval 

and portfolio management systems. 

A. Opt-In Proposal 

In the Basel IA ANPR, the Agencies 

recognized that certain banking 

organizations might not want to assume 

the additional burden that might 

accompany a more risk-sensitive 

approach and might prefer to continue 

to apply the existing risk-based capital 

rules. Additionally, many commenters, 

particularly community bank 

respondents, favored an approach that 

would allow well-capitalized banking 

organizations to remain under the 

existing risk-based capital rules. For 

these commenters, limiting regulatory 

burden was a higher priority than 

increasing the risk sensitivity of their 

risk-based capital charges. One group of 

midsize banking organizations 

recommended applying the proposed 

rules only to banking organizations with 

assets of $500 million or greater. Some 

commenters noted the risk of ‘‘cherry 

picking’’ in permitting a choice between 

the framework discussed in the Basel IA 

ANPR and the existing risk-based 

capital rules, or adoption of parts of 

each. 

The Agencies are proposing that a 

non-Basel II banking organization may, 

if it chooses, adopt the revisions in this 

proposed rule. If a banking organization 

chooses to use these proposed capital 

rules, however, it would be required to 

implement them in their entirety. The 

Agencies are proposing to permit a 

banking organization to adopt these 

proposals by notifying its primary 

Federal supervisor. Before a banking 

organization decides to opt in to these 

proposals, the Agencies expect that the 

organization would review its ability to 

collect and utilize the information 

required and evaluate the potential 

impact on its regulatory capital. A 

banking organization that chooses to 

adopt these proposals (that is, opts in) 

would also be able to request returning 

to the existing capital rules by first 

notifying its primary Federal supervisor. 

In its review of such a request, the 

primary Federal supervisor would 

ensure that the risk-based capital 

requirements appropriately reflect the 

risk profile of the banking organization 

and the change is not for purposes of 


sroberts on PROD1PC70 with PROPOSALS
77450 Federal Register / Vol. 71, No. 247 / Tuesday, December 26, 2006 / Proposed Rules 

10An NRSRO is an entity recognized by the 

Division of Market Regulation of the Securities and 

Exchange Commission (SEC) as a nationally 

recognized statistical rating organization for various 

purposes, including the SEC’s uniform net capital 

requirements for brokers and dealers 17 CFR 

240.15c3–1). On September 29, 2006, the President 

signed the Credit Rating Agency Reform Act of 2006 

(Reform Act) (Pub. L. 109–291) into law. The 

Reform Act requires a credit rating agency that 

wants to represent itself as an NRSRO to register 

with the SEC. The Agencies may review their riskbased capital rules, guidance and proposals from 

time to time in order to determine whether any 

modification of the Agencies’ definition of an 

NRSRO is appropriate. 

11Some synthetic structures may also be subject 

to the external rating approach. For example, 

certain credit-linked notes issued from a synthetic 

securitization are risk weighted according to the 

rating given to the notes. 66 FR 59614, 59622 

(November 29, 2001). 

12The ratings designations (for example, ‘‘AAA,’’

‘‘BBB,’’ ‘‘A–1,’’ and ‘‘P–1’’), are illustrative and do 

not indicate any preference for, or endorsement of, 

any particular rating agency description system. 

capital arbitrage. Further, the Agencies 

expect that a banking organization 

would not alternate between the 

existing and proposed risk-based capital 

rules. The Agencies would reserve the 

authority to require a banking 

organization to calculate its minimum 

risk-based capital requirements in 

accordance with this proposal or the 

existing risk-based capital rules. 

Under this proposal, a non-Basel II 

banking organization could continue to 

calculate its risk-based capital 

requirements using the existing riskbased capital rules. In this case, the 

banking organization would not need to 

notify its primary Federal supervisor or 

take any other action. As noted, above, 

however, the Agencies would retain the 

authority to require a non-Basel II 

banking organization to use either the 

existing or the proposed risk-based 

capital rules if the banking 

organization’s primary Federal 

supervisor determines that a particular 

capital rule is more appropriate for the 

risk profile of the banking organization. 

Question 2: The Agencies seek 

comment on all aspects of the proposal 

to allow banks to opt in to and out of 

the proposed rules. Specifically, the 

Agencies seek comment on any 

operational challenges presented by the 

proposed rules. How far in advance 

should a banking organization be 

required to notify its primary Federal 

supervisor that it intends to implement 

the proposed rule? If a banking 

organization wishes to ‘‘opt out’’ of the 

proposed rule, what criteria should 

guide the review of a request to opt out? 

When should a banking organization’s 

election to opt in or opt out be effective? 

In addition, the Agencies seek comment 

on the appropriateness of requiring a 

banking organization to apply the 

proposed Basel IA capital rules based 

on a banking organization’s asset size, 

level of complexity, risk profile, or scope 

of operations. 

B. Increase the Number of Risk Weight 

Categories 

The Agencies’ existing risk-based 

capital rules contain five risk-weight 

categories: Zero, 20, 50, 100, and 200 

percent. Differentiation of credit quality 

among individual exposures is generally 

limited to these few risk-weight 

categories. In the Basel IA ANPR, the 

Agencies suggested adding four new 

risk-weight categories (35, 75, 150, and 

350 percent) and invited comment on 

whether: (1) Increasing the number of 

risk-weight categories would allow 

supervisors to more closely align capital 

requirements with risk; (2) the suggested 

additional risk-weight categories would 

be appropriate; (3) the risk-based capital 

framework should include more riskweight categories than the four 

suggested; and (4) increasing the 

number of risk-weight categories would 

impose unnecessary burden on banking 

organizations. 

Commenters generally supported 

increasing the number of risk-weight 

categories to enhance the overall risksensitivity of the risk-based capital 

rules. However, many commenters 

noted that adding too many categories 

could make the rules too complex. 

Several commenters argued that the 350 

percent risk weight is too high and 

suggested that any new risk-weight 

categories should be lower than 100 

percent to reflect the lower risks 

associated with certain mortgages and 

other high-quality assets. A few 

commenters suggested that the Agencies 

create a new 10 percent risk weight 

category to account for very low-risk 

assets. 

The Agencies agree with the 

commenters that increasing the number 

of risk-weight categories would allow 

for greater risk sensitivity than the 

existing risk-based capital rules. 

Accordingly, the Agencies propose to 

add 35, 75, and 150 percent risk-weight 

categories. The Agencies believe that 

adding a 150 percent risk weight 

category and expanding the use of the 

existing 200 percent risk weight 

category would allow for somewhat 

greater differentiation of credit risk 

among more risky exposures than is 

permitted by the existing capital rules. 

At the same time, for certain types of 

relatively low-risk exposures, the 

existing risk-based capital charge may 

be higher than warranted. Therefore, the 

35 and 75 percent risk weight categories 

provide an opportunity to increase the 

risk sensitivity of the regulatory capital 

charges for these exposures. 

The Agencies agree that the credit 

risks covered by this NPR generally do 

not warrant a 350 percent category, and 

are not proposing to add this risk 

weight. Question 3: The Agencies seek 

comment on whether these or any other 

new risk weight categories would be 

appropriate. More specifically, the 

Agencies are interested in any 

comments regarding whether any 

categories of assets might warrant a risk 

weight higher than 200 percent and 

what risk weight might be appropriate 

for such assets. The Agencies also solicit 

comment on whether a 10 percent risk 

weight category would be appropriate 

and what exposures should be included 

in this risk weight category. 

C. Use of External Credit Ratings to Risk 

Weight Exposures 

The Agencies’ existing risk-based 

capital rules permit the use of external 

credit ratings issued by a nationally 

recognized statistical rating organization 

(NRSRO) 10 to assign risk weights to 

recourse obligations, direct credit 

substitutes (DCS), residual interests 

(other than a credit-enhancing interestonly strip), and asset- and mortgagebacked securities.11 For example, AAAand AA-rated mortgage-backed 

securities 12 are assigned to the 20 

percent risk weight category while BBrated mortgage-backed securities are 

assigned to the 200 percent risk weight 

category. When the Agencies revised the 

risk-based capital rules to allow for the 

use of external credit ratings issued by 

an NRSRO for the types of exposures 

listed above, the Agencies 

acknowledged that such ratings could 

be used to determine the risk-based 

capital requirements for other types of 

debt instruments, such as rated 

corporate debt. 

In the Basel IA ANPR, the Agencies 

suggested expanding the use of NRSRO 

ratings to determine the risk-based 

capital charge for most categories of 

NRSRO-rated exposures, including 

sovereign and corporate debt securities 

and rated loans. The Agencies 

indicated, however, that they were 

considering retaining the existing riskbased capital treatment for U.S. 

government and agency exposures, U.S. 

government-sponsored entity exposures, 

and municipal obligations. Tables 1 and 

2 in the Basel IA ANPR matched ratings 

and possible corresponding risk weights 

for long- and short-term exposures. The 

Agencies requested comment on the use 

of other methodologies to assign risk 

weights to unrated exposures. 


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13A transition matrix tracks the performance and 

stability (or ratings migration) of an NRSRO’s issued 

external ratings. 

14A sovereign is defined as a central government, 

including its agencies, departments, ministries, and 

the central bank. A soverign does not include state, 

provincial, or local governments, or commercial 

enterprises owned by a central government. 

15 12 CFR part 3, appendix A, section 4, Tables 

B and C (OCC); 12 CFR parts 208 and 225, appendix 

A, section III.B.3.c.i. (Board); 12 CFR part 325, 

appendix A, section II.B.5.(d) (FDIC); and 12 CFR 

567.6(b) (OTS) (the Recourse Rule). 

16With the exception of the clarification of the 

definition of an external rating and the proposed 

risk-based capital charge for securitizations with 

early amortization features described in section F of 

this NPR, the Agencies are not proposing to make 

other changes to the existing risk-based capital rules 

for recourse obligations, DCS, and residual 

interests. See 12 CFR part 3, appendix A, section 

4 (OCC); 12 CFR parts 208 and 225, appendix A, 

section III.B.3 (Board); 12 CFR part 325, appendix 

A, section II.B.5 (FDIC); and 12 CFR 567.6(b) (OTS) 

(Recourse Rule). 

17See 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 Agencies issued 

an NPR that proposes revisions to the Market Risk 

rules. OTS does not currently have a market risk 

rule, but has proposed to add a new rule on this 

topic in the Market Risk NPR. See 71 FR 55958 

(September 25, 2006). 

18Public-sector entities include states, local 

authorities and governmental subdivisions below 

the central government level in an Organization for 

Economic Cooperation and Development (OECD) 

country. In the United States, this definition 

encompasses a state, county, city, town, or other 

municipal corporation, a public authority, and 

generally any publicly-owned entity that is an 

instrument of a state or municipal corporation. This 

definition does not include commercial companies 

owned by the public sector. The OECD-based group 

of countries comprises all full members of the 

OECD, as well as countries that have concluded 

special lending arrangements with the International 

Monetary Fund (IMF) associated with the Fund’s 

General Arrangements to Borrow. 

Many commenters supported the use 

of external ratings in principle but noted 

that non-Basel II banking organizations’

holdings of securities and loans 

generally are not rated. Thus, they 

suggested that the expansion of the use 

of NRSRO ratings would have little 

impact on these banking organizations. 

A few commenters also asserted that 

using NRSRO ratings might discourage 

lending to non-rated entities. 

Many commenters argued that the risk 

weights suggested in the Basel IA ANPR 

were too high. In particular, many 

commenters said that the 350 percent 

and 200 percent risk weights for 

exposures rated BB+ and lower would 

be unnecessarily punitive. A few 

commenters also expressed concerns 

about NRSRO ratings generally. These 

commenters said that there are too few 

NRSROs to ensure adequate market 

discipline, NRSROs are inadequately 

supervised, and NRSRO ratings often 

react too slowly to crises. 

A number of commenters suggested 

alternative methods for differentiating 

risk among commercial exposures and 

making the capital requirements for 

these exposures more risk sensitive. 

Many larger banking organizations 

suggested allowing an internal risk 

measurement approach to determine 

risk-based capital requirements. Some 

smaller banking organizations sought 

increased recognition of a variety of risk 

mitigation techniques, such as personal 

guarantees and collateral. 

The Agencies acknowledge that 

expanding the use of external ratings 

may have little effect on the risk-based 

capital requirements for existing loan 

portfolios at most banking 

organizations. To the extent that assets 

in a banking organization’s investment 

portfolio are rated, however, the 

Agencies believe that using external 

ratings will improve risk sensitivity of 

the capital charges for these assets. 

Furthermore, implementing broader use 

of external ratings would also provide a 

basis for expanding recognition of 

eligible guarantees and recognized 

collateral. Accordingly, the Agencies are 

proposing to expand the use of external 

ratings for purposes of determining the 

risk-based capital charge for certain 

externally rated exposures as described 

below in the sections on direct 

exposures, recognized collateral, and 

eligible guarantees. 

An external rating would be defined 

as a credit rating that is assigned by an 

NRSRO, provided that the credit rating 

(1) fully reflects the entire amount of 

credit risk with regard to all payments 

owed to the holder and the credit risk 

associated with timely repayment of 

principal and interest; (2) is published 

in an accessible public form, for 

example, on the NRSRO’s Web site and 

in financial media; (3) is monitored by 

the NRSRO; and (4) is, or will be, 

included in the issuing NRSRO’s 

publicly available transition matrix.13 If 

an exposure has two or more external 

ratings, the banking organization must 

use the lowest assigned external rating 

to risk weight the exposure. If an 

exposure has components that are 

assigned different external ratings, a 

banking organization would be required 

to assign the lowest rating to the entire 

exposure. If a component is not 

externally rated, the entire exposure 

would be treated as unrated. 

i. Direct Exposures 

The Agencies are proposing to use 

external ratings to risk weight (1) 

sovereign 14 debt and debt securities, 

and (2) debt securities issued by and 

rated loans to non-sovereign entities 

including securities firms, insurance 

companies, bank holding companies, 

savings and loan holding companies, 

multilateral lending and regional 

development institutions, partnerships, 

limited liability companies, business 

trusts, special purpose entities, 

associations and other similar 

organizations. External ratings for direct 

exposures to sovereigns would be based 

on the external rating of the exposure or, 

if the exposure is unrated, on the 

sovereign’s issuer rating. Direct 

exposures to non-sovereigns would be 

risk weighted based on the external 

rating of the exposure. For example, a 

banking organization would assign any 

AAA-rated debt security issued by a 

corporation, insurance company, or 

securities firm to the 20 percent risk 

weight category. The Agencies are, 

however, not proposing to permit the 

use of issuer ratings for non-sovereigns. 

The risk weights for direct exposures 

are detailed in Table 1 (long-term 

exposures) and Table 2 (short-term 

exposures) below. The Agencies are also 

proposing to replace the existing riskweight tables for externally rated 

recourse obligations, DCS, residual 

interests (other than a credit-enhancing 

interest-only strip), and asset- and 

mortgage-backed securities 15 with the 

risk weights in Tables 1 and 2.16 This 

proposed treatment would apply to all 

externally rated exposures unless the 

banking organization uses a market risk 

rule.17 For a banking organization that 

uses a market risk rule, this treatment 

applies only to externally rated 

exposures held in the banking book. 

The Agencies intend to retain the 

existing risk-based capital treatment for 

direct exposures to public-sector 

entities,18 the U.S. government and its 

agencies, U.S. government-sponsored 

agencies, and depository institutions 

(U.S. and foreign) and for unrated loans 

made to non-sovereign entities. 

Exposures issued by these entities are 

not subject to Table 1 or 2. 


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19The Agencies’ rules for collateral transactions, 

however, differ somewhat as described in the 

Agencies’ joint report to Congress. ‘‘Joint Report: 

Differences in Accounting and Capital Standards 

among the Federal Banking Agences,’’ 70 FR 15379 

(March 25, 2005). 

TABLE 1.—PROPOSED RISK WEIGHTS BASED ON EXTERNAL RATINGS FOR LONG-TERM EXPOSURES

Long-term rating category Example 

Sovereign risk 

weight 

(in percent) 

Non-sovereign 

risk weight 

(in percent) 

Securitization 

exposure 1 risk 

weight 

(in percent) 

Highest investment grade rating ............................................................................ AAA ......... 0 20 20 

Second-highest investment grade rating ............................................................... AA ............ 20 20 20 

Third-highest investment grade rating ................................................................... A .............. 20 35 35

Lowest-investment grade rating—plus .................................................................. BBB+ ....... 35 50 50 

Lowest-investment grade rating ............................................................................ BBB ......... 50 75 75 

Lowest-investment grade rating—minus ............................................................... BBB¥ ...... 75 100 100 

One category below investment grade .................................................................. BB+, BB ... 75 150 200 

One category below investment grade—minus ..................................................... BB¥ ........ 100 200 200 

Two or more categories below investment grade ................................................. B, CCC .... 150 200 1

Unrated 2 ................................................................................................................ n/a ........... 200 200 1

1A securitization exposure includes asset- and mortgage-backed securities, recourse obligations, DCS, and residuals (other than a credit-enhancing interest-only strip). For long-term securitization exposures that are externally rated more than one category below investment grade, 

short-term exposures that are rated below investment grade, or any unrated securitization exposures, the existing risk-based capital treatment as 

described in the Agencies’ Recourse Rule would be used. 2 Unrated sovereign exposures and unrated debt securities issued by non-sovereigns would receive the risk weight indicated in Tables 1 and 

2. Other unrated exposures, for example, unrated loans to non-sovereigns, would continue to be risk weighted under the existing risk-based capital rules. 

TABLE 2.—PROPOSED RISK WEIGHTS BASED ON EXTERNAL RATINGS FOR SHORT-TERM EXPOSURES

Short-term rating category Example 

Sovereign risk 

weight 

(in percent) 

Non-sovereign 

risk weight 

(in percent) 

Securitization 

exposure 1 risk 

weight 

(in percent) 

Highest investment grade rating ............................................................................ A–1, P–1 .. 0 20 20 

Second-highest investment grade rating ............................................................... A–2, P–2 .. 20 35 3 

Lowest investment grade ....................................................................................... A–3, P–3 .. 50 75 75 

Unrated 2 ................................................................................................................ n/a ........... 100 100 (1) 

1A securitization exposure includes asset- and mortgage-backed securities, recourse obligations, DCS, and residuals (other than a credit-enhancing interest-only strip). For long-term securitization exposures that are externally rated more than one category below investment grade, 

short-term exposures that are rated below investment grade, or any unrated securitization exposures, the existing risk-based capital treatment as 

described in the Agencies’ Recourse Rule would be used. 2 Unrated sovereign exposures and unrated debt securities issued by non-sovereigns would receive the risk weight indicated in Tables 1 and 

2. Other unrated exposures, for example, unrated loans to non-sovereigns, would continue to be risk weighted under the existing risk-based capital rules. 

The proposed risk weights in Tables 

1 and 2 are generally consistent with the 

historical default rates reported in the 

default studies published by NRSROs. 

The Agencies believe that the additional 

application of external ratings to the 

exposures specified above would 

improve the risk sensitivity of the 

capital treatment for those exposures. 

Furthermore, the Agencies believe that 

the revised risk-weight tables for 

externally rated recourse obligations, 

DCS, residual interests (other than 

credit-enhancing interest only-strips), 

and asset- and mortgage-backed 

securities would also better reflect risk 

than the Agencies’ existing risk-based 

capital rules. 

Under the proposal, the Agencies 

would retain their authority to reassign 

an exposure to a different risk weight on 

a case-by-case basis to address the risk 

of a particular exposure. 

ii. Recognized Financial Collateral 

The Agencies’ existing risk-based 

capital rules recognize limited types of 

collateral: (1) Cash on deposit; (2) 

securities issued or guaranteed by 

central governments of the OECD 

countries; (3) securities issued or 

guaranteed by the U.S. government or 

its agencies; (4) securities issued or 

guaranteed by U.S. governmentsponsored agencies; and (5) securities 

issued by certain multilateral lending 

institutions or regional development 

banks.19 In the past, the banking 

industry has commented that the 

Agencies should recognize a wider array 

of collateral types for purposes of 

reducing risk-based capital 

requirements. 

In the Basel IA ANPR, the Agencies 

noted that they were considering 

expanding the list of recognized 

collateral to include short-or long-term 

debt securities (for example, corporate 

and asset- and mortgage-backed 

securities) that are externally rated at 

least investment grade by an NRSRO, or 

issued or guaranteed by a sovereign 

central government that is externally 

rated at least investment grade by an 

NRSRO. Consistent with the proposed 

treatment for direct exposures, the Basel 

IA ANPR suggested assigning exposures 

or portions of exposures collateralized 

by financial collateral to risk-weight 

categories based on the external rating 

of that collateral. To use this expanded 

list of collateral, the Basel IA ANPR 

considered requiring a banking 

organization to have collateral 

management systems to track collateral 

and readily determine its realizable 

value. The Agencies sought comment on 

whether this approach for expanding 

the scope of recognized collateral would 

improve risk sensitivity without being 

overly burdensome. 

Many commenters supported 

expanding the list of recognized 

collateral, but several also noted that 

using NRSRO ratings would have little 

effect on most community banks. Some 

commenters suggested reducing the risk 

weights applied to exposures secured by 


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20 12 CFR part 3, appendix A, section 3(a)(1)(viii) 

(OCC); and 12 CFR parts 208 and 225, appendix A, 

section III.C.1 (Board). 

21 If an exposure is partially guaranteed, the pro 

rata portion not covered by the guarantee would be 

assigned to the risk weight category appropriate to 

the obligor, after consideration of collateral and 

external ratings. 

any collateral that is legally perfected 

and has objective methods of valuation 

or can be readily marked-to-market. 

Many commenters also stated that any 

collateral valuation and monitoring 

requirements likely would be too costly 

to benefit smaller community banks. 

To increase the risk sensitivity of the 

existing risk-based capital rules, the 

Agencies are proposing to revise the list 

of recognized collateral to include a 

broader array of externally rated, liquid, 

and readily marketable financial 

instruments. The revised list would 

incorporate long- and short-term debt 

securities and securitization exposures 

that are: 

a. Issued or guaranteed by a sovereign 

where such securities are externally 

rated at least investment grade by an 

NRSRO; or an exposure issued or 

guaranteed by a sovereign with an issuer 

rating that is at least investment grade; 

or 

b. Issued by non-sovereigns where 

such securities are externally rated at 

least investment grade by an NRSRO. 

Consistent with the Agencies’ existing 

risk-based capital rules, the Agencies 

propose to continue to recognize 

collateral that is either issued or 

guaranteed by certain sovereigns. For 

non-sovereign exposures, however, the 

Agencies propose that the collateral 

itself must be externally rated 

investment grade or better to qualify as 

recognized collateral. The Agencies 

believe that this more conservative 

approach for recognizing non-sovereign 

collateral is appropriate and expect that 

any guarantee provided by a nonsovereign would be reflected in the 

external rating of the collateral. 

A banking organization would assign 

exposures collateralized by financial 

collateral externally rated at least 

investment grade to the appropriate risk 

weight in Table 1 or 2 above. If an 

exposure is partially collateralized, a 

banking organization could assign the 

portions of exposures collateralized by 

the market value of the externally rated 

collateral to the appropriate risk weight 

category in Tables 1 and 2 of this NPR. 

For example, the portion of an exposure 

collateralized by the market value of a 

AAA-rated corporate debt security 

would be assigned to the 20 percent risk 

weight category. The Agencies are 

proposing a minimum risk weight of 20 

percent for collateralized exposures 

except as noted below. 

The Agencies have decided to retain 

their respective risk-based capital rules 

that govern the following collateral: 

Cash, securities issued or guaranteed by 

the U.S. government or its agencies, and 

securities issued or guaranteed by U.S. 

government-sponsored agencies. The 

Agencies are also retaining the existing 

risk-based capital rules for exposures 

collateralized by securities issued or 

guaranteed by other OECD central 

governments that meet certain criteria.20

iii. Eligible Guarantors 

Under the Agencies’ existing riskbased capital rules, the recognition of 

third party guarantees is limited to 

guarantees provided by central 

governments of OECD countries, U.S. 

government and government-sponsored 

entities, public-sector entities in OECD 

countries, multilateral lending 

institutions and regional development 

banks, depository institutions and 

qualifying securities firms in OECD 

countries, depository institutions in 

non-OECD countries (short-term 

claims), and central governments of 

non-OECD countries (local currency 

exposures only). 

In the Basel IA ANPR, the Agencies 

suggested expanding the scope of 

eligible guarantors to include any entity 

whose long-term senior debt has been 

assigned an external credit rating of at 

least investment grade by an NRSRO. 

The applicable risk weight for 

guaranteed exposures would be based 

on the risk weights corresponding to the 

rating of the long-term debt of the 

guarantor. 

Most commenters supported, in 

principle, expanding the list of eligible 

guarantors. However, many commenters 

noted that very few community and 

midsize banking organizations have 

exposures that are guaranteed by 

externally rated entities. Thus, many 

commenters suggested that this 

provision would have little impact 

unless the proposed revisions 

recognized more types of guarantees. 

The Agencies believe that the range of 

eligible third-party guarantors under the 

existing risk-based capital rules is 

restrictive and ignores market practice. 

As a result, the Agencies are proposing 

to expand the list of eligible guarantors 

by recognizing entities that have longterm senior debt (without credit 

enhancement) rated at least investment 

grade by an NRSRO or, in the case of a 

sovereign, an issuer rating that is at least 

investment grade. Under this NPR, a 

recognized third-party guarantee would 

have to: 

(1) Be written and unconditional, and, 

for a sovereign guarantee, be backed by 

the full faith and credit of the sovereign; 

(2) Cover all or a pro rata portion of 

contractual payments of the obligor on 

the reference exposure; 21

(3) Give the beneficiary a direct claim 

against the protection provider; 

(4) Be non-cancelable by the 

protection provider for reasons other 

than the breach of the contract by the 

beneficiary; 

(5) Be 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; 

and 

(6) Require the protection provider to 

make payment to the beneficiary on the 

occurrence of a default (as defined in 

the guarantee) of the obligor on the 

reference exposure without first 

requiring the beneficiary to demand 

payment from the obligor. 

To be considered an eligible 

guarantor, a sovereign or its senior longterm debt (without credit enhancement) 

must be externally rated at least 

investment grade. Non-sovereigns must 

have long-term senior debt (without 

credit enhancement) that is externally 

rated at least investment grade. Under 

this proposal, a banking organization 

could assign the portions of exposures 

guaranteed by eligible guarantors to the 

proposed risk weight category 

corresponding to the external rating of 

the eligible guarantors’ long-term senior 

debt in accordance with Table 1 above. 

The Agencies would retain the 

existing risk-weight treatment of 

exposures guaranteed by the U.S. 

government and its agencies, U.S. 

government-sponsored agencies, publicsector entities, depository institutions in 

OECD countries, and depository 

institutions in non-OECD countries 

(short-term exposures only). 

Question 4: The Agencies solicit 

comment on all aspects of the proposed 

use of external ratings including the 

appropriateness of the risk weights, 

expanded collateral, and additional 

eligible guarantors. The Agencies also 

seek comment on whether to exclude 

certain externally rated exposures from 

the ratings treatment as proposed or to 

use external ratings as a measure for all 

externally rated exposures, collateral, 

and guarantees. Alternatively, should 

the Agencies retain the existing riskbased capital treatment for certain types 

of exposures, for example, qualifying 

securities firms? The Agencies are also 

interested in comments on all aspects of 

the scope of the terms sovereign, nonVerDate Aug<31>2005 16:17 Dec 22, 2006 Jkt 211001 PO 00000 Frm 00009 Fmt 4701 Sfmt 4702 E:\FR\FM\26DEP2.SGM 26DEP2

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22 ‘‘Freddie Mac and Fannie Mae Enhancements 

to Capital Strength, Disclosure and Market 

Discipline’’, October 19, 2000 (agreement between 

the GSEs and the Office of Federal Housing 

Enterprise Oversight). 

23 Ibid, p. 2. 

24Moody’s and S&P’s financial strength ratings 

would not meet the definition of an ‘‘external 

rating’’ as proposed in this NPR. Furthermore, the 

difficulty of defining an event of default and the 

lack of default data suggest that it would not be 

feasible to incorporate this type of rating into a 

transition matrix. 

25 12 CFR part 3 appendix A section 3(c)(iii) 

(OCC); 12 CFR parts 208 and 225 appendix A 

section III.C.3 (Board); 12 CFR part 325, appendix 

A, section II.C.3 (FDIC); and 12 CFR 567.1 

(definition of ‘‘qualifying mortgage loan’’) and 12 

CFR 567.6(a)(1)(iii)(B) (50 percent risk weight) 

(OTS). 

sovereign, and securitization exposures. 

Specifically, the Agencies seek comment 

on the scope of these terms, whether 

they should be expanded to cover other 

entities, or whether any entities 

included in these definitions should be 

excluded. 

iv. Government-Sponsored Agencies 

One area of particular interest to the 

Agencies is the risk weighting of 

exposures to U.S. governmentsponsored agencies, also commonly 

referred to as government-sponsored 

entities (GSEs). The Agencies’ existing 

risk-based capital regulations assign a 

20 percent risk weight to exposures 

issued or guaranteed by GSEs. The Basel 

IA NPR proposes to retain this riskbased capital treatment. The Agencies 

are aware that there are various types of 

ratings that might increase the risk 

sensitivity of risk weights assigned to 

GSE exposures. For example, NRSROs 

rate the creditworthiness of short-term 

senior debt, senior unsecured debt, 

subordinated debt and preferred stock of 

some GSEs. These ratings on individual 

exposures, however, are often based in 

part on the NRSROs’ assessment of the 

extent to which the U.S. government 

might come to the financial aid of a GSE 

if necessary. In this context, and as 

indicated in the preamble to the Basel 

II NPR, the Agencies do not believe that 

risk weight determinations should be 

based on the possibility of U.S. 

government financial assistance, except 

for the financial assistance the U.S. 

government has legally committed to 

provide. The Agencies believe the 

existing approach has thus far met this 

objective. However, the Agencies also 

note that as part of the October 19, 2000 

agreement with their regulator,22 both 

Fannie Mae and Freddie Mac agreed to 

obtain and disclose annually ratings that 

would ‘‘assess the risk to the 

government, or the independent 

financial strength, of each of the 

companies.’’ 23

In accordance with the agreement, 

Fannie Mae and Freddie Mac currently 

obtain and disclose separate ratings 

from two NRSROs—‘‘Standard & Poor’s 

(S&P) and Moody’s Investors Service 

(Moody’s). The S&P ‘‘risk to the 

government rating’’ uses the same scale 

as its standard corporate credit ratings. 

Currently, Fannie Mae and Freddie Mac 

both have a risk to the government 

issuer rating of AA¥ from S&P, which 

is unchanged from the initial AA¥ 

issuer rating that S&P initially provided 

in 2001. Moody’s ‘‘bank financial 

strength rating’’ (BFSR) uses a scale of 

A–E. In 2002, Moody’s provided a BFSR 

of A¥ to both GSEs. On March 28, 

2005, Moody’s downgraded Fannie 

Mae’s BFSR to B+. Based on Moody’s 

mapping of BFSRs to Moody’s basic 

credit assessment ratings, A− is 

the equivalent of an Aa1 and B+ maps 

to an Aa2. 

Both the risk to government rating 

and the BFSR (collectively, financial 

strength ratings) are issuer ratings that 

evaluate the financial strength of each 

GSE without respect to any implied 

financial assistance from the U.S. 

government. These financial strength 

ratings are published and monitored by 

the issuing NRSRO but they are not 

included in the NRSROs’ transition 

matrices. These ratings are an indicator 

of each GSE’s overall financial 

condition and safety and soundness 

and, thus, do not apply to any specific 

financial obligation or the probability of 

timely payment thereof.24 If the 

Agencies were to use these S&P and 

Moody’s financial strength ratings to 

risk weight exposures to Fannie Mae 

and Freddie Mac in a manner similar to 

the use of external ratings for rated 

exposures as proposed in the Basel IA 

NPR, the current ratings would map to 

a 20 percent risk weight. 

Question 5: The Agencies are 

considering whether to use financial 

strength ratings to determine risk 

weights for exposures to GSEs, where 

this type of rating is available, and are 

seeking comment on how a financial 

strength rating might be applied. For 

example, should the financial strength 

rating be mapped to the non-sovereign 

risk weights in Tables 1 and 2? Should 

these ratings apply to all GSE exposures 

including short- and long-term debt, 

mortgage-backed securities, collateral, 

and guarantees? How should exposures 

to a GSE that lacks a financial strength 

rating be risk weighted? Are there any 

requirements in addition to publication 

and on-going monitoring that should be 

incorporated into the definition of an 

acceptable financial strength rating? 

Question 6: The Agencies also seek 

comment on whether to exclude certain 

other externally rated exposures from 

the ratings treatment as proposed or to 

use external ratings as a measure for 

additional externally rated exposures, 

collateral, and guarantees. Should the 

proposed ratings treatment be 

applicable for direct exposures to public 

sector entities or depository institutions? 

Likewise, should the proposed ratings 

treatment be applicable to exposures 

guaranteed by public sector entities or 

depository institutions, and to 

exposures collateralized by debt 

securities issued by those entities? 

D. Mortgage Loans Secured by a Lien on 

a One-to-Four Family Residential 

Property 

i. First Lien Risk Weights 

The Agencies’ existing risk-based 

capital rules assign first-lien, one-to-four 

family residential mortgages to either 

the 50 percent or 100 percent risk 

weight category. Most mortgage loans 

secured by a first lien on a one-to-four 

family residential property (first lien 

mortgages) meet the criteria to receive a 

50 percent risk weight.25 The broad 

assignment of most first lien mortgages 

to the 50 percent risk weight category 

has been criticized for not being 

sufficiently risk sensitive. 

In the Basel IA ANPR, the Agencies 

stated they were considering options to 

make the risk-based capital requirement 

for residential mortgages more risk 

sensitive while not unnecessarily 

increasing regulatory burden. One 

option was to base the capital 

requirement on loan-to-value ratios 

(LTV), determined after consideration of 

private mortgage insurance (PMI). This 

option was illustrated by an LTV risk 

weight table that suggested risk weights 

of 20, 35, 50, and 100 percent. 

Another option discussed in the Basel 

IA ANPR was to assign risk weights 

based on LTV in combination with an 

evaluation of borrower 

creditworthiness. Under this scenario, 

different ranges of LTV could be paired 

with specified credit assessments, such 

as credit scores. A first lien mortgage 

with a lower LTV made to a borrower 

with higher creditworthiness would 

receive a lower risk weight than a loan 

with higher LTV made to a borrower 

with lower creditworthiness. 

The Agencies received many 

comments about how to risk weight first 

lien mortgages. Many commenters 

cautioned against rules that would be 

burdensome and costly to implement. 

Commenters generally supported the 

use of LTV and stated that use of LTV 

in assigning risk weights would not be 

overly burdensome because LTV 


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26 12 CFR part 3 appendix A, section 3(3)(iii) 

(OCC); 12 CFR Parts 208 and 225, appendix A, 

section III.C.3 (Board); 12 CFR part 325, appendix 

A, section II.C.3 (FDIC); and 12 CFR 567.1 

(definition of ‘‘qualifying mortgage loan’’) and 12 

CFR 567.6(a)(1)(iii)(B) (50 percent risk weight) 

(OTS). 

27This statutory risk weight applies to loans to 

builders secured by one-to-four family residential 

properties with substantial project equity for the 

construction of one-to-four family residences that 

have been pre-sold under firm contracts to 

purchasers who have obtained firm commitments 

for permanent qualifying mortgage loans and have 

made substantial earnest money deposits. See 

Resolution Trust Corporation Refinancing, 

Restructuring, and Improvement Act of 1991, Pub. 

L. 102–233, § 618(a), 105 Stat. 1761, 1789–91 

(codified at 12 U.S.C. 1831n note (1991)). 

28 12 CFR part 3 appendix A, section 3(3)(iv) 

(OCC); 12 CFR parts 208 and 225, appendix A, 

section III.C.3. (Board); 12 CFR part 325, appendix 

A, section II.C.3 (FDIC); and 12 CFR 567.1 

(definition of ‘‘qualifying mortgage loan’’) (OTS). 

information is collected when lenders 

originate mortgage loans. 

Some commenters supported the use 

of a matrix based on LTV and a measure 

of creditworthiness, to further improve 

the risk sensitivity of the risk weights 

assigned to residential mortgage loans. 

They stated that this approach would 

address both collateral and borrower 

risk and would mirror current practices 

among mortgage lenders. Other 

commenters expressed concern about 

the potential burden of this approach, 

particularly for smaller banking 

organizations. Some commenters noted 

that certain credit assessment measures 

such as credit-scoring models vary by 

region or credit reporting agency, and 

may harm lower income borrowers, 

borrowers without credit histories, and 

borrowers who have experienced 

unusual financial difficulties. Many of 

these commenters suggested that the use 

of credit scores as a measure of borrower 

creditworthiness be optional to alleviate 

the burden for some smaller banking 

organizations. 

To increase the risk sensitivity of the 

existing risk-based capital rules while 

minimizing the overall burden to 

banking organizations, the Agencies are 

proposing to risk weight first lien 

mortgages based on LTV. LTV is a 

meaningful indicator of potential loss 

and the likelihood of borrower default. 

Consequently, under this proposal a 

banking organization would assign a 

risk weight for a first lien mortgage, 

including mortgages held for sale and 

mortgages held in portfolio as outlined 

in Table 3. 

TABLE 3.—PROPOSED LTV AND RISK

WEIGHTS FOR 1–4 FAMILY FIRST

LIENS

Loan-to-Value ratios 

(in percent) 

Risk 

weight 

(in percent) 

60 or less .................................. 20 

Greater than 60 and less than 

or equal to 80 ........................ 35 

Greater than 80 and less than 

or equal to 85 ........................ 50 

Greater than 85 and less than 

or equal to 90 ........................ 75 

Greater than 90 and less than 

or equal to 95 ........................ 100 

Greater than 95 ........................ 150 

The Agencies believe the 

implementation of this proposed 

approach would not impose a 

significant burden on banking 

organizations because LTV information 

is readily available and is commonly 

used in the underwriting process. 

The Agencies believe that the use of 

LTV would enhance the risk sensitivity 

of regulatory capital but it remains a 

fairly simple measurement of risk. Use 

of LTV in risk weighting first lien 

mortgages does not substitute for, or 

otherwise release a banking organization 

from, its obligation to have prudent loan 

underwriting and risk management 

practices that are consistent with the 

size, type, and risk of a mortgage 

product. Through the supervisory 

process, the Agencies would continue to 

ensure that banking organizations 

engage in prudent underwriting and risk 

management practices consistent with 

existing rules, supervisory guidance, 

and safety and soundness. The Agencies 

would continue to reserve the authority 

to require banking organizations to hold 

additional capital where appropriate. 

In general, Table 3 would apply to 

first lien mortgages. The Agencies 

would maintain their respective riskbased capital criteria for a first lien 

mortgage (for example, prudent 

underwriting) to receive a risk weight 

less than 100 percent.26 Table 3 would 

not apply to loans to builders secured 

by certain pre-sold properties, which are 

subject to a statutory 50 percent risk 

weight.27 Other loans to builders for the 

construction of residential property 

would continue to be subject to a 100 

percent risk weight. The Agencies 

would maintain their respective capital 

treatment for a one-to-four family 

residential mortgage loan to a borrower 

for the construction of the borrower’s 

own home.28 Question 7: The Agencies 

seek comment on all aspects of using 

LTV to determine the risk weights for 

first lien mortgages. 

The Agencies’ existing risk-based 

capital rules place certain privatelyissued mortgage-backed securities that 

do not carry the guarantee of a 

government or a government-sponsored 

entity (for example, unrated senior 

positions) in the 50 percent risk weight 

category, provided the underlying 

mortgages would qualify for a 50 

percent risk weight. The Agencies 

intend to continue to risk weight these 

privately-issued mortgage-backed 

securities using the risk weights 

assigned to underlying mortgages under 

the Agencies’ existing capital rules. 

Question 8: The Agencies seek comment 

on this treatment and other methods for 

risk-weighting these privately-issued 

mortgage-backed securities, including 

the appropriateness of assigning risk 

weights to these securities based on the 

risk weights of the underlying mortgages 

as determined under Table 3. 

While the Agencies are not proposing 

to use LTV and borrower 

creditworthiness to risk weight 

mortgages, the Agencies continue to 

evaluate approaches that would 

consider borrower creditworthiness in 

risk weighting first lien mortgages. One 

such approach could use LTV and a 

measure of borrower creditworthiness to 

assign risk weights in a manner similar 

to that shown in Table 3A below. Table 

3A would assign a lower risk weight to 

mortgages with a lower LTV that are 

underwritten to borrowers with a 

stronger credit history and a higher risk 

weight to mortgages with a higher LTV 

that are underwritten to borrowers with 

a weaker credit history. 


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29See 15 U.S.C. 1681a(f), which defines a credit 

reporting agency. 

30 12 CFR part 34 (OCC); 12 CFR part 208, subpart 

E and part 225, subpart G (Board); 12 CFR part 323, 

12 CFR part 365 (FDIC); and 12 CFR part 564 (OTS). 

31 12 CFR part 34 Subpart C.43 (OCC); 12 CFR 

part 208, subpart E and part 225, subpart G (Board); 

12 CFR part 325, appendix A, section II.C.3 

(FDIC);12 CFR 560.100—560.101 (OTS). 

TABLE 3A.—ILLUSTRATIVE RISK-WEIGHT RANGES FOR LTV AND CREDIT HISTORY FOR 1–4 FAMILY

[First liens] 

First lien mortgages Illustrative risk weight ranges 

Loan-to-Value ratios 

(in percent) 

Credit history 

group 1 

(in percent) 

Credit history 

group 2 

(in percent) 

Credit history 

group 3 

(in percent) 

60 or less ..................................................................................................................................... 20–35 20–35 20–35 

Greater than 60 and less than or equal to 80 ............................................................................. 20–35 20–35 35–75 

Greater than 80 and less than or equal to 90 ............................................................................. 20–50 35–75 75–150 

Greater than 90 and less than or equal to 95 ............................................................................. 20–50 50–100 100–200 

Greater than 95 ........................................................................................................................... 35–75 50–100 150–200 

Table 3A presents three broad 

categories of relative credit performance 

(credit history groups). The Agencies 

would determine the credit history 

groups using default odds. The default 

odds would be based upon credit 

reporting agencies’ validation charts 

(also known as odds tables). A banking 

organization would determine a 

borrower’s default odds by mapping the 

borrower’s credit score, as obtained 

from a credit reporting agency,29 to the 

credit reporting agency’s validation 

chart. In order for a validation chart to 

qualify, it would be based on: (1) The 

same vendor and model as the credit 

scores used by the banking organization, 

(2) a nationally diverse group of credits, 

and (3) relevant default odds measured 

over no less than 18 months following 

the scoring date used in the validation 

chart. If the Agencies decide in the final 

rule to risk weight first lien mortgages 

based on LTV and borrower 

creditworthiness, the Agencies would 

generally determine a specific risk 

weight based on the ranges provided in 

Table 3A. 

Question 9: While the Agencies are 

not proposing to use LTV and borrower 

creditworthiness to risk weight 

mortgages, the Agencies may decide to 

risk weight first lien mortgages based on 

LTV and borrower creditworthiness in 

the final rule. Accordingly, the Agencies 

continue to seek comment on an 

approach using LTV combined with 

credit scores for determining risk-based 

capital. More specifically, the Agencies 

seek comment on: operational aspects 

for assessing the use of default odds to 

determine creditworthiness 

qualifications to determine acceptable 

models for calculating the default odds; 

the negative performance criteria 

against which the default odds are 

determined (that is, 60-days past due, 

90-days past due, etc.); regional 

disparity, especially for a banking 

organization whose borrowers are not 

geographically diverse; and how often 

credit scores should be updated. In 

addition, the Agencies seek comment on 

determining the proper credit history 

group for: an individual with multiple 

credit scores, a loan with multiple 

borrowers with different probabilities of 

default, an individual whose credit 

history was analyzed using inaccurate 

data, and individuals with insufficient 

credit history to calculate a probability 

of default. 

ii. Calculation of LTV 

The Agencies sought comment on 

whether LTV should be based on LTV 

at origination or should be periodically 

updated. Some commenters supported 

using LTV at origination only. These 

commenters stated that regularly 

updating and monitoring LTV would be 

unduly burdensome and costly. Other 

commenters said the Agencies should 

require periodic updates, especially 

during significant declines in housing 

values in a banking organization’s 

service area. Some commenters said that 

banking organizations should be able to 

update LTV at their discretion. Certain 

commenters suggested that updates be 

based on periodic property appraisals 

and loan balance updates. However, a 

number of commenters expressed 

concern about the reliability of 

appraisals, especially in over-heated 

markets. 

Commenters had varying opinions 

about how the Agencies should factor 

PMI into the LTV calculations. Most of 

the commenters that addressed the issue 

supported calculating LTV net of loanlevel PMI coverage. However, some 

commenters suggested that the Agencies 

should also consider the risk mitigation 

benefits of pool-level PMI. A few 

commenters suggested considering PMI 

issued only by highly rated insurers. 

One commenter endorsed a Basel IA 

ANPR suggestion to create risk-weight 

floors for mortgages supported by loanlevel PMI from highly rated insurers. 

Another commenter suggested 

considering PMI issued by non-affiliate 

insurers only. 

In proposing the LTV calculation 

method, the Agencies aim to balance 

burden and costs against the benefits of 

a more risk sensitive risk-weighting 

system. The Agencies propose to 

calculate LTV at origination of the first 

mortgage as follows. First, the value of 

the property would be equal to the 

lower of the purchase price for the 

property or the value at origination. The 

value at origination must be based on an 

appraisal or evaluation of the property 

in conformance with the Agencies’

appraisal regulations 30 and real estate 

lending guidelines.31 The value of the 

property could only be updated for riskweight purposes when the borrower 

refinances its mortgage and the banking 

organization extends additional funds. 

Second, for loans that are positively 

amortizing, banking organizations may 

adjust the LTV quarterly to reflect any 

decrease in the principal balance. For 

loans that negatively amortize, banking 

organizations would be required to 

adjust the LTV quarterly to reflect the 

increase in principal balance and risk 

weight the loan based on the updated 

LTV. However, where property values 

in a banking organization’s market 

subsequently experience a general 

decline in value, the Agencies continue 

to reserve their authority to require 

additional capital when warranted for 

supervisory reasons. The Agencies 

emphasize that the updating of LTV for 

regulatory capital purposes is not 

intended to replace good risk 

management practices at banking 

organizations for situations where more 

frequent updates of loan or property 

values might be appropriate. 

Question 10: The Agencies seek 

comment on whether there are other 

circumstances under which LTV should 

be adjusted for risk-weight purposes. 


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The Agencies believe that the risk 

mitigating impact of loan-level PMI 

should be reflected in calculating the 

LTV. Loan-level PMI is insurance that 

protects a mortgage lender in the event 

of borrower default up to a 

predetermined portion of the value of a 

one-to-four family residential property 

provided that there is no pool-level cap. 

A pool-level cap would effectively 

reduce coverage to any amount less than 

the predetermined portion. PMI would 

be recognized only if the loan-level 

insurer is not affiliated with the banking 

organization and has long-term senior 

debt (without credit enhancement) 

externally rated at least the third highest 

investment grade by an NRSRO. The 

Agencies believe that pool-level PMI 

should not generally reduce the LTV, 

because pool-level PMI absorbs losses 

based on a portfolio basis and is not 

attributable to a given loan. 

Question 11: The Agencies request 

comment on all aspects of PMI 

including, whether PMI providers must 

be non-affiliated companies of the 

banking organization. The Agencies also 

seek comment on the treatment of PMI 

in the calculation of LTV when the PMI 

provider is not an affiliate, but a portion 

of the mortgage insurance is reinsured 

by an affiliate of the banking 

organization. 

iii. Non-Traditional Mortgage Products 

The Basel IA ANPR sought comment 

on whether mortgages with nontraditional features pose unique risks 

that warrant higher risk-based capital 

requirements. Non-traditional loan 

features include the possibility of 

negative amortization of the loan 

balance, a borrower’s option to make 

interest-only payments, and interest rate 

reset provisions that may result in 

significant payment shock to the 

borrower. 

Commenters generally supported risk 

weighting mortgage loans with nontraditional features consistently with the 

risk weighting for traditional first lien 

mortgages. These commenters suggested 

that any additional risks posed by these 

mortgage products were the result of 

imprudent underwriting practices or the 

combining of risks, not risks inherent in 

the products. One commenter, however, 

supported higher capital requirements 

for all non-traditional mortgage loans. 

Other commenters supported additional 

capital for specific products, such as 

negative amortization loans. 

The Agencies recognize the difficultly 

in providing a clear and consistent 

definition of higher-risk mortgage loans 

with non-traditional features. Thus, the 

Agencies generally propose to risk 

weight first lien mortgages with nontraditional features in the manner 

described above. Notwithstanding this 

proposed treatment, the Agencies 

recognize that certain underwriting 

practices may increase the risk 

associated with a particular mortgage 

product. These practices may include 

underwriting of loans with less stringent 

income and asset verification 

requirements without offsetting 

mitigating factors; offering loans with 

very low introductory rates and short 

adjustment periods that may result in 

significant payment shock; and 

combining first lien loans with 

simultaneous junior lien loans that 

could result in an aggregate loan 

obligation with little borrower equity 

and the potential for a sizeable payment 

increase. The Agencies will continue to 

review banking organizations’ lending 

practices on a case-by-case basis and 

may require additional capital or 

reserves in appropriate circumstances. 

Loans with a negative amortization 

feature pose additional risks to a 

banking organization in the form of an 

unfunded commitment. Therefore, the 

Agencies propose to risk weight 

mortgage loans with negative 

amortization features consistent with 

the risk-based capital treatment for other 

unfunded commitments (for example, 

lines of credit). Under the proposed 

approach, the unfunded portion of the 

maximum negative amortization amount 

would be risk weighted separately from 

the funded portion of the loan. The 

funded portion of the loan would be risk 

weighted according to the risk weights 

for first-lien mortgages, and the 

unfunded portion of the maximum 

negative amortization amount would be 

risk weighted as a commitment based on 

the LTV for the maximum contractual 

loan amount. 

Therefore, banking organizations 

would need to calculate two LTVs for a 

loan with a negative amortization 

feature for risk-based capital purposes: 

the LTV for the funded commitment and 

the LTV for the unfunded commitment. 

To demonstrate how loans with negative 

amortization features would be risk 

weighted, assume that a property is 

valued at $100,000 and the banking 

organization grants a first-lien loan for 

$81,000 that includes a negative 

amortization feature with a 10 percent 

cap. The funded amount of $81,000 

results in an 81 percent LTV, which is 

risk weighted at 50 percent based on 

Table 3. In addition, the off-balance 

sheet unfunded commitment of $8,100 

would receive a 50 percent credit 

conversion factor (CCF) resulting in an 

on-balance sheet credit equivalent 

amount of $4,050. The combined LTV of 

the funded and unfunded commitment 

would be 89.1 percent, hence $4,050 

would receive a 75 percent risk weight 

based on Table 3. The total riskweighted assets for the first-lien 

mortgage with negative amortization 

feature would equal the risk-weighted 

assets for the funded amount plus the 

risk-weighted assets for the unfunded 

amount. 

That loan would be risk weighted at 

origination as follows: 

BILLING CODE 6720–01–P 


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32The unfunded portion of a HELOC that is a 

commitment for more than one year and that is not 

unconditionally cancelable is converted to an onbalance sheet asset using a 50 percent CCF. That 

amount plus the funded portion of the HELOC are 

BILLING CODE 6720–01–C 

The Agencies believe that this 

approach would result in a risk-based 

capital charge that more accurately 

reflects the risk of mortgage loans with 

negative amortization features. 

Question 12: The Agencies seek 

comment on the proposed risk-based 

capital treatment for all mortgage loans 

with non-traditional features and, in 

particular the proposed approach for 

mortgage loans with negative 

amortization features. The Agencies 

also seek comment on whether the 

maximum contractual amount is the 

appropriate measure of the unfunded 

exposure to loans with negative 

amortization features. The Agencies 

seek comment on whether the unfunded 

commitment for a reverse mortgage 

should be subject to a similar risk-based 

capital charge. 

iv. Junior Lien One-to-Four Family 

Residential Mortgages 

The Basel IA ANPR discussed the 

existing treatment for home equity lines 

of credit (HELOCs) and other junior lien 

mortgages.32 If a banking organization 


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added together to determine the amount of the 

HELOC that is combined with the first lien position 

and then risk weighted at either 50 percent or 100 

percent. See generally, 12 CFR part 3 appendix A, 

section (b)(2) and (a)(3)(iii) (OCC); 12 CFR parts 208 

and 225, appendix A, section III.C.3 and 12 CFR 

parts 208 and 225, appendix A, section III.D.2 

(Board); 12 CFR part 325, appendix A, section 

II.D.2.b. (FDIC); and 12 CFR 567.6(a)(2)(ii)(B) (OTS). 

33The unfunded portion of a HELOC that is a 

commitment for more than one year and that is not 

unconditionally cancelable is converted to an onbalance sheet asset using a 50 percent CCF. If the 

unfunded portion of the HELOC is a commitment 

for less than a year or is unconditionally cancelable 

it is converted to an on-balance sheet credit 

equivalent using a 0 percent CCF. 

holds both a first and a junior lien, and 

no other party holds an intervening lien, 

the Agencies’ existing capital rules 

require these loans to be combined to 

determine the LTV and then risk 

weighted as a first lien mortgage. The 

Basel IA ANPR indicated that the 

Agencies intended to continue this 

approach. 

Currently, stand-alone junior lien 

mortgages (a stand-alone junior lien 

mortgage is one where an institution 

holds a second or more junior lien 

without holding all of the more senior 

liens) receive a 100 percent risk weight. 

The Basel IA ANPR indicated that the 

Agencies were considering retaining 

this risk weight for stand-alone junior 

lien mortgages where the LTV 

(computed by combining the loan 

amounts for the junior lien and all 

senior liens) does not exceed 90 percent. 

However, for stand-alone junior lien 

mortgages where the LTV of the 

combined liens exceeds 90 percent, the 

Agencies suggested that a risk weight 

higher than 100 percent might be 

appropriate in recognition of the 

elevated credit risk associated with 

these exposures. 

Many commenters opposed this 

approach and suggested that a more 

risk-sensitive approach, similar to that 

proposed for first lien mortgages, would 

be more appropriate because not all 

stand-alone junior lien mortgages are 

riskier than first lien mortgages. Other 

commenters stated that the risk-based 

capital treatment of first and junior lien 

mortgages, regardless of whether the 

same banking organization holds both, 

should be consistent. In addition, many 

commented that it would be illogical 

and unjustifiable to impose higher risk 

weights (for example, 150 percent) for 

secured mortgage loans than for 

unsecured retail loans (for example, 100 

percent). 

Consistent with the existing riskbased capital rules, the Agencies 

propose that a banking organization that 

holds both the first and junior lien 

mortgages on a one-to-four family 

residential property, where there is no 

intervening lien, would assign the 

combined loans to the appropriate riskweight category in Table 3 above, based 

on the loans’ combined LTV. A banking 

organization that holds both the first 

and any subsequent liens may update 

the property value for calculation of the 

combined LTV of the senior loans and 

the junior lien if the organization 

obtains an appraisal or evaluation of the 

collateral in conformance with the 

Agencies’ appraisal regulations and 

related guidelines at the origination of 

the junior lien mortgage. 

For a stand-alone junior lien 

mortgage, the Agencies propose that a 

banking organization use the combined 

LTV of that loan and all senior loans to 

determine the appropriate risk weight 

for the junior lien. Using the combined 

LTV, a banking organization would risk 

weight the stand-alone junior lien based 

on Table 5. 

TABLE 5.—PROPOSED LTV AND RISK

WEIGHTS FOR 1–4 FAMILY JUNIOR

LIENS

Combined loan-to-value ratios 

(in percent) 

Risk weight 

(in percent) 

60 or less .................................. 75 

Greater than 60 and less than 

or equal to 90 ........................ 100 

Greater than 90 ........................ 150 

The combined LTV for the funded 

portion of stand-alone junior liens 

where the first lien can negatively 

amortize would be calculated using the 

maximum contractual loan amount 

under the terms of the first lien 

mortgage plus the funded portion of the 

junior lien. The combined LTV for the 

unfunded portion of all junior liens 

where the first lien can negatively 

amortize would be calculated using the 

maximum contractual loan amount 

under the terms of the first lien 

mortgage plus the funded unfunded 

portions of the junior lien. 

The Agencies propose that banking 

organizations will be required to hold 

capital for both the funded and 

unfunded portion of a HELOC. Banking 

organizations that hold a HELOC where 

there is no intervening lien would 

assign the first lien and funded portion 

of the HELOC to the appropriate risk 

weight category in Table 3 above, based 

on the loans’ combined LTV using the 

senior loans and the funded portion of 

the HELOC. The unfunded portion of 

the HELOC would be subject to the 

appropriate CCF 33 and risk weighted, 

using Table 3, based on the combined 

LTV, (senior loans plus the funded and 

unfunded portions of the HELOC). 

For stand-alone HELOCs, the funded 

and unfunded portion of the stand-alone 

HELOC would be risk weighted based 

on Table 5. The funded portion of a 

HELOC would receive a risk weight 

based on the combined LTV of all senior 

loans and funded portion of the HELOC. 

The unfunded portion of the HELOC 

would be subject to the appropriate CCF 

and risk weighted, using Table 5, based 

on the combined LTV of all senior loans 

and the funded portion of the HELOC 

and the unfunded portion of the 

HELOC. 

Question 13: The Agencies request 

comment on the appropriateness of the 

proposed risk-based capital treatment 

for HELOCs including the burden of 

adjusting LTV as the borrower utilizes 

the HELOC. 

While the Agencies are not proposing 

in this NPR to use LTV and borrower 

creditworthiness, they also continue to 

evaluate approaches that would 

consider borrower creditworthiness in 

risk weighting junior lien mortgages. 

The Agencies believe that greater risk 

sensitivity can be achieved by 

evaluating not only LTV but also 

borrower creditworthiness. If the 

Agencies decide in the final rule to risk 

weight junior lien mortgages based on 

LTV and a measure of borrower 

creditworthiness, the Agencies would 

generally determine a specific risk 

weight based on the ranges provided in 

Table 5A. 

Question 14: Accordingly, the 

Agencies seek further comment on all 

aspects of the use of LTV and borrower 

creditworthiness to determine the risk 

weight for a junior lien mortgage. 


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34An unconditionally cancelable commitment is 

one that can be canceled for any reason at any time 

without prior notice. In the case of a home equity 

line of credit, the banking organization is deemed 

able to unconditionally cancel the commitment if 

it can, at its option, prohibit additional extensions 

of credit, reduce the line, and terminate the 

commitment to the full extent permitted by relevant 

Federal law. 

TABLE 5A.—ILLUSTRATIVE RISK-WEIGHT RANGES FOR LTV AND CREDIT HISTORY FOR JUNIOR LIEN 1–4 FAMILY

MORTGAGES

Junior liens/HELOCs Illustrative risk weight ranges 

Loan-to-Value Ratios 

Credit history 

Group 1 

(in percent) 

Credit history 

Group 2 

(in percent) 

Credit history 

Group 3 

(in percent) 

60 or less ..................................................................................................................................... 20–50 75–150 150–200 

Greater than 60 and less than or equal to 80 ............................................................................. 35–50 75–150 150–200 

Greater than 80 and less than or equal to 95 ............................................................................. 35–75 75–200 200 

Greater than 90 and less than or equal to 95 ............................................................................. 35–75 75–200 200 

Greater than 95 ........................................................................................................................... 35–75 75–200 200 

v. Transitional Rule 

Some commenters raised concerns 

about the cost and burden associated 

with recoding existing loans to conform 

to a new system. To minimize burden 

while moving toward a more risksensitive approach, the Agencies 

propose to allow banking organizations 

that choose to apply the proposed rule 

an option to continue to risk weight 

existing mortgage loans using the 

existing risk-based capital rules. The 

option would apply only to those loans 

that the banking organization owned at 

the time it chose to apply the proposed 

rules. The banking organization would 

be required to apply the transitional 

provision to all of its existing mortgage 

loans. A banking organization may not 

use this transitional treatment if it 

previously used Tables 3 or 5 to risk 

weight these existing loans. 

E. Short-Term Commitments 

Under the Agencies’ existing riskbased capital rules, commitments with 

an original maturity of one year or less 

(short-term commitments) and 

commitments that are unconditionally 

cancelable 34 are generally converted to 

an on-balance sheet credit equivalent 

amount using a zero percent CCF. 

Accordingly, banking organizations 

extending short-term commitments or 

unconditionally cancelable 

commitments are not required to 

maintain risk-based capital against the 

credit risk inherent in these exposures. 

Short-term commitments that are 

eligible liquidity facilities that support 

asset-backed commercial paper (ABCP), 

however, are converted to on-balance 

sheet assets using a 10 percent CCF. 

Commitments with an original maturity 

of more than one year (long-term 

commitments), including eligible longterm liquidity facilities that support 

ABCP, are converted to on-balance sheet 

credit equivalent amounts using a 50 

percent CCF. 

In the Basel IA ANPR, the Agencies 

noted that they were considering 

amending the risk-based capital 

requirements for short-term 

commitments. Even though 

commitments with an original maturity 

of one year or less expose banking 

organizations to a lower degree of credit 

risk than longer-term commitments, 

some credit risk exists. Thus, the 

Agencies suggested applying a 10 

percent CCF to short-term 

commitments. The resulting credit 

equivalent amount would be riskweighted according to the rating of the 

facility or the underlying asset(s) or the 

obligor, after considering any collateral 

and guarantees. The Agencies noted that 

they planned to retain the zero percent 

CCF for commitments that are 

unconditionally cancelable. The 

Agencies also sought comment on an 

alternative approach that would apply a 

single CCF (for example, 20 percent) to 

all commitments, both short- and longterm. 

Almost universally, commenters 

agreed that unconditionally cancelable 

commitments should not receive a 

capital charge. However, commenters’

recommendations varied about how to 

approach other short- and long-term 

commitments. Some commenters 

suggested that all commitments, except 

unconditionally cancelable 

commitments, should receive a 20 

percent CCF, regardless of maturity. 

These commenters argued that this 

simple approach would ease burden and 

counterbalance new complexities 

within the Basel IA ANPR. 

Conversely, several commenters 

suggested that the capital treatment 

should reflect the fact that short-term 

commitments are less risky than longterm commitments. Of these 

commenters, a few argued that shortterm commitments should not receive 

any capital charge. A few others 

supported the Basel IA ANPR 

suggestion to apply a 10 percent CCF to 

short-term commitments and 50 percent 

CCF to long-term commitments. One 

commenter suggested using a 20 percent 

CCF for short-term commitments and a 

50 percent CCF for long-term 

commitments. 

In the Agencies’ view, banking 

organizations that provide short-term 

commitments that are not 

unconditionally cancelable are exposed 

to credit risk that the existing risk-based 

capital rules do not adequately address. 

The Agencies also recognize that shortterm commitments generally expose 

banking organizations to a lower degree 

of credit risk than long-term 

commitments, thereby justifying a CCF 

that is lower than the 50 percent CCF 

currently assigned to long-term 

commitments. Thus, the Agencies are 

proposing to assign a 10 percent CCF to 

short-term commitments. The resulting 

credit equivalent amount would then be 

risk-weighted according to the rating of 

the facility, the underlying assets, or the 

obligor, after considering any applicable 

collateral and guarantees. Commitments 

that are unconditionally cancelable 

would retain a zero percent CCF. 

Finally, the Agencies are not 

proposing to apply a CCF to 

commitments to originate one-to-four 

family residential mortgage loans that 

are provided in the ordinary course of 

business. The Agencies believe these 

types of commitments present only 

minimal credit risk because of their 

short durations, the significant number 

that expire before being funded, and the 

large percentage of originations that are 

held for resale. In addition, 

commitments on held-for-sale mortgages 

are treated as derivatives and are 

accounted for at fair value on the 

balance sheet of the issuer, and 

therefore already receive a capital 

charge. Given these mitigating factors, 

the Agencies do not wish to impose the 

burden of determining risk weights by 

LTV during the short commitment 

period. 


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35An 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 is solely triggered 

by events not directly related to the performance of 

the underlying exposures or the originating banking 

organization (such as material changes in tax laws 

or regulations). 

36 65 FR 12320 (March 8, 2000). 

37 Id. at 12330–12331. 

38 66 FR 59614, 59619 (November 29, 2001). 

39 In October 2003, the Agencies issued another 

proposed rule that included a risk-based capital 

charge for early amortization. See 68 FR 56568, 

56571–56573 (October 1, 2003). This proposal was 

based upon the Basel Committee’s third 

consultative paper issued April 2003. When the 

Agencies finalized other unrelated aspects of this 

proposed rule in July 2004, they did not implement 

the early amortization proposal. The Agencies 

determined that the change was inappropriate 

because the capital treatment of retail credit, 

including securitizations of revolving credit, was 

subject to change as the Basel framework proceeded 

through the U.S. rulemaking process. 69 FR 44908, 

44912–44913 (July 28, 2004). 

40Excess spread means gross finance charge 

collections (including market interchange fees) and 

other income received by a trust or the special 

purpose entity (SPE) minus interest paid to 

investors in the securitization exposures, servicing 

fees, charge-offs, and other similar trust or SPE 

expenses. 

Question 15: The Agencies continue 

to seek comments on an alternative 

approach that would apply a single CCF 

of 20 percent to all commitments, both 

short- and long-term (that are not 

unconditionally cancelable), and the 

advantages and disadvantages of such 

an approach. 

F. Assess a Risk-Based Capital Charge 

for Early Amortization 

The Agencies’ existing risk-based 

capital rules do not assess a capital 

charge for risks associated with early 

amortization of securitizations of 

revolving credits (for example, credit 

card receivables). When assets are 

securitized, the extent to which the 

selling or sponsoring entity transfers the 

risks associated with the assets depends 

on the structure of the securitization 

and the nature of the underlying assets. 

Early amortization provisions 35 in 

securitizations of revolving retail credit 

facilities increase the likelihood that 

investors will be repaid before being 

subject to any risk of significant credit 

losses. These provisions raise two 

concerns about the risks to banking 

organizations that sponsor 

securitizations with early amortization 

provisions: (1) The payment allocation 

formula can result in the subordination 

of the seller’s interest in the securitized 

assets during early amortization, and (2) 

an early amortization event can increase 

a banking organization’s capital and 

liquidity needs in order to finance new 

draws on the revolving credit facilities. 

In recognition of the risks associated 

with these structures, the Agencies have 

proposed a capital charge on 

securitizations of revolving credit 

exposures with early amortization 

provisions in prior rulemakings. On 

March 8, 2000, the Agencies published 

a proposed rule on recourse and direct 

credit substitutes.36 In that proposal, the 

Agencies proposed to apply a fixed CCF 

of 20 percent to the amount of assets 

under management in all revolving 

securitizations that contained early 

amortization features.37 The preamble to 

the final Recourse Rule 38 reiterated the 

concerns with early amortization, 

indicating that the risks associated with 

securitization, including those posed by 

an early amortization feature, are not 

fully captured in the Agencies’ capital 

rules. While the Agencies did not 

impose a risk-based capital charge for 

early amortization provisions in the 

final Recourse Rule, they indicated that 

they would revisit the issue at some 

point in the future.39

In the Basel IA ANPR, the Agencies 

suggested two approaches to address 

these risks. One option was to apply a 

flat CCF to off-balance sheet receivables 

in revolving securitizations with early 

amortization provisions. Alternatively, 

the Agencies suggested using a risksensitive methodology based on excess 

spread 40 compression. Under this 

methodology, the risk-based capital 

charge would increase as excess spread 

decreased and approached the early 

amortization trigger point. 

Most commenters that addressed this 

issue opposed the application of any 

capital charge on the investors’ interest 

in credit card securitizations. Of the few 

that supported such a charge, one 

recommended that the rules apply a flat 

CCF to securitizations with early 

amortization provisions, and four 

supported the approach based on excess 

spread. 

The Agencies are proposing to apply 

an approach based on excess spread to 

all revolving securitizations of credits 

with early-amortization features. This 

capital charge would be assessed against 

the investors’ interest (that is, the total 

amount of securities issued by a trust or 

special purpose entity to investors, 

which is the portion of the 

securitization that is not on the banking 

organization’s balance sheet) and would 

be imposed only in the event that the 

excess spread has declined to a 

predetermined percentage of the 

trapping point. The capital required 

would increase as the level of excess 

spread approaches the early 

amortization trigger. The Agencies are 

proposing to compare the three-month 

average excess spread against the point 

at which the securitization trust would 

be required to trap excess spread in a 

spread or reserve account as a basis for 

the capital charge. To determine the 

excess spread trapping point and the 

appropriate CCF, a banking organization 

would divide the level of excess spread 

by the spread trapping point as 

described below. In securitizations that 

do not require excess spread to be 

trapped, or that specify a trapping point 

based primarily on performance 

measures other than the three-month 

average excess spread, the excess spread 

trapping point would be set for 

purposes of this proposed rule at 4.5 

percent. 

To calculate the securitization’s 

excess spread trapping point ratio, a 

banking organization must first 

calculate the annualized three month 

ratio for excess spread as follows: 

a. For each of the three months, 

divide the month’s excess spread by the 

outstanding principal balance of the 

underlying pool of exposures at the end 

of each month. 

b. Calculate the average ratio for the 

three months and convert the resulting 

ratio to a compound annual rate. 

Then a banking organization must 

divide the annualized three month ratio 

for excess spread by the excess spread 

trapping point that is specified in the 

documentation for the securitization. 

Finally, a banking organization must 

apply the appropriate CCF from Table 6 

to the amount of investors’ interest. The 

resulting on-balance sheet credit 

equivalent amount would be assigned to 

the risk weight category appropriate to 

the securitized assets. 

TABLE 6.—EARLY AMORTIZATION

CREDIT CONVERSION FACTORS

Excess spread trapping point 

ratio 

CCF 

(in percent) 

133.33 percent of trapping 

point or more ......................... 0 

Less than 133.33 percent to 

100 percent of trapping point 5 

Less than 100 percent to 75 

percent of trapping point ....... 15 

Less than 75 percent to 50 percent of trapping point ............ 50 

Less than 50 percent of trapping point .............................. 100 

Question 16: The Agencies solicit 

comment on the appropriateness of the 

4.5 percent excess spread trapping point 

and on other types and levels of early 

amortization triggers used in 

securitizations of revolving exposures 

that should be considered, especially for 

HELOC securitizations. The Agencies 

also seek comment on whether a flat 10 


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41 60 FR 46169–46185 (September 5, 1995). 

percent CCF is a more appropriate 

capital charge for revolving 

securitizations with early amortization 

features. 

G. Remove the 50 Percent Limit on the 

Risk Weight for Derivatives 

Currently, the Agencies’ risk-based 

capital rules permit banks to apply a 

maximum 50 percent risk weight to the 

credit equivalent amount of certain 

derivative contracts. The risk weight 

assigned to derivatives contracts was 

limited to 50 percent when the 

derivatives counterparty credit risk rule 

was finalized in 1995 because most 

derivative counterparties were highly 

rated and were generally financial 

institutions.41 At the time, the Agencies 

noted that they intended to monitor the 

quality of credits in the interest rate and 

exchange rate markets to determine 

whether some transactions might merit 

a 100 percent risk weight. 

As the market for derivatives has 

developed, the types of counterparties 

acceptable to participants have 

expanded to include counterparties that 

the Agencies believe should receive a 

risk weight greater than 50 percent. 

Although the Basel IA ANPR did not 

discuss the limit on the risk weight for 

derivatives contracts, the Agencies have 

determined that it is appropriate to 

propose removing the 50 percent risk 

weight limit that applies to certain 

derivative contracts. In this proposed 

rule, the risk weight assigned to the 

credit equivalent amount of a derivative 

contract would be the risk weight 

assigned to the counterparty after 

consideration of any collateral or 

guarantees. 

H. Small Loans to Businesses 

The Agencies’ existing risk-based 

capital rules generally assign business 

loans to the 100 percent risk weight 

category unless the credit risk is 

mitigated by an acceptable guarantee or 

collateral. Banking organizations and 

other industry participants have 

criticized the lack of sensitivity in the 

measurement of credit risk associated 

with these exposures and maintained 

that the current risk-based capital 

charge is greater than warranted for high 

quality loans to businesses. 

In the Basel IA ANPR, the Agencies 

noted that they were considering a 

lower risk weight for certain business 

loans under $1 million on a 

consolidated basis to a single borrower 

(small loans to businesses). One 

alternative discussed in the Basel IA 

ANPR would allow small loans to 

businesses to be eligible for a lower risk 

weight if certain requirements were 

satisfied. These requirements would 

include, for example, full amortization 

over a period of seven years or less, 

performance according to the 

contractual provisions of the loan 

agreement, and full protection by 

collateral. The banking organization 

would also have to originate the loans 

according to its underwriting policies 

(or purchase loans that have been 

underwritten in a manner consistent 

with the banking organization’s 

underwriting policies), which would 

have to include an acceptable 

assessment of the collateral and the 

borrower’s financial condition and 

ability to repay the debt. The Agencies 

sought comment on whether this 

potential change would improve the risk 

sensitivity of the risk-based capital rules 

without unduly increasing complexity 

and burden. 

The Agencies also suggested an 

alternative approach that would assess 

risk-based capital requirements for 

small loans to businesses based on a 

credit assessment of the principals of 

the business and their ability to service 

the debt. This alternative could be 

applied in those cases where the 

principals personally guarantee the 

loan. The Agencies sought comment on 

any alternative approaches for 

improving the risk sensitivity of the 

risk-based capital treatment for small 

loans to businesses, including the use of 

credit assessments, LTV, collateral, 

guarantees, or other methods for 

stratifying credit risk. 

Most commenters supported a lower 

risk weight for small loans to 

businesses. However, it was apparent 

from the comments that there is no 

universal set of risk drivers used to 

measure credit risk for these loans. In 

addition, there was little agreement 

among commenters about how credit 

risk for these loans should be measured 

without generating undue burden. 

One commenter asked the Agencies to 

create a small-business risk-based 

capital model that takes into account 

various risk drivers, including financing 

leverage, use of funds, loss modeling, 

and lending shelf and securitization. 

Another commenter recommended 

measuring credit risk based on results 

obtained by the Fair Isaac Small 

Business Scoring Service, which the 

commenter claimed allows businesses 

to assess the creditworthiness of the 

principals of a small business and of the 

ability of the small business to make 

repayment on credit obligations up to 

$750,000. 

Another commenter suggested that 

small loans to businesses that are 

collateralized should be risk weighted 

according to the LTV using the ratio of 

the amount of the loan to the value of 

eligible collateral. This commenter 

suggested that non-collateralized loans 

should be risk-weighted according to 

several factors, including credit 

assessments of personal guarantors, loan 

terms, size of the loan, amortization 

schedule, and past history of the 

borrower. Other commenters offered 

similar suggestions that would use risk 

measures such as credit assessments 

and debt-to-income ratios. 

Several commenters suggested that 

the dollar threshold for receiving a 

lower risk weight was too low. A few 

commenters suggested increasing the 

threshold to $2 million. One commenter 

suggested setting the threshold at $5 

million and indexing it to inflation. 

Although the Agencies are not making 

a specific proposal in this NPR, they are 

exploring options for permitting certain 

small loans to businesses that meet 

certain criteria to qualify for a 75 

percent risk weight. The Agencies 

believe that the application of the 75 

percent risk weight to loans to 

businesses should be limited to 

situations where the banking 

organization’s consolidated business 

credit exposure to the individual or 

company is $1 million or less. 

Second, the Agencies believe that to 

qualify for the lower risk weight, these 

loans should be personally guaranteed 

by the owner or owners of the business 

and that the loans should be fully 

collateralized by the assets of the 

business. The Agencies believe that 

these requirements provide prudential 

safeguards to ensure that the banking 

organization is in the position to 

minimize losses in the event of default. 

Third, the Agencies are considering 

requiring that qualifying loans fully 

amortize over a period of no more than 

seven years. The full amortization 

requirement encourages conservative 

cash management practices by the 

borrower and ensures that the banking 

organization can monitor the continued 

ability of the business to service the 

debt. The Agencies have chosen a 

seven-year limitation to coincide with 

the maturity structure of many loans 

used to finance equipment purchases. 

The Agencies are also considering 

criteria for short-term loans that do not 

amortize, such as working capital loans 

and other revolving lines of credit. 

Under one alternative, the Agencies 

would allow loans or draws from a 

revolving line of credit that matures 

within 18 months to forgo the 

amortization requirement to the extent 

that the loan is to be repaid from the 

anticipated proceeds of a previously 

established financial transaction and 


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such proceeds are pledged for the 

repayment of the loan. 

Fourth, the Agencies are considering 

requiring that the loans be (1) prudently 

underwritten in a manner that justifies 

the assessment of a lower-than-100 

percent risk weight and (2) performing, 

that is, the loan payments must be 

current. Thus, consistent with 

prudential standards required for the 

underwriting of any small loans to 

businesses, the Agencies would require 

that a banking organization establish 

standards for assessing the quality and 

sufficiency of pledged collateral, the 

financial condition of the borrower, the 

financial condition of any guarantors to 

the loan, and the ability of the business 

to meet certain debt service coverage 

criteria. The Agencies would also set 

requirements for an acceptable debt 

service coverage ratio, that is, the ratio 

of net operating income divided by total 

loan payments or net operating cash 

flow divided by debt service cost. The 

Agencies are considering a minimum 

debt service coverage ratio of 1.3. 

Finally, the Agencies are analyzing 

the need for additional qualifying 

criteria. Among other criteria, the 

Agencies might require that the loans 

have not been restructured to prevent a 

past due occurrence and that none of 

the proceeds of the loans are used to 

service any other outstanding loan 

obligation. 

Question 17: The Agencies seek 

comment on this or other approaches 

that might improve the risk sensitivity of 

the existing risk-based capital rules for 

small loans to businesses. 

I. Multifamily Residential Mortgages, 

Other Retail Exposures, Loans 90 Days 

or More Past Due or In Nonaccrual, and 

Commercial Real Estate (CRE) 

Exposures 

In the Basel IA ANPR, the Agencies 

sought comment on the risk-based 

capital treatment for multifamily 

residential mortgages, other retail 

exposures, loans 90 days or more past 

due or in nonaccrual, and commercial 

real estate exposures. After considering 

the comments that addressed the 

Agencies’ approaches to the risk-based 

capital treatment for these exposures, 

the Agencies have decided that any 

increase in risk sensitivity is 

outweighed by the additional burden 

that would result from the suggested 

approaches. Consequently, the Agencies 

are not proposing any changes in this 

NPR with respect to these exposures. 

The Agencies will continue to examine 

these issues and may address the riskbased capital treatment for these 

exposures at some future time. 

Question 18: The Agencies remain 

interested in industry comments on any 

methods that would increase the risk 

sensitivity of the risk-based capital 

requirements for other retail exposures, 

particularly through the use of credit 

assessments, such as the borrower’s 

credit score or ability to service debt. 

The Agencies are particularly interested 

in whether and how credit assessments 

might be applied consistently and 

uniformly in the determination of risk 

weights without creating undue burden. 

J. Other Issues Raised by Commenters 

Although the issue was not addressed 

in the Basel IA ANPR, several 

commenters suggested that the Agencies 

should conduct a study of the potential 

effects of any proposed revisions to the 

Agencies’ existing risk-based capital 

rules. They asserted that such a study 

would help the Agencies better 

understand the potential costs and 

benefits of the potential revisions, and 

help compare the revisions to the Basel 

II framework. 

The Agencies intend to analyze the 

potential impact of these proposed 

changes, as well as any changes to the 

proposals that may result from the 

public comment process. The Agencies 

may make changes to these proposals if 

warranted based on this impact 

analysis. 

III. Possible Alternatives for Basel II 

Banking Organizations 

As noted in the ‘‘Background’’

section, on September 25, 2006, the 

Agencies issued the Basel II NPR. The 

Basel II advanced capital adequacy 

framework proposed in the Basel II NPR 

is highly complex and is directed 

primarily at banking organizations with 

total consolidated assets of $250 billion 

or more, or total consolidated onbalance sheet foreign exposure of $10 

billion or more, and other banks that opt 

in to the Basel II framework—referred to 

as ‘‘Basel II banking organizations.’’ In 

the Basel II NPR, the Agencies requested 

comment on whether Basel II banking 

organizations should be permitted to 

use other credit and operational risk 

approaches similar to those provided 

under Basel II. 

The Agencies seek comment on all 

aspects of the following questions and 

seek the perspectives of banking 

organizations of different sizes and 

complexity. 

Question 19: To what extent should 

the Agencies consider allowing Basel II 

banking organizations the option to 

calculate their risk based capital 

requirements using approaches other 

than the Advanced Internal Ratings 

Based (A–IRB) approach for credit risk 

and the Advanced Measurement 

Approach (AMA) for operational risk? 

What would be the appropriate length of 

time for such an option? 

Question 20: If Basel II banking 

organizations are provided the option to 

use alternatives to the advanced 

approaches, would either this Basel IA 

proposal or the standardized approach 

in Basel II be a suitable basis for a 

regulatory capital framework for credit 

risk for those organizations? What 

modifications would make either of 

these proposals more appropriate for 

use by large complex banking 

organizations? For example, what 

approaches should be considered for 

derivatives and other capital markets 

transactions, unsettled trades, equity 

exposures, and other significant risks 

and exposures typical of Basel II 

banking organizations? 

Question 21: The risk weights in this 

Basel IA proposal were designed with 

the assumption that there would be no 

accompanying capital charge for 

operational risk. Basel II, however, 

requires banking organizations to 

calculate capital requirements for 

exposure to both credit risk and 

operational risk. If the Agencies were to 

proceed with a rulemaking for a U.S. 

version of a standardized approach for 

credit risk, should operational risk be 

addressed using one of the three 

methods set forth in Basel II? 

Question 22: What additional 

requirements should the Agencies 

consider to encourage Basel II banking 

organizations to enhance their risk 

management practices or their financial 

disclosures, if they are provided the 

option to use alternatives to the 

advanced approaches of the Basel II 

NPR? 

IV. Regulatory Analysis 

Regulatory Flexibility Act Analysis 

Pursuant to section 605(b) of the 

Regulatory Flexibility Act, 5 U.S.C. 

605(b) (RFA), the regulatory flexibility 

analysis otherwise required under 

section 604 of the RFA is not required 

if an agency certifies that the rule will 

not have a significant economic impact 

on a substantial number of small entities 

(defined for purposes of the RFA to 

include banking organizations with 

assets less than or equal to $165 million) 

and publishes its certification and a 

short, explanatory statement in the 

Federal Register along with its rule. 

Pursuant to section 605(b) of the RFA, 

the Agencies certify that this proposed 

rule will not have a significant 

economic impact on a substantial 

number of small entities. Accordingly, a 

regulatory flexibility analysis is not 


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42 71 FR 55830 (September 25, 2006). 

43Executive Order 12866 (September 30, 1993), 

58 FR 51735 (October 4, 1993), as amended by 

Executive Order 13258, 67 FR 9385 (February 28, 

2002). For the complete text of the definition of 

‘‘significant regulatory action,’’ see E.O. 12866 at 

section 3(f). A ‘‘regulatory action’’ is ‘‘any 

substantive action by an agency (normally 

published in the Federal Register) that promulgates 

or is expected to lead to the promulgation of a final 

rule or regulation, including notices of inquiry, 

advance notices of proposed rulemaking, and 

notices of proposed rulemaking.’’ E.O. 12866 at 

section 3(e). 

needed. The amendments to the 

Agencies’ regulations described above 

are elective. They will apply only to 

banking organizations that opt to take 

advantage of the proposed revisions to 

the existing domestic risk-based capital 

framework and that will not be required 

to use the advanced approaches 

contained in the Basel II proposal.42 The 

Agencies believe that banking 

organizations that elect to adopt these 

proposals will generally be able to do so 

with data they currently use as part of 

their credit approval and portfolio 

management processes. Banking 

organizations not exercising this option 

would remain subject to the current 

capital framework. The proposal does 

not impose any new mandatory 

requirements or burdens. Moreover, 

industry groups representing small 

banking organizations that commented 

on the Basel IA ANPR noted that small 

banking organizations typically hold 

more capital than is required by the 

capital rules and would prefer to remain 

under the existing risk-based capital 

framework. For these reasons, the 

proposal will not result in a significant 

economic impact on a substantial 

number of small entities. 

OCC Executive Order 12866 

Determination 

Executive Order 12866 requires 

Federal agencies to prepare a regulatory 

impact analysis for agency actions that 

are found to be ‘‘significant regulatory 

actions.’’ ‘‘Significant regulatory 

actions’’ include, among other things, 

rulemakings that ‘‘have an annual effect 

on the economy of $100 million or more 

or adversely affect in a material way the 

economy, a sector of the economy, 

productivity, competition, jobs, the 

environment, public health or safety, or 

State, local, or tribal governments or 

communities.’’ 43 Regulatory actions 

that satisfy one or more of these criteria 

are referred to as ‘‘economically 

significant regulatory actions.’’

The OCC anticipates that the 

proposed rule will meet the $100 

million criterion and therefore is an 

economically significant regulatory 

action. In conducting the regulatory 

analysis for an economically significant 

regulatory action, Executive Order 

12866 requires each Federal agency to 

provide to the Administrator of the 

Office of Management and Budget’s 

(OMB) Office of Information and 

Regulatory Affairs (OIRA): 

• The text of the draft regulatory 

action, together with a reasonably 

detailed description of the need for the 

regulatory action and an explanation of 

how the regulatory action will meet that 

need; 

• An assessment of the potential costs 

and benefits of the regulatory action, 

including an explanation of the manner 

in which the regulatory action is 

consistent with a statutory mandate and, 

to the extent permitted by law, promotes 

the President’s priorities and avoids 

undue interference with State, local, 

and tribal governments in the exercise 

of their governmental functions; 

• An assessment, including the 

underlying analysis, of benefits 

anticipated from the regulatory action 

(such as, but not limited to, the 

promotion of the efficient functioning of 

the economy and private markets, the 

enhancement of health and safety, the 

protection of the natural environment, 

and the elimination or reduction of 

discrimination or bias) together with, to 

the extent feasible, a quantification of 

those benefits; 

• An assessment, including the 

underlying analysis, of costs anticipated 

from the regulatory action (such as, but 

not limited to, the direct cost both to the 

government in administering the 

regulation and to businesses and others 

in complying with the regulation, and 

any adverse effects on the efficient 

functioning of the economy, private 

markets (including productivity, 

employment, and competitiveness), 

health, safety, and the natural 

environment), together with, to the 

extent feasible, a quantification of those 

costs; and 

• An assessment, including the 

underlying analysis, of costs and 

benefits of potentially effective and 

reasonably feasible alternatives to the 

planned regulation, identified by the 

agencies or the public (including 

improving the current regulation and 

reasonably viable nonregulatory 

actions), and an explanation why the 

planned regulatory action is preferable 

to the identified potential alternatives. 

Set forth below is a summary of the 

OCC’s regulatory impact analysis, which 

can be found in its entirety at http:// 

www.occ.treas.gov/law/basel.htm. 

i. The Need for Regulatory Action 

Federal banking law directs federal 

banking agencies including the Office of 

the Comptroller of the Currency (OCC) 

to require banking organizations to hold 

adequate capital. The law authorizes 

federal banking agencies to set 

minimum capital levels to ensure that 

banking organizations maintain 

adequate capital. The law also gives 

banking agencies broad discretion with 

respect to capital regulation by 

authorizing them to also use any other 

methods that they deem appropriate to 

ensure capital adequacy. 

Capital regulation seeks to address 

market failures that stem from several 

sources. Asymmetric information about 

the risk in a bank’s portfolio creates a 

market failure by hindering the ability 

of creditors and outside monitors to 

discern a bank’s actual risk and capital 

adequacy. Moral hazard creates market 

failure in which the bank’s creditors fail 

to restrain the bank from taking 

excessive risks because deposit 

insurance either fully or partially 

protects them from losses. Public policy 

addresses these market failures because 

individual banks fail to adequately 

consider the positive externality or 

public benefit that adequate capital 

brings to financial markets and the 

economy as a whole. 

Capital regulations cannot be static. 

Innovation in and transformation of 

financial markets require periodic 

reassessments of what may count as 

capital and what amount of capital is 

adequate. Continuing changes in 

financial markets create both a need and 

an opportunity to refine capital 

standards in banking. The proposed 

revisions to U.S. risk-based capital 

rules, ‘‘Risk-Based Capital Guidelines; 

Capital Adequacy Guidelines; Capital 

Maintenance: Domestic Capital 

Modifications’’ (‘‘Basel IA NPR’’), which 

we address in this impact analysis, 

provide a new option for determining 

risk-based capital for banking 

organizations that would not be 

required to operate under the other riskbased capital adequacy proposal, ‘‘RiskBased Capital Standards: Advanced 

Capital Adequacy Framework’’ (‘‘Basel 

II’’). 

ii. Regulatory Background 

The proposed capital regulation 

examined in this analysis would apply 

to commercial banks and thrifts. Three 

banking agencies, the OCC, the Board of 

Governors of the Federal Reserve 

System (Board), and the FDIC regulate 

commercial banks, while the Office of 

Thrift Supervision (OTS) regulates all 

federally chartered and many statechartered thrifts. Throughout this 

document, the four are jointly referred 

to as the federal banking agencies. 


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44Unless otherwise noted, the population of 

banks and thrifts used in this analysis consists of 

all FDIC-insured institutions. Banking organizations 

are aggregated to the top holding company level. 

The Basel IA proposal seeks to 

improve the risk sensitivity of the 

existing risk-based capital rules. This 

framework would be optional and 

would be available to banking 

organizations not covered by the Basel 

II proposal. Any institution that is not 

a Basel II bank would be able to remain 

under the existing risk-based capital 

rules or elect to adopt Basel IA. The 

proposed changes in Basel IA would: 

1. Increase the number of risk weight 

categories from five to eight. 

2. Allow the greater use of external 

credit ratings. 

3. Expand the range of recognized 

collateral and eligible guarantors. 

4. Use loan-to-value ratios to riskweight residential mortgages. 

5. Increase the credit conversion 

factor for certain commitments with an 

original maturity of one year or less. 

6. Assess a capital charge for early 

amortizations in securitizations of 

revolving retail exposures. 

7. Remove the 50 percent limit on the 

risk weight for certain derivative 

transactions. 

The Agencies would continue to 

reserve the authority to require banking 

organizations to hold additional capital 

where appropriate. 

iii. Benefit-Cost Analysis of the 

Proposed Rule 

A cost-benefit analysis considers the 

costs and benefits of a proposal as they 

relate to society as a whole. The social 

benefits of a proposal are benefits that 

accrue directly to those subject to a 

proposal plus benefits that might accrue 

indirectly to the rest of society. 

Similarly, the overall social costs of a 

proposal are costs incurred directly by 

those subject to the rule and costs 

incurred indirectly by others. In the case 

of Basel IA, direct costs and benefits are 

those that apply to the banking 

organizations that are subject to the 

proposal. Indirect costs and benefits 

then stem from banks and other 

financial institutions that are not subject 

to the proposal, bank customers, and, 

through the safety and soundness 

externality, society as a whole. 

The enormous social and economic 

benefit that derives from a safe and 

sound banking system supported by 

vigorous and comprehensive 

supervision, including ensuring 

adequate capital clearly dwarfs any 

direct benefits that might accrue to 

institutions adopting Basel IA. 

Similarly, the social and economic cost 

of any reduction in the safety and 

soundness of the banking system would 

dramatically overshadow any cost borne 

by banking organizations subject to the 

rule. The banking agencies are confident 

that the enhanced risk sensitivity of the 

proposed rule could allow banking 

organizations to more effectively 

achieve objectives that are consistent 

with a safe and sound banking system. 

Beyond the relatively minor societal 

benefit from the relatively minor 

enhancement to bank safety and 

soundness, we do not anticipate any 

benefits accruing other than directly to 

the banking organizations that elect to 

adopt Basel IA. Because many factors 

besides regulatory capital requirements 

affect pricing and lending decisions, we 

do not expect the adoption or nonadoption of Basel IA to affect pricing or 

lending. Hence, we do not anticipate 

any costs or benefits affecting the 

customers or competitors of Basel IA 

institutions. For these reasons, the cost 

and benefit analysis of Basel IA reduces 

to an analysis of the costs and benefits 

directly attributable to institutions that 

might elect to adopt Basel IA capital 

rules. 

A. Organizations Affected by the 

Proposed Rule 44

As of June 30, 2006, eleven banking 

organizations meet the criteria that 

would require them to adopt the U.S. 

implementation of Basel II. Removing 

those 11 mandatory Basel II institutions 

from the 7,606 FDIC-insured banking 

organizations active in June 2006 leaves 

7,595 organizations that would be 

eligible to adopt Basel IA. Among 

national banks, six of the eleven 

mandatory Basel II institutions are 

national banks. Out of 1,545 banking 

organizations with national banks, 1,539 

national banking organizations would 

thus be eligible to adopt Basel IA. 

B. Benefits of the Proposed Rule 

The proposed rule aims to improve 

the risk sensitivity of regulatory capital 

requirements. The five benefits of the 

proposed rule are: 

1. Enhances the risk sensitivity of 

capital charges. 

2. More efficient use of required bank 

capital. 

3. Recognizes new developments in 

financial markets. 

4. Mitigates potential distortions in 

minimum regulatory capital 

requirements between large and small 

banking organizations. 

5. Ability to opt in offers long-term 

flexibility to banking organizations. 

C. Costs of the Proposed Rule 

As with any rule, the costs of the 

proposal include expenditures by banks 

and thrifts necessary to comply with the 

new regulation and costs to the federal 

banking agencies of implementing the 

new rules. Because of a lack of cost 

estimates from banking organizations, 

the OCC found it necessary to use a 

scope-of-work comparison with Basel II 

in order to arrive at a cost estimate for 

Basel IA. Based on this rough 

assessment, we estimate that 

implementation costs for Basel IA could 

range from $100,000 at smaller 

institutions to $3 million at larger 

institutions. 

1. Costs to Banking Organizations 

Explicit costs of implementing the 

proposed rule at banking organizations 

fall into two categories: setup costs and 

ongoing costs. Setup costs are typically 

one-time expenses associated with 

introducing the new programs and 

procedures necessary to achieve initial 

compliance with the proposed rule. 

Setup costs may also involve expenses 

related to tracking and retrieving data 

needed to implement the proposed rule. 

Ongoing costs are also likely to reflect 

data costs associated with retrieving and 

preserving data. 

The total cost to national banks of 

adopting Basel IA depends entirely on 

the number of institutions that elect to 

adopt the voluntary rule and the size of 

those institutions. Obviously, if no 

institutions adopt Basel IA, the cost will 

be zero. Based on comment letters and 

discussions with bank supervision staff, 

we sought to identify national banks 

that would be more likely to adopt Basel 

IA. We selected national banks with 

significant mortgage holdings (over $500 

million in 1–4 family first-lien 

mortgages and mortgages comprise at 

least 10 percent of their portfolio) as 

well as national banks that do not 

currently meet the well-capitalized 

threshold for their risk based capital-toassets ratio. Using those criteria, we 

identified 46 national banks. We 

estimate that the total cost of the rule for 

national banks will be approximately 

$78 million. Over time, Basel IA may 

become more appealing to a larger 

number of banks. The total cost of the 

proposed rule would consequently 

increase to the extent that more 

institutions opt into Basel IA over time. 

At present, it is unclear how many 

national banks will ultimately elect to 

adopt Basel IA. 

2. Government Administrative Costs 

Like the banking organizations subject 

to new requirements, the costs to 

government agencies of implementing 

the proposed rule also involve both 

startup and ongoing costs. Startup costs 

include expenses related to the 


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development of the regulatory 

proposals, costs of establishing new 

programs and procedures, and costs of 

initial training of bank examiners in the 

new programs and procedures. Ongoing 

costs include maintenance expenses for 

any additional examiners and analysts 

needed to regularly apply the new 

supervisory processes. In the case of 

Basel IA, because modest changes to 

Call Reports will capture most of the 

rule changes, these ongoing costs are 

likely to be minor. 

OCC expenditures fall into three 

broad categories: training, guidance, and 

supervision. Training includes expenses 

for workshops and other training 

courses and seminars for examiners. 

Guidance expenses reflect expenditures 

on the development of Basel IA 

guidance. Supervision expenses reflect 

organization-specific supervisory 

activities. We estimate that OCC 

expenses for Basel IA will be 

approximately $2.4 million through 

2006. We also expect expenditures of $1 

million per year between 2007 and 

2010. Applying a five percent discount 

rate to future expenditures, past 

expenses ($2.4 million) plus the present 

value of future expenditures ($3.6 

million) equals total OCC expenditures 

of $6 million on Basel IA. 

3. Total Cost Estimate of Proposed Rule 

The OCC’s estimate of the total cost of 

the proposed rule includes expenditures 

by banking organizations and the OCC 

from the present through 2010. Based on 

our estimate that approximately 46 

national banks will adopt Basel IA at a 

cost to each institution of between 

$100,000 and $3 million depending on 

the size of the institution, we estimate 

that national banks will spend 

approximately $78 million on Basel IA. 

Combining expenditures provides an 

estimate of $84 million for the total cost 

of the proposed rule for the OCC and 

national banks. 

iv. Analysis of Baseline and Alternatives 

In order to place the costs and 

benefits of the proposed rule in context, 

Executive Order 12866 requires a 

comparison between the proposed rule, 

a baseline of what the world would look 

like without the proposed rule, and a 

reasonable alternative to the proposed 

rule. In this regulatory impact analysis, 

we analyze one baseline and one 

alternative to the proposed rule. The 

baseline considers the possibility that 

the proposed Basel IA rule is not 

adopted and current capital standards 

continue to apply. 

The baseline scenario appears in this 

analysis in order to estimate the effects 

of adopting the proposed rule relative to 

a hypothetical regulatory regime that 

might exist without Basel IA. Because 

the baseline scenario considers costs 

and benefits as if the proposed rule 

never existed, we set the costs and 

benefits of the baseline scenario to zero. 

Obviously, banking organizations face 

compliance costs and reap the benefits 

of a well-capitalized banking system 

even under the baseline. However, 

because we cannot quantify these costs 

and benefits, we normalize the baseline 

costs and benefits to zero and estimate 

the costs and benefits of the proposed 

rule and alternative as deviations from 

this zero baseline. 

1. Baseline Scenario: Current capital 

standards based on the 1988 Basel 

Accord continue to apply. 

Description of Baseline Scenario 

Under the Baseline Scenario, current 

capital rules would continue to apply to 

all banking organizations in the United 

States that are not subject to the U.S. 

implementation of Basel II. Under this 

scenario, the United States would not 

adopt the proposed Basel IA rule but the 

implementation of the Basel II 

framework would continue. 

Change in Benefits: Baseline Scenario 

Staying with current capital rules 

instead of adopting the Basel IA 

proposal would eliminate essentially all 

of the benefits of the proposed rule 

listed above. Under the baseline, 

banking organizations not subject to 

Basel II would not be given the option 

of voluntarily selecting Basel IA. 

Institutions that would have adopted 

the proposed rule would not be able to 

take advantage of the enhanced risk 

sensitivity of Basel IA capital charges 

and the more efficient use of bank 

capital that implies. 

One benefit that would remain under 

the baseline is that there would be no 

rule changes instead of just simple and 

voluntary rule changes. Without Basel 

IA as an available option, an institution 

would have to choose between the 

advanced approaches of Basel II and the 

status quo. The baseline without Basel 

IA would leave a level playing field for 

all the non-Basel II banks. However, the 

absence of an opportunity to mitigate 

potential distortions in minimum 

required capital would likely diminish 

this benefit in the eyes of an institution 

concerned about potential distortions 

created by Basel II. 

Changes in Costs: Baseline Scenario 

Continuing to use current capital 

rules eliminates the benefits and the 

costs of adopting the proposed rule. As 

discussed above, under the proposed 

rule we estimate that organizations 

would spend up to $78 million on 

implementation-related expenditures. 

Retaining current capital rules would 

eliminate any costs associated with the 

proposed rule, even though banking 

organizations would only incur those 

costs if they elected to do so. 

2. Alternative: Require all U.S. 

banking organizations not subject to 

Basel II to adopt Basel IA. 

Description of Alternative 

The only change under the alternative 

is that adoption of the proposed rule 

would be mandatory rather than 

voluntary. Under this alternative, the 

provisions of the proposed rule would 

remain intact and apply to all national 

banks that are not subject to Basel II. 

Institutions subject to Basel II would 

include mandatory Basel II institutions 

and those institutions that elect to adopt 

the U.S. implementation of the Basel II 

framework. 

Change in Benefits: Alternative 

Because there are no changes to the 

elements of the proposed rule under the 

alternative, the list of benefits remains 

the same. Among these benefits, only 

one benefit is lost by making the 

proposed rule mandatory: the benefit 

derived from the fact that the proposed 

rule is voluntary. As for the benefits 

relating to the enhanced risk sensitivity 

of capital charges, because adoption of 

Basel IA is mandatory under the 

alternative, more banks will be subject 

to Basel IA provisions and the aggregate 

level of benefits will be higher. Because 

we anticipate that only 46 national 

banks would adopt Basel IA voluntarily, 

the difference in the aggregate benefit 

level could be considerable. 

Changes in Costs: Alternative 

Clearly the most significant drawback 

to the alternative is the dramatically 

increased cost of applying a new set of 

capital rules to all U.S. banking 

organizations. Under the alternative, 

direct costs would increase for every 

U.S. banking organization that would 

have elected to continue to use current 

capital rules under the proposed rule. 

The cost estimate for the alternative is 

the total cost estimate for a 100 percent 

adoption rate of Basel IA. With 1,545 

national banking organizations eligible 

for Basel IA, we estimate that the cost 

to national banking organizations of the 

alternative is approximately $662 

million. The actual cost may be 

somewhat less depending on the 

number of national banks that elect to 

adopt Basel II capital rules, but it is 

much greater than our cost estimate of 

$78 million for the proposed rule. 


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45Savings associations, for example, do not have 

significant holdings that would be affected by the 

ratings-based approaches for exposures, collateral, 

or guarantors. Rather, savings associations’ assets 

are more heavily concentrated in mortgage-backed 

securities issued or guaranteed by the government 

sponsored enterprises, whose risk weightings 

would not change under the Basel IA NPR. 

46This is the number of well-capitalized thrifts 

that hold total assets of $500 million or more, and 

that have a total risk-based capital ratio of 15 

percent or less. 

47The other benefits of the Basel IA NPR are more 

fully discussed in the OCC analysis. 

3. Overall Comparison of Proposed 

Rule with Baseline and Alternative. 

The objective of the proposed rule is 

to enhance the risk sensitivity of capital 

charges for institutions not subject to 

Basel II capital regulations. The 

proposal also seeks to mitigate any 

potential distortions in minimum 

regulatory capital requirements that the 

U.S. implementation of Basel II might 

create between large and small banking 

organizations. Like Basel II, the 

anticipated benefits of the Basel IA 

proposal are difficult to quantify in 

dollar terms. Nevertheless, the OCC 

believes that the proposed rule provides 

benefits without posing any threat to the 

safety and soundness of the banking 

industry or the security of the Federal 

Deposit Insurance system. To offset the 

costs of the proposed rule, its voluntary 

nature offers regulatory flexibility that 

will allow institutions to adopt Basel IA 

on a bank-by-bank basis when an 

institution’s anticipated benefits exceed 

the anticipated costs of adopting this 

regulation. 

The banking agencies are confident 

that the proposed rule could serve to 

strengthen institutions electing to adopt 

Basel IA while the safety and soundness 

of institutions electing to forgo Basel IA 

and Basel II will not diminish. On the 

basis of our analysis, we believe that the 

benefits of the proposed rule are 

sufficient to offset the costs of 

implementing the proposed rule. 

However, because there is no social cost 

to allowing institutions to remain 

subject to current capital rules, we 

believe it is best to make the proposed 

rule voluntary in order to let each 

national bank decide whether it is in 

that institution’s best interest to adopt 

Basel IA. Because adoption is voluntary, 

the proposed rule offers an 

improvement over the baseline scenario 

and the alternative. The proposed rule 

offers an important degree of flexibility 

unavailable with either the baseline or 

the alternative. The baseline does not 

give banking organizations a way into 

Basel IA and the alternative does not 

offer them a way out. The alternative 

would compel most banking 

organizations to follow a new set of 

capital rules and require them to 

undertake the time and expense of 

adjusting to these new rules. The 

proposed rule offers a better balance 

between costs and benefits than either 

the baseline or the alternative. Overall, 

the OCC believes that the benefits of the 

proposed rule justify its costs. 

OTS Executive Order 12866 

Determination 

OTS concurs with OCC’s RIA. Rather 

than replicate that analysis, OTS drafted 

an RIA incorporating OCC’s analysis by 

reference and adding appropriate 

material reflecting the unique aspects of 

the thrift industry. The full text of OTS’s 

RIA is available at the locations for 

viewing the OTS docket indicated in the 

ADDRESSES section above. OTS believes 

that its analysis meets the requirements 

of Executive Order 12866. The following 

discussion supplements OCC’s 

summary of its RIA. 

OTS is the primary federal regulator 

for 854 federal and state-chartered 

savings associations with assets of $1.5 

trillion as of June 30, 2006. OTSregulated savings associations assets are 

highly concentrated in residential 

mortgage-related assets. Approximately 

68 percent of total thrift assets are 

residential mortgage-related assets. As a 

result, the most important change made 

by the proposed rule for OTS-regulated 

savings associations involves the 

proposed changes to the risk weighting 

of residential mortgages. Other aspects 

of the Basel IA NPR should not have a 

significant effect on saving 

associations.45 Accordingly, OTS’s 

analysis focuses on the proposed riskweighting of residential mortgages. 

Benefit-Cost Analysis 

Overall OTS believes that the benefits 

of the proposed rule justify its costs. 

Under OTS’s analysis, direct costs and 

benefits include costs and benefits to 

savings associations that opt-in to the 

proposed rule. OTS estimates that 

approximately 115 savings associations 

will opt-in to the proposed rule.46 Direct 

costs and benefits also include OTS’s 

costs of implementing the proposed 

rule. Indirect costs and benefits are 

those that may affect the economy as a 

whole. These indirect and direct costs 

arise from how the primary business of 

banking (i.e., credit availability) is 

impacted by requirements for risk-based 

capital adequacy. 

A. Direct Benefits 

In general, the proposed rule seeks to 

improve the risk sensitivity of minimum 

regulatory capital requirements and, by 

doing so, to address some of the 

shortcomings of the current regulatory 

minimum capital requirements.47 For 

OTS-regulated savings associations, the 

most important change involves the risk 

weighting of residential mortgages. 

Well-underwritten residential mortgages 

with LTV ratios at origination of less 

than 90 percent are all currently risk 

weighed for regulatory capital purposes 

at 50 percent. Data from a variety of 

sources, including the security markets, 

indicate that this risk weight may be too 

high for the credit risk of low LTV 

mortgages and insufficient for the credit 

risk of higher LTV mortgages. As a 

result, to the extent that minimum 

regulatory capital requirements affect 

savings associations’ investment 

decisions, the current rules may 

discourage saving associations from 

retaining higher quality low LTV 

mortgages in their portfolios or 

encourage them to retain lower quality 

high LTV mortgages. 

In addition, for the largest banking 

organizations, the recently published 

Basel II NPR addresses the credit risks 

of exposures more directly than under 

the current capital requirement regime 

by relating their probability of default 

and loss given default to minimum 

regulatory capital requirements. 

Preliminary survey results suggest that, 

on average, residential mortgages are 

likely to receive a lower credit risk 

weight under the Basel II NPR than 

under the current regime. The Basel IA 

NPR is intended to offer savings 

associations not covered under the Basel 

II NPR a more risk sensitive weighting 

scheme for residential mortgages, and, if 

adopted, may offer saving associations a 

more level playing field on which to 

compete against Basel II banking 

organizations in offering residential 

mortgage related products. 

B. Direct Costs 

OTS estimates that the total direct 

costs of the proposed rule for the sixyear period from design through 

implementation will be $72 million. 

This includes direct costs of $67 million 

for the 115 savings associations that 

may opt-in to the proposed rule, and 

direct costs of $5 million for OTS 

implementation expenses. 

C. Indirect Benefits and Costs 

The primary business of banking is 

making credit available to borrowers. A 

myriad of considerations affect credit 

decisions by individual institutions. 

Among these considerations are the 

regulatory cost of capital and how 

closely the regulatory cost matches an 

institution’s internal assessment of its 


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48Consolidated Reports of Condition and Income 

(Call Report) (OMB Nos. 7100–0036, 3064–0052, 

1557–0081), Thrift Financial Report (TFR) (OMB 

No. 1550–0023), Consolidated Financial Statemetns 

for Bank Holding Companies (FR Y–9C) (OMB No. 

7100–0128). 

capital needs. To the extent that 

regulatory risk-based capital 

requirements for capital adequacy may 

overstate (or understate) the amount of 

capital that an institution must 

otherwise hold to support its credit 

decisions, the regulatory requirements 

add costs of compliance and, thus, 

introduce inefficiencies to the extent 

that a savings association is unable to 

price its credit products consistent with 

the underlying credit risk. 

The Basel II NPR attempted to 

develop a models-based system that 

more closely harmonized risk-based 

capital at the largest internationally 

active banks with their internal capital 

allocation models. For residential 

mortgages, the underwriting, risk 

differentiation, and system tracking 

processes described in the Basel II NPR 

are much closer to industry practice 

than the simple risk weight bucket 

system based on Basel I. The 

centerpiece of the Basel IA NPR is the 

expansion of the number of risk buckets 

and the establishment of new risk-based 

capital criteria that should, for 

residential mortgages, more closely 

mirror the underwriting, risk 

differentiation, and system tracking at 

likely opt-in institutions. 

To the extent that the Basel IA NPR 

achieves its goal of more closely 

aligning risk-based capital requirements 

to real credit risk, it should reduce the 

inefficiency inherent in the simpler 

Basel I-based framework. This should 

enable adopters to price their mortgage 

credits more closely to their internal 

assessment of credit risk. Competitive 

equity would be easier to maintain, 

particularly vis-a ́-vis the largest 

institutions. Moreover, there may be 

fewer forced consolidations, which 

could also help maintain a more 

competitive mortgage credit 

environment. Credit decisions could be 

made more rationally, and could be 

based more exclusively on sound 

underwriting since capital adequacy 

requirements would more closely match 

internal risk assessments. 

Smaller institutions that choose to 

hold risk-based capital in excess of the 

well-capitalized level could continue to 

operate under their distinct business 

model. These institutions hold those 

capital levels primarily due to 

concentration risk, their localized needs 

for liquidity, and other factors. Because 

their capital levels already exceed the 

regulatory minimums, these institutions 

have already harmonized their own 

assessment of risk with a Basel I-based 

system, and can presumably price their 

mortgage credits efficiently and 

competitively in the current 

environment. 

It would be nearly impossible to 

estimate a dollar amount of the potential 

indirect cost or benefit to the economy 

derived from introduction of an optional 

risk-based capital framework that more 

closely aligns capital requirements with 

credit risk for residential mortgages. 

However, since the decision to opt in or 

not would be made by thousands of 

banks, even partial success at 

harmonizing risk-based capital with 

internal risk assessment should improve 

the efficiency of the mortgage credit 

decision and therefore reduce the cost to 

the economy. 

Analysis of Baseline and Alternatives 

The OCC analysis includes a 

comparison between the Basel IA NPR, 

a baseline scenario of what the world 

would look like without the Basel IA 

NPR, and an alternative to the Basel IA 

NPR. The alternative would require all 

banking organizations that are not 

subject to the Basel II NPR to apply the 

Basel IA NPR. Except for the 

discussions focusing on the benefit 

derived from the recognition of new 

developments in financial markets, 

which is only a minor benefit for 

savings associations, OTS believes that 

the OCC analysis is reasonable and 

equally applicable to savings 

associations. OTS supports the OCC’s 

conclusion that the Basel IA NPR offers 

a better balance between costs and 

benefits than the alternative. OTS has 

the following additional comments: 

A. Baseline Scenario 

In its analysis of the baseline scenario, 

which would leave the current riskbased capital rules unchanged, OCC 

determines that national banks could 

avoid $78 million of implementationrelated expenditures that would 

otherwise be required by the Basel IA 

NPR. As noted above, OTS estimates 

that 115 savings associations would 

spend up to $67 million to implement 

the Basel IA NPR. Retaining the current 

capital rules without adopting Basel IA 

would permit these savings associations 

to avoid these new expenditures. 

As an indirect cost to the economy, 

the baseline scenario of maintaining a 

less risk-sensitive capital framework 

would continue to pose some cost of 

inefficiency and compliance for some 

institutions. This may lead to less 

competitive equity for those 

institutions, and less efficiently and 

mis-priced mortgage credits for 

borrowers generally. 

B. Alternative Scenario 

In its analysis of the alternative 

scenario, OCC concludes that the 

aggregate benefits would considerably 

increase because 1,539, rather than 46, 

national banks would implement the 

alternative. Under the alternative 

scenario, OTS estimates that the 

aggregate costs to savings associations 

would also increase considerably. 

Specifically, OTS estimates that these 

costs would increase from $67 million 

(for 115 savings associations) to $164 

million (for 850 savings associations). 

The alternative scenario would 

impose direct costs on institutions and 

indirect costs on the economy generally. 

Many savings associations elect to hold 

capital in excess of the well-capitalized 

levels to address other risks. This is a 

prudent decision regulators should 

encourage and not discourage. For these 

institutions, the mandatory imposition 

of the Basel IA NPR would only increase 

capital compliance costs. These 

institutions would not obtain an 

offsetting benefit in the form of lower 

capital requirements for mortgage credit 

risk. In such a scenario, some of these 

institutions could choose to pass on the 

increased costs, which would render 

them less competitive and could lead to 

inefficiently and mis-priced mortgage 

credits for borrowers, and hence, the 

economy generally. Alternatively, some 

of these institutions might choose to 

absorb the costs in the form of weaker 

earnings, which would make them more 

vulnerable targets for consolidation, and 

reduce the competitive environment in 

that manner. 

OCC Executive Order 13132 

Determination 

The OCC has determined that this 

proposed rule does not have any 

Federalism implications, as required by 

Executive Order 13132. 

Paperwork Reduction Act 

Implementation of these proposed 

rules would require revisions to the 

Agencies’ quarterly regulatory reports 48

to reflect the program and system 

changes required for a banking 

organization that adopts Basel IA. The 

Agencies project issuing a Federal 

Register notice for certain upcoming 

changes to the quarterly regulatory 

reports in early 2007. This notice will 

separately present a detailed discussion 

of the program and system changes and 

associated burden estimates for the 

potential future changes to the quarterly 

regulatory reports for banking 

organizations that decide to adopt Basel 

IA. This will afford the public ample 


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opportunity to consider potential future 

reporting changes associated with the 

Basel IA proposed rule before the 

comment period for this proposed 

rulemaking closes. Prior to the 

publication of the upcoming notice, 

public commenters may submit 

comments on aspects of this notice that 

may affect reporting requirements at the 

addresses listed in the ADDRESSES

section of this NPR. The Agencies will 

submit such required revisions to the 

quarterly regulatory reports to the Office 

of Management and Budget (OMB) for 

review and approval under the 

Paperwork Reduction Act. 

OCC and OTS Unfunded Mandates 

Reform Act of 1995 Determination 

Section 202 of the Unfunded 

Mandates Reform Act of 1995, Public 

Law 104–4 (Unfunded Mandates Act) 

requires that an agency prepare a 

budgetary impact statement before 

promulgating a rule that includes a 

Federal mandate that may result in 

expenditure by State, local, and tribal 

governments, in the aggregate, or by the 

private sector, of $100 million or more 

in any one year. If a budgetary impact 

statement is required, section 205 of the 

Unfunded Mandates Act also requires 

an agency to identify and consider a 

reasonable number of regulatory 

alternatives before promulgating a rule. 

The OCC and OTS each has determined 

that this proposed rule will not result in 

expenditures by State, local, and tribal 

governments, or by the private sector, of 

$100 million or more. Accordingly, 

neither the OCC nor the OTS has 

prepared a budgetary impact statement 

or specifically addressed the regulatory 

alternatives considered. 

Solicitation of Comments on Use of 

Plain Language 

Section 722 of the GLBA requires the 

Federal banking agencies to use plain 

language in all proposed and final rules 

published after January 1, 2000. The 

Federal banking agencies invite 

comment on how to make this proposed 

rule easier to understand. For example: 

• Have we organized the material to 

suit your needs? If not, how could this 

material be better organized? 

• Are the requirements in the rule 

clearly stated? If not, how could the rule 

be more clearly stated? 

• Do the regulations contain technical 

language or jargon that is not clear? If 

so, which language requires 

clarification? 

• Would a different format (grouping 

and order of sections, use of headings, 

paragraphing) make the regulation 

easier to understand? If so, what 

changes to the format would make the 

regulation easier to understand? 

• Would more, but shorter, sections 

be better? If so, which sections should 

be changed? 

• What else could we do to make the 

regulation easier to understand? 

List of Subjects 

12 CFR Part 3 

Administrative practice and 

procedure, Capital, National banks, 

Reporting and recordkeeping 

requirements, Risk. 

12 CFR Part 208 

Accounting, Agriculture, Banks, 

Banking, Confidential business 

information, Crime, Currency, 

Mortgages, Reporting and recordkeeping 

requirements, Securities. 

12 CFR Part 225 

Administrative practice and 

procedure, Banks, Banking, Holding 

companies, Reporting and 

recordkeeping requirements, Securities. 

12 CFR Part 325 

Administrative practice and 

procedure, Bank deposit insurance, 

Banks, banking, Capital adequacy, 

Reporting and recordkeeping 

requirements, Savings associations, 

State non-member banks. 

12 CFR Part 567 

Capital, Reporting and recordkeeping 

requirements, Savings associations. 

DEPARTMENT OF THE TREASURY 

Office of the Comptroller of the 

Currency 

12 CFR Chapter I 

Authority and Issuance 

For the reasons set out in the 

preamble, part 3 of chapter I of title 12 

of the Code of Federal Regulations is 

proposed to be amended as follows: 

PART 3—MINIMUM CAPITAL RATIOS; 

ISSUANCE OF DIRECTIVES 

1. The authority citation for part 3 

continues to read as follows: 

Authority: 12 U.S.C. 93a, 161, 1818, 

1828(n), 1828 note, 1831n note, 1835, 3907, 

and 3909. 

2. Amend § 3.4 by revising paragraph 

(b) and adding paragraphs (c) and (d) to 

read as follows: 

§ 3.4 Reservation of Authority. 

* * * * * 

(b) Risk-weight categories. 

Notwithstanding the risk categories in 

appendices A and D of this part, the 

OCC will look to the substance of the 

transaction and may find that the 

assigned risk weight for any asset, the 

credit equivalent amount or credit 

conversion factor for any off-balance 

sheet item, or the use of an external 

rating or the external rating on any 

instrument does not appropriately 

reflect the risks imposed on a bank and 

may require another risk weight, credit 

equivalent amount, credit conversion 

factor or external rating that the OCC 

deems appropriate. Similarly, if no risk 

weight, credit equivalent amount, credit 

conversion factor, or external rating is 

specifically assigned, the OCC may 

assign any risk weight, credit equivalent 

amount, credit conversion factor, or 

external rating that the OCC deems 

appropriate. In making its 

determination, the OCC considers risks 

associated with the asset or off-balance 

sheet item as well as other relevant 

factors. 

(c) In addition to the reservations of 

authority described in paragraph (b) of 

this section, the OCC reserves the 

authority to assign different risk weights 

to exposures as set forth in sections 

1(c)(2)(i), and (ii) of appendix C and 

section 6 of appendix B of this part. 

(d) Applicability. The OCC reserves 

the authority to require a bank calculate 

its minimum risk-based capital ratio 

according to either appendix A, 

appendix C, or appendix D of this part. 

In making this determination, the OCC 

will consider the bank’s information 

systems and risk profile and apply 

notice and response procedures in the 

same manner and to the same extent as 

the notice and response procedures in 

§ 3.12. Additionally, the OCC reserves 

the authority to require any bank to 

apply the market risk capital adjustment 

set forth in appendix B of this part. 

3. Revise § 3.6 to read as follows: 

§ 3.6 Minimum capital ratios. 

(a) General. A national bank must 

maintain a capital to total assets 

leverage ratio and a risk-based capital 

ratio. The risk-based capital ratio may 

be subject to a market risk adjustment. 

(b) Total assets leverage ratio. All 

national banks must have and maintain 

Tier 1 capital in an amount equal to at 

least 3.0 percent of adjusted total assets. 

(c) Additional leverage ratio 

requirement. An institution operating at 

or near the level in paragraph (a) of this 

section should have well-diversified 

risks, including no undue interest rate 

risk exposure; excellent control systems; 

good earnings; high asset quality; high 

liquidity; and well managed on- and offbalance sheet activities; and in general 

be considered a strong banking 

organization, rated composite 1 under 

the Uniform Financial Institutions 


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Rating System (CAMELS) rating system 

of banks. For all but the most highlyrated banks meeting the conditions set 

forth in this paragraph (c), the minimum 

Tier 1 leverage ratio is 4 percent. In all 

cases, banking institutions should hold 

capital commensurate with the level 

and nature of all risks. 

(d) Risk-based capital ratio. A 

national bank must have and maintain 

the minimum risk-based capital ratio in 

either appendix A (risk-based capital 

ratio), appendix C (internal ratingsbased and advanced measurement 

approaches), or appendix D (alternative 

risk-based capital ratio), and, for certain 

banks, in appendix B of this part 

(market risk capital adjustment). 

(1) Risk-based capital ratio 

requirement. Except as provided by 

paragraph (d)(2) (alternative risk-based 

capital ratio) and paragraph (f) of this 

section (internal ratings-based and 

advanced measurement approaches), a 

bank must maintain a minimum riskbased capital ratio as calculated in 

accordance with appendix A of this 

part. 

(2) Alternative risk-based capital ratio 

requirement. A bank that is not subject 

(either mandatorily or by election) to the 

internal ratings-based and advanced 

measurement approaches under 

Appendix C, may adopt the alternative 

risk-based capital ratio requirements 

pursuant to section 1(c) of appendix D 

of this part. A bank subject to appendix 

D must maintain a minimum alternative 

risk-based capital ratio as calculated in 

accordance with appendix D of this 

part. 

(3) Internal ratings-based and 

advanced measurement approaches 

requirement. (i) Applicability. A bank 

that meets any of the following internal 

ratings-based and advanced 

measurement approaches applicability 

requirements must apply appendix C of 

this part in determining its minimum 

risk-based capital ratio: 

(A) The bank’s consolidated total 

assets, as reported on its most recent 

year-end Call Report, equal to $250 

billion or more; 

(B) The bank’s most recent year-end 

consolidated total on-balance sheet 

foreign exposure equals 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) The bank is a subsidiary of a 

depository institution that is subject to 

12 CFR Part 3, Appendix C, 12 CFR Part 

208, Appendix F, 12 CFR Part 325, 

Appendix D, or 12 CFR Part 566, 

subpart A; or 

(D) The bank is a subsidiary of a bank 

holding company (as defined in 12 

U.S.C. 1841) that is subject to 12 CFR 

Part 225, Appendix F. 

(ii) Mandatory banks. A bank that 

meets the applicability requirements 

under paragraph (d)(3)(i) of this section 

must maintain a minimum risk-based 

capital ratio as calculated in accordance 

with appendix C of this part. 

(iii) Opt-in banks. A bank not 

otherwise required to use appendix C, 

may elect to use the internal ratingsbased and advanced measurement 

approaches to calculate its minimum 

risk-based capital ratio, subject to prior 

OCC approval as provided by section 21 

of appendix C of this part. A bank 

approved to use the internal ratingsbased and advanced measurement 

approaches, must maintain a minimum 

risk-based capital ratio as calculated in 

accordance with appendix C of this part 

[Basel II]. 

(4) Market risk capital adjustment 

requirement. (i) Market risk capital 

adjustment applicability requirement. A 

bank that meets any of the following 

applicability requirements, as 

determined by the bank’s most recent 

year-end Call Report, must apply the 

additional market risk capital 

adjustment as provided by appendix B 

of this part: 

(A) The bank has trading activities (on 

a worldwide consolidated basis) equals 

to, or greater than, 10 percent of its total 

assets; or 

(B) The bank has trading activities (on 

a worldwide consolidated basis) equal 

to $1 billion or more. 

(ii) Mandatory market risk bank. A 

bank that meets the market risk 

applicability requirements under 

paragraph (d)(4) of this section must 

apply the additional market risk capital 

adjustment in determining its minimum 

risk-based capital ratio (or alternative 

risk-based capital ratio, if applicable), as 

calculated in accordance with appendix 

B of this part. 

(iii) Opt-in market risk bank. A bank 

not otherwise required to use appendix 

B, may elect to use the market risk 

capital adjustment, subject to prior OCC 

approval as provided by section 3(c) of 

appendix B of this part. A bank 

approved to use the market risk capital 

adjustment, must apply the additional 

market risk capital adjustment in 

determining its minimum risk-based 

capital ratio (or alternative risk-based 

capital ratio, if applicable), as calculated 

in accordance with appendix B of this 

part. 

4. Appendix C to Part 3 is added and 

reserved. 

5. Add Appendix D to Part 3 to read 

as follows: 

Appendix D To Part 3—Alternative 

Risk-Based Capital Guidelines 

Section 1. Purpose, Applicability of 

Guidelines, and Definitions 

(a) Scope. This Appendix applies to all 

banks that have opted-in in accordance with 

section 1(b) of this appendix D. 

(b) Opt-in procedures. (1) Initial opt-in. 

Unless otherwise subject to appendix C of 

this part, any bank may adopt the capital 

requirements set forth in this appendix D by 

notifying the OCC of its intent to do so. 

(2) Opt-Out. Any bank that has opted into 

the capital requirements of this appendix D 

subsequently may elect to adopt the capital 

requirements set forth in appendix A by 

filing a notice with the appropriate 

supervisory office. 

(c) Reservation of authority. (1) The OCC 

may apply this appendix D to any bank if the 

OCC deems it necessary or appropriate for 

safe and sound banking practices or if the 

OCC determines that this appendix D would 

produce risk-based capital requirements that 

more accurately reflect the risk profile of the 

bank. In making a determination under this 

paragraph, the OCC will apply notice and 

response procedures in the same manner and 

to the same extent as the notice and response 

procedures in § 3.12. 

(2) The OCC may exclude a bank that has 

otherwise opted-in according to section 

1(b)(1) of this appendix from applying the 

capital requirements of this appendix D, if 

the OCC determines such action is consistent 

with safe and sound banking practices. In 

making a determination under this 

paragraph, the OCC will apply notice and 

response procedures in the same manner and 

to the same extent as the notice and response 

procedures in § 3.12. 

(d) Definitions. (1) Except where noted, the 

definitions listed in sections 1 and 4 of 

appendix A to this part 3 shall apply to this 

appendix D to this part 3. For the purposes 

of this appendix D, where the definitions in 

appendix A include cross references to other 

sections in appendix A, the OCC will 

construe them to refer to the appropriate 

sections in this appendix D. 

(2) For the purposes of this appendix D, the 

following additional definitions apply: 

Affiliate means, with respect to a company, 

any company that controls, is controlled by, 

or is under common control with, the 

company. For the purposes of this definition, 

a person or company controls a company if 

it: 

(A) Owns, controls, or holds with power to 

vote 25 percent or more of a class of voting 

securities of the company; or 

(B) Consolidates the company for financial 

reporting purposes. 

Company means a corporation, 

partnership, limited liability company, 


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business trust, special purpose entity, 

association, or similar organization. 

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 is solely triggered by events not 

directly related to the performance of the 

underlying exposures or the originating 

banking organization (such as material 

changes in tax laws or regulations). 

Eligible guarantee means a guarantee 

provided by a third party eligible guarantor 

that is: 

(A) Written and unconditional; and if 

extended by a central government, is backed 

by the full faith and credit of the central 

government; 

(B) Covers all or a pro rata portion of the 

contractual payments of the obligor on the 

reference exposure; 

(C) Gives the beneficiary a direct claim 

against the protection provider; 

(D) Is non-cancelable by the protection 

provider for reasons other than the breach of 

the contract by the beneficiary; 

(E) 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; 

(F) Requires the protection provider to 

make payment to the beneficiary on the 

occurrence of a default (as defined in the 

guarantee) of the obligor on the reference 

exposure without first requiring the 

beneficiary to demand payment from the 

obligor. 

Eligible guarantor means: 

(A) A foreign central government with 

senior long-term debt externally rated at least 

investment grade by a NRSRO; or 

(B) An entity, other than a central 

government, (for example, securities firms, 

insurance companies, bank holding 

companies, savings and loan holding 

companies, multilateral lending and regional 

development institutions, partnerships, 

limited liability companies, business trusts, 

special purpose entities, associations and 

other similar organizations) with senior longterm debt externally rated at least investment 

grade by a NRSRO. 

Excess spread means gross finance charge 

collections (including market interchange 

fees) and other income received by a trust or 

the special purpose entity (SPE) minus 

interest paid to investors in the securitization 

exposures, servicing fees, charge-offs, and 

other similar trust or SPE expenses. 

Excess spread trapping point means the 

point at which the bank is required by the 

documentation governing a securitization to 

divert and hold excess spread in a spread or 

reserve account, expressed as a percentage. 

External rating means: 

(A) A credit rating that is assigned by an 

NRSRO to a claim, provided that the credit 

rating: 

(1) Fully reflects the entire amount of 

credit risk with regard to all payments owed 

on the claim (that is, the rating must fully 

reflect the credit risk associated with timely 

repayment of principal and interest); 

(2) Is monitored by the issuing NRSRO; 

(3) Is published in an accessible public 

form; and 

(4) Is, or will be, included in the issuing 

NRSRO’s publicly available transition matrix, 

which tracks the performance and stability 

(or ratings migrations) of an NRSRO’s issued 

external ratings for the specific type of claim 

(for example, corporate debt); or 

(B) An unrated claim on a foreign central 

government shall be deemed to have an 

external rating equal to the foreign central 

government’s issuer rating assigned by an 

NRSRO. 

Investor’s interest means the total amount 

of securitization exposures represented by 

securities issued by a trust or special purpose 

entity to investors. 

Loan-level private mortgage insurance 

means insurance provided by a regulated 

mortgage insurance company that protects 

the mortgage lender in the event of a default 

of a mortgage borrower up to a 

predetermined portion of the value of a 

single one-to-four residential property, 

provided there is no pool-level cap that 

would effectively reduce coverage. 

Non-central government entity means an 

entity that is not a central government as that 

term is defined in this section. This term 

includes securities firms, insurance 

companies, bank holding companies, savings 

and loan holding companies, multilateral 

lending and regional development 

institutions, partnerships, limited liability 

companies, business trusts, special purpose 

entities, associations and other similar 

organizations. 

Revolving credit means a line of credit 

where the borrower is permitted to vary both 

the drawn amount and the amount of 

repayment. 

Section 2. Components of Capital 

(a) A national bank’s qualifying capital 

base is comprised as set forth in section 2 of 

appendix A to this part 3. 

(b) For the purposes of this appendix D, the 

OCC will construe cross references in 

appendix A of this part to other sections in 

appendix A as cross references to the 

appropriate sections in this appendix D. 

Section 3. Risk Categories/Weights for OnBalance Sheet Assets and Off-Balance Sheet 

Items. 

(a) General. (1) Calculations. The 

denominator of the risk-based capital ratio, 

i.e., a national bank’s risk-weighted assets, is 

derived by assigning that bank’s assets and 

off-balance sheet items to one of the risk 

categories set out in this appendix D. Each 

category has a specific risk weight. Offbalance sheet items are converted to onbalance sheet equivalent amounts according 

to section 3(c) of this appendix D and then 

assigned a risk category. The risk weight 

assigned to a particular asset or on-balance 

sheet credit equivalent amount determines 

the percentage of that asset/credit equivalent 

that is included in the denominator of the 

bank’s risk-based capital ratio. Any asset 

deducted from a bank’s capital in computing 

the numerator of the risk-based capital ratio 

is not included as part of the bank’s riskweighted assets. The OCC reserves the right 

to require a bank to compute its risk-based 

capital ratio on the basis of average, rather 

than period-end, risk-weighted assets when 

necessary to carry out the purposes of these 

guidelines. 

(2) Indirect Holdings. Some of the assets on 

a bank’s balance sheet may represent an 

indirect holding of a pool of assets, e.g., 

mutual funds, that encompasses more than 

one risk weight within the pool. In those 

situations, the bank may assign the asset to 

the risk-weight category applicable to the 

highest risk-weighted asset that pool is 

permitted to hold pursuant to its stated 

investment objectives in the fund’s 

prospectus. Alternatively, the bank may 

assign the asset on a pro rata basis to 

different risk categories according to the 

investment limits in the fund’s prospectus. In 

either case, the minimum risk weight that 

may be assigned to such a pool is 20 percent. 

If a bank assigns the asset on a pro rata basis, 

and the sum of the investment limits in the 

fund’s prospectus exceeds 100 percent, the 

bank must assign the highest pro rata 

amounts of its total investment to the higher 

risk-weight category. If, in order to maintain 

a necessary degree of liquidity, the fund is 

permitted to hold an insignificant amount of 

its assets in short-term, highly-liquid 

securities of superior credit quality (that do 

not qualify for a preferential risk weight), 

such securities generally will not be taken 

into account in determining the risk category 

into which the bank’s holding in the overall 

pool should be assigned. The prudent use of 

hedging instruments by a fund to reduce the 

risk of its assets will not increase the risk 

weighting of the investment in that fund 

above the 20 percent category. However, if a 

fund engages in any activities that are 

deemed to be speculative in nature or has 

any other characteristics that are inconsistent 

with the preferential risk weighting assigned 

to the fund’s assets, the bank’s investment in 

the fund will be assigned to the 100 percent 

risk-weight category. More detail on the 

treatment of mortgage-backed securities is 

provided in sections 3(b)(1)(ii)(F) and (G), 

3(b)(1)(iv)(D), and 4(c) and (d) of this 

appendix D. 

(b) On-Balance Sheet Assets. (1) RiskWeight Categories. Unless otherwise 

provided by sections 3(b)(2) or 3(b)(3) of this 

appendix, a bank must assign a risk weight 

to an on-balance sheet asset according to the 

following risk-weight categories. 

(i) Zero percent risk weight. (A) Cash, 

including domestic and foreign currency 

owned and held in all offices of a national 

bank or in transit. Any foreign currency held 

by a national bank should be converted into 

U.S. dollar equivalents. 

(B) Deposit reserves and other balances at 

Federal Reserve Banks. 

(C) Gold bullion held in the bank’s own 

vaults or in another bank’s vaults on an 

allocated basis, to the extent it is backed by 

gold bullion liabilities. 

(D) The book value of paid-in Federal 

Reserve Bank stock. 

(E) Securities issued by, and other direct 

claims on, the United States Government or 

its agencies. 

(F) That portion of assets directly and 

unconditionally guaranteed by the United 

States Government or its agencies. 


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1See footnote 18 in section 3(c)(1)(vii)(C) of this 

appendix D (collateral held against derivative 

contracts). 

2Assets and off-balance sheet transactions 

collateralized by securities issued or guaranteed by 

the United States Government or its agencies 

include, but are not limited to, securities lending 

transactions, repurchase agreements, collateralized 

letters of credit, such as reinsurance letters of 

credit, and other similar financial guarantees. 

Swaps, forwards, futures, and options transactions 

are also eligible, if they meet the collateral 

requirements. However, the OCC may at its 

discretion require that certain collateralized 

transactions be risk weighted at 20 percent if they 

involve more than a minimal risk. 

3Privately issued mortgage-backed securities, e.g., 

CMOs and REMICs, where the underlying pool is 

comprised solely of mortgage-related securities 

issued by GNMA, FNMA and FHLMC, will be 

treated as an indirect holding of the underlying 

assets and assigned to the 20 percent risk category. 

If the underlying pool is comprised of assets which 

attract different risk weights, e.g., FNMA securities 

and conventional mortgages, the bank should 

generally assign the security to the highest risk 

category appropriate for any asset in the pool. 

However, on a case-by-case basis, the OCC may 

allow the bank to assign the security 

proportionately to the various risk categories based 

on the proportion in which the risk categories are 

represented by the composition cash flows of the 

underlying pool of assets. Before the OCC will 

consider a request to proportionately risk-weight 

such a security, the bank must have current 

information for the reporting date that details the 

composition and cash flows of the underlying pool 

of assets. 

4These institutions include, but are not limited 

to, the International Bank for Reconstruction and 

Development (World Bank), the Inter-American 

Development Bank, the Asian Development Bank, 

the European Investments Bank, the International 

Monetary Fund, and the Bank for International 

Settlements. 

(G) That portion of assets and off-balance 

sheet transactions 1 collateralized by cash or 

securities issued or directly and 

unconditionally guaranteed by the United 

States Government or its agencies, or the 

central government of an OECD country, 

provided that: 2

(1) The bank maintains control over the 

collateral: 

(i) If the collateral consists of cash, the cash 

must be held on deposit by the bank or by 

a third-party for the account of the bank; 

(ii) If the collateral consists of OECD 

government securities, then the securities 

must be held by the bank or by a third-party 

acting on behalf of the bank; 

(2) The bank maintains a daily positive 

margin of collateral fully taking into account 

any change in the market value of the 

collateral held as security; 

(3) Where the bank is acting as a 

customer’s agent in a transaction involving 

the loan or sale of securities that is 

collateralized by cash or OECD government 

securities delivered to the bank, any 

obligation by the bank to indemnify the 

customer is limited to no more than the 

difference between the market value of the 

securities lent and the market value of the 

collateral received, and any reinvestment risk 

associated with the collateral is borne by the 

customer; and 

(4) The transaction involves no more than 

minimal risk. 

(H) Externally rated debt securities issued 

by, certain other externally rated claims on, 

and that portion of assets supported by an 

eligible guarantee of, a foreign central 

government that receive a zero percent risk 

weight, as provided in section 3(b)(3) of this 

appendix D. 

(ii) Twenty Percent Risk Weight. (A) All 

claims on depository institutions 

incorporated in an OECD country, and all 

assets backed by the full faith and credit of 

depository institutions incorporated in an 

OECD country. This includes the credit 

equivalent amount of participations in 

commitments and standby letters of credit 

sold to other depository institutions 

incorporated in an OECD country, but only 

if the originating bank remains liable to the 

customer or beneficiary for the full amount 

of the commitment or standby letter of credit. 

Also included in this category are the credit 

equivalent amounts of risk participations in 

bankers’ acceptances conveyed to other 

depository institutions incorporated in an 

OECD country. However, bank-issued 

securities that qualify as capital of the issuing 

bank are not included in this risk category, 

but are assigned to the 100 percent risk 

category. 

(B) Claims on, or guaranteed by depository 

institutions, other than the central bank, 

incorporated in a non-OECD country, with a 

residual maturity of one year or less. 

(C) Cash items in the process of collection. 

(D) That portion of assets collateralized by 

cash or by securities issued or directly and 

unconditionally guaranteed by the United 

States Government or its agencies that does 

not qualify for the zero percent risk-weight 

category. 

(E) That portion of assets conditionally 

guaranteed by the United States government 

or its agencies. 

(F) Securities issued by, or other direct 

claims on, United States Governmentsponsored agencies. 

(G) That portion of assets guaranteed by 

United States Government-sponsored 

agencies.3

(H) That portion of assets collateralized by 

the current market value of securities issued 

or guaranteed by United States Governmentsponsored agencies. 

(I) Claims representing general obligations 

of any public-sector entity in an OECD 

country, and that portion of any claims 

guaranteed by any such public-sector entity. 

In the United States, these obligations must 

meet the requirements of 12 CFR 1.2(b). 

(J) Unrated loans to official multilateral 

lending institutions or regional development 

institutions in which the United States 

Government is a shareholder or contributing 

member.4 Rated loans to, debt securities 

issued by, claims guaranteed by, and claims 

collateralized by debt securities issued by, 

official multilateral lending institutions or 

regional development institutions shall be 

risk weighted according to section 3(b)(3) of 

this appendix D. 

(K) An unrated loan to a securities firm 

incorporated in an OECD country, that 

satisfies the following conditions: 

(1) If the securities firm is incorporated in 

the United States, then the firm must be a 

broker-dealer that is registered with the SEC 

and must be in compliance with the SEC’s 

net capital regulation (17 CFR 240.15c3(1)). 

(2) If the securities firm is incorporated in 

any other OECD country, then the bank must 

be able to demonstrate that the firm is subject 

to consolidated supervision and regulation, 

including its subsidiaries, comparable to that 

imposed on depository institutions in OECD 

countries; such regulation must include riskbased capital standards comparable to those 

applied to depository institutions under the 

Basel Capital Accord. 

(3) The securities firm, whether 

incorporated in the United States or another 

OECD country, must also have a long-term 

credit rating in accordance with section 

3(b)(1)(ii)(K)(3)(i) of this appendix D; a parent 

company guarantee in accordance with 

section 3(b)(1)(ii)(K)(3)(ii) of this appendix D; 

or a collateralized claim in accordance with 

section 3(b)(1)(ii)(K)(3)(iii) of this appendix 

D. Claims representing capital of a securities 

firm must be risk weighted at 100 percent. 

(i) Credit rating. The securities firm must 

have either a long-term issuer credit rating or 

a credit rating on at least one issue of longterm unsecured debt, from a NRSRO that is 

in one of the three highest investment-grade 

categories used by the NRSRO. If the 

securities firm has a credit rating from more 

than one NRSRO, the lowest credit rating 

must be used to determine the credit rating 

under this paragraph. 

(ii) Parent company guarantee. The claim 

on the securities firm must be guaranteed by 

the firm’s parent company, and the parent 

company must have either a long-term issuer 

credit rating or a credit rating on at least one 

issue of long-term unsecured debt, from a 

NRSRO that is in one of the three highest 

investment-grade categories used by the 

NRSRO. 

(iii) Collateralized claim. The claim on the 

securities firm must be collateralized subject 

to all of the following requirements: 

(A) The claim must arise from a reverse 

repurchase/repurchase agreement or 

securities lending/borrowing contract 

executed using standard industry 

documentation. 

(B) The collateral must consist of debt or 

equity securities that are liquid and readily 

marketable. 

(C) The claim and collateral must be 

marked-to-market daily. 

(D) The claim must be subject to daily 

margin maintenance requirements under 

standard industry documentation. 

(E) The contract from which the claim 

arises can be liquidated, terminated, or 

accelerated immediately in bankruptcy or 

similar proceedings, and the security or 

collateral agreement will not be stayed or 

avoided under the applicable law of the 

relevant jurisdiction. To be exempt from the 

automatic stay in bankruptcy in the United 

States, the claim must arise from a securities 

contract or a 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 

(12 U.S.C. 1821(e)(8)), or a netting contract 

between or among financial institutions 

under sections 401–407 of the Federal 

Deposit Insurance Corporation Improvement 


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Federal Register / Vol. 71, No. 247 / Tuesday, December 26, 2006 / Proposed Rules 77473 

5The portion of multifamily residential property 

loans that is sold subject to a pro rata loss sharing 

arrangement may be treated by the selling bank as 

sold to the extent that the sales agreement provides 

for the purchaser of the loan to share in any loss 

incurred on the loan on a pro rata basis with the 

selling bank. The portion of multifamily residential 

property loans sold subject to any loss sharing 

arrangement other than pro rata sharing of the loss 

shall be accorded the same treatment as any other 

asset sold under an agreement to repurchase or sold 

with recourse under section 4(b) of appendix D. 

6For the purposes of the debt service 

requirements in sections 3(b)(1)(iv)(C)(5)(ii) and 

3(b)(1)(iv)(C)(6)(ii) of this Appendix D, other forms 

of debt service coverage that generate sufficient 

cash flows to provide comparable protection to the 

institution may be considered for (a) a loan secured 

by cooperative housing or (b) a multifamily 

residential property loan if the purpose of the loan 

is for the development or purchase of multifamily 

residential property primarily intended to provide 

low- to moderate-income housing, including special 

operating reserve accounts or special operating 

subsidies provided by federal, state, local or private 

sources. However, the OCC reserves the right, on a 

case-by-case basis, to review the adequacy of any 

other forms of comparable debt service coverage 

relied on by the bank. 

Act of 1991 (12 U.S.C. 4407), or Regulation 

EE (12 CFR part 231). Externally rated loans 

to, externally rated debt securities issued by, 

claims guaranteed by, and claims 

collateralized by externally rated debt 

securities issued by, securities firms shall be 

risk weighted according to section 3(b)(3) of 

this appendix. 

(L) Externally rated debt securities issued 

by, certain other externally rated claims on, 

and that portion of assets supported by an 

eligible guarantee from, a foreign central 

government that receive a 20 percent risk 

weight as provided in section 3(b)(3) of this 

appendix D. 

(M) Externally rated debt securities issued 

by, certain other rated claims on, and that 

portion of assets supported by an eligible 

guarantee of, a non-central government 

entity, that receive a 20 percent risk weight 

as provided in section 3(b)(3) of this 

appendix D. 

(N) Assets collateralized by liquid and 

readily marketable externally rated debt 

securities that receive a 20 percent risk 

weight as provided in section 3(b)(3) of this 

appendix D, and recourse obligations, direct 

credit substitutes, residual interests, and 

asset- and mortgage-backed securities that 

receive a 20 percent risk weight as provided 

in section 4(c)(1) of this appendix D. 

(O) Mortgage loans secured by liens on 

one-to-four family residential properties that 

receive a 20 percent risk weight as provided 

in section 3(b)(2) of this appendix D. 

(iii) Thirty Five Percent Risk Weight. (A) 

Externally rated debt securities issued by, 

certain other externally rated claims on, and 

that portion of assets supported by an eligible 

guarantee of, a foreign central government, 

that receive a 35 percent risk weight as 

provided in section 3(b)(3) of this appendix 

D. 

(B) Externally rated debt securities issued 

by, certain other rated claims on, and that 

portion of assets supported by an eligible 

guarantee of, a non-central government 

entity, that receive a 35 percent risk weight 

as provided in section 3(b)(3) of this 

appendix D. 

(C) Assets collateralized by liquid and 

readily marketable externally rated debt 

securities that receive a 35 percent risk 

weight as provided in section 3(b)(3) of this 

appendix D, and recourse obligations, direct 

credit substitutes, residual interests, and 

asset- and mortgage-backed securities that 

receive a 35 percent risk weight as provided 

in section 4(c)(1) of this appendix D. 

(D) Mortgage loans secured by liens on 

one-to-four family residential properties that 

receive a 35 percent risk weight as provided 

in section 3(b)(2) of this appendix D. 

(iv) Fifty Percent Risk Weight. (A) Revenue 

obligations of any public-sector entity in an 

OECD country for which the underlying 

obligor is the public-sector entity, but which 

are repayable solely from the revenues 

generated by the project financed through the 

issuance of the obligations. 

(B) Loans to residential real estate builders 

for one-to-four family residential property 

construction, if the bank obtains sufficient 

documentation demonstrating that the buyer 

of the home intends to purchase the home 

(i.e., a legally binding written sales contract) 

and has the ability to obtain a mortgage loan 

sufficient to purchase the home (i.e., a firm 

written commitment for permanent financing 

of the home upon completion), subject to the 

following additional criteria: 

(1) The builder must incur at least the first 

10 percent of the direct costs (i.e., actual 

costs of the land, labor, and material) before 

any drawdown is made under the 

construction loan and the construction loan 

may not exceed 80 percent of the sales price 

of the resold home; 

(2) The individual purchaser has made a 

substantial earnest money deposit of no less 

than 3 percent of the sales price of the home 

that must be subject to forfeiture by the 

individual purchaser if the sales contract is 

terminated by the individual purchaser; 

however, 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; 

(3) The earnest money deposit must be 

held in escrow by the bank financing the 

builder or by an independent party in a 

fiduciary capacity; the escrow agreement 

must provide that in the event of default the 

escrow funds must be used to defray any cost 

incurred relating to any cancellation of the 

sales contract by the buyer; 

(4) If the individual purchaser terminates 

the contract or if the loan fails to satisfy any 

other criterion under this section, then the 

bank must immediately recategorize the loan 

at a 100 percent risk weight and must 

accurately report the loan in the bank’s next 

quarterly Consolidated Reports of Condition 

and Income (Call Report); 

(5) The individual purchaser must intend 

that the home will be owner-occupied; 

(6) The loan is made by the bank in 

accordance with prudent underwriting 

standards; 

(7) The loan is not more than 90 days past 

due, or on nonaccrual; and 

(8) The purchaser is an individual(s) and 

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 homes for 

speculative purposes. 

(C) Loans secured by a first mortgage on 

multifamily residential properties: 5

(1) The amortization of principal and 

interest occurs in not more than 30 years; 

(2) The minimum original maturity for 

repayment of principal is not less than 7 

years; 

(3) All principal and interest payments 

have been made on a timely basis in 

accordance with the terms of the loan for at 

least one year immediately preceding the risk 

weighting of the loan in the 50 percent riskweight category, and the loan is not 

otherwise 90 days or more past due, or on 

nonaccrual status; 

(4) The loan is made in accordance with all 

applicable requirements and prudent 

underwriting standards; 

(5) If the rate of interest does not change 

over the term of the loan: 

(i) The current loan amount outstanding 

does not exceed 80 percent of the current 

value of the property, as measured by either 

the value of the property at origination of the 

loan (which is the lower of the purchase 

price or the value as determined by the initial 

appraisal, or if appropriate, the initial 

evaluation) or the most current appraisal, or 

if appropriate, the most current evaluation; 

and 

(ii) In the most recent fiscal year, the ratio 

of annual net operating income generated by 

the property (before payment of any debt 

service on the loan) to annual debt service on 

the loan is not less than 120 percent; 6

(6) If the rate of interest changes over the 

term of the loan: 

(i) The current loan amount outstanding 

does not exceed 75 percent of the current 

value of the property, as measured by either 

the value of the property at origination of the 

loan (which is the lower of the purchase 

price or the value as determined by the initial 

appraisal, or if appropriate, the initial 

evaluation) or the most current appraisal, or 

if appropriate, the most current evaluation; 

and 

(ii) In the most recent fiscal year, the ratio 

of annual net operating income generated by 

the property (before payment of any debt 

service on the loan) to annual debt service on 

the loan is not less than 115 percent; and 

(7) If the loan was refinanced by the 

borrower: 

(i) All principal and interest payments on 

the loan being refinanced which were made 

in the preceding year prior to refinancing 

shall apply in determining the one-year 

timely payment requirement under section 

3(b)(1)(iv)(C)(3) of this appendix D; and 

(ii) The net operating income generated by 

the property in the preceding year prior to 

refinancing shall apply in determining the 

applicable debt service requirements under 

sections 3(b)(1)(iv)(C)(5) and (a)(2)(iv)(C)(6) 

of this appendix D. 

(D) Unrated privately-issued mortgagebacked securities, i.e. those that do not carry 

the guarantee of a government or 

government-sponsored agency, if the unrated 

privately-issued mortgage-backed securities 

are at the time the mortgage-backed securities 

are originated fully secured by or otherwise 


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77474 Federal Register / Vol. 71, No. 247 / Tuesday, December 26, 2006 / Proposed Rules 

7 If all of the underlying mortgages in the pool do 

not qualify, the bank should generally assign the 

entire value of the unrated security to the 200 

percent risk category of this appendix D; however, 

on a case-by-case basis, the OCC may allow the 

bank to assign only the portion of the security 

which represents an interest in, and the cash flows 

of, nonqualifying mortgages to the 200 percent risk 

category, with the remainder being assigned a risk 

weight of 50 percent. Before the OCC will consider 

a request to risk weight a mortgage-backed security 

on a proportionate basis, the bank must have 

current information for the reporting date that 

details the composition and cash flows of the 

underlying pool of mortgages. 

8A bank subject to the market risk capital 

requirements pursuant to Appendix B of this part 

3 may calculate the capital requirement for 

qualifying securities borrowing transactions 

pursuant to section 3(a)(1)(ii) of appendix B of this 

part 3. 

represent a sufficiently secure interest in 

mortgages secured by multifamily residential 

properties that qualify for the 50 percent risk 

weight under section 3(b)(1)(iv)(C) of this 

appendix D; loans to residential real estate 

builders for one-to-four family residential 

property construction that qualify for the fifty 

percent risk weight under section 

3(b)(1)(iv)(B) of this appendix D; and 

mortgages secured by residential properties 

that are either owner-occupied or rented, 

meet prudent underwriting standards in 

accordance with 12 CFR Part 34, and are not 

90 days or more past due, have not been 

placed in nonaccrual status, and have not 

been restructured, provided that they meet 

the following criteria: 7

(1) The underlying assets must be held by 

an independent trustee that has a first 

priority, perfected security interest in the 

underlying assets for the benefit of the 

holders of the security; 

(2) The holder of the security must have an 

undivided pro rata ownership interest in the 

underlying assets or the trust that issues the 

security must have no liabilities unrelated to 

the issued securities; 

(3) The trust that issues the security must 

be structured such that the cash flows from 

the underlying assets fully meet the cash 

flows requirements of the security without 

undue reliance on any reinvestment income; 

and 

(4) There must not be any material 

reinvestment risk associated with any funds 

awaiting distribution to the holder of the 

security. 

(E) Externally rated debt securities issued 

by, certain other externally rated claims on, 

and that portion of assets supported by an 

eligible guarantee of, a foreign central 

government, that receive a 50 percent risk 

weight as provided in section 3(b)(3) of this 

appendix D. 

(F) Externally rated debt securities issued 

by, certain other rated claims on, and that 

portion of assets supported by an eligible 

guarantee of, a non-central government 

entity, that receive a 50 percent risk weight 

as provided in section 3(b)(3) of this 

appendix D. 

(G) Assets collateralized by liquid and 

readily marketable externally rated debt 

securities that receive a 50 percent risk 

weight as provided in section 3(b)(3) of this 

appendix D, and recourse obligations, direct 

credit substitutes, residual interests, and 

asset- and mortgage-backed securities that 

receive a 50 percent risk weight as provided 

in section 4(c)(1) of this appendix D. 

(H) Mortgage loans secured by liens on 

one-to-four family residential properties that 

receive a 50 percent risk weight as provided 

in section 3(b)(2) of this appendix D. 

(v) Seventy Five Percent Risk Weight. (A) 

Externally rated debt securities issued by, 

certain other externally rated claims on, and 

that portion of assets supported by an eligible 

guarantee of, a foreign central government, 

that receive a 75 percent risk weight as 

provided in section 3(b)(3) of this appendix 

D. 

(B) Externally rated debt securities issued 

by, certain other rated claims on, and that 

portion of assets supported by an eligible 

guarantee of non-central government entity, 

that receive a 75 percent risk weight as 

provided in section 3(b)(3) of this appendix 

D. 

(C) Assets collateralized by liquid and 

readily marketable externally rated debt 

securities that receive a 75 percent risk 

weight as provided in section 3(b)(3) of this 

appendix D, and recourse obligations, direct 

credit substitutes, residual interests, and 

asset- and mortgage-backed securities that 

receive a 75 percent risk weight as provided 

in section 4(c)(1) of this appendix D. 

(D) Mortgage loans secured by liens on 

one-to-four family residential properties that 

receive a 75 percent risk weight as provided 

in section 3(b)(2) of this appendix D. 

(vi) One Hundred Percent Risk Weight. All 

other assets not specified in this appendix 

D,8 including: 

(A) Asset- or mortgage-backed securities 

that are externally rated are risk weighted in 

accordance with section 4 of this appendix 

D. 

(B) All stripped mortgage-backed 

securities, including interest only portions 

(IOs), principal only portions (POs) and other 

similar instruments, regardless of the issuer 

or guarantor. 

(C) Obligations issued by any state or any 

political subdivision thereof for the benefit of 

a private party or enterprise where that party 

or enterprise, rather than the issuing state or 

political subdivision, is responsible for the 

timely payment of principal and interest on 

the obligation, e.g., industrial development 

bonds. 

(D) Claims on commercial enterprises 

owned by foreign central governments. 

(E) Any investment in an unconsolidated 

subsidiary that is not required to be deducted 

from total capital pursuant to section 2(c) of 

this appendix D. 

(F) Instruments issued by depository 

institutions incorporated in OECD and nonOECD countries that qualify as capital of the 

issuer. 

(G) Investments in fixed assets, premises, 

and other real estate owned. 

(H) Claims representing capital of a 

securities firm. 

(I) Bank-issued securities that qualify as 

capital of the issuing bank. 

(J) Externally rated debt securities issued 

by, certain other externally rated claims on, 

and that portion of assets supported by an 

eligible guarantee of, a foreign central 

government, that receive a 100 percent risk 

weight as provided in section 3(b)(3) of this 

appendix D. 

(K) Externally rated marketable debt 

securities issued by, certain other rated 

claims on, and that portion of assets 

supported by an eligible guarantee of, a noncentral government entity, that receive a 100 

percent risk weight as provided in section 

3(b)(3) of this appendix D. 

(L) Assets collateralized by liquid and 

readily marketable externally rated debt 

securities that receive a 100 percent risk 

weight as provided in section 3(b)(3) of this 

appendix D, and recourse obligations, direct 

credit substitutes, residual interests, and 

asset- and mortgage-backed securities that 

receive a 100 percent risk weight as provided 

in section 4(c)(1) of this appendix D. 

(M) Mortgage loans secured by liens on 

one-to-four family residential properties that 

receive a 100 percent risk weight as provided 

in section 3(b)(2) of this appendix D. 

(vii) One Hundred and Fifty Percent Risk 

Weight. (A) Externally rated debt securities 

issued by, certain other externally rated 

claims on, and that portion of assets 

supported by an eligible guarantee of, a 

foreign central government, that receive a 150 

percent risk weight as provided in section 

3(b)(3) of this appendix D. 

(B) Externally rated debt securities issued 

by, certain other rated claims on, and that 

portion of assets supported by an eligible 

guarantee of, a non-central government 

entity, that receive a 150 percent risk weight 

as provided in section 3(b)(3) of this 

appendix D. 

(C) Mortgage loans secured by liens on oneto-four family residential properties that 

receive a 150 percent risk weight as provided 

in section 3(b)(2) of this appendix D. 

(viii) Two Hundred Percent Risk Weight. 

(A) Unrated debt securities issued by, certain 

other unrated and rated claims on, and that 

portion of assets supported by an eligible 

guarantee of, a foreign central government, 

that receive a 200 percent risk weight as 

provided in section 3(b)(3) of this appendix 

D. 

(B) Externally rated and unrated debt 

securities issued by, certain other externally 

rated and unrated claims on, and that portion 

of assets supported by an eligible guarantee 

of, a non-central government entity, that 

receive a 200 percent risk weight as provided 

in section 3(b)(3) of this appendix D. 

(2) Mortgage Loans Secured by Liens on 

One-to-Four Family Residential Properties. (i) 

First Lien Mortgages. (A) Risk-Weight Table. 

Unless otherwise provided in section 

3(b)(2)(iii) (mortgage loans with negative 

amortization features) of this appendix D, a 

bank shall assign a mortgage loan secured by 

a first lien on a one-to-four family residential 

property to a risk weight based on its loanto-value ratio, in accordance with Table 1 of 

this appendix D. 

(B) Minimum Risk Weight for Certain 

Mortgage Loans Secured by Liens on One-toFour Family Residential Properties. 

Notwithstanding section 3(b)(2)(i)(A) of this 

appendix D, a loan secured by a one-to-four 

family residential property that is not either 

owner-occupied or rented, that is 90 days or 

more past due, that has been placed in 


sroberts on PROD1PC70 with PROPOSALS
Federal Register / Vol. 71, No. 247 / Tuesday, December 26, 2006 / Proposed Rules 77475 

nonaccrual status, has been restructured, or 

that does not meet prudent underwriting 

standards, shall receive a risk weight of 100 

percent, or higher if warranted by the loanto-value ratio, according to Table 1 of this 

appendix D. 

(C) First and Junior Liens. If a bank holds 

a first lien and junior lien on a one-to-four 

family residential property and no other 

party holds an intervening lien, the 

combined exposure is treated as a single loan 

secured by a first lien for the purposes of 

both determining the loan-to-value ratio and 

assigning a risk weight to the combined 

exposure. 

(D) Loan-to-value ratio. (1) Initial loan-tovalue ratio calculation. (i) Generally. For the 

purpose of determining the appropriate risk 

weight in accordance with Table 1 of this 

appendix D, a bank shall determine the loanto-value ratio for a mortgage loan secured by 

first lien mortgage on a one-to-four family 

residential property using the lower of the 

purchase price or the appraisal or evaluation 

at origination. 

(ii) Loan level private mortgage insurance. 

In determining the loan-to-value ratio, a bank 

may take in to account loan-level private 

mortgage insurance, provided the insurer is 

not affiliated with the bank and has longterm debt rated at least third highest 

investment grade (without credit 

enhancements) by an NRSRO. 

(iii) Appraisal or Evaluation. Any appraisal 

or evaluation used by a bank for the purposes 

of this appendix D must satisfy the real estate 

lending and appraisal requirements set forth 

in subpart C of 12 CFR part 34. 

(2) Adjustments to the loan-to-value ratio. 

After origination of a mortgage loan, a bank 

may update the value of a one-to-four family 

residential property based on an appraisal or 

evaluation only if the borrower refinances the 

mortgage loan and the bank extends 

additional funds. On a quarterly basis, a bank 

may adjust the amount of the loan to reflect 

any decrease in the principal balance. In the 

case of a home equity line of credit, the bank 

shall adjust the amount of the loan quarterly 

to reflect any increase in the balance of the 

loan. 

TABLE 1.—RISK WEIGHTS APPLICABLE

TO MORTGAGE LOANS SECURED BY

FIRST LIENS ON ONE-TO-FOUR FAMILY RESIDENTIAL PROPERTIES

Loan-to-value ratio Risk weight 

(in percent) 

Less than or equal to 60 percent ....................................... 20 

Greater than 60 percent but 

less than or equal to 80 percent ....................................... 35 

Greater than 80 percent but 

less than or equal to 85 percent ....................................... 50 

Greater than 85 percent but 

less than or equal to 90 percent ....................................... 75 

Greater than 90 percent but 

less than or equal to 95 percent ....................................... 100 

Greater than 95 percent ........... 150 

(ii) Junior lien mortgages. (A) Risk-weight 

table. Unless otherwise provided in section 

3(b)(2)(i) (when a junior lien mortgages and 

all senior lien mortgages are held by same 

bank, the transaction is treated as a single 

loan), or section 3(b)(2)(iii) (mortgage loans 

with negative amortization features) of this 

appendix D, a bank shall assign a mortgage 

loan secured by a junior lien on a one-to-four 

family residential property to a risk weight 

based on its loan-to-value ratio, in 

accordance with Table 2 of this appendix D. 

(B) Minimum Risk Weight for Certain 

Mortgage Loans Secured by Junior Liens on 

One-to-Four Family Residential Properties. 

Notwithstanding paragraph (b)(2)(ii)(A) of 

this section, a loan secured by a one-to-four 

family residential property that is not either 

owner-occupied or rented, that is 90 days or 

more past due, that has been placed in 

nonaccrual status, has been restructured, or 

that does not meet prudent underwriting 

standards, shall receive a risk weight of 100 

percent or higher, if warranted by the loanto-value ratio, according to Table 2 of this 

appendix D. 

(C) Loan-to-value ratio calculation. (1) 

Initial loan-to-value ratio calculation. (i) 

Generally. For the purpose of determining 

the appropriate risk weight in accordance 

with Table 2 of this appendix D, a bank shall 

determine the loan-to-value ratio for a 

mortgage loan secured by junior lien a oneto-four family residential property, including 

a structured mortgage or a home equity line 

of credit, by dividing the aggregate principal 

outstanding on the junior lien mortgage and 

all senior lien mortgages by the appraisal or 

evaluation at the origination of the junior 

lien. For the purposes of this calculation, if 

a third party holds a senior or intervening 

lien mortgage with a negative amortization 

feature, the bank must adjust the principal 

amount of the senior or intervening lien 

mortgage to reflect the amount of that loan 

if it were to fully negatively amortize under 

the applicable contract. 

(ii) Loan level private mortgage insurance. 

In determining the loan-to-value ratio, a bank 

may take into account loan-level private 

mortgage insurance, provided the insurer is 

not affiliated with the bank and has long term 

debt rated at least third highest investment 

grade (without credit enhancements) by an 

NRSRO. 

(iii) Appraisal or evaluation. Any appraisal 

or evaluation used by a bank for the purposes 

of this section must satisfy the real estate 

lending and appraisal requirements set forth 

in subpart C of 12 CFR part 34. 

(2) Adjustments to the loan-to-value ratio. 

After origination of a mortgage loan, a bank 

may update the value of a one-to-four family 

residential property based on an appraisal or 

evaluation only if the borrower refinances the 

mortgage loan and the bank extends 

additional funds. On a quarterly basis, a bank 

may adjust the amount of the loan to reflect 

any decrease in the principal balance. In the 

case of a home equity line of credit, the bank 

shall adjust the amount of the loan quarterly 

to reflect any increase in the balance of the 

loan. 

TABLE 2.—RISK WEIGHTS APPLICABLE

TO MORTGAGE LOANS SECURED BY

STAND-ALONE JUNIOR LIENS ON

ONE-TO-FOUR FAMILY RESIDENTIAL

PROPERTIES

Combined loan-to-value ratio Risk weight 

(in percent) 

Less than 60 percent ................ 75 

Greater than 60 percent but 

less than or equal to 90 percent ....................................... 100 

Greater than 90 percent ........... 150 

(iii) Mortgage loans with negative 

amortization features. (A) Risk weight table. 

The funded portion of a mortgage loan 

secured by a lien on a one-to-four family 

residential property that includes a negative 

amortization feature shall be assigned to a 

risk-weight category based on that portion’s 

loan-to-value ratio, in accordance with Table 

1 or Table 2. The amount equal to the 

maximum unfunded amount of the loan if it 

were to negatively amortize to the fullest 

extent allowed under the applicable loan 

contract shall be treated as a commitment, as 

set forth in section 3(c) of this appendix D. 

The risk weight applicable to the unfunded 

amount is the risk weight that would be 

assigned to a loan with a LTV ratio computed 

using a loan amount that is equal to the 

funded amount of the loan plus the 

maximum unfunded amount of the loan if it 

were to negatively amortize to the fullest 

extent allowed under the applicable contract. 

(B) Loan-to-value ratio calculation. (1) 

Initial LTV ratio calculation. (i) Generally. 

For the purpose of determining the 

appropriate risk weight for a mortgage loan 

secured by lien on a one-to-four family 

residential property in accordance with Table 

1 or Table 2 of this appendix D, a bank 

initially shall determine the loan-to-value 

ratio using the lower of the purchase price or 

the appraisal or evaluation at origination. 

(ii) Loan level private mortgage insurance. 

In determining the loan-to-value ratio, a bank 

may take into account loan-level private 

mortgage insurance, provided the insurer is 

not affiliated with the bank and has longterm debt rated at least third highest 

investment grade (without credit 

enhancements) by an NRSRO. 

(iii) Appraisal or evaluation. Any appraisal 

or evaluation used by a bank for the purposes 

of this appendix D must satisfy the real estate 

lending and appraisal requirements set forth 

in subpart C of part 34 of this title 12. 

(2) Adjustments to the loan-to-value ratio. 

After origination of a mortgage loan, a bank 

may update the value of a one-to-four family 

residential property based on an appraisal or 

evaluation only if the borrower refinances the 

mortgage loan and the bank extends 

additional funds. As the loan balance 

increases, banks must recalculate the LTV 

ratio on a quarterly basis. 

(iv) Grandfathered loans. (A) If a bank 

owns mortgage loans secured by liens on 

one-to-four-family residential properties 

prior to electing to apply the requirements set 

forth in this appendix D of this Part 3, the 

bank may elect to determine the risk weights 


sroberts on PROD1PC70 with PROPOSALS
77476 Federal Register / Vol. 71, No. 247 / Tuesday, December 26, 2006 / Proposed Rules 

9Non-central government entities include 

securities firms, insurance companies, bank holding 

companies, savings and loan holding companies, 

multilateral lending and regional development 

institutions, partnerships, limited liability 

companies, business trusts, special purpose entities, 

associations and other similar organizations. 

applicable to all such mortgage loans 

according to the requirements set forth in 

appendix A of this part 3. 

(B) If a bank has previously applied the 

requirements set forth in this appendix D to 

determine the risk weight applicable to a 

mortgage loan secured by a lien on a one-tofour family residential property, the bank 

may not thereafter elect to determine the risk 

weight applicable the mortgage loan 

according to the requirements set forth in 

section 3(b)(2)(iv)(A) of this appendix D. 

(3) Externally rated exposures. (i) Claims 

on foreign central governments. A bank shall 

determine the risk weight applicable to an 

externally rated short-or long-term foreign 

central government security or claim based 

on the external rating of the issued security 

or claim in accordance with Table 3 or Table 

4 of this appendix D. The lowest single rating 

shall apply if there are two or more relevant 

external ratings. If the security or loan is not 

rated, a bank shall determine the risk weight 

based on the external rating of the issuing 

central government in accordance with Table 

3 of this appendix D. The lowest single rating 

shall apply if the central government receives 

two or more external ratings. 

(ii) Claims collateralized by foreign central 

government debt securities. A bank may 

determine the risk weight applicable to the 

portion of a claim collateralized by a liquid 

and readily marketable short-or long-term 

foreign central government security based on 

the external rating of the issued security, 

provided that either the central government 

or the security is externally rated at least 

investment grade by an NRSRO, in 

accordance with Table 3 or Table 4 of this 

Appendix D. The lowest single rating shall 

apply if the collateral receives more than one 

external rating. If the collateral is not rated, 

a bank may determine the risk weight 

applicable to the collateralized portion of the 

claim based on the risk weight of the central 

government that issued the security, in 

accordance with Table 3 or Table 4 of this 

appendix D. The lowest single rating shall 

apply if the central government receives two 

or more external ratings. 

(iii) Claims guaranteed by foreign central 

governments. A bank may determine the risk 

weight applicable to the portion of a claim 

supported by an eligible guarantee from a 

foreign central government based on the 

long-term external rating of the central 

government or the external rating of the 

foreign central government’s senior long-term 

debt (without credit enhancement), provided 

that it is rated at least investment grade by 

an NRSRO, in accordance with Table 3 of 

this appendix D. The lowest single rating 

shall apply if there are two or more relevant 

external ratings. 

(iv) Other externally rated claims. Unless 

otherwise provided in section 3(b)(1) in this 

Appendix D (risk-weight categories), a bank 

shall determine the risk weight applicable to 

a claim on non-central government entity 9

based on the external rating of the claim, in 

accordance with Table 3 or Table 4 of this 

appendix D. The lowest single rating shall 

apply if the claim receives more than one 

external rating. This section does not apply 

to asset- and mortgage-backed securities, 

direct credit substitutes, and residual 

interests. Asset- and mortgage-backed 

securities, direct credit substitutes and 

residual interests are risk-weighted according 

to section 4 of this appendix D. 

(v) Other collateralized claims. Unless 

otherwise provided in section 3(b)(1) in this 

appendix D (risk-weight categories), a bank 

may determine the risk weight applicable to 

the portion of a claim collateralized by a 

liquid and readily marketable externally 

rated debt security based on the external 

rating of the security, provided that the 

security is externally rated at least 

investment grade by an NRSRO, in 

accordance with Table 3 or Table 4 of this 

appendix D. A bank may determine the risk 

weight applicable to a claim collateralized by 

an externally rated recourse obligation, direct 

credit substitute, residual interest, or asset-or 

mortgage-backed security, provided the 

collateral is rated at least investment grade by 

an NRSRO, in accordance with section 4(c)(1) 

and Table 6 of this appendix D. The lowest 

single rating shall apply if the collateral 

receives more than one external rating. 

(vi) Other guaranteed claims. Unless 

otherwise provided in section 3(b)(1) in this 

appendix D (risk-weight categories), a bank 

may determine the risk weight applicable to 

the portion of a claim supported by an 

eligible guarantee based on the external 

rating of the guarantor’s senior long-term 

debt (without credit enhancement), provided 

that it is rated at least investment grade by 

an NRSRO, in accordance with Table 3 of 

this appendix D. The lowest single rating 

shall apply if the guarantor’s externally rated 

senior long-term debt receives more than one 

external rating. 

TABLE 3.—RISK WEIGHTS BASED ON EXTERNAL RATINGS FOR LONG-TERM EXPOSURES

Long-term rating category Examples 

Central 

government 

risk weight 

(in percent) 

Non-central 

government 

risk weight 

(in percent) 

Highest investment grade rating .................................................................................................... AAA ............. 0 20 

Second-highest investment grade rating ....................................................................................... AA ............... 20 20 

Third-highest investment grade rating ........................................................................................... A .................. 20 35 

Lowest-investment grade rating—plus ........................................................................................... BBB+ ........... 35 50 

Lowest-investment grade rating ..................................................................................................... BBB ............. 50 75 

Lowest-investment grade rating—minus ........................................................................................ BBB¥ ......... 75 100 

One category below investment grade .......................................................................................... BB+,BB ....... 75 150 

One category below investment grade—minus ............................................................................. BB¥ ............ 100 200 

Two or more categories below investment grade ......................................................................... B, CCC ........ 150 200 

Unrated (excludes unrated loans to non-central government 1 ..................................................... n/a ............... 200 200 

1 Unrated claims on foreign central governments and unrated debt securities issued by non-central governments would receive the risk weight 

indicated in Table 3. Other unrated claims, for example, unrated loans to non-central governments, would continue to be risk weighted under the 

existing risk-based capital rules. 

TABLE 4.—RISK WEIGHTS BASED ON EXTERNAL RATINGS FOR SHORT-TERM EXPOSURES

Short-term rating category Examples 

Central 

government 

risk weight 

(in percent) 

Non-central 

government 

risk weight 

(in percent) 

Highest investment grade rating ........................................................................................................ A–1, P–1 .. 0 20 

Second-highest investment grade rating ........................................................................................... A–2, P–2 .. 20 35 

Lowest investment grade rating ........................................................................................................ A–3, P–3 .. 50 75 


sroberts on PROD1PC70 with PROPOSALS
Federal Register / Vol. 71, No. 247 / Tuesday, December 26, 2006 / Proposed Rules 77477 

10When a bank lends its own securities, the 

transaction is treated as a loan. When a bank lends 

its own securities or, acting as agent, agrees to 

indemnify a customer, the transaction is assigned 

to the risk weight appropriate to the obligor or 

collateral that is delivered to the lending or 

indemnifying institution or to an indepdent 

custodian acting on their behalf. 

11For purposes of this section, a ‘‘performancebased standby letter of credit’’ is any letter of credit, 

or similar arrangement, however named or 

described, which represents an irrevocable 

obligation to the beneficiary on the part of the 

issuer to make payment on account of any default 

by the account party in the performance of a nonfinancial or commercial obligation. Participations in 

performance-based standy letters of credit are 

treated in accordance with 4 of this appendix D. 

12Participations in commitments are treated in 

accordance with section 4 of appendix D. 

13Participations in commitments are treated in 

accordance with section of appendix D. 

14See section 1(c)(35) of appendix A to this 

part 3. 

TABLE 4.—RISK WEIGHTS BASED ON EXTERNAL RATINGS FOR SHORT-TERM EXPOSURES—Continued 

Short-term rating category Examples 

Central 

government 

risk weight 

(in percent) 

Non-central 

government 

risk weight 

(in percent) 

Unrated (excludes unrated loans to non-sovereigns) 1 ..................................................................... n/a ........... 100 100 

1 Unrated claims on foreign central governments and unrated debt securities issued by non-central governments would receive the risk weight 

indicated in Table 4. Other unrated claims, for example, unrated loans to non-central governments, would continue to be risk weighted under the 

existing risk-based capital rules. 

(c) Off-Balance Sheet Activities. (1) The 

risk weights assigned to off-balance sheet 

activities are determined by a two-step 

process. First, the face amount of the offbalance sheet item is multiplied by the 

appropriate credit conversion factor specified 

in this section. This calculation translates the 

face amount of an off-balance sheet item into 

an on-balance sheet credit equivalent 

amount. Second, the resulting credit 

equivalent amount is then assigned to the 

proper risk-weight category using the criteria 

regarding obligors, guarantors, and collateral 

listed in sections 3(b)(1) and 3(b)(3) of this 

appendix D. Collateral and guarantees are 

applied to the face amount of an off-balance 

sheet item; however, with respect to 

derivative contracts, collateral and 

guarantees are applied to the credit 

equivalent amounts of such derivative 

contracts. The following are the off-balance 

sheet items subject to this appendix D, and 

their respective credit conversion factors. 

(i) 100 percent credit conversion factor. (A) 

Risk participations purchased in bankers’

acceptances. 

(B) Contingent obligations with a certain 

draw down, e.g., legally binding agreements 

to purchase assets at a specified future date. 

(C) Indemnification of customers whose 

securities the bank has lent as agent. If the 

customer is not indemnified against loss by 

the bank, the transaction is excluded from 

the risk-based capital calculation.10

(ii) 50 percent credit conversion factor. (A) 

Transaction-related contingencies including, 

among other things, performance bonds and 

performance-based standby letters of credit 

related to a particular transaction.11 To the 

extent permitted by law or regulation, 

performance-based standby letters of credit 

include such things as arrangements backing 

subcontractors’ and suppliers’ performance, 

labor and materials contracts, and 

construction bids; 

(B) Unused portions of commitments with 

an original maturity exceeding one-year that 

are not unconditionally cancelable; 12

however, commitments that are asset-backed 

commercial paper liquidity facilities must 

satisfy the eligibility requirements under 

section 3(c)(1)(vi)(B) of this appendix D. 

(C) Unused portions of negatively 

amortizing mortgage loans with an original 

maturity exceeding one-year that are secured 

by liens on one-to-four family residential 

properties and are not unconditionally 

cancelable. If a mortgage loan secured by a 

lien on a one-to-four family residential 

property may negatively amortize, the bank 

shall calculate the risk-weighted asset 

amount for the unfunded portion of the loan 

by multiplying the amount of the off-balance 

sheet exposure by the applicable credit 

conversion factor. 

(1) The amount of the off-balance sheet 

exposure is the maximum unfunded amount 

of the loan if it were to negatively amortize 

to the fullest extent allowed under the 

applicable contract; and 

(2) The applicable risk weight is the risk 

weight that would be assigned under section 

3(b)(2) of this appendix D to a loan with an 

LTV computed using a loan amount that is 

equal to the funded amount of the loan plus 

the maximum unfunded amount of the loan 

if it were to negatively amortize to the fullest 

extent allowed under the applicable contract. 

(D) Revolving underwriting facilities, note 

issuance facilities, and similar arrangements 

pursuant to which the bank’s customer can 

issue short-term debt obligations in its own 

name, but for which the bank has a legally 

binding commitment to either: 

(1) Purchase the obligations the customer 

is unable to sell by a stated date; or 

(2) Advance funds to its customer if the 

obligations cannot be sold. 

(iii) 20 percent credit conversion factor. (A) 

Trade-related contingencies. These are shortterm self-liquidating instruments used to 

finance the movement of goods and are 

collateralized by the underlying shipment. A 

commercial letter of credit is an example of 

such an instrument. 

(B) [Reserved]. 

(iv) 10 percent credit conversion factor. (A) 

Unused portion of asset-backed commercial 

paper liquidity facilities with an original 

maturity of one year or less that satisfy the 

eligibility requirements under section 

3(c)(1)(vi)(B) of this appendix. 

(B) Unused portions of commitments with 

maturities of one year or less that are not 

unconditionally cancelable,13 except for 

commitments to originate mortgage loans 

secured by one-to-four family residential 

properties provided in the ordinary course of 

business. 

(C) Unused portions of negatively 

amortizing mortgage loans with an original 

maturity of one-year or less that are secured 

by liens on one-to-four family residential 

properties and that are not unconditionally 

cancelable. If a mortgage loan secured by a 

lien on a one-to-four family residential 

property may negatively amortize, the bank 

shall calculate the risk-weighted asset 

amount for the unfunded portion of the loan 

by multiplying the amount of the off-balance 

sheet exposure by the applicable credit 

conversion factor. 

(1) The amount of the off-balance sheet 

exposure is the maximum unfunded amount 

of the loan if it were to negatively amortize 

to the fullest extent allowed under the 

applicable contract; and 

(2) The applicable risk weight is the risk 

weight that would be assigned under section 

3(b)(2) of this appendix D to a loan with a 

loan-to-value ratio computed using a loan 

amount that is equal to the funded amount 

of the loan plus the maximum unfunded 

amount of the loan if it were to negatively 

amortize to the fullest extent allowed under 

the applicable contract. 

(v) Zero percent credit conversion factor. 

(A) Unused portion of commitments, 

regardless of maturity, if they are 

unconditionally cancelable 14 at any time at 

the option of the bank and the bank has the 

contractual right to make, and in fact does 

make, either—

(1) A separate credit decision based upon 

the borrower’s current financial condition, 

before each drawing under the lending 

facility; or 

(2) An annual (or more frequent) credit 

review based upon the borrower’s current 

financial condition to determine whether or 

not the lending facility should be continued. 

(B) The unused portion of retail credit card 

lines or other related plans that are 

unconditionally cancelable by the bank in 

accordance with applicable law. 

(vi) Liquidity facility provided to assetbacked commercial paper. (A) Noneligible 

asset-backed commercial paper liquidity 

facilities treated as recourse or direct credit 

substitute. Unused portion of asset-backed 

commercial paper liquidity facilities that do 

not meet the criteria for an eligible liquidity 


sroberts on PROD1PC70 with PROPOSALS
77478 Federal Register / Vol. 71, No. 247 / Tuesday, December 26, 2006 / Proposed Rules 

15For purposes of calculating either the potential 

future credit exposure under section 

3(c)(1)(vii)(A)(2) of this appendix D or the gross 

potential future credit exposure under section 

3(c)(1)(vii)(B)(1)(ii) of this appendix D for foreign 

exchange contracts and other similar contracts in 

which the notional principal is equivalent to the 

cash flows, total notional principal is the net 

receipts to each party falling due on each value date 

in each currency. 

16No potential future credit exposure is 

calculated for single currency interest rate swaps in 

which payments are made based upon two floating 

indices, so-called floating/floating or basis swaps; 

the credit equivalent amount is measured solely on 

the basis of the current credit exposure. 

facility provided to asset-backed commercial 

paper in accordance with section 

3(c)(1)(vi)(B) of this appendix must be treated 

as recourse or as a direct credit substitute, 

and assessed the appropriate risk-based 

capital charge in accordance with section 4 

of this appendix. 

(B) Eligible asset-backed commercial paper 

liquidity facility. Except as provided in 

section 3(c)(1)(vi)(C) of this appendix D, in 

order for the unused portion of an assetbacked commercial paper liquidity facility to 

be eligible for either the 50 percent or 10 

percent credit conversion factors under 

sections 3(c)(1)(ii)(B) or 3(c)(1)(iv)(A) of this 

appendix D, the asset-backed commercial 

paper liquidity facility must satisfy the 

following criteria: 

(1) At the time of draw, the asset-backed 

commercial paper liquidity facility must be 

subject to an asset quality test that: 

(i) Precludes funding of assets that are 90 

days or more past due or in default; and 

(ii) If the assets that an asset-backed 

commercial paper liquidity facility is 

required to fund are externally rated 

securities at the time they are transferred into 

the program, the asset-backed commercial 

paper liquidity facility must be used to fund 

only securities that are externally rated 

investment grade at the time of funding. If 

the assets are not externally rated at the time 

they are transferred into the program, then 

they are not subject to this investment grade 

requirement. 

(2) The asset-backed commercial paper 

liquidity facility must provide that, prior to 

any draws, the bank’s funding obligation is 

reduced to cover only those assets that satisfy 

the funding criteria under the asset quality 

test as provided in section 3(c)(1)(vi)(B)(1) of 

this appendix D. 

(C) Exception to eligibility requirements for 

assets guaranteed by the United States 

Government or its agencies, or the central 

government of an OECD country. 

Notwithstanding the eligibility requirements 

for asset-backed commercial paper program 

liquidity facilities in section 3(c)(1)(vi)(B), 

the unused portion of an asset-backed 

commercial paper liquidity facility may still 

qualify for either the 50 percent or 10 percent 

credit conversion factors under sections 

3(c)(1)(ii)(B) or 3(c)(1)(iv)(A) of this appendix 

D, if the assets required to be funded by the 

asset-backed commercial paper liquidity 

facility are guaranteed, either conditionally 

or unconditionally, by the United States 

Government or its agencies, or the central 

government of an OECD country. 

(vii) Derivative contracts. (A) Calculation 

of credit equivalent amounts. The credit 

equivalent amount of a derivative contract 

equals the sum of the current credit exposure 

and the potential future credit exposure of 

the derivative contract. The calculation of 

credit equivalent amounts must be measured 

in U.S. dollars, regardless of the currency or 

currencies specified in the derivative 

contract. 

(1) Current credit exposure. The current 

credit exposure for a single derivative 

contract is determined by the mark-to-market 

value of the derivative contract. If the markto-market value is positive, then the current 

credit exposure equals that mark-to-market 

value. If the mark-to-market is zero or 

negative, then the current credit exposure is 

zero. The current credit exposure for 

multiple derivative contracts executed with a 

single counterparty and subject to a 

qualifying bilateral netting contract is 

determined as provided by section 

3(c)(1)(vii)(B) of this appendix D. 

(2) Potential future credit exposure. The 

potential future credit exposure for a single 

derivative contract, including a derivative 

contract with negative mark-to-market value, 

is calculated by multiplying the notional 

principal 15 of the derivative contract by one 

of the credit conversion factors in Table 5 of 

this appendix D, for the appropriate 

category.16 The potential future credit 

exposure for gold contracts shall be 

calculated using the foreign exchange rate 

conversion factors. For any derivative 

contract that does not fall within one of the 

specified categories in Table 5 of this 

appendix D, the potential future credit 

exposure shall be calculated using the other 

commodity conversion factors. Subject to 

examiner review, banks should use the 

effective rather than the apparent or stated 

notional amount in calculating the potential 

future credit exposure. The potential future 

credit exposure for multiple derivatives 

contracts executed with a single counterparty 

and subject to a qualifying bilateral netting 

contract is determined as provided by section 

3(c)(1)(vii)(B)(1) of this appendix D. 

TABLE 5.—CONVERSION FACTOR MATRIX 1

Remaining maturity 2 Interest rate 

(in percent) 

Foreign 

exchange rate 

and gold 

(in percent) 

Equity 

(in percent) 

Precious 

metals 

(in percent) 

Other 

commodity 

(in percent) 

One year or less .................................................................. 0.0 1.0 6.0 7.0 10.0 

Over one year to five ........................................................... 0.5 5.0 8.0 7.0 12.0 

Over five years ..................................................................... 1.5 7.5 10.0 8.0 15.0 

1For derivative contracts with multiple exchanges of principal, the conversion factors are multiplied by the number of remaining payments in 

the derivative contract. 2For derivative contracts that automatically reset to zero value following a payment, the remaining maturity equals the time until the next payment. However, interest rate contracts with remaining maturities of greater than one year shall be subject to a minimum conversion factor of 0.5 

percent. 

(B) Derivative contracts subject to a 

qualifying bilateral netting contract. (1) 

Netting calculation. The credit equivalent 

amount for multiple derivative contracts 

executed with a single counterparty and 

subject to a qualifying bilateral netting 

contract as provided by section 

(3)(c)(1)(vii)(B)(2) of this appendix D is 

calculated by adding the net current credit 

exposure and the adjusted sum of the 

potential future credit exposure for all 

derivative contracts subject to the qualifying 

bilateral netting contract. 

(i) Net current credit exposure. The net 

current credit exposure is the net sum of all 

positive and negative mark-to-market values 

of the individual derivative contracts subject 

to a qualifying bilateral netting contract. If 

the net sum of the mark-to-market value is 

positive, then the net current credit exposure 

equals that net sum of the mark-to-market 

value. If the net sum of the mark-to-market 

value is zero or negative, then the net current 

credit exposure is zero. 

(ii) Adjusted sum of the potential future 

credit exposure. The adjusted sum of the 

potential future credit exposure is calculated 

as: 

Anet=0.4×Agross+(0.6×NGR×Agross) 

Anet is the adjusted sum of the potential 

future credit exposure, Agross is the gross 

potential future credit exposure, and NGR is 

the net to gross ratio. Agross is the sum of the 

potential future credit exposure (as 

determined under section 3(c)(1)(vii)(A)(2) of 

this appendix D) for each individual 

derivative contract subject to the qualifying 

bilateral netting contract. The NGR is the 

ratio of the net current credit exposure to the 

gross current credit exposure. In calculating 


sroberts on PROD1PC70 with PROPOSALS
Federal Register / Vol. 71, No. 247 / Tuesday, December 26, 2006 / Proposed Rules 77479 

17By netting individual derivative contracts for 

the purpose of calculating its credit equivalent 

amount, a bank represents that documentation 

adequate to support the netting of a set of derivative 

contract is in the bank’s files and available for 

inspection by the OCC. Upon determination by the 

OCC that a bank’s files are inadequate or that a 

qualifying bilateral netting contract may not be 

legally enforceable in any one of the bodies of law 

described in sections 3(c)(1)(vii)(B)(2)(i) through 

(iii) of this appendix D, the underlying derivative 

contracts may not be netted for the purposes of this 

section. 

18 Derivative contracts are an exception to the 

general rule of applying collateral and guarantees to 

the face value of off-balance sheet items. The 

sufficiency of collateral and guarantees is 

determined on the basis of the credit equivalent 

amount of derivative contracts. However, collateral 

and guarantees held against a qualifying bilateral 

netting contract is not recognized for capital 

purposes unless it is legally available for all 

contracts included in the qualifying bilateral netting 

contract. 

19Notwithstanding section 3(c)(1)(v)(A) of this 

appendix D, gold contracts do not qualify for this 

exception. 

20Stripped mortgage-backed securities or other 

similar instruments, such as interest-only or 

principal-only strips, that are not credit enhancing 

must be assigned to the 100 percent risk category. 

the NGR, the gross current credit exposure 

equals the sum of the positive current credit 

exposures (as determined under section 

3(c)(1)(vii)(A)(1) of this appendix D) of all 

individual derivative contracts subject to the 

qualifying bilateral netting contract. 

(2) Qualifying bilateral netting contract. In 

determining the current credit exposure for 

multiple derivative contracts executed with a 

single counterparty, a bank may net 

derivative contracts subject to a qualifying 

bilateral netting contract by offsetting 

positive and negative mark-to-market values, 

provided that: 

(i) The qualifying bilateral netting contract 

is in writing. 

(ii) The qualifying bilateral netting contract 

is not subject to a walkaway clause. 

(iii) The qualifying bilateral netting 

contract creates a single legal obligation for 

all individual derivative contracts covered by 

the qualifying bilateral netting contract. In 

effect, the qualifying bilateral netting contract 

must provide that the bank would have a 

single claim or obligation either to receive or 

to pay only the net amount of the sum of the 

positive and negative mark-to-market values 

on the individual derivative contracts 

covered by the qualifying bilateral netting 

contract. The single legal obligation for the 

net amount is operative in the event that a 

counterparty, or a counterparty to whom the 

qualifying bilateral netting contract has been 

assigned, fails to perform due to any of the 

following events: default, insolvency, 

bankruptcy, or other similar circumstances. 

(iv) The bank obtains a written and 

reasoned legal opinion(s) that represents, 

with a high degree of certainty, that in the 

event of a legal challenge, including one 

resulting from default, insolvency, 

bankruptcy, or similar circumstances, the 

relevant court and administrative authorities 

would find the bank’s exposure to be the net 

amount under: 

(A) The law of the jurisdiction in which the 

counterparty is chartered or the equivalent 

location in the case of noncorporate entities, 

and if a branch of the counterparty is 

involved, then also under the law of the 

jurisdiction in which the branch is located; 

(B) The law of the jurisdiction that governs 

the individual derivative contracts covered 

by the bilateral netting contract; and 

(C) The law of the jurisdiction that governs 

the qualifying bilateral netting contract. 

(v) The bank establishes and maintains 

procedures to monitor possible changes in 

relevant law and to ensure that the qualifying 

bilateral netting contract continues to satisfy 

the requirement of this section. 

(vi) The bank maintains in its files 

documentation adequate to support the 

netting of a derivative contract.17

(C) Risk weighting. Once the bank 

determines the credit equivalent amount for 

a derivative contract or a set of derivative 

contracts subject to a qualifying bilateral 

netting contract, the bank assigns that 

amount to the risk weight category 

appropriate to the counterparty, or, if 

relevant, the nature of any collateral or 

guarantee.18

(D) Exceptions. The following derivative 

contracts are not subject to the above 

calculation, and therefore, are not part of the 

denominator of a national bank’s risk-based 

capital ratio: 

(1) An exchange rate contract with an 

original maturity of 14 calendar days or 

less; 19 and 

(2) A derivative contract that is traded on 

an exchange requiring the daily payment of 

any variations in the market value of the 

contract. 

Section 4. Securitizations. 

(a) Credit equivalent amounts and risk 

weights of recourse obligations and direct 

credit substitutes. (1) Credit-equivalent 

amount. Except as otherwise provided, the 

credit-equivalent amount for a recourse 

obligation or direct credit substitute is the 

full amount of the credit-enhanced assets for 

which the bank directly or indirectly retains 

or assumes credit risk multiplied by a 100 

percent conversion factor. 

(2) Risk-weight factor. To determine the 

bank’s risk-weighted assets for off-balance 

sheet recourse obligations and direct credit 

substitutes, the credit equivalent amount is 

assigned to the risk category appropriate to 

the obligor in the underlying transaction, 

after considering any associated guarantees 

or collateral. For a direct credit substitute 

that is an on-balance sheet asset (e.g., a 

purchased subordinated security), a bank 

must calculate risk-weighted assets using the 

amount of the direct credit substitute and the 

full amount of the assets it supports, i.e., all 

the more senior positions in the structure. 

(b) Credit equivalent amount and risk 

weight of participations in, and syndications 

of, direct credit substitutes. The credit 

equivalent amount for a participation interest 

in, or syndication of, a direct credit substitute 

is calculated and risk weighted as follows: 

(1) In the case of a direct credit substitute 

in which a bank has conveyed a risk 

participation, the full amount of the assets 

that are supported by the direct credit 

substitute is converted to a credit equivalent 

amount using a 100 percent conversion 

factor. The pro rata share of the credit 

equivalent amount that has been conveyed 

through a risk participation is then assigned 

to whichever risk-weight category is lower: 

the risk-weight category appropriate to the 

obligor in the underlying transaction, after 

considering any associated guarantees or 

collateral, or the risk-weight category 

appropriate to the party acquiring the 

participation. The pro rata share of the credit 

equivalent amount that has not been 

participated out is assigned to the risk-weight 

category appropriate to the obligor after 

considering any associated guarantees or 

collateral. 

(2) In the case of a direct credit substitute 

in which the bank has acquired a risk 

participation, the acquiring bank’s pro rata 

share of the direct credit substitute is 

multiplied by the full amount of the assets 

that are supported by the direct credit 

substitute and converted using a 100 percent 

credit conversion factor. The resulting credit 

equivalent amount is then assigned to the 

risk-weight category appropriate to the 

obligor in the underlying transaction, after 

considering any associated guarantees or 

collateral. 

(3) In the case of a direct credit substitute 

that takes the form of a syndication where 

each bank or participating entity is obligated 

only for its pro rata share of the risk and 

there is no recourse to the originating entity, 

each bank’s credit equivalent amount will be 

calculated by multiplying only its pro rata 

share of the assets supported by the direct 

credit substitute by a 100 percent conversion 

factor. The resulting credit equivalent 

amount is then assigned to the risk-weight 

category appropriate to the obligor in the 

underlying transaction, after considering any 

associated guarantees or collateral. 

(c) Externally rated positions: creditequivalent amounts and risk weights. (1) 

Traded positions. With respect to a recourse 

obligation, direct credit substitute, residual 

interest (other than a credit-enhancing 

interest-only strip) or asset-or mortgagebacked security that is a ‘‘traded position’’

and that has received an external rating on 

a long-term position that is one grade below 

investment grade or better or a short-term 

position that is investment grade, the bank 

may multiply the face amount of the position 

by the appropriate risk weight, determined in 

accordance with Table 6 or Table 7 of this 

appendix D.20 If a traded position receives 

more than one external rating, the lowest 

single rating will apply. 


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TABLE 6.—RISK WEIGHTS BASED ON EXTERNAL RATINGS FOR LONG-TERM EXPOSURES

Long-term rating category Examples Risk weight 

(in percent) 

Highest investment grade ............................................................................................................................ AAA ........................... 20 

Second highest investment grade ............................................................................................................... AA .............................. 20 

Third highest investment grade ................................................................................................................... A ................................ 35 

Lowest investment grade—plus .................................................................................................................. BBB+ ......................... 50 

Lowest investment grade ............................................................................................................................. BBB ........................... 75 

Lowest-investment grade—minus ............................................................................................................... BBB¥ ........................ 100 

One category below investment grade ........................................................................................................ BB+, BB ..................... 200 

One category below investment grade—minus .......................................................................................... BB¥ .......................... 200 

TABLE 7.—RISK WEIGHTS BASED ON EXTERNAL RATINGS FOR SHORT-TERM EXPOSURES

Short-term rating category Examples Risk Weight 

(in percent) 

Highest investment grade ............................................................................................................................ A–1, P–1 ................... 20 

Second highest investment grade ............................................................................................................... A–2, P–2 ................... 35 

Lowest investment grade ............................................................................................................................. A–3, P–3 ................... 75 

(2) Non-traded positions. A recourse 

obligation, direct credit substitute, residual 

interest (but not a credit-enhancing interestonly strip) or asset-or mortgage-backed 

security extended in connection with a 

securitization that is not a ‘‘traded position’’

may be assigned a risk weight in accordance 

with section 4(c)(1) of this appendix D if: 

(i) It has been externally rated by more 

than one NRSRO; 

(ii) It has received an external rating on a 

long-term position that is one category below 

investment grade or better or a short-term 

position that is investment grade by all 

NRSROs providing a rating; 

(iii) The ratings are publicly available; and 

(iv) The ratings are based on the same 

criteria used to rate traded positions. 

If the ratings are different, the lowest rating 

will determine the risk category to which the 

recourse obligation, residual interest or direct 

credit substitute will be assigned. 

(d) Senior positions not externally rated. 

For a recourse obligation, direct credit 

substitute, residual interest or asset- or 

mortgage-backed security that is not 

externally rated but is senior or preferred in 

all features to a traded position (including 

collateralization and maturity), a bank may 

apply a risk weight to the face amount of the 

senior position in accordance with section 

4(c)(1) of this appendix D, based upon the 

traded position, subject to any current or 

prospective supervisory guidance and the 

bank satisfying the OCC that this treatment 

is appropriate. This section will apply only 

if the traded position provides substantive 

credit support to the unrated position until 

the unrated position matures. 

(e) Residual Interests—(1) Concentration 

limit on credit-enhancing interest-only strips. 

In addition to the capital requirement 

provided by section 4(e)(2) of this appendix 

D, a bank must deduct from Tier 1 capital all 

credit-enhancing interest-only strips in 

excess of 25 percent of Tier 1 capital in 

accordance with section 2(c)(2)(iv) of 

appendix A of this part. 

(2) Credit-enhancing interest-only strip 

capital requirement. After applying the 

concentration limit to credit-enhancing 

interest-only strips in accordance with 

section 4(e)(1) of this appendix D, a bank 

must maintain risk-based capital for a creditenhancing interest-only strip equal to the 

remaining amount of the credit-enhancing 

interest-only strip (net of any existing 

associated deferred tax liability), even if the 

amount of risk-based capital required to be 

maintained exceeds the full risk-based 

capital requirement for the assets transferred. 

Transactions that, in substance, result in the 

retention of credit risk associated with a 

transferred credit-enhancing interest-only 

strip will be treated as if the credit-enhancing 

interest-only strip was retained by the bank 

and not transferred. 

(3) Other residual interests capital 

requirement. Except as provided in sections 

3(d) or (e) of this appendix D, a bank must 

maintain risk-based capital for a residual 

interest (excluding a credit-enhancing 

interest-only strip) equal to the face amount 

of the residual interest that is retained on the 

balance sheet (net of any existing associated 

deferred tax liability), even if the amount of 

risk-based capital required to be maintained 

exceeds the full risk-based capital 

requirement for the assets transferred. 

Transactions that, in substance, result in the 

retention of credit risk associated with a 

transferred residual interest will be treated as 

if the residual interest was retained by the 

bank and not transferred. 

(4) Residual interests and other recourse 

obligations. Where the aggregate capital 

requirement for residual interests (including 

credit-enhancing interest-only strips) and 

recourse obligations arising from the same 

transfer of assets exceed the full risk-based 

capital requirement for those assets, a bank 

must maintain risk-based capital equal to the 

greater of the risk-based capital requirement 

for the residual interest as calculated under 

section 4(e)(1)–(3) of this appendix D or the 

full risk-based capital requirement for the 

assets transferred. 

(f) Positions that are not rated by an 

NRSRO. A position (but not a residual 

interest) extended in connection with a 

securitization and that is not rated by an 

NRSRO may be risk-weighted based on the 

bank’s determination of the credit rating of 

the position, as specified in Table 8 of this 

appendix D, multiplied by the face amount 

of the position. In order to qualify for this 

treatment, the bank’s system for determining 

the credit rating of the position must meet 

one of the three alternative standards set out 

in section 4(f)(1)through (3) of this appendix 

D. 

TABLE 8.—RISK WEIGHTS BASED ON INTERNAL RATINGS

Rating category Examples Risk weight 

(in percent) 

Investment grade ......................................................................................................................................... BBB or better ............ 100 

One category below investment grade ........................................................................................................ BB .............................. 200 


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(1) Internal risk rating used for assetbacked programs. A direct credit substitute 

(but not a purchased credit-enhancing 

interest-only strip) is assumed by a bank in 

connection with an asset-backed commercial 

paper program sponsored by the bank and 

the bank is able to demonstrate to the 

satisfaction of the OCC, prior to relying upon 

its use, that the bank’s internal credit risk 

rating system is adequate. Adequate internal 

credit risk rating systems usually contain the 

following criteria: 

(i) The internal credit risk system is an 

integral part of the bank’s risk management 

system that explicitly incorporates the full 

range of risks arising from a bank’s 

participation in securitization activities; 

(ii) Internal credit ratings are linked to 

measurable outcomes, such as the probability 

that the position will experience any loss, the 

position’s expected loss given default, and 

the degree of variance in losses given default 

on that position; 

(iii) The bank’s internal credit risk system 

must separately consider the risk associated 

with the underlying loans or borrowers, and 

the risk associated with the structure of a 

particular securitization transaction; 

(iv) The bank’s internal credit risk system 

must identify gradations of risk among 

‘‘pass’’ assets and other risk positions; 

(v) The bank must have clear, explicit 

criteria that are used to classify assets into 

each internal risk grade, including subjective 

factors; 

(vi) The bank must have independent 

credit risk management or loan review 

personnel assigning or reviewing the credit 

risk ratings; 

(vii) An internal audit procedure should 

periodically verify that internal risk ratings 

are assigned in accordance with the bank’s 

established criteria; 

(viii) The bank must monitor the 

performance of the internal credit risk ratings 

assigned to nonrated, nontraded direct credit 

substitutes over time to determine the 

appropriateness of the initial credit risk 

rating assignment and adjust individual 

credit risk ratings, or the overall internal 

credit risk ratings system, as needed; and 

(ix) The internal credit risk system must 

make credit risk rating assumptions that are 

consistent with, or more conservative than, 

the credit risk rating assumptions and 

methodologies of NRSROs. 

(2) Program Ratings. A direct credit 

substitute or recourse obligation (but not a 

residual interest) is assumed or retained by 

a bank in connection with a structured 

finance program and a NRSRO has reviewed 

the terms of the program and stated a rating 

for positions associated with the program. If 

the program has options for different 

combinations of assets, standards, internal 

credit enhancements and other relevant 

factors, and the NRSRO specifies ranges of 

rating categories to them, the bank may apply 

the rating category applicable to the option 

that corresponds to the bank’s position. In 

order to rely on a program rating, the bank 

must demonstrate to the OCC’s satisfaction 

that the credit risk rating assigned to the 

program meets the same standards generally 

used by NRSROs for rating traded positions. 

The bank must also demonstrate to the OCC’s 

satisfaction that the criteria underlying the 

NRSRO’s assignment of ratings for the 

program are satisfied for the particular 

position. If a bank participates in a 

securitization sponsored by another party, 

the OCC may authorize the bank to use this 

approach based on a program rating obtained 

by the sponsor of the program. 

(3) Computer Program. The bank is using 

an acceptable credit assessment computer 

program to determine the rating of a direct 

credit substitute or recourse obligation (but 

not a residual interest) extended in 

connection with a structured finance 

program. A NRSRO must have developed the 

computer program and the bank must 

demonstrate to the OCC’s satisfaction that 

ratings under the program correspond 

credibly and reliably with the rating of traded 

positions. 

(g) Limitations on risk-based capital 

requirements. (1) Low-level exposure rule. If 

the maximum contractual exposure to loss 

retained or assumed by a bank is less than 

the effective risk-based capital requirement, 

as determined in accordance with section 

4(a) of this appendix D, for the asset 

supported by the bank’s position, the risk 

based capital required under this appendix D 

is limited to the bank’s contractual exposure, 

less any recourse liability account 

established in accordance with generally 

accepted accounting principles. This 

limitation does not apply when a bank 

provides credit enhancement beyond any 

contractual obligation to support assets that 

it has sold. 

(2) Related on-balance sheet assets. If an 

asset is included in the calculation of the 

risk-based capital requirement under this 

section 4 of this appendix D and also appears 

as an asset on a bank’s balance sheet, the 

asset is risk-weighted only under this section 

4 of this appendix D, except in the case of 

loan servicing assets and similar 

arrangements with embedded recourse 

obligations or direct credit substitutes. In that 

case, both the on-balance sheet servicing 

assets and the related recourse obligations or 

direct credit substitutes must both be 

separately risk weighted and incorporated 

into the risk-based capital calculation. 

(h) Alternative Capital Calculation for 

Small Business Obligations. (1) Definitions. 

For purposes of this section 4(h): 

Qualified bank means a bank that: 

(A) Is well capitalized as defined in 12 CFR 

6.4 without applying the capital treatment 

described in this section 4(h), or 

(B) Is adequately capitalized as defined in 

12 CFR 6.4 without applying the capital 

treatment described in this section 4(h) and 

has received written permission from the 

appropriate district office of the OCC to 

apply the capital treatment described in this 

section 4(h). 

Recourse has the meaning given to such 

term under generally accepted accounting 

principles. 

Small business means a business that 

meets the criteria for a small business 

concern established by the Small Business 

Administration in 13 CFR part 121 pursuant 

to 15 U.S.C. 632. 

(2) Capital and reserve requirements. 

Notwithstanding the risk-based capital 

treatment outlined in section 2(c)(4) and any 

other paragraph (other than paragraph (h)) of 

this section 4, with respect to a transfer of a 

small business loan or a lease of personal 

property with recourse that is a sale under 

generally accepted accounting principles, a 

qualified bank may elect to apply the 

following treatment: 

(i) The bank establishes and maintains a 

non-capital reserve under generally accepted 

accounting principles sufficient to meet the 

reasonable estimated liability of the bank 

under the recourse arrangement; and 

(ii) For purposes of calculating the bank’s 

risk-based capital ratio, the bank includes 

only the face amount of its recourse in its 

risk-weighted assets. 

(3) Limit on aggregate amount of recourse. 

The total outstanding amount of recourse 

retained by a qualified bank with respect to 

transfers of small business loans and leases 

of personal property and included in the riskweighted assets of the bank as described in 

section 4(h)(2) of this appendix D may not 

exceed 15 percent of the bank’s total capital 

after adjustments and deductions, unless the 

OCC specifies a greater amount by order. 

(4) Bank that ceases to be qualified or that 

exceeds aggregate limit. If a bank ceases to 

be a qualified bank or exceeds the aggregate 

limit in section 4(h)(3) of this appendix D, 

the bank may continue to apply the capital 

treatment described in section 4(h)(2) of this 

appendix D to transfers of small business 

loans and leases of personal property that 

occurred when the bank was qualified and 

did not exceed the limit. 

(5) Prompt Corrective Action not affected. 

(i) A bank shall compute its capital without 

regard to this section 4(h) for purposes of 

prompt corrective action (12 U.S.C. 1831o 

and 12 CFR part 6) unless the bank is an 

adequately or well capitalized bank (without 

applying the capital treatment described in 

this section 4(h)) and, after applying the 

capital treatment described in this section 

4(h), the bank would be well capitalized. 

(ii) A bank shall compute its capital 

without regard to this section 4(h) for 

purposes of 12 U.S.C. 1831o(g) regardless of 

the bank’s capital level. 

(i) Additional capital charge for revolving 

securitizations with an early amortization 

trigger. A bank that securitizes revolving 

credits where the securitization structure 

contains an early amortization provision 

must maintain risk-based capital against the 

investors’ interest as required under this 

section. 

(1) Capital for securitizations of revolving 

credit exposures that incorporate earlyamortization provisions will be assessed 

based on a comparison of the securitization’s 

annualized three-month average excess 

spread against the excess spread trapping 

point. 

(2) To calculate the securitization’s excess 

spread trapping point ratio: 

(i) A bank must first calculate the 

annualized three month ratio for excess 

spread as follows: 

(A) For each of the three months, divide 

the month’s excess spread by the outstanding 

principal balance of the underlying pool of 

exposures at the end of each month. 


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77482 Federal Register / Vol. 71, No. 247 / Tuesday, December 26, 2006 / Proposed Rules 

1A leverage capital measure for state member 

banks is outlined in appendix B of this part. 

2The risk-based capital measure is based upon a 

framework developed jointly by supervisory 

authorities from the countries represented on the 

Basel Committee on Banking Supervision (Basel 

Supervisors’ Committee) and endorsed by the 

Group of Ten Central Bank Governors. The 

framework is described in a paper prepared by the 

Basel Supervisors’ Committee entitled 

‘‘International Convergence of Capital 

Measurement,’’ July 1988. 

3Banks will initially be expected to utilize 

period-end amounts in calculating their risk-based 

capital ratios. When necessary and appropriate, 

ratios based on average balances may also be 

calculated on a case-by-case basis. Moreover, to the 

extent banks have data on average balances that can 

be used to calculate risk-based ratios, the Federal 

Reserve will take such data into account. 

(B) Calculate the average ratio for the three 

months, then convert the result to a 

compound annual rate. 

(ii) Then the bank must divide the 

annualized three month ratio for excess 

spread by the excess spread trapping point 

that is specified in the documentation for the 

securitization. 

(3) Banks shall compare the excess spread 

trapping point ratio to the ratios contained in 

Table 9 in appendix D to determine the 

appropriate conversion factor to apply to the 

investor’s interest. The amount of investor’s 

interest after conversion is then assigned to 

a risk-weight category in accordance with 

that appropriate to the underlying obligor, 

collateral, or guarantor. For securitizations 

that do not require excess spread to be 

trapped, or that specify trapping points based 

primarily on performance measures other 

than the three-month average excess spread, 

the excess spread trapping point is 4.5 

percent. 

TABLE 9.—EARLY AMORTIZATION CREDIT CONVERSION FACTORS

3-month average excess spread CCF 

(in percent) 

133.33 percent of trapping point or more ............................................................................................................................................ 0 

Less than 133.33 percent to 100 percent of trapping point ................................................................................................................ 5 

Less than 100 percent to 75 percent of trapping point ....................................................................................................................... 15 

Less than 75 percent to 50 percent of trapping point ......................................................................................................................... 50 

Less than 50 percent of trapping point ............................................................................................................................................... 100 

(4) Limitations on risk-based capital 

requirements. For a bank subject to the early 

amortization requirements in this section, the 

total risk-based capital requirement for all of 

the bank’s exposures to a securitization of 

revolving retail credits is limited to the 

greater of the risk-based capital requirement 

for residual interests plus any early 

amortization charges as described in this 

section 4(i), or the risk-based capital 

requirement for the underlying securitized 

assets calculated as if the bank continued to 

hold the assets on its balance sheet. 

Section 5. Target Ratios 

(a) All national banks are expected to 

maintain a minimum ratio of total capital 

(after deductions) to risk-weighted assets of 

8.0 percent. 

(b) Tier 2 capital elements qualify as part 

of a national bank’s total capital base up to 

a maximum of 100 percent of that bank’s Tier 

1 capital. 

(c) In addition to the standards established 

by these risk-based capital guidelines, all 

national banks must maintain a minimum 

capital-to-total assets ratio in accordance 

with the provisions of 12 CFR part 3. 

Federal Reserve System 

12 CFR Chapter II 

Authority and Issuance 

For the reasons set forth in the joint 

preamble, the Board of Governors of the 

Federal Reserve System proposes to 

amend parts 208 and 225 of chapter II 

of title 12 of the Code of Federal 

Regulations as follows: 

PART 208—MEMBERSHIP OF STATE 

BANKING INSTITUTIONS IN THE 

FEDERAL RESERVE SYSTEM 

(REGULATION H) 

1. The authority citation for part 208 

continues 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), 

1823(j), 1828(o), 1831, 1831o, 1831p–1, 

1831r–1, 1831w, 1831x, 1835a, 1882, 2901–

2907, 3105, 3310, 3331–3351, and 3906–

3909; 15 U.S.C. 78b, 78l(b), 78l(g), 78l(i), 

78o–4(c)(5), 78q, 78q–1, and 78w; 31 U.S.C. 

5318; 42 U.S.C. 4012a, 4104a, 4104b, 4106, 

and 4128. 

2. In appendix A to part 208, the 

following amendments are proposed: 

a. Section I, Overview, is revised. 

b. In section II, Definition of 

Qualifying Capital for the Risk-Based 

Capital Ratio, the first paragraph is 

revised. 

c. In section III.A, Procedures, the first 

paragraph is revised, the fifth paragraph 

is redesignated as the sixth paragraph, 

and a new fifth paragraph is added. 

d. In section III.C, the first paragraph 

is revised. 

e. Section IV is removed and a new 

section IV, Alternative Approach for 

Computing Weighted Risk Assets and 

Off-Balance-Sheet Items, is added. 

f. Attachment I is removed. 

Appendix A To Part 208—Capital 

Adequacy Guidelines For State Member 

Banks: Risk-Based Measure 

I. Overview 

The Board of Governors of the Federal 

Reserve System has adopted a risk-based 

capital measure to assist in the assessment of 

the capital adequacy of state member banks.1

The principal objectives of this measure are 

to: (i) Make regulatory capital requirements 

more sensitive to differences in risk profiles 

among banks; (ii) factor off-balance sheet 

exposures into the assessment of capital 

adequacy; (iii) minimize disincentives to 

holding liquid, low-risk assets; and (iv) 

achieve greater consistency in the evaluation 

of the capital adequacy of major banks 

throughout the world.2

The risk-based capital guidelines include 

both a definition of capital and a framework 

for calculating weighted risk assets by 

assigning assets and off-balance sheet items 

to broad risk categories. A bank’s risk-based 

capital ratio is calculated by dividing its 

qualifying capital (the numerator of the ratio) 

by its weighted risk assets (the 

denominator).3 The definition of qualifying 

capital is outlined in section II, and the 

procedures for calculating weighted risk 

assets are discussed in sections III and IV. 

In addition, when certain banks that 

engage in trading activities calculate their 

risk-based capital ratios under this appendix 

A, they must also refer to appendix E of this 

part, which incorporates capital charges for 

certain market risks into the risk-based 

capital ratios. When calculating their riskbased capital ratios under this appendix A, 

such banks are required to refer to appendix 

E of this part for supplemental rules to 

determine qualifying and excess capital, 

calculate weighted risk assets, calculate 

market risk equivalent assets, and calculate 

risk-based capital ratios adjusted for market 

risk. 

The risk-based capital guidelines apply to 

all state member banks on a consolidated 

basis. They are to be used in the examination 

and supervisory process as well as in the 

analysis of applications acted upon by the 

Federal Reserve. Thus, in considering an 

application filed by a state member bank, the 

Federal Reserve will take into account the 

bank’s risk-based capital ratios, the 

reasonableness of its capital plans, and the 

extent to which it meets the risk-based 

capital standards. 

The risk-based capital ratios focus 

principally on broad categories of credit risk, 

although the framework for assigning assets 

and off-balance-sheet items to risk categories 

does incorporate elements of transfer risk, as 

well as limited instances of interest rate and 

market risk. The framework incorporates 

risks arising from traditional banking 


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58For purposes of this section IV, a sovereign is 

defined as a central government, including its 

agencies, departments, ministries, and the central 

bank. This definition does not include state, 

provincial, or local governments, or commercial 

enterprises owned by a central government. 

activities as well as risks arising from 

nontraditional activities. The risk-based 

capital ratios do not, however, incorporate 

other factors that can affect an institution’s 

financial condition. These factors include 

overall interest-rate exposure; liquidity, 

funding and market risks; the quality and 

level of earnings; investment, loan portfolio, 

and other concentrations of credit; certain 

risks arising from nontraditional activities; 

the quality of loans and investments; the 

effectiveness of loan and investment policies; 

and management’s overall ability to monitor 

and control financial and operating risks, 

including the risks presented by 

concentrations of credit and nontraditional 

activities. 

In addition to evaluating capital ratios, an 

overall assessment of capital adequacy must 

take account of those factors, including, in 

particular, the level and severity of problem 

and classified assets as well as a bank’s 

exposure to declines in the economic value 

of its capital due to changes in interest rates. 

For this reason, the final supervisory 

judgment on a bank’s capital adequacy may 

differ significantly from conclusions that 

might be drawn solely from the level of its 

risk-based capital ratios. 

The risk-based capital guidelines establish 

a minimum ratio of qualifying total capital to 

weighted risk assets of 8 percent, of which 

at least 4 percentage points must be in the 

form of tier 1 capital. In light of the 

considerations just discussed, banks 

generally are expected to operate well above 

the minimum risk-based ratios. In particular, 

banks 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. Institutions with high or 

inordinate levels of risk are also expected to 

operate well above minimum capital 

standards. In all cases, institutions should 

hold capital commensurate with the level 

and nature of the risks to which they are 

exposed. Banks that do not meet the 

minimum risk-based capital standard, or that 

are otherwise considered to be inadequately 

capitalized, are expected to develop and 

implement plans acceptable to the Federal 

Reserve for achieving adequate levels of 

capital within a reasonable period of time. 

The Board will monitor the 

implementation and effect of these guidelines 

in relation to domestic and international 

developments in the banking industry. When 

necessary and appropriate, the Board will 

consider the need to modify the guidelines in 

light of any significant changes in the 

economy, financial markets, banking 

practices, or other relevant factors. 

II. * * * 

A bank’s qualifying total capital consists of 

two types of capital components: ‘‘core 

capital elements’’ (comprising tier 1 capital) 

and ‘‘supplementary capital elements’’

(comprising tier 2 capital). These capital 

elements and the various limits, restrictions, 

and deductions to which they are subject, are 

discussed in this section II. 

* * * * * 

III. * * * 

A. * * * 

Assets and credit-equivalent amounts of 

off-balance-sheet items of state member 

banks are assigned to one of several broad 

risk categories, according to the obligor, or, 

if relevant, the guarantor, the nature of the 

collateral, or an external rating. The aggregate 

dollar value of the amount in each category 

is then multiplied by the risk weight 

associated with the category. The resulting 

weighted values from each of the risk 

categories are added together, and this sum 

is the bank’s total weighted risk assets that 

comprise the denominator of the risk-based 

capital ratios. 

* * * * * 

A bank may elect to apply the alternative 

procedures for computing weighted risk 

assets set forth in section IV of this appendix 

A (‘‘Alternative Approach’’). The Federal 

Reserve also may require a bank to apply the 

Alternative Approach if the Federal Reserve 

determines that the Alternative Approach 

would produce risk-based capital 

requirements that more accurately reflect the 

risk profile of the bank or would otherwise 

enhance the safety and soundness of the 

bank. A bank that applies the Alternative 

Approach must apply all the procedures set 

forth in section IV of this appendix A and 

also must apply all the procedures set forth 

in this section that are not inconsistent with 

the procedures in section IV. 

* * * * * 

C. * * * 

Assets and on-balance-sheet credit 

equivalent amounts are assigned to the 

following risk weight categories: 0 percent, 

20 percent, 50 percent, or 100 percent. A 

brief explanation of the components of each 

category follows. 

* * * * * 

IV. Alternative Approach for Computing 

Weighted Risk Assets and Off-Balance-sheet 

Items 

A. Scope of Application 

A bank may elect to use the Alternative 

Approach for computing weighted risk assets 

and off-balance sheet items set forth in this 

section IV by giving the Federal Reserve 

written notice on the first day of the quarter 

during which the bank elects to begin using 

the Alternative Approach. A bank that has 

elected to apply the Alternative Approach 

may opt out of the Alternative Approach after 

it has given the Federal Reserve 30 days prior 

written notice. The Federal Reserve may 

require a bank to apply the Alternative 

Approach if the Federal Reserve determines 

that the Alternative Approach would 

produce risk-based capital requirements that 

more accurately reflect the risk profile of the 

bank or would otherwise enhance the safety 

and soundness of the bank. 

A bank that applies the Alternative 

Approach must apply all the procedures set 

forth in this section IV and also must apply 

all the procedures set forth in section III that 

are not inconsistent with the procedures in 

section IV. 

B. External Ratings, Collateral, Guarantees, 

and Other Considerations 

1. External Credit Ratings. A bank must use 

Table 1 in this section IV.B.1. to assign risk 

weights to covered claims with an original 

maturity of one year or more and Table 2 in 

this section IV.B.1. to assign risk weights to 

covered claims with an original maturity of 

less than one year. Covered claims are all 

claims other than (i) claims on an excluded 

entity, (ii) loans to non-sovereigns that do not 

have an external rating, and (iii) OTC 

derivative contracts. Excluded entities are (i) 

the U.S. central government and U.S. 

government agencies, (ii) state and local 

governments of the United States and other 

countries of the OECD, (iii) U.S. governmentsponsored agencies, and (iv) U.S. depository 

institutions and foreign banks. 

A bank must use column three of the tables 

for covered claims on a non-U.S. sovereign 58

and column four of the tables for covered 

claims on an entity other than a non-U.S. 

sovereign (excluding securitization 

exposures). A bank must use column five of 

the tables for covered claims that are 

securitization exposures, which include 

asset-backed securities, mortgage-backed 

securities, recourse obligations, direct credit 

substitutes, and residual interests (other than 

credit-enhancing interest-only strips). 

TABLE 1.—RISK WEIGHTS BASED ON LONG-TERM EXTERNAL RATINGS

Long-term rating category Rating 

Non-U.S. sovereign risk 

weight 

(percent) 

Non-sovereign 

risk weight 

(percent) 

Securitization 

exposure risk 

weight 

(percent) 

Highest investment grade rating ........................................................................ AAA ............. 0 20 20 

Second-highest investment grade rating ........................................................... AA ............... 20 20 20 

Third-highest investment grade rating ............................................................... A .................. 20 35 35

Lowest investment grade rating—plus ............................................................... BBB+ ........... 35 50 50 


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TABLE 1.—RISK WEIGHTS BASED ON LONG-TERM EXTERNAL RATINGS—Continued 

Long-term rating category Rating 

Non-U.S. sovereign risk 

weight 

(percent) 

Non-sovereign 

risk weight 

(percent) 

Securitization 

exposure risk 

weight 

(percent) 

Lowest investment grade rating—naught .......................................................... BBB ............. 50 75 75 

Lowest investment grade rating—negative ........................................................ BBB¥ ......... 75 100 100 

One category below investment grade—plus & naught .................................... BB+, BB ...... 75 150 200 

One category below investment grade—negative ............................................. BB¥ ............ 100 200 200 

Two or more categories below investment grade .............................................. B, CCC ........ 150 200 2

Unrated ............................................................................................................... n/a ............... 200 200 2

1 Claims collateralized by AAA-rated non-U.S. sovereign debt would be assigned to the 20 percent risk weight category. 

2Apply the risk-based capital requirements set forth in section III.B.3.b. of this appendix A. 

TABLE 2.—RISK WEIGHTS BASED ON SHORT-TERM EXTERNAL RATINGS

Short-term rating category Examples 

Non-U.S. sovereign risk 

weight* 

(percent) 

Non-U.S. sovereign risk 

weigh 

(percent) 

Securitization 

exposure risk 

weight 

Highest investment grade rating 1 ...................................................................... A–1, P–1 ..... 0 20 20 

Second-highest investment grade rating ........................................................... A–2, P–2 ..... 20 35 35 

Lowest investment grade rating ......................................................................... A–3, P–3 ..... 50 75 75 

Unrated ............................................................................................................... ..................... 100 100 100 

1 Claims collateralized by A1/P1 rated sovereign debt would be assigned to the 20 percent risk weight category. 

For purposes of this section IV, an external 

rating is defined as a credit rating that is 

assigned by an NRSRO, provided that the 

credit rating: 

a. Fully reflects the entire amount of credit 

risk with regard to all payments owed on the 

claim (that is, the rating must fully reflect the 

credit risk associated with timely repayment 

of principal and interest); 

b. Is monitored by the issuing NRSRO; 

c. Is published in an accessible public form 

(for example, on the NRSRO’s Web site or in 

financial media); and 

d. Is, or will be, included in the issuing 

NRSRO’s publicly available ratings transition 

matrix which tracks the performance and 

stability (or ratings migration) of an NRSRO’s 

issued external ratings for the specific type 

of claim (for example, corporate debt). 

In addition, an unrated covered claim on 

a non-U.S. sovereign that has an external 

rating from an NRSRO should be deemed to 

have an external rating equal to the 

sovereign’s issuer rating. If a claim has two 

or more external ratings, the bank must use 

the least favorable external rating to risk 

weight the claim. Similarly, if a claim has 

components that are assigned different 

external ratings, the lowest component rating 

must be applied to the entire claim. For 

example, if a securitization exposure has a 

principal component externally rated BBB, 

but the interest component is externally rated 

B, the entire exposure will be subject to the 

gross-up treatment accorded to a 

securitization exposure rated B or lower. 

Similarly, if a portion of a specific claim is 

unrated, then the entire claim must be treated 

as if it were unrated. The Federal Reserve 

retains the authority to override the use of 

certain ratings or the ratings on certain 

instruments, either on a case-by-case basis or 

through broader supervisory policy, if 

necessary or appropriate to address the risk 

that an instrument poses to banking 

organizations. 

2. Collateral. In addition to the forms of 

recognized financial collateral set forth in 

section III.B.1. of this appendix A, a bank 

also may recognize as collateral (i) covered 

claims in the form of liquid and readily 

marketable debt securities that are externally 

rated no less than investment grade and (ii) 

liquid and readily marketable debt securities 

guaranteed by non-U.S. sovereigns whose 

issuer rating is at least investment grade. 

Claims, or portions of claims, collateralized 

by such collateral may be assigned to the risk 

weight appropriate to the collateral’s external 

rating as set forth in Table 1 or 2 of section 

IV.B.1. For example, the portion of a claim 

collateralized with an AA-rated mortgagebacked security is assigned to the 20 percent 

risk weight category. 

Subject to the final sentence of this 

paragraph, there is, however, a 20 percent 

risk weight floor on collateralized claims 

under this section IV. Thus, the portion of a 

claim collateralized by a security issued by 

a non-U.S. sovereign with an issuer rating of 

AAA would be assigned to the 20 percent 

risk weight category instead of the zero 

percent risk weight category. The procedures 

set forth in section III of this appendix A 

continue to apply, however, to claims 

collateralized by securities issued or 

guaranteed by OECD central governments for 

which a positive margin of collateral is 

maintained on a daily basis, fully taking into 

account any change in the bank’s exposure to 

the obligor and counterparty under the claim 

in relation to the market value of the 

collateral held to support the claim. 

In the event that the external rating of a 

security used to collateralize a claim results 

in a higher risk weight than would have 

otherwise been assigned to the claim, then 

the lower risk weight appropriate to the 

underlying claim could be applied. 

3. Guarantees. Claims, or portions of 

claims, guaranteed by a third-party entity 

(other than an excluded entity) whose 

unsecured long-term senior debt (without 

credit enhancements) is externally rated at 

least investment grade or by a non-U.S. 

sovereign that has an issuer rating of at least 

investment grade may be assigned to the risk 

weight of the guarantor as set forth in Table 

1 of section IV.B.1., corresponding to the 

protection provider’s long-term senior debt 

rating (or issuer rating in the case of a nonU.S. sovereign), provided that the guarantee: 

a. Is written and unconditional, 

b. Covers all or a pro rata portion of 

contractual payments of the obligor on the 

underlying claim, 

c. Gives the beneficiary a direct claim 

against the protection provider, 

d. Is non-cancelable by the protection 

provider for reasons other than the breach of 

contract by the beneficiary, 

e. 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, and 

f. Requires the protection provider to make 

payment to the beneficiary upon default of 

the obligor on the underlying claim without 

first requiring the beneficiary to demand 

payment from the obligor. 

C. Residential Mortgages 

1. A bank may separate its residential 

mortgage portfolio into two subportfolios, 

where the first subportfolio includes 

mortgage loans originated by the bank or 

acquired by the bank prior to the date the 

bank becomes subject to this section IV and 

the second includes mortgage loans 

originated or acquired by the bank after that 

date. The bank may apply the risk-based 

capital treatment set forth in section III of 

this appendix A to the first subportfolio 

while applying the requirements set forth in 


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59Loans that qualify as mortgages that are secured 

by 1- to 4-family residential properties are listed in 

the instructions to the commercial bank Call 

Reports. 

this section IV to the second subportfolio. A 

bank that does not so separate its residential 

mortgage portfolio must apply the capital 

treatment in this section IV to all of its 

qualifying residential mortgage exposures. If 

a bank at any time opts-out of the Alternative 

Approach and, subsequently, again becomes 

subject to this section IV, it may not apply 

the procedures set forth in this section 

IV.C.1. 

2. Subject to section IV.C.1., a bank assigns 

its residential mortgage exposures to risk 

weight categories based on their loan-tovalue (LTV) or combined loan-to-value 

(CLTV) ratios, as appropriate, in accordance 

with Tables 3 and 4 of sections IV.C.3.a. and 

IV.C.3.b., respectively, but must risk-weight a 

nonqualifying residential mortgage exposure 

at no less than 100 percent. Residential 

mortgage exposures include all loans secured 

by a lien on a one- to four-family residential 

property 59 that is either owner-occupied or 

rented. Qualifying residential mortgage 

exposures are residential mortgage exposures 

that (1) have been made in accordance with 

prudent underwriting standards; (2) are 

performing in accordance with their original 

terms; (3) are not 90 days or more past due 

or carried in nonaccrual status; and (4) are 

not made for the purpose of speculative 

property development. Nonqualifying 

residential mortgage exposures are 

residential mortgage exposures other than 

qualifying residential mortgage exposures. 

3. For purposes of Tables 3 and 4, LTV is 

defined as (i) the current outstanding 

principal balance of the loan less the amount 

covered by any loan-level private mortgage 

insurance (‘‘PMI’’) divided by (ii) the most 

recent purchase price of the property or the 

most recent appraisal or evaluation value of 

the property (if the appraisal or evaluation is 

more recent than the most recent purchase 

and was obtained by the bank in connection 

with an extension of new credit). Loan-level 

PMI means insurance (i) provided by a nonaffiliated PMI provider whose unsecured 

long-term senior debt (without credit 

enhancements) is externally rated at least the 

third highest investment grade by an NRSRO, 

and (ii) which protects a mortgage lender in 

the event of the default of a mortgage 

borrower up to a predetermined portion of 

the value of a residential mortgage exposure. 

For purposes of the loan-level PMI definition, 

(i) an affiliate of a company means any 

company that controls, is controlled by, or is 

under common control with, the company; 

and (ii) a person or company controls a 

company if it owns, controls, or has power 

to vote 25 percent or more of a class of voting 

securities of the company or consolidates the 

company for financial reporting purposes. 

CLTV for a junior lien mortgage is defined as 

(i) the current outstanding principal balance 

of the junior mortgage and all more senior 

mortgages less the amount covered by any 

loan-level PMI covering the junior lien 

divided by (ii) the most recent purchase price 

of the property or the most recent appraisal 

or evaluation value of the property (if the 

appraisal or evaluation is more recent than 

the most recent purchase and was obtained 

by the bank in connection with an extension 

of new credit). The procedures for residential 

mortgage exposures that have negative 

amortization features are set forth in section 

IV.C.3.c. 

a. First Lien Residential Mortgage Exposures 

First lien residential mortgage exposures 

are risk-weighted in accordance with Table 3 

of this section IV.C.3.a. (with nonqualifying 

residential mortgage exposures subject to a 

risk weight floor of 100 percent). If a bank 

holds both the senior and junior lien(s) on a 

residential property and no other party holds 

an intervening lien, the bank’s claims are 

treated as a single claim secured by a senior 

lien for purposes of determining the LTV 

ratio and assigning a risk weight. 

TABLE 3.—RISK WEIGHTS FOR FIRST

LIEN RESIDENTIAL MORTGAGE EXPOSURES

Loan-to-Value ratio Risk weight 

(percent) 

Up to 60% ................................. 20 

>60% and up to 80% ............... 35 

>80% and up to 85% ............... 50 

>85% and up to 90% ............... 75 

>90% and up to 95% ............... 100 

>95% ........................................ 150 

b. Stand-Alone Junior Liens 

Stand-alone junior lien residential 

mortgage exposures, including structured 

mortgages and home equity lines of credit, 

must be risk weighted using the CLTV ratio 

of the stand-alone junior lien and all senior 

liens in accordance with Table 4 (with 

nonqualifying residential mortgage exposures 

subject to a risk weight floor of 100 percent). 

TABLE 4.—RISK WEIGHTS FOR STANDALONE JUNIOR LIEN RESIDENTIAL

MORTGAGE EXPOSURES

Combined Loan-to-Value ratio Risk weight 

(percent) 

Up to 60% ................................. 75 

>60% and up to 90% ............... 100 

>90% ........................................ 150 

c. Residential Mortgage Exposures With 

Negative Amortization Features 

Residential mortgage exposures with 

negative amortization features are assigned to 

a risk weight category using a loan’s current 

LTV ratio in accordance with Table 3 of 

section IV.C.3.a. Any remaining potential 

increase in the mortgage’s principal balance 

permitted through the negative amortization 

feature is to be treated as a long-term 

commitment and converted to an on-balance 

sheet credit equivalent amount as set forth in 

section III.D.2. of this appendix. The credit 

equivalent amount of the commitment is then 

risk-weighted according to Table 3 based on 

the loan’s ‘‘highest contractual LTV ratio.’’

The highest contractual LTV ratio of a 

mortgage loan equals the current outstanding 

principal balance of the loan plus the credit 

equivalent amount of the remaining negative 

amortization ‘‘commitment’’ less the amount 

covered by any loan-level PMI divided by the 

most recent purchase price of the property or 

the most recent appraisal or evaluation value 

of the property (if the appraisal or evaluation 

is more recent than the most recent purchase 

and was obtained by the bank in connection 

with an extension of new credit). A bank 

with a stand-alone second lien where the 

more senior lien(s) can negatively amortize 

must first adjust the principal amount of 

those senior or intervening liens that can 

negatively amortize to reflect the maximum 

contractual loan amount as if it were to fully 

negatively amortize under the applicable 

contract. The adjusted LTV would then be 

added to the stand-alone junior lien to 

calculate the appropriate CLTV. 

D. Short-Term Commitments 

Unused portions of commitments with an 

original maturity of one year or less 

(including eligible asset backed commercial 

paper liquidity facilities) (that is, short-term 

commitments) are converted using the 10 

percent conversion factor. Unconditionally 

cancelable commitments, as defined in 

section III.D.2.b. of this appendix, retain the 

zero percent conversion factor. Short-term 

commitments to originate one-to four-family 

residential mortgage loans provided in the 

ordinary course of business that are not 

treated as a derivative under GAAP will 

continue to be converted to an on-balancesheet credit equivalent amount using the zero 

percent conversion factor. 

E. Securitizations of Revolving Credit with 

Early Amortization Provisions 

1. Definitions 

a. 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 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). 

b. Excess spread means gross finance 

charge collections and other income received 

by a trust or special purpose entity minus 

interest paid to the investors in the 

securitization exposures, servicing fees, 

charge-offs, and other similar trust or special 

purpose entity expenses. 

c. Excess spread trapping point is the point 

at which the bank is required by the 

documentation governing a securitization to 

divert and hold excess spread in a spread or 

reserve account, expressed as a percentage. 

d. Investors’ interest is the total amount of 

securitization exposures issued by a trust or 

special purpose entity to investors. 

e. Revolving credit means a line of credit 

where the borrower is permitted to vary both 

the drawn amount and the amount of 

repayment within an agreed limit. 

2. A bank that securitizes revolving credits 

where the securitization structure contains 

an early amortization provision must 

maintain risk-based capital against the 

investors’ interest as required under this 

section. Capital for securitizations of 


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1A leverage capital measure for state member 

banks is outlined in appendix D of this part. 

2The risk-based capital measure is based upon a 

framework developed jointly by supervisory 

authorities from the countries represented on the 

Basel Committee on Banking Supervision (Basel 

Supervisors’ Committee) and endorsed by the 

Group of Ten Central Bank Governors. The 

framework is described in a paper prepared by the 

Basel Supervisors’ Committee entitled 

‘‘International Convergence of Capital 

Measurement,’’ July 1988. 

3Banking organizations will initially be expected 

to utilize period-end amounts in calculating their 

risk-based capital ratios. When necessary and 

appropriate, ratios based on average balances may 

also be calculated on a case-by-case basis. 

Moreover, to the extent banking organizations have 

data on average balances that can be used to 

calculate risk-based ratios, the Federal Reserve will 

take such data into account. 

4A parent company that is engaged in significant 

off-balance sheet activities would generally be 

deemed to be engaged in activities that involve 

significant leverage. 

revolving credit exposures that incorporate 

early-amortization provisions will be 

assessed based on a comparison of the 

securitization’s annualized three-month 

average excess spread against the excess 

spread trapping point. To calculate the 

securitization’s excess spread trapping point 

ratio, a bank must calculate the three-month 

average of (1) the dollar amount of excess 

spread divided by (2) the outstanding 

principal balance of underlying pool of 

exposures at the end of each of the prior 

three months. The annualized three month 

average of excess spread is then divided by 

the excess spread trapping point that is 

required by the securitization structure. The 

excess spread trapping point ratio is 

compared to the ratios contained in Table 5 

of section IV.E.3 to determine the appropriate 

conversion factor to apply to the investor’s 

interest. The amount of investor’s interest 

after conversion is then assigned capital in 

accordance with that appropriate to the 

underlying obligor, collateral or guarantor. 

For securitizations that do not require excess 

spread to be trapped, or that specify trapping 

points based primarily on performance 

measures other than the three-month average 

excess spread, the excess spread trapping 

point is 4.5 percent. 

3. For a bank subject to the early 

amortization requirements in this section 

IV.E., if the aggregate risk-based capital 

requirement for residual interests, direct 

credit substitutes, other securitization 

exposures, and early amortization provisions 

in connection with the same securitization of 

revolving credit exposures exceeds the riskbased capital requirement on the underlying 

securitized assets, then the capital 

requirement for the securitization transaction 

will be limited to the greater of the risk-based 

capital requirement for (1) residual interests 

or (2) the underlying securitized assets 

calculated as if the bank continued to hold 

the assets on its balance sheet. 

TABLE 5.—EARLY AMORTIZATION

CREDIT CONVERSION FACTOR

Excess spread trapping point 

ratio 

Credit conversion factor (CCF) 

(percent) 

133.33 percent or more ............ 0 

less than 133.33 percent to 100 

percent .................................. 5 

less than 100 percent to 75 

percent .................................. 15 

less than 75 percent to 50 percent ....................................... 50 

less than 50 percent ................. 100 

F. Risk Weights for Derivatives 

A bank may not apply the 50 percent risk 

weight cap for derivative contract 

counterparties set forth in section III.E. of 

this appendix A. 

PART 225—BANK HOLDING 

COMPANIES AND CHANGE IN BANK 

CONTROL (REGULATION Y) 

1. 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. 6801 and 6805.1. 

2. In Appendix A to part 225, the 

following amendments are proposed: 

a. Section I, Overview, is revised. 

b. In section III.A, Procedures, the 

first paragraph is revised, the fourth 

paragraph is redesignated as the fifth 

paragraph, and a new fourth paragraph 

is added. 

c. In section III.C, the first paragraph 

is revised. 

d. Section IV is removed and a new 

section IV, Alternative Approach for 

Computing Weighted Risk Assets and 

Off-Balance-Sheet Items, is added. 

e. Attachment I is removed. 

Appendix A to Part 225—Capital 

Adequacy Guidelines for Bank Holding 

Companies: Risk-Based Measure 

I. Overview 

The Board of Governors of the Federal 

Reserve System has adopted a risk-based 

capital measure to assist in the assessment of 

the capital adequacy of bank holding 

companies (banking organizations).1 The 

principal objectives of this measure are to: (i) 

Make regulatory capital requirements more 

sensitive to differences in risk profiles among 

banking organizations; (ii) factor off-balance 

sheet exposures into the assessment of 

capital adequacy; (iii) minimize disincentives 

to holding liquid, low-risk assets; and (iv) 

achieve greater consistency in the evaluation 

of the capital adequacy of major banking 

organizations throughout the world.2

The risk-based capital guidelines include 

both a definition of capital and a framework 

for calculating weighted risk assets by 

assigning assets and off-balance sheet items 

to broad risk categories. An institution’s riskbased capital ratio is calculated by dividing 

its qualifying capital (the numerator of the 

ratio) by its weighted risk assets (the 

denominator).3 The definition of qualifying 

capital is outlined in section II, and the 

procedures for calculating weighted risk 

assets are discussed in sections III and IV. 

In addition, when certain organizations 

that engage in trading activities calculate 

their risk-based capital ratios under this 

appendix A, they must also refer to appendix 

E of this part, which incorporates capital 

charges for certain market risks into the riskbased capital ratios. When calculating their 

risk-based capital ratios under this appendix 

A, such organizations are required to refer to 

appendix E of this part for supplemental 

rules to determine qualifying and excess 

capital, calculate weighted risk assets, 

calculate market risk equivalent assets, and 

calculate risk-based capital ratios adjusted for 

market risk. 

The risk-based capital guidelines apply on 

a consolidated basis to bank holding 

companies with consolidated assets of $500 

million or more. For bank holding companies 

with less than $500 million in consolidated 

assets, the guidelines will be applied on a 

bank-only basis unless: (a) The parent bank 

holding company is engaged in nonbank 

activity involving significant leverage; 4 or (b) 

the parent company has a significant amount 

of outstanding debt that is held by the 

general public. 

The risk-based capital guidelines are to be 

used in the inspection and supervisory 

process as well as in the analysis of 

applications acted upon by the Federal 

Reserve. Thus, in considering an application 

filed by a bank holding company, the Federal 

Reserve will take into account the 

organization’s risk-based capital ratio, the 

reasonableness of its capital plans, and the 

extent to which it meets the risk-based 

capital standards. 

The risk-based capital ratios focus 

principally on broad categories of credit risk, 

although the framework for assigning assets 

and off-balance-sheet items to risk categories 

does incorporate elements of transfer risk, as 

well as limited instances of interest rate and 

market risk. The risk-based capital ratio does 

not, however, incorporate other factors that 

can affect an organization’s financial 

condition. These factors include overall 

interest-rate exposure; liquidity, funding and 

market risks; the quality and level of 

earnings; investment or loan portfolio 

concentrations; the quality of loans and 

investments, the effectiveness of loan and 

investment policies; and management’s 

ability to monitor and control financial and 

operating risks. 

In addition to evaluating capital ratios, an 

overall assessment of capital adequacy must 

take account of these other factors, including, 

in particular, the level and severity of 

problem and classified assets. For this 

reason, the final supervisory judgment on an 

organization’s capital adequacy may differ 

significantly from conclusions that might be 

drawn solely from the level of the 

organization’s risk-based capital ratio. 

The risk-based capital guidelines establish 

a minimum ratio of qualifying total capital to 

weighted risk assets of 8 percent, of which 

at least 4 percentage points must be in the 

form of tier 1 capital. In light of the 

considerations just discussed, banking 

organizations generally are expected to 


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58For purposes of this section IV, a sovereign is 

defined as a central government, including its 

agencies, departments, ministries, and the central 

bank. This definition does not include state, 

provincial, or local governments, or commercial 

enterprises owned by a central government. 

operate well above the minimum risk-based 

ratios. In particular, 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. Institutions with high or 

inordinate levels of risk are also expected to 

operate well above minimum capital 

standards. In all cases, institutions should 

hold capital commensurate with the level 

and nature of the risks to which they are 

exposed. Banking organizations that do not 

meet the minimum risk-based capital 

standard, or that are otherwise considered to 

be inadequately capitalized, are expected to 

develop and implement plans acceptable to 

the Federal Reserve for achieving adequate 

levels of capital within a reasonable period 

of time. 

The Board will monitor the 

implementation and effect of these guidelines 

in relation to domestic and international 

developments in the banking industry. When 

necessary and appropriate, the Board will 

consider the need to modify the guidelines in 

light of any significant changes in the 

economy, financial markets, banking 

practices, or other relevant factors. 

* * * * * 

III. * * * 

A. * * * 

Assets and credit-equivalent amounts of 

off-balance-sheet items of bank holding 

companies are assigned to one of several 

broad risk categories, according to the 

obligor, or, if relevant, the guarantor, the 

nature of the collateral, or an external rating. 

The aggregate dollar value of the amount in 

each category is then multiplied by the risk 

weight associated with the category. The 

resulting weighted values from each of the 

risk categories are added together, and this 

sum is the banking organization’s total 

weighted risk assets that comprise the 

denominator of the risk-based capital ratios. 

* * * * * 

A bank holding company may elect to 

apply the alternative procedures for 

computing weighted risk assets set forth in 

section IV of this appendix A (‘‘Alternative 

Approach’’). The Federal Reserve also may 

require a bank holding company to apply the 

Alternative Approach if the Federal Reserve 

determines that the Alternative Approach 

would produce risk-based capital 

requirements that more accurately reflect the 

risk profile of the banking organization or 

would otherwise enhance the safety and 

soundness of the institution. A bank holding 

company that applies the Alternative 

Approach must apply all the procedures set 

forth in section IV of this appendix A and 

also must apply all the procedures set forth 

in this section that are not inconsistent with 

the procedures in section IV. 

* * * * * 

C. * * * 

Assets and on-balance-sheet credit 

equivalent amounts are assigned to the 

following risk weight categories: 0 percent, 

20 percent, 50 percent, or 100 percent. A 

brief explanation of the components of each 

category follows. 

* * * * * 

IV. Alternative Approach for Computing 

Weighted Risk Assets and Off-Balance-Sheet 

Items 

A. Scope of Application 

A bank holding company may elect to use 

the Alternative Approach for computing 

weighted risk assets and off-balance sheet 

items set forth in this section IV by giving the 

Federal Reserve written notice on the first 

day of the quarter during which the banking 

organization elects to begin using the 

Alternative Approach. A bank holding 

company that has elected to apply the 

Alternative Approach may opt out of the 

Alternative Approach after it has given the 

Federal Reserve 30 days prior written notice. 

The Federal Reserve may require a bank 

holding company to apply the Alternative 

Approach if the Federal Reserve determines 

that the Alternative Approach would 

produce risk-based capital requirements that 

more accurately reflect the risk profile of the 

banking organization or would otherwise 

enhance the safety and soundness of the 

institution. 

A bank holding company that applies the 

Alternative Approach must apply all the 

procedures set forth in this section IV and 

also must apply all the procedures set forth 

in section III that are not inconsistent with 

the procedures in section IV. 

B. External Ratings, Collateral, Guarantees, 

and Other Considerations 

1. External Credit Ratings. A bank holding 

company must use Table 1 in this section 

IV.B.1. to assign risk weights to covered 

claims with an original maturity of one year 

or more and Table 2 in this section IV.B.1. 

to assign risk weights to covered claims with 

an original maturity of less than one year. 

Covered claims are all claims other than (i) 

claims on an excluded entity, (ii) loans to 

non-sovereigns that do not have an external 

rating, and (iii) OTC derivative contracts. 

Excluded entities are (i) the U.S. central 

government and U.S. government agencies, 

(ii) state and local governments of the United 

States and other countries of the OECD, (iii) 

U.S. government-sponsored agencies, and (iv) 

U.S. depository institutions and foreign 

banks. 

A bank holding company must use column 

three of the tables for covered claims on a 

non-U.S. sovereign 58 and column four of the 

tables for covered claims on an entity other 

than a non-U.S. sovereign (excluding 

securitization exposures). A bank holding 

company must use column five of the tables 

for covered claims that are securitization 

exposures, which include asset-backed 

securities, mortgage-backed securities, 

recourse obligations, direct credit substitutes, 

and residual interests (other than creditenhancing interest-only strips). 

TABLE 1.—RISK WEIGHTS BASED ON LONG-TERM EXTERNAL RATINGS

Long-term rating category Rating 

Non-U.S. sovereign risk 

weight 1

(percent) 

Non-sovereign 

risk weight 

(percent) 

Securitization 

exposure risk 

weight 

(percent) 

Highest investment grade rating ........................................................................ AAA ............. 0 20 20 

Second-highest investment grade rating ........................................................... AA ............... 20 20 20 

Third-highest investment grade rating ............................................................... A .................. 20 35 35

Lowest investment grade rating—plus ............................................................... BBB+ ........... 35 50 50 

Lowest investment grade rating—naught .......................................................... BBB ............. 50 75 75 

Lowest investment grade rating—negative ........................................................ BBB¥ ......... 75 100 100 

One category below investment grade—plus & naught .................................... BB+, BB ...... 75 150 200 

One category below investment grade—negative ............................................. BB¥ ............ 100 200 200 

Two or more categories below investment grade .............................................. B, CCC ........ 150 200 2

Unrated ............................................................................................................... n/a ............... 200 200 2

1 Claims collateralized by AAA-rated non-U.S. sovereign debt would be assigned to the 20 risk weight category. 

2Apply the risk-based capital requirements set forth in section III.B.3.b. of this appendix A. 


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59Loans that qualify as mortgages that are secured 

by 1- to 4-family residential properties are listed in 

the instructions to the commercial bank Call 

Reports. 

TABLE 2.—RISK WEIGHTS BASED ON SHORT-TERM EXTERNAL RATINGS

Short-term rating category Examples 

Non-U.S. sovereign risk 

weight 1

(percent) 

Non-sovereign 

risk weight 

(percent) 

Securitization 

exposure risk 

weight 

(percent) 

Highest investment grade rating * ....................................................................... A–1, P–1 ..... 0 20 20 

Second-highest investment grade rating ............................................................ A–2, P–2 ..... 20 35 35 

Lowest investment grade rating ......................................................................... A–3, P–3 ..... 50 75 75 

Unrated ............................................................................................................... ..................... 100 100 100 

1 Claims collateralized by A1/P1 rated sovereign debt would be assigned to the 20 percent risk weight category. 

For purposes of this section IV, an external 

rating is defined as a credit rating that is 

assigned by an NRSRO, provided that the 

credit rating: 

a. Fully reflects the entire amount of credit 

risk with regard to all payments owed on the 

claim (that is, the rating must fully reflect the 

credit risk associated with timely repayment 

of principal and interest); 

b. Is monitored by the issuing NRSRO; 

c. Is published in an accessible public form 

(for example, on the NRSRO’s Web site or in 

financial media); and 

d. Is, or will be, included in the issuing 

NRSRO’s publicly available ratings transition 

matrix which tracks the performance and 

stability (or ratings migration) of an NRSRO’s 

issued external ratings for the specific type 

of claim (for example, corporate debt). 

In addition, an unrated covered claim on 

a non-U.S. sovereign that has an external 

rating from an NRSRO should be deemed to 

have an external rating equal to the 

sovereign’s issuer rating. If a claim has two 

or more external ratings, the bank holding 

company must use the least favorable 

external rating to risk weight the claim. 

Similarly, if a claim has components that are 

assigned different external ratings, the lowest 

component rating must be applied to the 

entire claim. For example, if a securitization 

exposure has a principal component 

externally rated BBB, but the interest 

component is externally rated B, the entire 

exposure will be subject to the gross-up 

treatment accorded to a securitization 

exposure rated B or lower. Similarly, if a 

portion of a specific claim is unrated, then 

the entire claim must be treated as if it were 

unrated. The Federal Reserve retains the 

authority to override the use of certain 

ratings or the ratings on certain instruments, 

either on a case-by-case basis or through 

broader supervisory policy, if necessary or 

appropriate to address the risk that an 

instrument poses to banking organizations. 

2. Collateral. In addition to the forms of 

recognized financial collateral set forth in 

section III.B.1 of this appendix A, a bank 

holding company also may recognize as 

collateral (i) covered claims in the form of 

liquid and readily marketable debt securities 

that are externally rated no less than 

investment grade and (ii) liquid and readily 

marketable debt securities guaranteed by 

non-U.S. sovereigns whose issuer rating is at 

least investment grade. Claims, or portions of 

claims, collateralized by such collateral may 

be assigned to the risk weight appropriate to 

the collateral’s external rating as set forth in 

Table 1 or 2 of section IV.B.1. For example, 

the portion of a claim collateralized with an 

AA-rated mortgage-backed security is 

assigned to the 20 percent risk weight 

category. 

Subject to the final sentence of this 

paragraph, there is, however, a 20 percent 

risk weight floor on collateralized claims 

under this section IV. Thus, the portion of a 

claim collateralized by a security issued by 

a non-U.S. sovereign with an issuer rating of 

AAA would be assigned to the 20 percent 

risk weight category instead of the zero 

percent risk weight category. The procedures 

set forth in section III of this appendix A 

continue to apply, however, to claims 

collateralized by securities issued or 

guaranteed by OECD central governments for 

which a positive margin of collateral is 

maintained on a daily basis, fully taking into 

account any change in the banking 

organization’s exposure to the obligor and 

counterparty under the claim in relation to 

the market value of the collateral held to 

support the claim. 

In the event that the external rating of a 

security used to collateralize a claim results 

in a higher risk weight than would have 

otherwise been assigned to the claim, then 

the lower risk weight appropriate to the 

underlying claim could be applied. 

3. Guarantees. Claims, or portions of 

claims, guaranteed by a third party entity 

(other than an excluded entity) whose 

unsecured long-term senior debt (without 

credit enhancements) is externally rated at 

least investment grade or by a non-U.S. 

sovereign that has an issuer rating of at least 

investment grade may be assigned to the risk 

weight of the guarantor as set forth in Table 

1 of section IV.B.1 corresponding to the 

protection provider’s long-term senior debt 

rating (or issuer rating in the case of a nonU.S. sovereign), provided that the guarantee: 

a. Is written and unconditional, 

b. Covers all or a pro rata portion of 

contractual payments of the obligor on the 

underlying claim, 

c. Gives the beneficiary a direct claim 

against the protection provider, 

d. Is non-cancelable by the protection 

provider for reasons other than the breach of 

contract by the beneficiary, 

e. 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, and 

f. Requires the protection provider to make 

payment to the beneficiary upon default of 

the obligor on the underlying claim without 

first requiring the beneficiary to demand 

payment from the obligor. 

C. Residential Mortgages 

1. A bank holding company may separate 

its residential mortgage portfolio into two 

subportfolios, where the first subportfolio 

includes mortgage loans originated by the 

banking organization or acquired by the 

banking organization prior to the date the 

institution becomes subject to this section IV 

and the second includes mortgage loans 

originated or acquired by the bank holding 

company after that date. The bank holding 

company may apply the risk-based capital 

treatment set forth in section III of this 

appendix A to the first subportfolio while 

applying the requirements set forth in this 

section IV to the second subportfolio. A bank 

holding company that does not so separate its 

residential mortgage portfolio must apply the 

capital treatment in this section IV to all of 

its qualifying residential mortgage exposures. 

If a banking organization at any time opts-out 

of the Alternative Approach and, 

subsequently, again becomes subject to this 

section IV, it may not apply the procedures 

set forth in this section IV.C.1. 

2. Subject to section IV.C.1., a bank holding 

company assigns its residential mortgage 

exposures to risk weight categories based on 

their loan-to-value (LTV) or combined loanto-value (CLTV) ratios, as appropriate, in 

accordance with Tables 3 and 4 of sections 

IV C.3.a. and IV.C.3.b., respectively, but must 

risk-weight a nonqualifying residential 

mortgage exposure at no less than 100 

percent. Residential mortgage exposures 

include all loans secured by a lien on a oneto four-family residential property 59 that is 

either owner-occupied or rented. Qualifying 

residential mortgage exposures are 

residential mortgage exposures that (1) have 

been made in accordance with prudent 

underwriting standards; (2) are performing in 

accordance with their original terms; (3) are 

not 90 days or more past due or carried in 

nonaccrual status; and (4) are not made for 

the purpose of speculative property 

development. Nonqualifying residential 

mortgage exposures are residential mortgage 

exposures other than qualifying residential 

mortgage exposures. 

3. For purposes of Tables 3 and 4, LTV is 

defined as (i) the current outstanding 

principal balance of the loan less the amount 

covered by any loan-level private mortgage 

insurance (‘‘PMI’’) divided by (ii) the most 

recent purchase price of the property or the 

most recent appraisal or evaluation value of 


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the property (if the appraisal or evaluation is 

more recent than the most recent purchase 

and was obtained by the bank holding 

company in connection with an extension of 

new credit). Loan-level PMI means insurance 

(i) provided by a non-affiliated PMI provider 

whose unsecured long-term senior debt 

(without credit enhancements) is externally 

rated at least the third highest investment 

grade by an NRSRO, and (ii) which protects 

a mortgage lender in the event of the default 

of a mortgage borrower up to a 

predetermined portion of the value of 

residential mortgage exposure. For purposes 

of the loan level PMI definition, (i) an 

affiliate of a company means any company 

that controls, is controlled by, or is under 

common control with, the company; and (ii) 

a person or company controls a company if 

it owns, controls, or has power to vote 25 

percent or more of a class of voting securities 

of the company or consolidates the company 

for financial reporting purposes. CLTV for a 

junior lien mortgage is defined as (i) the 

current outstanding principal balance of the 

junior mortgage and all more senior 

mortgages less the amount covered by any 

loan-level PMI covering the junior lien 

divided by (ii) the most recent purchase price 

of the property or the most recent appraisal 

or evaluation value of the property (if the 

appraisal or evaluation is more recent than 

the most recent purchase and was obtained 

by the bank holding company in connection 

with an extension of new credit). The 

procedures for residential mortgage 

exposures that have negative amortization 

features are set forth in section IV.C.3.c. 

a. First Lien Residential Mortgage 

Exposures 

First lien residential mortgage exposures 

are risk-weighted in accordance with Table 3 

of this section IV.C.3.a (with nonqualifying 

residential mortgage exposures subject to a 

risk weight floor of 100 percent). If a banking 

organization holds both the senior and junior 

lien(s) on a residential property and no other 

party holds an intervening lien, the banking 

organization’s claims are treated as a single 

claim secured by a senior lien for purposes 

of determining the LTV ratio and assigning 

a risk weight. 

TABLE 3.—RISK WEIGHTS FOR FIRST

LIEN RESIDENTIAL MORTGAGE EXPOSURES

Loan-to-value ratio Risk weight 

(percent) 

Up to 60% ................................. 20 

>60% and up to 80% ............... 35 

>80% and up to 85% ............... 50 

>85% and up to 90% ............... 75 

>90% and up to 95% ............... 100 

>95% ........................................ 150 

b. Stand-Alone Junior Liens 

Stand-alone junior lien residential 

mortgage exposures, including structured 

mortgages and home equity lines of credit, 

must be risk weighted using the CLTV ratio 

of the stand-alone junior lien and all senior 

liens in accordance with Table 4 (with 

nonqualifying residential mortgage exposures 

subject to a risk weight floor of 100 percent). 

TABLE 4.—RISK WEIGHTS FOR STANDALONE JUNIOR LIEN RESIDENTIAL

MORTGAGE EXPOSURES

Combined loan-to-value ratio Risk weight 

(percent) 

Up to 60% ................................. 75 

>60% and up to 90% ............... 100 

>90% ........................................ 150 

c. Residential Mortgage Exposures With 

Negative Amortization Features 

Residential mortgage exposures with 

negative amortization features are assigned to 

a risk weight category using a loan’s current 

LTV ratio in accordance with Table 3 of 

section IV.C.3.a. Any remaining potential 

increase in the mortgage’s principal balance 

permitted through the negative amortization 

feature is to be treated as a long-term 

commitment and converted to an on-balance 

sheet credit equivalent amount as set forth in 

section III.D.2. of this appendix. The credit 

equivalent amount of the commitment is then 

risk-weighted according to Table 3 based on 

the loan’s ‘‘highest contractual LTV ratio.’’

The highest contractual LTV ratio of a 

mortgage loan equals the current outstanding 

principal balance of the loan plus the credit 

equivalent amount of the remaining negative 

amortization ‘‘commitment’’ less the amount 

covered by any loan-level PMI divided by the 

most recent purchase price of the property or 

the most recent appraisal or evaluation value 

of the property (if the appraisal or evaluation 

is more recent than the most recent purchase 

and was obtained by the bank holding 

company in connection with an extension of 

new credit). A bank holding company with 

a stand-alone second lien where the more 

senior lien(s) can negatively amortize must 

first adjust the principal amount of those 

senior or intervening liens that can 

negatively amortize to reflect the maximum 

contractual loan amount as if it were to fully 

negatively amortize under the applicable 

contract. The adjusted LTV would then be 

added to the stand-alone junior lien to 

calculate the appropriate CLTV. 

D. Short-Term Commitments 

Unused portions of commitments with an 

original maturity of one year or less 

(including eligible asset backed commercial 

paper liquidity facilities) (that is, short-term 

commitments) are converted using the 10 

percent conversion factor. Unconditionally 

cancelable commitments, as defined in 

section III.D.2.b. of this appendix, retain the 

zero percent conversion factor. Short-term 

commitments to originate one- to four-family 

residential mortgage loans provided in the 

ordinary course of business that are not 

treated as a derivative under GAAP will 

continue to be converted to an on-balancesheet credit equivalent amount using the zero 

percent conversion factor. 

E. Securitizations of Revolving Credit with 

Early Amortization Provisions 

1. Definitions 

a. 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 is triggered solely by events not 

directly related to the performance of the 

underlying exposures or the originating 

banking organization (such as material 

changes in tax laws or regulations). 

b. Excess spread means gross finance 

charge collections and other income received 

by a trust or special purpose entity minus 

interest paid to the investors in the 

securitization exposures, servicing fees, 

charge-offs, and other similar trust or special 

purpose entity expenses. 

c. Excess spread trapping point is the point 

at which the banking organization is required 

by the documentation governing a 

securitization to divert and hold excess 

spread in a spread or reserve account, 

expressed as a percentage. 

d. Investors’ interest is the total amount of 

securitization exposure issued by a trust or 

special purpose entity to investors. 

e. Revolving credit means a line of credit 

where the borrower is permitted to vary both 

the drawn amount and the amount of 

repayment within an agreed limit. 

2. A bank holding company that securitizes 

revolving credits where the securitization 

structure contains an early amortization 

provision must maintain risk-based capital 

against the investors’ interest as required 

under this section. Capital for securitizations 

of revolving credit exposures that incorporate 

early-amortization provisions will be 

assessed based on a comparison of the 

securitization’s annualized three-month 

average excess spread against the excess 

spread trapping point. To calculate the 

securitization’s excess spread trapping point 

ratio, a bank holding company must calculate 

the three-month average of (1) the dollar 

amount of excess spread divided by (2) the 

outstanding principal balance of underlying 

pool of exposures at the end of each of the 

prior three months. The annualized three 

month average of excess spread is then 

divided by the excess spread trapping point 

that is required by the securitization 

structure. The excess spread trapping point 

ratio is compared to the ratios contained in 

Table 5 of section IV.E.3 to determine the 

appropriate conversion factor to apply to the 

investor’s interest. The amount of investor’s 

interest after conversion is then assigned 

capital in accordance with that appropriate to 

the underlying obligor, collateral or 

guarantor. For securitizations that do not 

require excess spread to be trapped, or that 

specify trapping points based primarily on 

performance measures other than the threemonth average excess spread, the excess 

spread trapping point is 4.5 percent. 

3. For a banking organization subject to the 

early amortization requirements in this 

section IV.E., if the aggregate risk-based 

capital requirement for residual interests, 

direct credit substitutes, other securitization 

exposures, and early amortization provisions 

in connection with the same securitization of 

revolving credit exposures exceeds the riskbased capital requirement on the underlying 

securitized assets, then the capital 

requirement for the securitization transaction 

will be limited to the greater of the risk-based 

capital requirement for (1) residual interests 


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or (2) the underlying securitized assets 

calculated as if the banking organization 

continued to hold the assets on its balance 

sheet. 

TABLE 5.—EARLY AMORTIZATION

CREDIT CONVERSION FACTOR

Excess spread trapping point 

ratio 

Credit conversion factor (CCF) 

(percent) 

133.33 percent or more ............ 0 

Less than 133.33 percent to 

100 percent ........................... 5 

Less than 100 percent to 75 

percent .................................. 15 

Less than 75 percent to 50 percent ....................................... 50 

Less than 50 percent ................ 100 

F. Risk Weights for Derivatives 

A bank holding company may not apply 

the 50 percent risk weight cap for derivative 

contract counterparties set forth in section 

III.E. of this appendix A. 

* * * * * 

Federal Deposit Insurance Corporation 

12 CFR Part 325 

For the reasons set out in the 

preamble, part 325 of chapter III of title 

12 of the Code of Federal Regulations is 

proposed to be amended as follows: 

PART 325—CAPITAL MAINTENANCE 

1. The authority citation for part 325 

continues to read as follows: 

Authority: U.S.C. 1815(a), 1815(b), 1816, 

1818(a), 1818(b), 1818(c), 1818(t), 1819 

(Tenth), 1828(c), 1828(d), 1828(i), 1828(n), 

1828(o), 1831o, 1835, 3907, 3909, 4808; Pub. 

L. 102–233, 105 Stat. 1761, 1789, 1790 (12 

U.S.C. 1831n note); Pub. L. 102–242, 105 

Stat. 2236, 2355, as amended by Pub. L. 103–

325, 108 Stat. 2160, 2233 (12 U.S.C. 1828 

note); Pub. L. 102–242, 105 Stat. 2236, 2386, 

as amended by Pub. L. 102–550, 106 Stat. 

3672, 4089 (12 U.S.C. 1828 note). 

2. Revise § 325.1 of subpart A to read 

as follows: 

§ 325.1 Scope. 

The provisions of this part apply to 

those circumstances for which the 

Federal Deposit Insurance Act or this 

chapter requires an evaluation of the 

adequacy of an insured depository 

institution’s capital structure. The FDIC 

is required to evaluate capital before 

approving various applications by 

insured depository institutions. The 

FDIC also must evaluate capital, as an 

essential component, in determining the 

safety and soundness of state 

nonmember banks it insures and 

supervises and in determining whether 

depository institutions are in an unsafe 

or unsound condition. This subpart A 

establishes the criteria and standards 

FDIC will use in calculating the 

minimum leverage capital requirement 

and in determining capital adequacy. In 

addition, appendices A, D, and E to part 

325 (appendices A, D, and E) set forth 

the FDIC’s risk-based capital policy 

statements and appendix B to this 

subpart includes a statement of policy 

on capital adequacy that provides 

interpretational guidance as to how this 

subpart will be administered and 

enforced. In accordance with subpart B 

of part 325, the FDIC also must evaluate 

an institution’s capital for purposes of 

determining whether the institution is 

subject to the prompt corrective action 

provisions set forth in section 38 of the 

Federal Deposit Insurance Act (12 

U.S.C. 1831o). 

3. Revise § 325.2(s), (w) and (y) of 

subpart A to read as follows: 

§ 325.2 Definitions 

* * * * * 

(s) Risk-weighted assets means total 

risk-weighted assets, as calculated in 

accordance with appendices A, D, or E 

to part 325. 

* * * * * 

(w) Tier 1 risk-based capital ratio 

means the ratio of Tier 1 capital to riskweighted assets, as calculated in 

accordance with appendices A, D, or E 

to part 325. 

* * * * * 

(y) Total risk-based capital ratio 

means the ratio of qualifying total 

capital to risk-weighted assets, as 

calculated in accordance with 

appendices A, D, or E to part 325. 

* * * * * 

4. Revise § 325.6(d) of subpart A to 

read as follows: 

§ 325.6 Issuance of directives 

* * * * * 

(d) Enforcement of a directive. (1) 

Whenever a bank fails to follow the 

directive or to submit or adhere to its 

capital adequacy plan, the FDIC may 

seek enforcement of the directive in the 

appropriate United States district court, 

pursuant to 12 U.S.C. 3907(b)(2)(B)(ii), 

in the same manner and to the same 

extent as if the directive were a final 

cease-and-desist order. In addition to 

enforcement of the directive, the FDIC 

may seek assessment of civil money 

penalties for violation of the directive 

against any bank, any officer, director, 

employee, agent, or other person 

participating in the conduct of the 

affairs of the bank, pursuant to 12 U.S.C. 

3909(d). 

(2) The directive may be issued 

separately, in conjunction with, or in 

addition to, any other enforcement 

mechanisms available to the FDIC, 

including cease-and-desist orders, 

orders of correction, the approval or 

denial of applications, or any other 

actions authorized by law. In addition to 

addressing a bank’s minimum leverage 

capital requirement, the capital 

directive may also address minimum 

risk-based capital requirements that are 

to be maintained and calculated in 

accordance with appendices A, D, and 

E to this part 325. 

5. Revise § 325.103(a) of subpart B to 

read as follows: 

§ 325.103 Capital measures and capital 

category definitions. 

(a) Capital measures (1) For purposes 

of section 38 and this subpart the 

relevant capital measures shall be: 

(i) The total risk-based capital ratio; 

(ii) The Tier 1 risk-based capital ratio; 

and 

(iii) The leverage ratio. 

(2) Risk-based capital ratios. All state 

nonmember banks must maintain the 

minimum risk-based capital ratios as 

calculated under appendices A, D, or E 

to part 325 (and under appendix C to 

part 325, as applicable). 

(i) Except as provided in paragraph 

(a)(2)(ii) of this section, any state 

nonmember bank that does not use 

appendix D, as provided in section 1(b) 

of appendix D to part 325, must 

calculate its minimum risk-based capital 

ratios under appendix A. 

(ii) Any state nonmember bank that 

uses appendix D to part 325 must 

calculate its minimum risk-based capital 

ratios under appendix D. 

(iii) Any state nonmember bank that 

does not use appendix D to part 325 

may elect to calculate its minimum riskbased capital ratios under appendix E to 

part 325. Any state nonmember bank 

that makes this election must comply 

with the notice procedures in appendix 

E. 

* * * * * 

6. Add Appendix E to part 325 to read 

as follows: 

Appendix E to Part 325—Statement of 

Policy on Risk-Based Capital: 

Alternative Approach for Computing 

Risk-Weighted Assets and Off-BalanceSheet Items 

I–1. Risk-Based Capital Framework 

A. Introduction 

1. Capital adequacy is one of the critical 

factors that the FDIC is required to analyze 

when taking action on various types of 

applications and when conducting 

supervisory activities related to the safety 

and soundness of individual banks and the 

banking system. In view of this, the FDIC’s 

Board of Directors has adopted part 325 of its 

regulations (12 CFR part 325), which sets 


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1Period-end amounts, rather than average 

balances, normally will be used when calculating 

risk-based capital ratios. However, on a case-by-case 

basis, ratios based on average balances may also be 

required if supervisory concerns render it 

appropriate. 

2A nationally recognized statistical rating 

organization is an entity recognized by the Division 

of Market Regulation of the Securities and Exchange 

Commission (or any successor Division) 

(Commission) as a nationally recognized statistical 

rating organization for various purposes, including 

the Commission’s uniform net capital requirements 

for brokers and dealers (17 CFR 240.15c3–1). 

forth minimum standards of capital adequacy 

for insured state nonmember banks and 

standards for determining when an insured 

bank is in an unsafe or unsound condition by 

reason of the amount of its capital. 

2. This capital maintenance regulation was 

designed to establish, in conjunction with 

other federal bank regulatory agencies, 

uniform capital standards for all federallyregulated banking organizations, regardless of 

size. The uniform capital standards were 

based on ratios of capital to total assets. 

While those leverage ratios have served as a 

useful tool for assessing capital adequacy, the 

FDIC believes there is a need for a capital 

measure that is more explicitly and 

systematically sensitive to the risk profiles of 

individual banks. As a result, the FDIC’s 

Board of Directors has adopted appendices A, 

D, and E that establish the minimum riskbased capital requirements for banks. This 

statement of policy does not replace or 

eliminate the existing part 325 capital-to-total 

assets leverage ratios. 

3. The framework set forth in appendices 

A, D, and E to this part 325 consists of a 

definition of capital for risk-based capital 

purposes, and a system for calculating riskweighted assets. A bank’s risk-based capital 

ratio is calculated by dividing its qualifying 

total capital base (the numerator of the ratio) 

by its risk-weighted assets (the 

denominator).1

4. In addition, when certain banks that 

engage in trading activities calculate their 

risk-based capital ratio under these 

appendices A, D, and E, they must also refer 

to appendix C of this part, which 

incorporates capital charges for certain 

market risks into the risk-based capital ratio. 

When calculating their risk-based capital 

ratio under these appendices A, D, and E, 

such banks are required to refer to appendix 

C of this part for supplemental rules to 

determine qualifying and excess capital, 

calculate risk-weighted assets, calculate 

market risk equivalent assets and add them 

to risk-weighted assets, and calculate riskbased capital ratios as adjusted for market 

risk. 

5. This statement of policy applies to all 

FDIC-insured state-chartered banks 

(excluding insured branches of foreign banks) 

that have elected to use this appendix E and 

that are not members of the Federal Reserve 

System, hereafter referred to as ‘‘state 

nonmember banks,’’ regardless of size, and to 

all circumstances in which the FDIC is 

required to evaluate the capital of a banking 

organization. Therefore, the risk-based 

capital framework set forth in this statement 

of policy will be used in the examination and 

supervisory process as well as in the analysis 

of applications that the FDIC is required to 

act upon. 

6. The risk-based capital ratio focuses 

principally on broad categories of credit risk, 

however, the ratio does not take account of 

many other factors that can affect a bank’s 

financial condition. These factors include 

overall interest rate risk exposure, liquidity, 

funding and market risks; the quality and 

level of earnings; investment, loan portfolio, 

and other concentrations of credit risk, 

certain risks arising from nontraditional 

activities; the quality of loans and 

investments; the effectiveness of loan and 

investment policies; and management’s 

overall ability to monitor and control 

financial and operating risks, including the 

risk presented by concentrations of credit 

and nontraditional activities. In addition to 

evaluating capital ratios, an overall 

assessment of capital adequacy must take 

account of each of these other factors, 

including, in particular, the level and 

severity of problem and adversely classified 

assets as well as a bank’s interest rate risk as 

measured by the bank’s exposure to declines 

in the economic value of its capital due to 

changes in interest rates. For this reason, the 

final supervisory judgment on a bank’s 

capital adequacy may differ significantly 

from the conclusions that might be drawn 

solely from the absolute level of the bank’s 

risk-based capital ratio. 

B. Election Into and Exit From Appendix E 

1. Unless a bank uses appendix D of this 

part, any state nonmember bank may elect to 

use the capital requirements set forth in this 

appendix E by filing the appropriate 

Schedule of the Consolidated Reports of 

Condition and Income (Call Reports) to 

calculate its risk-based capital requirements. 

After a bank has filed its quarterly Call 

Reports under this appendix E, the bank’s 

election to use appendix E will be effective 

on the date of filing its Call Reports and will 

apply retrospectively to the quarter covered 

by the filing. 

2. Any bank that has elected to use this 

appendix E to calculate its risk-based capital 

ratios may elect to use appendix A of this 

part to calculate its risk-based capital ratios 

by giving the FDIC prior notice. This election 

will not apply retrospectively to the current 

quarter, but will apply prospectively for the 

next quarter. After the notice becomes 

effective, the bank must use appendix A, and 

the bank must file all subsequent Call 

Reports in accordance with appendix A. 

C. Reservation of Authority 

The FDIC reserves the authority to exclude 

a bank from coverage under this appendix E 

if the FDIC determines that the exclusion is 

appropriate based on the risk profile of the 

bank or would otherwise enhance the safety 

and soundness of the bank. The FDIC also 

reserves the authority to: Require a bank that 

has elected to use the capital requirements in 

this appendix E to continue to use appendix 

E; or require a bank that uses appendix A to 

calculate its risk-based capital requirements 

to instead use appendix E to calculate its 

capital requirements, if the FDIC determines 

that the exclusion from coverage under 

appendix A to this part 325 is appropriate 

based on the risk profile of the bank or would 

otherwise enhance the safety and soundness 

of the bank. In making a determination under 

this paragraph, the FDIC will apply notice 

and response procedures in the same manner 

as the notice and response procedures in 12 

CFR 325.6(c). 

D. Definitions 

1. Affiliate means, with respect to a 

company, any company that controls, is 

controlled by, or is under common control 

with, the company. For purposes of this 

definition, a person or company controls a 

company if it: 

(a) Owns, controls, or holds with power to 

vote 25 percent or more of a class of voting 

securities of the company; or 

(b) Consolidates the company for financial 

reporting purposes. 

2. Company means a corporation, 

partnership, limited liability company, 

business trust, special purpose entity, 

association, or similar organization. 

3. Eligible guarantee means a guarantee 

provided by a third party eligible guarantor 

that: 

(a) Is written and unconditional; 

(b) Covers all or a pro rata portion of the 

contractual payments of the obligor on the 

reference exposure; 

(c) Gives the beneficiary a direct claim 

against the protection provider; 

(d) Is non-cancelable by the protection 

provider for reasons other than the breach of 

the contract by the beneficiary; 

(e) 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; 

(f) Requires the protection provider to 

make payment to the beneficiary on the 

occurrence of a default (as defined in the 

guarantee) of the obligor on the reference 

exposure without first requiring the 

beneficiary to demand payment from the 

obligor; and 

(g) If extended by a sovereign, is backed by 

the full faith and credit of the sovereign. 

4. Eligible guarantor means a sovereign 

with senior long-term debt externally rated at 

least investment grade (without credit 

enhancements) by a nationally recognized 

statistical rating organization (NRSRO) 2 or a 

non-sovereign with senior long-term debt 

externally rated at least investment grade 

(without credit enhancements) by a NRSRO. 

A sovereign or non-sovereign rated less than 

investment grade by any NRSRO is not an 

eligible guarantor for purposes of this 

definition. 

5. External rating means a credit rating that 

is assigned by a NRSRO to a claim or issuer, 

provided that the credit rating: 

(a) Fully reflects the entire amount of 

credit risk with regard to all payments owed 

on the claim (that is, the rating must fully 

reflect the credit risk associated with timely 

repayment of principal and interest); 

(b) Is monitored by the issuing NRSRO; 

(c) Is published in an accessible public 

forum, for example, on the NRSRO’s Web site 

and in financial media; and 

(d) Is, or will be, included in the issuing 

NRSRO’s publicly available ratings transition 


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3See footnote 31. 

4Preferred stock issues where the dividend is 

reset periodically based, in whole or in part, upon 

the bank’s current credit standing, including but not 

limited to, auction rate, money market or 

remarketable preferred stock, are assigned to Tier 2 

capital, regardless of whether the dividends are 

cumulative or noncumulative. 

5An exception is allowed for intangible assets 

that are explicitly approved by the FDIC as part of 

the bank’s regulatory capital on a specific case 

basis. These intangibles will be included in capital 

for risk-based capital purposes under the terms and 

conditions that are specifically approved by the 

FDIC. 

matrix which tracks the performance and 

stability (or ratings migration) of an NRSRO’s 

issued external ratings for the specific type 

of claim (for example, corporate debt). 

6. Loan level private mortgage insurance 

(PMI) means insurance provided by a 

regulated mortgage insurance company, with 

senior long-term debt rated at least thirdhighest investment grade (without credit 

enhancements) by a NRSRO, that protects a 

mortgage lender in the event of the default 

of a mortgage borrower up to a 

predetermined portion of the value of a 

single one-to four-family residential property, 

provided the mortgage insurance company is 

not an affiliate of the bank and provided 

there is no pool-level cap that would 

effectively reduce coverage. 

7. Non-sovereign. 

(a) Non-sovereign means: 

(i) A company (including a securities firm, 

insurance company, bank holding company, 

and savings and loan holding company), or 

(ii) A multilateral lending institution or 

regional development institution. 

(b) For purposes of this definition, nonsovereign does not include the United States 

(including U.S. Government Agencies); states 

or other political subdivisions of the United 

States and other OECD countries; U.S. 

Government-sponsored Agencies; or U.S. 

depository institutions and foreign banks. In 

addition, for purposes of determining the 

appropriate risk weight of claims on or 

guaranteed by qualifying securities firms that 

are collateralized by cash or securities issued 

or guaranteed by OECD central governments 

and that meet the requirements of section 

II.C.1(c) of this appendix E, non-sovereign 

also does not include a qualifying securities 

firm.3

8. Securitization exposures include assetand mortgage-backed securities, recourse 

obligations, direct credit substitutes, and 

residual interests (other than creditenhancing interest-only strips). 

9. Sovereign. 

(a) Sovereign means a central government, 

including its departments and ministries, and 

the central bank. It does not include states, 

provinces, local governments, or other 

political subdivisions of a country, or 

commercial enterprises owned by a central 

government. 

(b) For purposes of this appendix E, 

sovereign does not include the United States, 

U.S. Government agencies, or the U.S. central 

bank (including the twelve Federal Reserve 

banks). In addition, for purposes of 

determining the appropriate risk weight of 

claims on qualifying securities firms that are 

collateralized by securities issued or 

guaranteed by OECD central governments 

that meet the requirements of section II.C.1(c) 

of this appendix E, sovereign does not 

include an OECD central government 

(including the United States). 

10. Unconditionally cancelable means, 

with respect to a commitment-type lending 

arrangement, that a bank may, at any time, 

with or without cause, refuse to advance 

funds or extend credit under the facility. In 

the case of home equity lines of credit or 

mortgage lines of credit, a commitment is 

unconditionally cancelable if the bank can, at 

its option, prohibit additional extensions of 

credit, reduce the line, and terminate the 

commitment to the full extent permitted by 

applicable Federal law. 

I–2. Definition of Capital for the Risk-Based 

Capital Ratio 

A bank’s qualifying total capital base 

consists of two types of capital elements: 

‘‘core capital elements’’ (Tier 1) and 

‘‘supplementary capital elements’’ (Tier 2). 

To qualify as an element of Tier 1 or Tier 2 

capital, a capital instrument should not 

contain or be subject to any conditions, 

covenants, terms, restrictions, or provisions 

that are inconsistent with safe and sound 

banking practices. 

A. The Components of Qualifying Capital 

(see Table I) 

1. Core capital elements (Tier 1) consists 

of: Common stockholders’ equity capital 

(includes common stock and related surplus, 

undivided profits, disclosed capital reserves 

that represent a segregation of undivided 

profits, and foreign currency translation 

adjustments, less net unrealized holding 

losses on available for-sale equity securities 

with readily determinable fair values); 

noncumulative perpetual preferred stock,4

including any related surplus; and minority 

interests in the equity capital accounts of 

consolidated subsidiaries. 

(a) At least 50 percent of the qualifying 

total capital base should consist of Tier 1 

capital. Core (Tier 1) capital is defined as the 

sum of core capital elements minus all 

intangible assets (other than mortgage 

servicing assets, nonmortgage servicing assets 

and purchased credit card relationships 

eligible for inclusion in core capital pursuant 

to § 325.5(f)),5 minus credit-enhancing 

interest-only strips that are not eligible for 

inclusion in core capital pursuant to 

§ 325.5(f)), minus any disallowed deferred 

tax assets, and minus any amount of 

nonfinancial equity investments required to 

be deducted pursuant to section II.B.6 of this 

appendix E. 

(b) Although nonvoting common stock, 

noncumulative perpetual preferred stock, 

and minority interests in the equity capital 

accounts of consolidated subsidiaries are 

normally included in Tier 1 capital, voting 

common stockholders’ equity generally will 

be expected to be the dominant form of Tier 

1 capital. Thus, banks should avoid undue 

reliance on nonvoting equity, preferred stock 

and minority interests. 

(c) Although minority interests in 

consolidated subsidiaries are generally 

included in regulatory capital, exceptions to 

this general rule will be made if the minority 

interests fail to provide meaningful capital 

support to the consolidated bank. Such a 

situation could arise if the minority interests 

are entitled to a preferred claim on 

essentially low risk assets of the subsidiary. 

Similarly, although credit-enhancing interestonly strips and intangible assets in the form 

of mortgage servicing assets, nonmortgage 

servicing assets and purchased credit card 

relationships are generally recognized for 

risk-based capital purposes, the deduction of 

part or all of the credit-enhancing interestonly strips, mortgage servicing assets, 

nonmortgage servicing assets and purchased 

credit card relationships may be required if 

the carrying amounts of these assets are 

excessive in relation to their market value or 

the level of the bank’s capital accounts. 

Credit-enhancing interest-only strips, 

mortgage servicing assets, nonmortgage 

servicing assets, purchased credit card 

relationships and deferred tax assets that do 

not meet the conditions, limitations and 

restrictions described in § 325.5(f) and (g) of 

this part will not be recognized for risk-based 

capital purposes. 

(d) Minority interests in small business 

investment companies, investment funds that 

hold nonfinancial equity investments (as 

defined in section II.B.6(b) of this appendix 

E), and subsidiaries that are engaged in 

nonfinancial activities are not included in a 

bank’s Tier 1 or total capital base if the bank 

excludes the consolidated assets of such 

programs from risk-weighted assets pursuant 

to section II.B.6(b) of this appendix. 

2. Supplementary capital elements (Tier 2). 

The maximum amount of Tier 2 capital that 

may be recognized for risk-based capital 

purposes is limited to 100 percent of Tier 1 

capital (after any deductions for disallowed 

intangibles and disallowed deferred tax 

assets). In addition, the combined amount of 

term subordinated debt and intermediateterm preferred stock that may be treated as 

part of Tier 2 capital for risk-based capital 

purposes is limited to 50 percent of Tier 1 

capital. Amounts in excess of these limits 

may be issued but are not included in the 

calculation of the risk-based capital ratio. 

Supplementary capital elements (Tier 2) 

consist of: Allowance for loan and lease 

losses, up to a maximum of 1.25 percent of 

risk-weighted assets; cumulative perpetual 

preferred stock, long-term preferred stock 

(original maturity of at least 20 years) and 

any related surplus; perpetual preferred stock 

(and any related surplus) where the dividend 

is reset periodically based, in whole or part, 

on the bank’s current credit standing, 

regardless of whether the dividends are 

cumulative or noncumulative; hybrid capital 

instruments, including mandatory 

convertible debt securities; term 

subordinated debt and intermediate-term 

preferred stock (original average maturity of 

five years or more) and any related surplus; 

and net unrealized holding gains on equity 

securities (subject to the limitations 

discussed in paragraph I–2.A.2(f) of this 

section). 

(a) Allowance for loan and lease losses. (i) 

Allowances for loan and lease losses are 

reserves that have been established through 

a charge against earnings to absorb future 


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6Allocated transfer risk reserves are reserves that 

have been established in accordance with section 

905(a) of the International Lending Supervision Act 

of 1983 against certain assets whose value has been 

found by the U.S. supervisory authorities to have 

been significantly impaired by protracted transfer 

risk problems. 

7The amount of the allowance for loan and lease 

losses that may be included as a supplementary 

capital element is based on a percentage of gross 

risk-weighted assets. A bank may deduct reserves 

for loan and lease losses that are in excess of the 

amount permitted to be included in capital, as well 

as allocated transfer risk reserves, from gross riskweighted assets when computing the denominator 

of the risk-based capital ratio. 

losses on loans or lease financing receivables. 

Allowances for loan and lease losses exclude 

‘‘allocated transfer risk reserves.’’ 6 and 

reserves created against identified losses. 

(ii) This risk-based capital framework 

provides a phasedown during the transition 

period of the extent to which the allowance 

for loan and lease losses may be included in 

an institution’s capital base. By year-end 

1990, the allowance for loan and lease losses, 

as an element of supplementary capital, may 

constitute no more than 1.5 percent of riskweighted assets and, by year-end 1992, no 

more than 1.25 percent of risk-weighted 

assets.7

(b) Preferred stock. (i) Perpetual preferred 

stock is defined as preferred stock that does 

not have a maturity date, that cannot be 

redeemed at the option of the holder, and 

that has no other provisions that will require 

future redemption of the issue. Long-term 

preferred stock includes limited-life 

preferred stock with an original maturity of 

20 years or more, provided that the stock 

cannot be redeemed at the option of the 

holder prior to maturity, except with the 

prior approval of the FDIC. 

(ii) Cumulative perpetual preferred stock 

and long-term preferred stock qualify for 

inclusion in supplementary capital provided 

that the instruments can absorb losses while 

the issuer operates as a going concern (a 

fundamental characteristic of equity capital) 

and provided the issuer has the option to 

defer payment of dividends on these 

instruments. Given these conditions, and the 

perpetual or long-term nature of the 

instruments, there is no limit on the amount 

of these preferred stock instruments that may 

be included with Tier 2 capital. 

(iii) Noncumulative perpetual preferred 

stock where the dividend is reset periodically 

based, in whole or in part, on the bank’s 

current credit standing, including auction 

rate, money market, or remarketable 

preferred stock, are also assigned to Tier 2 

capital without limit, provided the above 

conditions are met. 

(c) Hybrid capital instruments. (i) Hybrid 

capital instruments include instruments that 

have certain characteristics of both debt and 

equity. In order to be included as 

supplementary capital elements, these 

instruments should meet the following 

criteria: 

(A) The instrument should be unsecured, 

subordinated to the claims of depositors and 

general creditors, and fully paid-up. 

(B) The instrument should not be 

redeemable at the option of the holder prior 

to maturity, except with the prior approval of 

the FDIC. This requirement implies that 

holders of such instruments may not 

accelerate the payment of principal except in 

the event of bankruptcy, insolvency, or 

reorganization. 

(C) The instrument should be available to 

participate in losses while the issuer is 

operating as a going concern. (Term 

subordinated debt would not meet this 

requirement.) To satisfy this requirement, the 

instrument should convert to common or 

perpetual preferred stock in the event that 

the sum of the undivided profits and capital 

surplus accounts of the issuer results in a 

negative balance. 

(D) The instrument should provide the 

option for the issuer to defer principal and 

interest payments if: the issuer does not 

report a profit in the preceding annual 

period, defined as combined profits (i.e., net 

income) for the most recent four quarters; 

and the issuer eliminates cash dividends on 

its common and preferred stock. 

(ii) Mandatory convertible debt securities, 

which are subordinated debt instruments that 

require the issuer to convert such 

instruments into common or perpetual 

preferred stock by a date at or before the 

maturity of the debt instruments, will qualify 

as hybrid capital instruments provided the 

maturity of these instruments is 12 years or 

less and the instruments meet the criteria set 

forth below for ‘‘term subordinated debt.’’

There is no limit on the amount of hybrid 

capital instruments that may be included 

within Tier 2 capital. 

(d) Term subordinated debt and 

intermediate-term preferred stock. The 

aggregate amount of term subordinated debt 

(excluding mandatory convertible debt 

securities) and intermediate-term preferred 

stock (including any related surplus) that 

may be treated as Tier 2 capital for risk-based 

capital purposes is limited to 50 percent of 

Tier 1 capital. Term subordinated debt and 

intermediate-term preferred stock should 

have an original average maturity of at least 

five years to qualify as supplementary capital 

and should not be redeemable at the option 

of the holder prior to maturity, except with 

the prior approval of the FDIC. For state 

nonmember banks, a ‘‘term subordinated 

debt’’ instrument is an obligation other than 

a deposit obligation that: 

(i) Bears on its face, in boldface type, the 

following: This obligation is not a deposit 

and is not insured by the Federal Deposit 

Insurance Corporation; 

(ii)(A) Has a maturity of at least five years; 

or 

(B) In the case of an obligation or issue that 

provides for scheduled repayments of 

principal, has an average maturity of at least 

five years; provided that the Director of the 

Division of Supervision may permit the 

issuance of an obligation or issue with a 

shorter maturity or average maturity if the 

Director has determined that exigent 

circumstances require the issuance of such 

obligation or issue; provided further that the 

provisions of this paragraph I.A.2(d)(2) shall 

not apply to mandatory convertible debt 

obligations or issues; 

(iii) States expressly that the obligation: 

(A) Is subordinated and junior in right of 

payment to the issuing bank’s obligations to 

its depositors and to the bank’s other 

obligations to its general and secured 

creditors; and 

(B) Is ineligible as collateral for a loan by 

the issuing bank; 

(iv) Is unsecured; 

(v) States expressly that the issuing bank 

may not retire any part of its obligation 

without any prior written consent of the 

FDIC or other primary federal regulator; and 

(vi) Includes, if the obligation is issued to 

a depository institution, a specific waiver of 

the right of offset by the lending depository 

institution. 

(e) Subordinated debt obligations issued 

prior to December 2, 1987 that satisfied the 

definition of the term ‘‘subordinated note and 

debenture’’ that was in effect prior to that 

date also will be deemed to be term 

subordinated debt for risk-based capital 

purposes. An optional redemption (‘‘call’’) 

provision in a subordinated debt instrument 

that is exercisable by the issuing bank in less 

than five years will not be deemed to 

constitute a maturity of less than five years, 

provided that the obligation otherwise has a 

stated contractual maturity of at least five 

years; the call is exercisable solely at the 

discretion or option of the issuing bank, and 

not at the discretion or option of the holder 

of the obligation; and the call is exercisable 

only with the express prior written consent 

of the FDIC under 12 U.S.C. 1828(i)(1) at the 

time early redemption or retirement is 

sought, and such consent has not been given 

in advance at the time of issuance of the 

obligation. Optional redemption provisions 

will be accorded similar treatment when 

determining the perpetual nature and/or 

maturity of preferred stock and other capital 

instruments. 

(f) Discount of limited-life supplementary 

capital instruments. As a limited-life capital 

instrument approaches maturity, the 

instrument begins to take on characteristics 

of a short-term obligation and becomes less 

like a component of capital. Therefore, for 

risk-based capital purposes, the outstanding 

amount of term subordinated debt and 

limited-life preferred stock eligible for 

inclusion in capital will be adjusted 

downward, or discounted, as the instruments 

approach maturity. Each limited-life capital 

instrument will be discounted by reducing 

the outstanding amount of the capital 

instrument eligible for inclusion as 

supplementary capital by a fifth of the 

original amount (less redemptions) each year 

during the instrument’s last five years before 

maturity. Such instruments, therefore, will 

have no capital value when they have a 

remaining maturity of less than a year. 

(g) Unrealized gains on equity securities 

and unrealized gains (losses) on other assets. 

Up to 45 percent of pretax net unrealized 

holding gains (that is, the excess, if any, of 

the fair value over historical cost) on 

available-for-sale equity securities with 

readily determinable fair values may be 

included in supplementary capital. However, 

the FDIC may exclude all or a portion of 

these unrealized gains from Tier 2 capital if 

the FDIC determines that the equity 

securities are not prudently valued. 

Unrealized gains (losses) on other types of 

assets, such as bank premises and availableVerDate Aug<31>2005 16:17 Dec 22, 2006 Jkt 211001 PO 00000 Frm 00049 Fmt 4701 Sfmt 4702 E:\FR\FM\26DEP2.SGM 26DEP2

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8Any assets deducted from capital when 

computing the numerator of the risk-based capital 

ratio will also be excluded from risk-weighted 

assets when computing the denominator of the 

ratio. 

9 In addition to mortgage servicing assets, 

nonmortgage servicing assets and purchased credit 

card relationships, certain other intangibles may be 

allowed if explicitly approved by the FDIC as part 

of the bank’s regulatory capital on a specific case 

basis. In evaluating whether other types of 

intangibles should be recognized for regulatory 

capital purposes on a specific case basis, the FDIC 

will accord special attention to the general 

characteristics of the intangibles, including: (1) the 

separability of the intangible asset and the ability 

to sell it separate and apart from the bank or the 

bulk of the bank’s assets, (2) the certainty that a 

readily identifiable stream of cash flows associated 

with the intangible asset can hold its value 

notwithstanding the future prospects of the bank, 

and (3) the existence of a market of sufficient depth 

to provide liquidity for the intangible asset. 

10For risk-based capital purposes, these 

subsidiaries are generally defined as any company 

that is primarily engaged in banking or finance and 

in which the bank, either directly or indirectly, 

owns more than 50 percent of the outstanding 

voting stock but does not consolidate the company 

for regulatory capital purposes. In addition to 

investments in unconsolidated banking and finance 

subsidiaries, the FDIC may, on a case-by-case basis, 

deduct investments in associated companies or 

joint ventures, which are generally defined as any 

companies in which the bank, either directly or 

indirectly, owns 20 to 50 percent of the outstanding 

voting stock. Alternatively, the FDIC may, in certain 

cases, apply an appropriate risk-weighted capital 

charge against a bank’s proportionate interest in the 

assets of associated companies and joint ventures. 

The definitions for subsidiaries, associated 

companies and joint ventures are contained in the 

instructions for the preparation of the Consolidated 

Reports of Condition and Income. 

11Consolidation requirements for regulatory 

capital purposes generally follow the consolidation 

requirements set forth in the instructions for 

preparation of the consolidated Reports of 

Condition and Income. However, although 

investments in subsidiaries representing majority 

ownership in another federally-insured depository 

institution are not consolidated for purposes of the 

consolidated Reports of Condition and Income that 

are filed by the parent bank, they are generally 

consolidated for purposes of determining FDIC 

regulatory capital requirements. Therefore, 

investments in these depository institution 

subsidiaries generally will not be deducted for riskbased capital purposes; rather, assets and liabilities 

of such subsidiaries will be consolidated with those 

of the parent bank when calculating the risk-based 

capital ratio. In addition, although securities 

subsidiaries established pursuant to 12 CFR 337.4 

are consolidated for Report of Condition and 

Income purposes, they are not consolidated for 

regulatory capital purposes. 

12Any asset deducted from a bank’s capital 

accounts when computing the numerator of the 

risk-based capital ratio will also be excluded from 

risk-weighted assets when calculating the 

denominator for the ratio. 

for-sale debt securities, are not included in 

supplementary capital, but the FDIC may 

take these unrealized gains (losses) into 

account as additional factors when assessing 

a bank’s overall capital adequacy. 

B. Deductions from Capital and Other 

Adjustments. Certain assets are deducted 

from a bank’s capital base for the purpose of 

calculating the numerator of the risk-based 

capital ratio.8 These assets include: 

(1) All intangible assets other than 

mortgage servicing assets, nonmortgage 

servicing assets and purchased credit card 

relationships.9 These disallowed intangibles 

are deducted from the core capital (Tier 1) 

elements. 

(2) Investments in unconsolidated banking 

and finance subsidiaries.10 This includes any 

equity or debt capital investments in banking 

or finance subsidiaries if the subsidiaries are 

not consolidated for regulatory capital 

requirements.11 Generally, these investments 

include equity and debt capital securities and 

any other instruments or commitments that 

are deemed to be capital of the subsidiary. 

These investments are deducted from the 

bank’s total (Tier 1 plus Tier 2) capital base. 

(3) Investments in securities subsidiaries 

established pursuant to 12 CFR 337.4. The 

FDIC may also consider deducting 

investments in other subsidiaries, either on a 

case-by-case basis or, as with securities 

subsidiaries, based on the general 

characteristics or functional nature of the 

subsidiaries. 

(4) Reciprocal holdings of capital 

instruments of banks that represent 

intentional cross-holdings by the banks. 

These holdings are deducted from the bank’s 

total capital base. 

(5) Deferred tax assets in excess of the limit 

set forth in § 325.5(g). These disallowed 

deferred tax assets are deducted from the 

core capital (Tier 1) elements. On a case-bycase basis, and in conjunction with 

supervisory examinations, other deductions 

from capital may also be required, including 

any adjustments deemed appropriate for 

assets classified as loss. 

II. Procedures For Computing Risk-Weighted 

Assets 

A. General Procedures 

1. Under the risk-based capital framework, 

a bank’s balance sheet assets and credit 

equivalent amounts of off-balance sheet items 

are assigned to one of eight broad risk 

categories according to the obligor or, if 

relevant, the guarantor or the nature of the 

collateral. The aggregate dollar amount in 

each category is then multiplied by the risk 

weight assigned to that category. The 

resulting weighted values from each of the 

eight risk categories are added together and 

this sum is the risk-weighted assets total that, 

as adjusted,12 comprises the denominator of 

the risk-based capital ratio. 

2. The risk-weighted amounts for all offbalance sheet items are determined by a twostep process. First, the notional principal, or 

face value, amount of each off-balance sheet 

item generally is multiplied by a credit 

conversion factor to arrive at a balance sheet 

‘‘credit equivalent amount.’’ Second, the 

credit equivalent amount generally is 

assigned to the appropriate risk category, like 

any balance sheet asset, according to the 

obligor or, if relevant, the guarantor or the 

nature of the collateral. 

3. The Director of the Division of 

Supervision and Consumer Protection 

(Director) of DSC may, on a case-by-case 

basis, determine the appropriate risk weight 

for any asset or credit equivalent amount that 

does not fit wholly within one of the risk 

categories set forth in this appendix E or that 

imposes risks on a bank that are not 

commensurate with the risk weight otherwise 

specified in this appendix E for the asset or 

credit equivalent amount. In addition, the 

Director of DSC may, on a case-by-case basis, 

determine the appropriate credit conversion 

factor for any off-balance sheet item that does 

not fit wholly within one of the credit 

conversion factors set forth in this appendix 

E or that imposes risks on a bank that are not 

commensurate with the credit conversion 

factor otherwise specified in this appendix E 

for the off-balance sheet item. In making such 

a determination, the Director of DSC will 

consider the similarity of the asset or offbalance sheet item to assets or off-balance 

sheet items explicitly treated in sections II.B 

and II.C of this appendix E, as well as other 

relevant factors. 

B. Other Considerations 

1. Indirect Holdings of Assets. Some of the 

assets on a bank’s balance sheet may 

represent an indirect holding of a pool of 

assets; for example, mutual funds. An 

investment in shares of a mutual fund whose 

portfolio consists solely of various securities 

or money market instruments that, if held 

separately, would be assigned to different 

risk categories, generally is assigned to the 

risk category appropriate to the highest riskweighted asset that the fund is permitted to 

hold in accordance with the stated 

investment objectives set forth in its 

prospectus. The bank may, at its option, 

assign the investment on a pro rata basis to 

different risk categories according to the 

investment limits in the fund’s prospectus, 

but in no case will indirect holdings through 

shares in any mutual fund be assigned to a 

risk weight less than 20 percent. If the bank 

chooses to assign its investment on a pro rata 

basis, and the sum of the investment limits 

in the fund’s prospectus exceeds 100 percent, 

the bank must assign risk weights in 

descending order. If, in order to maintain a 

necessary degree of short-term liquidity, a 

fund is permitted to hold an insignificant 

amount of its assets in short-term, highly 

liquid securities of superior credit quality 

that do not qualify for a preferential risk 

weight, such securities will generally be 

disregarded in determining the risk category 

to which the bank’s holdings in the overall 

fund should be assigned. The prudent use of 

hedging instruments by a mutual fund to 

reduce the risk of its assets will not increase 

the risk weighting of the mutual fund 

investment. For example, the use of hedging 

instruments by a mutual fund to reduce the 

interest rate risk of its government bond 

portfolio will not increase the risk weight of 

that fund above the 20 percent category. 

Nonetheless, if the fund engages in any 

activities that appear speculative in nature or 

has any other characteristics that are 

inconsistent with the preferential risk 

weighting assigned to the fund’s assets, 

holdings in the fund will be assigned to the 

100 percent risk category. 

2. Collateral (a) Cash and securities issued 

or guaranteed by the United States, other 

OECD central Governments and U.S. 

Government-sponsored entities. In 

determining risk weights of various assets, 

the following forms of collateral are formally 

recognized under this appendix E: cash on 


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13Securities issued or guaranteed by OECD 

central governments are only recognized under the 

zero percent risk weight if they meet the collateral 

requirements of section II.C.1 of appendix E. The 

OECD-based group of countries comprises all full 

members of the Organization for Economic 

Cooperation and Development (OECD) regardless of 

entry date, as well as countries that have concluded 

special lending arrangements with the International 

Monetary Fund (IMF) associated with the IMF’s 

General Arrangements to Borrow, but excludes any 

country that has rescheduled its external sovereign 

debt within the previous five years. As of November 

1995, the OECD included the following countries: 

Australia, Austria, Belgium, Canada, Denmark, 

Finland, France, Germany, Greece, Iceland, Ireland, 

Italy, Japan, Luxembourg, Mexico, the Netherlands, 

New Zealand, Norway, Portugal, Spain, Sweden, 

Switzerland, Turkey, the United Kingdom and the 

United States; and Saudi Arabia had concluded 

special lending arrangements with the IMF 

associated with the IMF’s General Arrangements to 

Borrow. A rescheduling of external sovereign debt 

generally would include any renegotiation of terms 

arising from a country’s inability or unwillingness 

to meet its external debt service obligations, but 

generally would not include renegotiations of debt 

in the normal course of business, such as 

renegotiation to allow the borrower to take 

advantage of a decline in interest rates or other 

change in market conditions. 

14However, claims on or guaranteed by 

qualifying securities firms may receive a zero 

percent risk weight if such claims are: (i) 

collateralized by cash or securities issued by an 

OECD central government (including the United 

States) and (ii) meet the other requirements of 

section II.C.1(c) of this appendix E. See footnote 31. 

15 In the event that the external rating of a 

security used to collateralize a claim results in a 

higher risk weight than would have otherwise been 

assigned based on the claim’s underlying asset type, 

obligor, or external rating, if applicable, then the 

lower risk weight appropriate to the underlying 

asset type or the obligor may be applied. 

deposit in the lending bank; securities issued 

or guaranteed by the United States, other 

central governments of the OECD-based 

group of countries,13 U.S. Government 

agencies, and U.S. Government-sponsored 

agencies. Claims fully secured by such 

collateral are assigned to the 20 percent risk 

category.14 The extent to which these 

securities are recognized as collateral for riskbased capital purposes is determined by their 

current market value. If a claim is partially 

secured, the portion of the claim that is not 

covered by the collateral is assigned to the 

risk category appropriate to the obligor or, if 

relevant, the guarantor. 

(b) Collateral that requires an external 

rating. The following forms of liquid and 

readily marketable financial collateral also 

are recognized: both short- and long-term 

debt securities that are either issued or 

guaranteed by sovereigns where either the 

sovereign or the issued debt security are 

externally rated at least than investment 

grade by a NRSRO; issued by non-sovereigns 

where the issued security is externally rated 

at least investment grade by a NRSRO; or 

securitization exposures rated at least 

investment grade by a NRSRO. Claims or 

portion of claims collateralized by financial 

collateral externally rated at least investment 

grade are assigned to the risk weight 

appropriate to the collateral’s external rating 

as set forth in section II.C.9(a) and Tables F1 

and F2, or section II.B.5 and Tables A and 

B.15 The extent to which externally rated 

securities are recognized as collateral for riskbased capital purposes is determined by their 

current market value. If a claim is partially 

secured, the pro rata portion of the claim that 

is not covered by the collateral is assigned to 

the risk category appropriate to the obligor 

or, if relevant, the guarantor. 

Notwithstanding Tables F1 and F2 there is a 

20 percent risk weight floor on collateral. 

3. Guarantees (a) Guarantees of the United 

States, U.S. Government-sponsored entities, 

OECD state and local governments, and 

certain banking organizations. Guarantees of 

the United States, U.S. Government agencies, 

U.S. Government-sponsored agencies, state 

and local governments of the OECD-based 

group of countries, U.S. depository 

institutions, and foreign banks in OECD 

countries are recognized under this appendix 

E. If a claim is partially guaranteed, the 

portion of the claim that is not fully covered 

by the guarantee is assigned to the risk 

category appropriate to the obligor or, if 

relevant, the collateral. 

(b) Eligible guarantees by sovereigns and 

non-sovereigns. A claim backed by an eligible 

guarantee may be assigned to the risk weight 

in section II.C.9(a) and Table F1 of this 

appendix E corresponding to the eligible 

guarantor(s)’ senior long-term debt rating or 

issuer rating, in the case of a sovereign. 

Portions of claims backed by an eligible 

guarantee may be assigned to the risk-weight 

category appropriate to the external credit 

rating of the eligible guarantor(s)’ senior longterm debt or issuer rating in accordance with 

section II.C.9(a) and Table F1 of this 

appendix E. 

4. Maturity. Maturity is generally not a 

factor in assigning items to risk categories 

with the exceptions of claims on non-OECD 

banks, commitments, and interest rate and 

foreign exchange rate related contracts. 

Except for commitments, short-term is 

defined as one year or less remaining 

maturity and long-term is defined as over one 

year remaining maturity. In the case of 

commitments, short-term is defined as one 

year or less original maturity and long-term 

is defined as over one year original maturity. 

5. Recourse, Direct Credit Substitutes, 

Residual Interests and Mortgage- and AssetBacked Securities. For purposes of this 

section II.B.5 of this appendix E, the 

following definitions will apply. 

(a) Definitions. (i) Credit derivative means 

a contract that allows one party (‘‘the 

protection purchaser’’) to transfer the credit 

risk of an asset or off-balance sheet credit 

exposure to another party (the protection 

provider). The value of a credit derivative is 

dependent, at least in part, on the credit 

performance of the ‘‘reference asset.’’

(ii) Credit-enhancing interest-only strip is 

defined in § 325.2(g). 

(iii) Credit-enhancing representations and 

warranties means representations and 

warranties that are made or assumed in 

connection with a transfer of assets 

(including loan servicing assets) and that 

obligate a bank to protect investors from 

losses arising from credit risk in the assets 

transferred or the loans serviced. Creditenhancing representations and warranties 

include promises to protect a party from 

losses resulting from the default or 

nonperformance of another party or from an 

insufficiency in the value of the collateral. 

Credit-enhancing representations and 

warranties do not include: 

(A) 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; 

(B) Premium refund clauses that cover 

assets guaranteed, in whole or in part, by the 

U.S. Government, a U.S. Government agency 

or a government-sponsored enterprise, 

provided the premium refund clauses are for 

a period not to exceed 120 days from the date 

of transfer; or 

(C) Warranties that permit the return of 

assets in instances of misrepresentation, 

fraud or incomplete documentation. 

(iv) Direct credit substitute means an 

arrangement in which a bank assumes, in 

form or in substance, credit risk associated 

with an on- or off-balance sheet credit 

exposure that was not previously owned by 

the bank (third-party asset) and the risk 

assumed by the bank exceeds the pro rata 

share of the bank’s interest in the third-party 

asset. If the bank has no claim on the thirdparty asset, then the bank’s assumption of 

any credit risk with respect to the third party 

asset is a direct credit substitute. Direct credit 

substitutes include, but are not limited to: 

(A) Financial standby letters of credit, 

which includes any letter of credit or similar 

arrangement, however named or described, 

that support financial claims on a third party 

that exceeds a bank’s pro rata share of losses 

in the financial claim; 

(B) Guarantees, surety arrangements, credit 

derivatives, and similar instruments backing 

financial claims; 

(C) Purchased subordinated interests or 

securities that absorb more than their pro rata 

share of credit losses from the underlying 

assets; 

(D) Credit derivative contracts under which 

the bank assumes more than its pro rata share 

of credit risk on a third party asset or 

exposure; 

(E) Loans or lines of credit that provide 

credit enhancement for the financial 

obligations of an account party; 

(F) Purchased loan servicing assets if the 

servicer: is responsible for credit losses 

associated with the loans being serviced; is 

responsible for making mortgage servicer 

cash advances (unless the advances are not 

direct credit substitutes because they meet 

the conditions specified in II.B.5 (a)(ix) of 

this appendix E), or makes or assumes creditenhancing representations and warranties 

with respect to the loans serviced; 

(G) Clean-up calls on third party assets. 

Clean-up calls that are exercisable at the 

option of the bank (as servicer or as an 

affiliate of the servicer) when the pool 

balance is 10 percent or less of the original 

pool balance are not direct credit substitutes; 

and 

(v) Eligible ABCP liquidity facility means a 

liquidity facility supporting ABCP, in form or 

in substance, that is subject to an asset 


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quality test at the time of draw that precludes 

funding against assets that are 90 days or 

more past due or in default. In addition, if 

the assets that an eligible ABCP liquidity 

facility is required to fund against are 

externally rated assets or exposures at the 

inception of the facility, the facility can be 

used to fund only those assets or exposures 

that are externally rated investment grade at 

the time of funding. Notwithstanding the 

eligibility requirements set forth in the two 

preceding sentences, a liquidity facility will 

be considered an eligible ABCP liquidity 

facility if the assets that are funded under the 

liquidity facility and which do not meet the 

eligibility requirements are guaranteed, either 

conditionally or unconditionally, by the U.S. 

government or its agencies, or by the central 

government of an OECD country. 

(vi) External rating is defined above in the 

definitions to this appendix E. 

(vii) Face amount means the notional 

principal, or face value, amount of an offbalance sheet item; the amortized cost of an 

asset not held for trading purposes; and the 

fair value of a trading asset. 

(viii) Financial asset means cash or other 

monetary instrument, evidence of debt, 

evidence of an ownership interest in an 

entity, or a contract that conveys a right to 

receive or exchange cash or another financial 

instrument from another party. 

(ix) Financial standby letter of credit 

means a letter of credit or similar 

arrangement that represents an irrevocable 

obligation to a third-party beneficiary: 

(A) To receive money borrowed by, or 

advanced to, or for the account of, a second 

party (the account party), or 

(B) To make payment on behalf of the 

account party, in the event that the account 

party fails to fulfill its obligation to the 

beneficiary. 

(x) Liquidity facility means a legally 

binding commitment to provide liquidity 

support to ABCP by lending to, or purchasing 

assets from, any structure, program, or 

conduit in the event that funds are required 

to repay maturing ABCP. 

(xi) Mortgage servicer cash advance means 

funds that a residential mortgage servicer 

advances to ensure an uninterrupted flow of 

payments, including advances made to cover 

foreclosure costs or other expenses to 

facilitate the timely collection of the loan. A 

mortgage servicer cash advance is not a 

recourse obligation or a direct credit 

substitute if: 

(A) The mortgage servicer is entitled to full 

reimbursement and this right is not 

subordinated to other claims on the cash 

flows from the underlying asset pool; or 

(B) For any one loan, the servicer’s 

obligation to make nonreimbursable 

advances is contractually limited to an 

insignificant amount of the outstanding 

principal of that loan. 

(xii) Nationally recognized statistical rating 

organization (NRSRO) means an entity 

recognized by the Division of Market 

Regulation of the Securities and Exchange 

Commission (or any successor Division) 

(Commission) as a nationally recognized 

statistical rating organization for various 

purposes, including the Commission’s 

uniform net capital requirements for brokers 

and dealers (17 CFR 240.15c3–1). 

(xiii) Recourse means an arrangement in 

which a bank retains, in form or in substance, 

of any credit risk directly or indirectly 

associated with an asset it has sold (in 

accordance with generally accepted 

accounting principles) that exceeds a pro rata 

share of the bank’s claim on the asset. If a 

bank has no claim on an asset it has sold, 

then the retention of any credit risk is 

recourse. A recourse obligation typically 

arises when an institution transfers assets in 

a sale and retains an obligation to repurchase 

the assets or absorb losses due to a default 

of principal or interest or any other 

deficiency in the performance of the 

underlying obligor or some other party. 

Recourse may exist implicitly where a bank 

provides credit enhancement beyond any 

contractual obligation to support assets it has 

sold. The following are examples of recourse 

arrangements: 

(A) Credit-enhancing representations and 

warranties made on the transferred assets; 

(B) Loan servicing assets retained pursuant 

to an agreement under which the bank: is 

responsible for losses associated with the 

loans being serviced; or is responsible for 

making mortgage servicer cash advances 

(unless the advances are not a recourse 

obligation because they meet the conditions 

specified in section II.B.5(a)(xi) of this 

appendix E). 

(C) Retained subordinated interests that 

absorb more than their pro rata share of 

losses from the underlying assets; 

(D) Assets sold under an agreement to 

repurchase, if the assets are not already 

included on the balance sheet; 

(E) Loan strips sold without contractual 

recourse where the maturity of the 

transferred portion of the loan is shorter than 

the maturity of the commitment under which 

the loan is drawn; 

(F) Credit derivative contracts under which 

the bank retains more than its pro rata share 

of credit risk on transferred assets; 

(G) Clean-up calls at inception that are 

greater than 10 percent of the balance of the 

original pool of transferred loans. Clean-up 

calls that are 10 percent or less of the original 

pool balance that are exercisable at the 

option of the bank are not recourse 

arrangements; and 

(H) Liquidity facilities that provide 

liquidity support to ABCP (other than eligible 

ABCP liquidity facilities). 

(xiv) Residual interest means any onbalance sheet asset that represents an interest 

(including a beneficial interest) created by a 

transfer that qualifies as a sale (in accordance 

with generally accepted accounting 

principles (GAAP)) of financial assets, 

whether through a securitization or 

otherwise, and that exposes a bank to credit 

risk directly or indirectly associated with the 

transferred assets that exceeds a pro rata 

share of the bank’s claim on the assets, 

whether through subordination provisions or 

other credit enhancement techniques. 

Residual interests generally include creditenhancing I/Os, spread accounts, cash 

collateral accounts, retained subordinated 

interests, other forms of overcollateralization, and similar assets that 

function as a credit enhancement. Residual 

interests further include those exposures 

that, in substance, cause the bank to retain 

the credit risk of an asset or exposure that 

had qualified as a residual interest before it 

was sold. Residual interests generally do not 

include interests purchased from a third 

party, except that purchased creditenhancing I/Os are residual interests for 

purposes of the risk-based capital treatment 

in this appendix. 

(xv) Risk participation means a 

participation in which the originating party 

remains liable to the beneficiary for the full 

amount of an obligation (e.g., a direct credit 

substitute) notwithstanding that another 

party has acquired a participation in that 

obligation. 

(xvi) Securitization means the pooling and 

repackaging by a special purpose entity of 

assets or other credit exposures into 

securities that can be sold to investors. 

Securitization includes transactions that 

create stratified credit risk positions whose 

performance is dependent upon an 

underlying pool of credit exposures, 

including loans and commitments. 

(xvii) Sponsor means a bank that 

establishes an ABCP program; approves the 

sellers permitted to participate in the 

program; approves the asset pools to be 

purchased by the program; or administers the 

ABCP program by monitoring the assets, 

arranging for debt placement, compiling 

monthly reports, or ensuring compliance 

with the program documents and with the 

program’s credit and investment policy. 

(xviii) Structured finance program means a 

program where receivable interests and assetbacked securities issued by multiple 

participants are purchased by a special 

purpose entity that repackages those 

exposures into securities that can be sold to 

investors. Structured finance programs 

allocate credit risks, generally, between the 

participants and credit enhancement 

provided to the program. 

(xix) Traded position means a position that 

has an external rating and is retained, 

assumed or issued in connection with an 

asset securitization, where there is a 

reasonable expectation that, in the near 

future, the rating will be relied upon by 

unaffiliated investors to purchase the 

position; or an unaffiliated third party to 

enter into a transaction involving the 

position, such as a purchase, loan, or 

repurchase agreement. 

(b) Credit equivalent amounts and risk 

weights of recourse obligations and direct 

credit substitutes—(i) General rule for 

determining the credit-equivalent amount. 

Except as otherwise provided, the creditequivalent amount for a recourse obligation 

or direct credit substitute is the full amount 

of the credit-enhanced assets for which the 

bank directly or indirectly retains or assumes 

credit risk multiplied by a 100% conversion 

factor. Thus, a bank that extends a partial 

direct credit substitute, e.g., a financial 

standby letter of credit that absorbs the first 

10 percent of loss on a transaction, must 

maintain capital against the full amount of 

the assets being supported. 

(ii) Risk-weight factor. To determine the 

bank’s risk-weighted assets for an off-balance 

sheet recourse obligation or a direct credit 

substitute, the credit equivalent amount is 


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16A risk participation with a remaining maturity 

of one year or less that is conveyed to a non-OECD 

bank is also assigned to the 20 percent risk category. 

17Stripped mortgage-backed securities and 

similar instruments, such as interest-only strips that 

are not credit-enhancing and principal-only strips, 

must be assigned to the 100% risk category. 

assigned to the risk category appropriate to 

the obligor in the underlying transaction, 

after considering any associated guarantees 

or collateral. For a direct credit substitute 

that is an on-balance sheet asset, e.g., a 

purchased subordinated security, a bank 

must calculate risk-weighted assets using the 

amount of the direct credit substitute and the 

full amount of the assets it supports, i.e., all 

the more senior positions in the structure. 

The treatment covered in this paragraph (ii) 

is subject to the low-level exposure rule 

provided in section II.B.5(h)(i) of this 

appendix E. 

(c) Credit equivalent amount and risk 

weight of participations in, and syndications 

of, direct credit substitutes. Subject to the 

low-level exposure rule provided in section 

II.B.5(h)(i) of this appendix E, the credit 

equivalent amount for a participation interest 

in, or syndication of, a direct credit substitute 

(excluding purchased credit-enhancing 

interest-only strips) is calculated and risk 

weighted as follows: 

(i) Treatment for direct credit substitutes 

for which a bank has conveyed a risk 

participation. In the case of a direct credit 

substitute in which a bank has conveyed a 

risk participation, the full amount of the 

assets that are supported by the direct credit 

substitute is converted to a credit equivalent 

amount using a 100% conversion factor. 

However, the pro rata share of the credit 

equivalent amount that has been conveyed 

through a risk participation is then assigned 

to whichever risk-weight category is lower: 

the risk-weight category appropriate to the 

obligor in the underlying transaction, after 

considering any associated guarantees or 

collateral, or the risk-weight category 

appropriate to the party acquiring the 

participation. The pro rata share of the credit 

equivalent amount that has not been 

participated out is assigned to the risk-weight 

category appropriate to the obligor guarantor, 

or collateral. For example, the pro rata share 

of the full amount of the assets supported, in 

whole or in part, by a direct credit substitute 

conveyed as a risk participation to a U.S. 

domestic depository institution or an OECD 

bank is assigned to the 20 percent risk 

category.16

(ii) Treatment for direct credit substitutes 

in which the bank has acquired a risk 

participation. In the case of a direct credit 

substitute in which the bank has acquired a 

risk participation, the acquiring bank’s pro 

rata share of the direct credit substitute is 

multiplied by the full amount of the assets 

that are supported by the direct credit 

substitute and converted using a 100% credit 

conversion factor. The resulting credit 

equivalent amount is then assigned to the 

risk-weight category appropriate to the 

obligor in the underlying transaction, after 

considering any associated guarantees or 

collateral. 

(iii) Treatment for direct credit substitutes 

related to syndications. In the case of a direct 

credit substitute that takes the form of a 

syndication where each party is obligated 

only for its pro rata share of the risk and 

there is no recourse to the originating entity, 

each bank’s credit equivalent amount will be 

calculated by multiplying only its pro rata 

share of the assets supported by the direct 

credit substitute by a 100% conversion 

factor. The resulting credit equivalent 

amount is then assigned to the risk-weight 

category appropriate to the obligor in the 

underlying transaction, after considering any 

associated guarantees or collateral. 

(d) Positions with external ratings: creditequivalent amounts and risk weights.—(i) 

Traded positions. With respect to a recourse 

obligation, direct credit substitute, residual 

interest (other than a credit-enhancing 

interest-only strip) or mortgage- or assetbacked security that is a ‘‘traded position’’

and that has received an external rating on 

a long-term position that is one grade below 

investment grade or better or a short-term 

position that is investment grade, the bank 

may multiply the face amount of the position 

by the appropriate risk weight, determined in 

accordance with Table A or B of this 

appendix E, as appropriate.17 If a traded 

position receives more than one external 

rating, the lowest rating will apply and that 

external rating must apply to the claim or 

exposure in its entirety. Thus, for banks that 

hold split or partially-rated instruments, the 

risk weight that corresponds to the lowest 

component rating will apply to the entire 

exposure. For example, a purchased 

subordinated security where the principal 

component is rated BBB, but the interest 

component is rated B, will be subject to the 

gross-up treatment accorded to residual 

interests rated B or lower. Similarly, if a 

portion of an instrument is unrated, the 

entire position will be treated as if it were 

unrated. The FDIC reserves the authority to 

override the use of certain ratings or the 

ratings on certain instruments, either on a 

case-by-case basis or through broader 

supervisory policy, if necessary or 

appropriate to address the risk that an 

instrument poses to a bank. 

TABLE A.—RISK WEIGHTS FOR LONG-TERM EXTERNAL RATINGS OF SECURITIZATION EXPOSURES

Long-term rating category Examples Risk weight 

(percent) 

Highest investment grade rating ................................................................................................................................ AAA ............. 20 

Second-highest investment grade rating ................................................................................................................... AA ............... 20 

Third-highest investment grade rating ....................................................................................................................... A .................. 35 

Lowest-investment grade rating—plus ....................................................................................................................... BBB+ ........... 50 

Lowest-investment grade rating—naught .................................................................................................................. BBB ............. 75 

Lowest-investment grade rating—negative ................................................................................................................ BBB¥ ......... 100 

One category below investment grade—plus & naught ............................................................................................ BB+, BB ...... 200 

One category below investment grade—negative ..................................................................................................... BB¥ ............ 200 

Two or more categories below investment grade ..................................................................................................... B, CCC ........ Dollar for 

Dollar 

Unrated ....................................................................................................................................................................... n/a Dollar for 

Dollar 

TABLE B.—RISK WEIGHTS FOR SHORT-TERM EXTERNAL RATINGS OF SECURITIZATION EXPOSURES

Short-term rating category Examples Risk weight 

(percent) 

Highest investment grade rating ................................................................................................................................ A–1, P–1 ..... 20 

Second-highest investment grade rating ................................................................................................................... A–2, P–2 ..... 35 

Lowest investment grade rating ................................................................................................................................. A–3, P–3 ..... 75 

Unrated ....................................................................................................................................................................... n/a 


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18The adequacy of a bank’s use of its internal 

credit risk system must be demonstrated to the 

FDIC considering the criteria listed on this section 

and the size and complexity of the credit exposures 

assumed by the bank. 

(ii) Non-traded positions. A recourse 

obligation, direct credit substitute, residual 

interest (but not a credit-enhancing interestonly strip) or mortgage- or asset-backed 

security extended in connection with a 

securitization that is not a ‘‘traded position’’

may be assigned a risk weight in accordance 

with section II.B.5(d)(i) of this appendix E if: 

(A) It has been externally rated by more 

than one NRSRO; 

(B) It has received an external rating on a 

long-term position that is one category below 

investment grade or better or a short-term 

position that is investment grade by all 

NRSROs providing a rating; 

(C) The ratings are publicly available; and 

(D) The ratings are based on the same 

criteria used to rate traded positions. If the 

ratings are different, the lowest rating will 

determine the risk category to which the 

recourse obligation, direct credit substitute, 

residual interest, or mortgage- or asset-backed 

security will be assigned. 

(e) Senior positions not externally rated. 

For a recourse obligation, direct credit 

substitute, residual interest or mortgage-or 

asset-backed security that is not externally 

rated but is senior in all features to a traded 

position (including collateralization and 

maturity), a bank may apply a risk weight to 

the face amount of the senior position in 

accordance with section II.B.5(d)(i) of this 

appendix E, based upon the risk weight of 

the traded position, subject to any current or 

prospective supervisory guidance and the 

bank satisfying the FDIC that this treatment 

is appropriate. This section will apply only 

if the traded position provides substantial 

credit support for the entire life of the 

unrated position. 

(f) Residual interests—(i) Concentration 

limit on credit-enhancing interest-only strips. 

In addition to the capital requirement 

provided by section II.B.5(f)(ii) of this 

appendix E, a bank must deduct from Tier 1 

capital the face amount of all creditenhancing interest-only strips in excess of 25 

percent of Tier 1 capital in accordance with 

§ 325.5(f)(3). 

(ii) Credit-enhancing interest-only strip 

capital requirement. After applying the 

concentration limit to credit-enhancing 

interest-only strips in accordance with 

§ 325.5(f)(3), a bank must maintain risk-based 

capital for a credit-enhancing interest-only 

strip, equal to the remaining face amount of 

the credit-enhancing interest-only strip (net 

of the remaining proportional amount of any 

existing associated deferred tax liability 

recorded on the balance sheet), even if the 

amount if risk-based capital required to be 

maintained exceeds the full risk-based 

capital requirement for the assets transferred. 

Transactions that, in substance, result in the 

retention of credit risk associated with a 

transferred credit-enhancing interest-only 

strip will be treated as if the credit-enhancing 

interest-only strip was retained by the bank 

and not transferred. 

(iii) Other residual interests capital 

requirement. Except as otherwise provided in 

section II.B.5(d) or (e) of this appendix E, a 

bank must maintain risk-based capital for a 

residual interest (excluding a creditenhancing interest-only strip) equal to the 

face amount of the residual interest (net of 

any existing associated deferred tax liability 

recorded on the balance sheet), even if the 

amount of risk-based capital required to be 

maintained exceeds the full risk-based 

capital requirement for the assets transferred. 

Transactions that, in substance, result in the 

retention of credit risk associated with a 

transferred residual interest will be treated as 

if the residual interest was retained by the 

bank and not transferred. 

(iv) Residual interests and other recourse 

obligations. Where the aggregate capital 

requirement for residual interests (including 

credit-enhancing interest-only strips) and 

recourse obligations arising from the same 

transfer of assets exceed the full risk-based 

capital requirement for assets transferred, a 

bank must maintain risk-based capital equal 

to the greater of the risk-based capital 

requirement for the residual interest as 

calculated under sections II.B.5(f)(ii) through 

(iii) of this appendix E or the full risk-based 

capital requirement for the assets transferred. 

(g) Positions that are not rated by an 

NRSRO. A bank’s position (other than a 

residual interest) in a securitization or 

structured finance program that is not rated 

by an NRSRO may be risk-weighted based on 

the bank’s determination of the credit rating 

of the position, as specified in Table C of this 

appendix E, multiplied by the face amount of 

the position. In order to qualify for this 

treatment, the bank’s system for determining 

the credit rating of the position must meet 

one of the three alternative standards set out 

in section II.B.5(g)(i) through (iii) of this 

appendix E. Table C 

Rating category Examples Risk weight 

(percent) 

Investment grade .................................................................................................................................................. BBB or other ..... 100 

One category below investment grade ................................................................................................................. BB ..................... 200 

(i) Internal risk rating used for assetbacked programs. A bank extends a direct 

credit substitute (but not a purchased creditenhancing interest-only strip) to an assetbacked commercial paper program sponsored 

by the bank and the bank is able to 

demonstrate to the satisfaction of the FDIC, 

prior to relying upon its use, that the bank’s 

internal credit risk rating system is adequate. 

Adequate internal credit risk rating systems 

usually contain the following criteria: 18

(A) The internal credit risk rating system 

is an integral part of the bank’s risk 

management system that explicitly 

incorporates the full range of risks arising 

form a bank’s participation in securitization 

activities; 

(B) Internal credit ratings are linked to 

measurable outcomes, such as the probability 

that the position will experience any loss, the 

position’s expected loss given default, and 

the degree of variance in losses given default 

on that position; 

(C) The internal credit risk rating system 

must separately consider the risk associated 

with the underlying loans or borrowers, and 

the risk associated with the structure of a 

particular securitization transaction; 

(D) The internal credit risk rating system 

identifies gradations of risk among ‘‘pass’’

assets and other risk positions; 

(E) The internal credit risk rating system 

must have clear, explicit criteria (including 

for subjective factors), that are used to 

classify assets into each internal risk grade; 

(F) The bank must have independent credit 

risk management or loan review personnel 

assigning or reviewing the credit risk ratings; 

(G) An internal audit procedure should 

periodically verify that internal risk ratings 

are assigned in accordance with the bank’s 

established criteria; 

(H) The bank must monitor the 

performance of the internal credit risk ratings 

assigned to nonrated, nontraded direct credit 

substitutes over time to determine the 

appropriateness of the initial credit risk 

rating assignment and adjust individual 

credit risk ratings, or the overall internal 

credit risk ratings system, as needed; and 

(I) The internal credit risk rating system 

must make credit risk rating assumptions that 

are consistent with, or more conservative 

than, the credit risk rating assumptions and 

methodologies of NRSROs. 

(ii) Program Ratings. A bank extends a 

direct credit substitute or retains a recourse 

obligation (but not a residual interest) in 

connection with a structured finance 

program and an NRSRO has reviewed the 

terms of the program and stated a rating for 

positions associated with the program. If the 

program has options for different 

combinations of assets, standards, internal 

credit enhancements and other relevant 

factors, and the NRSRO specified ranges of 

rating categories to them, the bank may apply 

the rating category applicable to the option 

that corresponds to the bank’s position. In 

order to rely on a program rating, the bank 

must demonstrate to the FDIC’s satisfaction 

that the credit risk rating assigned to the 

program meets the same standards generally 

used by NRSROs for rating traded positions. 

The bank must also demonstrate to the 

FDIC’s satisfaction that the criteria 

underlying the NRSRO’s assignment of 

ratings for the program are satisfied for the 

particular position issued by the bank. If a 

bank participates in a securitization 

sponsored by another party, the FDIC may 

authorize the bank to use this approach based 


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19An equity investment made under section 

302(b) of the Small Business Investment Act of 1958 

in a SBIC that is not consolidated with the bank is 

treated as a nonfinancial equity investment. 

20The Board of Directors of the FDIC, acting 

directly, may, in exceptional cases and after a 

review of the proposed activity, permit a lower 

capital deduction for investments approved by the 

Board of Directors under section 24 of the FDI Act 

so long as the bank’s investments under section 24 

and SBIC investments represent, in the aggregate, 

less than 15 percent of the Tier 1 capital of the 

bank. The FDIC reserves the authority to impose 

higher capital charges on any investment where 

appropriate. 

on a program rating obtained by the sponsor 

of the program. 

(iii) Computer Program. A bank is using an 

acceptable credit assessment computer 

program that has been developed by an 

NRSRO to determine the rating of a direct 

credit substitute or recourse obligation (but 

not a residual interest) extended in 

connection with a structured finance 

program. In order to rely on the rating 

determined by the computer program, the 

bank must demonstrate to the FDIC’s 

satisfaction that ratings under the program 

correspond credibly and reliably with the 

ratings of traded positions. The bank must 

also demonstrate to the FDIC’s satisfaction 

the credibility of the program in financial 

markets, the reliability of the program in 

assessing credit risk, the applicability of the 

program to the bank’s position, and the 

proper implementation of the program. 

(h) Limitations on risk-based capital 

requirements—(i) Low-level exposure rule. If 

the maximum exposure to loss retained or 

assumed by a bank in connection with a 

recourse obligation, a direct credit substitute, 

or a residual interest is less than the effective 

risk-based capital requirement for the creditenhanced assets, the risk-based capital 

required under this appendix E is limited to 

the bank’s maximum contractual exposure, 

less any recourse liability account 

established in accordance with generally 

accepted accounting principles. This 

limitation does not apply when a bank 

provides credit enhancement beyond any 

contractual obligation to support assets it has 

sold. 

(ii) Mortgage-related securities or 

participation certificates retained in a 

mortgage loan swap. If a bank holds a 

mortgage-related security or a participation 

certificate as a result of a mortgage loan swap 

with recourse, capital is required to support 

the recourse obligation plus the percentage of 

the mortgage-related security or participation 

certificate that is not covered by the recourse 

obligation. The total amount of capital 

required for the on-balance sheet asset and 

the recourse obligation, however, is limited 

to the capital requirement for the underlying 

loans, calculated as if the bank continued to 

hold these loans as an on-balance sheet asset. 

(iii) Related on-balance sheet assets. If a 

recourse obligation or direct credit substitute 

also appears as a balance sheet asset, the 

asset is risk-weighted only under this section 

II.B.5 of this appendix E, except in the case 

of loan servicing assets and similar 

arrangements with embedded recourse 

obligations or direct credit substitutes. In that 

case, the on-balance sheet servicing assets 

and the related recourse obligations or direct 

credit substitutes must both be separately 

risk weighted and incorporated into the riskbased capital calculation. 

(i) Alternative Capital Calculation for 

Small Business Obligations. 

(i) Definitions. For purposes of this section 

II.B.5(i): 

(A) Qualified bank means a bank that: is 

well capitalized as defined in § 325.103(b)(1) 

without applying the capital treatment 

described in this section II.B.5(i), or is 

adequately capitalized as defined in 

§ 325.103(b)(2) without applying the capital 

treatment described in this section II.B.5(i) 

and has received written permission by order 

of the FDIC to apply the capital treatment 

described in this section II.B.5(i). 

(B) Small business means a business that 

meets the criteria for a small business 

concern established by the Small Business 

Administration in 13 CFR part 121 pursuant 

to 15 U.S.C. 632. 

(ii) Capital and reserve requirements. 

Notwithstanding the risk-based capital 

treatment outlined in any other paragraph 

(other than paragraph (i) of this section 

II.B.5), with respect to a transfer with 

recourse of a small business loan or a lease 

to a small business of personal property that 

is a sale under generally accepted accounting 

principles, and for which the bank 

establishes and maintains a non-capital 

reserve under generally accepted accounting 

principles sufficient to meet the reasonable 

estimated liability of the bank under the 

recourse arrangement; a qualified bank may 

elect to include only the face amount of its 

recourse in its risk-weighted assets for 

purposes of calculating the bank’s risk-based 

capital ratio. 

(iii) Limit on aggregate amount of recourse. 

The total outstanding amount of recourse 

retained by a qualified bank with respect to 

transfers of small business loans and leases 

to small businesses of personal property and 

included in the risk-weighted assets of the 

bank as described in section II.B.5(i)(ii) of 

this appendix E may not exceed 15 percent 

of the bank’s total risk-based capital, unless 

the FDIC specifies a greater amount by order. 

(iv) Bank that ceases to be qualified or that 

exceeds aggregate limit. If a bank ceases to 

be a qualified bank or exceeds the aggregate 

limit in section II.B.5(i)(iii) of this appendix 

E, the bank may continue to apply the capital 

treatment described in section II.B.5(i)(ii) of 

this appendix E to transfers of small business 

loans and leases to small businesses of 

personal property that occurred when the 

bank was qualified and did not exceed the 

limit. 

(v) Prompt correction action not affected. 

(A) A bank shall compute its capital without 

regard to this section II.B.5(i) for purposes of 

prompt corrective action (12 U.S.C. 1831o) 

unless the bank is a well capitalized bank 

(without applying the capital treatment 

described in this section II.B.5(i)) and, after 

applying the capital treatment described in 

this section II.B.5(i), the bank would be well 

capitalized. 

(B) A bank shall compute its capital 

without regard to this section II.B.5(i) for 

purposes of 12 U.S.C. 1831o(g) regardless of 

the bank’s capital level. 

6. Nonfinancial equity investments. (a) 

General. A bank must deduct from its Tier 1 

capital the sum of the appropriate percentage 

(as determined below) of the adjusted 

carrying value of all nonfinancial equity 

investments held by the bank or by its direct 

or indirect subsidiaries. For purposes of this 

section II.B.6, investments held by a bank 

include all investments held directly or 

indirectly by the bank or any of its 

subsidiaries. 

(b) Scope of nonfinancial equity 

investments. A nonfinancial equity 

investment means any equity investment 

held by the bank in a nonfinancial company: 

through a small business investment 

company (SBIC) under section 302(b) of the 

Small Business Investment Act of 1958 (15 

U.S.C. 682(b)); 19 under the portfolio 

investment provisions of Regulation K issued 

by the Board of Governors of the Federal 

Reserve System (12 CFR 211.8(c)(3)); or 

under section 24 of the Federal Deposit 

Insurance Act (12 U.S.C. 1831a), other than 

an investment held in accordance with 

section 24(f) of that Act.20 A nonfinancial 

company is an entity that engages in any 

activity that has not been determined to be 

permissible for the bank to conduct directly, 

or to be financial in nature or incidental to 

financial activities under section 4(k) of the 

Bank Holding Company Act (12 U.S.C. 

1843(k)). 

(c) Amount of deduction from core capital. 

(i) The bank must deduct from its Tier 1 

capital the sum of the appropriate 

percentages, as set forth in Table D following 

this paragraph, of the adjusted carrying value 

of all nonfinancial equity investments held 

by the bank. The amount of the percentage 

deduction increases as the aggregate amount 

of nonfinancial equity investments held by 

the bank increases as a percentage of the 

bank’s Tier 1 capital. 


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77500 Federal Register / Vol. 71, No. 247 / Tuesday, December 26, 2006 / Proposed Rules 

21For example, if 8 percent of the adjusted 

carrying value of a nonfinancial equity investment 

is deducted from Tier 1 capital, the entire adjusted 

carrying value of the investment will be excluded 

from both risk-weighted assets and total assets in 

calculating the respective denominators for the riskbased capital and leverage ratios. 

22 If a bank has an investment in a SBIC that is 

consolidated for accounting purposes but that is not 

wholly owned by the bank, the adjusted carrying 

value of the bank’s nonfinancial equity investments 

through the SBIC is equal to the bank’s 

proportionate share of the adjusted carrying value 

of the SBIC’s investments in nonfinancial 

companies. The remainder of the SBIC’s adjusted 

carrying value (i.e., the minority interest holders’

proportionate share) is excluded from the riskweighted assets of the bank. If a bank has an 

investment in a SBIC that is not consolidated for 

accounting purposes and has current information 

that identifies the percentage of the SBIC’s assets 

that are equity investments in nonfinancial 

companies, the bank may reduce the adjusted 

carrying value of its investment in the SBIC 

proportionately to reflect the percentage of the 

adjusted carrying value of the SBIC’s assets that are 

not equity investments in nonfinancial companies. 

If a bank reduces the adjusted carrying value of its 

investment in a non-consolidated SBIC to reflect 

financial investments of the SBIC, the amount of the 

adjustment will be risk-weighted at 100 percent and 

included in the bank’s risk-weighted assets. 

23A ‘‘binding written commitment’’ means a 

legally binding written agreement that requires the 

bank to acquire shares or other equity of the 

company, or make a capital contribution to the 

company, under terms and conditions set forth in 

the agreement. Options, warrants, and other 

agreements that give a bank the right to acquire 

equity or make an investment, but do not require 

the bank to take such actions, are not considered 

a binding written commitment for purposes of this 

section II.B.6(e). 

24For example, if a bank made an equity 

investment in 100 shares of a nonfinancial company 

prior to March 13, 2000, the adjusted carrying value 

of that investment would not be subject to a 

deduction under this section II.B.6. However, if the 

bank made any additional equity investment in the 

company after March 13, 2000, such as by 

purchasing additional shares of the company 

(including through the exercise of options or 

warrants acquired before or after March 13, 2000) 

or by making a capital contribution to the company 

and such investment was not made pursuant to a 

binding written commitment entered into before 

March 13, 2000, the adjusted carrying value of the 

additional investment would be subject to a 

deduction under this section II.B.6. In addition, if 

the bank sold and repurchased, after March 13, 

2000, 40 shares of the company, the adjusted 

carrying value of those 40 shares would be subject 

to a deduction under this section II.B.6. 

TABLE D.—DEDUCTION FOR NONFINANCIAL EQUITY INVESTMENTS

Aggregate adjusted carrying value of all nonfinancial equity investments held directly or indirectly by the bank (as a percentage 

of the Tier 1 capital of the bank) 1

Deduction 

from Tier 1 

Capital (as a 

percentage of 

the adjusted 

carrying value 

of the investment) 

(percent) 

Less than 15 percent ........................................................................................................................................................................... 8 

15 percent to 24.99 percent ................................................................................................................................................................ 12 

25 percent and above .......................................................................................................................................................................... 25 

1For purposes of calculating the adjusted carrying value of nonfinancial equity investments as a percentage of Tier 1 capital. Tier 1 capital is 

defined as the sum of core capital elements net of goodwill and net of all identifiable intangible assets other than mortgage servicing assets, nonmortgage servicing assets and purchased credit card relationships, but prior to the deduction for any disallowed mortgage servicing assets, any 

disallowed nonmortgage servicing assets, any disallowed purchased credit card relationships, any disallowed credit-enhancing interest-only strips 

(both purchased and retained), any disallowed deferred tax assets, and any nonfinancial equity investments. 

(ii) These deductions are applied on a 

marginal basis to the portions of the adjusted 

carrying value of nonfinancial equity 

investments that fall within the specified 

ranges of the parent bank’s Tier 1 capital. For 

example, if the adjusted carrying value of all 

nonfinancial equity investments held by a 

bank equals 20 percent of the Tier 1 capital 

of the bank, then the amount of the 

deduction would be 8 percent of the adjusted 

carrying value of all investments up to 15 

percent of the bank’s Tier capital, and 12 

percent of the adjusted carrying value of all 

investments in excess of 15 percent of the 

bank’s Tier 1 capital. 

(iii) The total adjusted carrying value of 

any nonfinancial equity investment that is 

subject to deduction under this paragraph is 

excluded from the bank’s risk-weighted 

assets for purposes of computing the 

denominator of the bank’s risk-based capital 

ratio and from total assets for purposes of 

calculating the denominator of the leverage 

ratio.21

(iv) This appendix E establishes minimum 

risk-based capital ratios and banks are at all 

times expected to maintain capital 

commensurate with the level and nature of 

the risks to which they are exposed. The risk 

to a bank from nonfinancial equity 

investments increases with its concentration 

in such investments and strong capital levels 

above the minimum requirements are 

particularly important when a bank has a 

high degree of concentration in nonfinancial 

equity investments (e.g., in excess of 50 

percent of Tier 1 capital). The FDIC intends 

to monitor banks and apply heightened 

supervision to equity investment activities as 

appropriate, including where the bank has a 

high degree of concentration in nonfinancial 

equity investments, to ensure that each bank 

maintains capital levels that are appropriate 

in light of its equity investment activities. 

The FDIC also reserves authority to impose 

a higher capital charge in any case where the 

circumstances, such as the level of risk of the 

particular investment or portfolio of 

investments, the risk management systems of 

the bank, or other information, indicate that 

a higher minimum capital requirement is 

appropriate. 

(d) SBIC investments. (i) No deduction is 

required for nonfinancial equity investments 

that are held by a bank through one or more 

SBICs that are consolidated with the bank or 

in one or more SBICs that are not 

consolidated with the bank to the extent that 

all such investments, in the aggregate, do not 

exceed 15 percent of the bank’s Tier 1 

capital. Any nonfinancial equity investment 

that is held through an SBIC or in an SBIC 

and that is not required to be deducted from 

Tier 1 capital under this section II.B.6(d) will 

be assigned a 100 percent risk-weight and 

included in the bank’s consolidated riskweighted assets.22

(ii) To the extent the adjusted carrying 

value of all nonfinancial equity investments 

that a bank holds through one or more SBICs 

that are consolidated with the bank or in one 

or more SBICs that are not consolidated with 

the bank exceeds, in the aggregate, 15 percent 

of the bank’s Tier 1 capital, the appropriate 

percentage of such amounts (as set forth in 

the table in section II.B.6(c)(i)) must be 

deducted from the bank’s common 

stockholders’ equity in determining the 

bank’s Tier 1 capital. In addition, the 

aggregate adjusted carrying value of all 

nonfinancial equity investments held by a 

bank through a consolidated SBIC and in a 

non-consolidated SBIC (including any 

investments for which no deduction is 

required) must be included in determining, 

for purposes of the table in section 

II.B.6(c)(i), the total amount of nonfinancial 

equity investments held by the bank in 

relation to its Tier 1 capital. 

(e) Transition provisions. No deduction 

under this section II.B.6 is required to be 

made with respect to the adjusted carrying 

value of any nonfinancial equity investment 

(or portion of such an investment) that was 

made by the bank prior to March 13, 2000, 

or that was made by the bank after such date 

pursuant to a binding written commitment 23

entered into prior to March 13, 2000, 

provided that in either case the bank has 

continuously held the investment since the 

relevant investment date.24 For purposes of 

this section II.B.6(e) a nonfinancial equity 

investment made prior to March 13, 2000, 

includes any shares or other interests 


sroberts on PROD1PC70 with PROPOSALS
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25Unrealized gains on available-for-sale equity 

investments may be included in Tier 2 capital to the 

extent permitted under section I–2.A(2)(f) of this 

appendix E. In addition, the net unrealized losses 

on available-for-sale equity investments are 

deducted from Tier 1 capital in accordance with 

section I–2.A(1) of this appendix E. 

received by the bank through a stock split or 

stock dividend on an investment made prior 

to March 13, 2000, provided the bank 

provides no consideration for the shares or 

interests received and the transaction does 

not materially increase the bank’s 

proportional interest in the company. The 

exercise on or after March 13, 2000, of 

options or warrants acquired prior to March 

13, 2000, is not considered to be an 

investment made prior to March 13, 2000, if 

the bank provides any consideration for the 

shares or interests received upon exercise of 

the options or warrants. Any nonfinancial 

equity investment (or portion thereof) that is 

not required to be deducted from Tier 1 

capital under this section II.B.6(e) must be 

included in determining the total amount of 

nonfinancial equity investments held by the 

bank in relation to its Tier 1 capital for 

purposes of the table in section II.B.6(c)(i). In 

addition, any nonfinancial equity investment 

(or portion thereof) that is not required to be 

deducted from Tier 1 capital under this 

section II.B.6(e) will be assigned a 100- 

percent risk weight and included in the 

bank’s consolidated risk-weighted assets. 

(f) Adjusted carrying value. (i) For 

purposes of this section II.B.6, the ‘‘adjusted 

carrying value’’ of investments is the 

aggregate value at which the investments are 

carried on the balance sheet of the bank 

reduced by any unrealized gains on those 

investments that are reflected in such 

carrying value but excluded from the bank’s 

Tier 1 capital and associated deferred tax 

liabilities. For example, for equity 

investments held as available-for-sale (AFS), 

the adjusted carrying value of the 

investments would be the aggregate carrying 

value of those investments (as reflected on 

the consolidated balance sheet of the bank) 

less any unrealized gains on those 

investments that are included in other 

comprehensive income and not reflected in 

Tier 1 capital, and associated deferred tax 

liabilities.25

(ii) As discussed above with respect to 

consolidated SBICs, some equity investments 

may be in companies that are consolidated 

for accounting purposes. For investments in 

a nonfinancial company that is consolidated 

for accounting purposes under generally 

accepted accounting principles, the bank’s 

adjusted carrying value of the investment is 

determined under the equity method of 

accounting (net of any intangibles associated 

with the investment that are deducted from 

the bank’s core capital in accordance with 

section I–2.B(a)(i) of this appendix E). Even 

though the assets of the nonfinancial 

company are consolidated for accounting 

purposes, these assets (as well as the credit 

equivalent amounts of the company’s offbalance sheet items) should be excluded from 

the bank’s risk-weighted assets for regulatory 

capital purposes. 

(g) Equity investments. For purposes of this 

section II.B.6, an equity investment means 

any equity instrument (including common 

stock, preferred stock, partnership interests, 

interests in limited liability companies, trust 

certificates and warrants and call options that 

give the holder the right to purchase an 

equity instrument), any equity feature of a 

debt instrument (such as a warrant or call 

option), and any debt instrument that is 

convertible into equity where the instrument 

or feature is held under one of the legal 

authorities listed in section II.B.6(b) of this 

appendix E. An investment in any other 

instrument (including subordinated debt) 

may be treated as an equity investment if, in 

the judgment of the FDIC, the instrument is 

the functional equivalent of equity or exposes 

the bank to essentially the same risks as an 

equity instrument. 

7. Asset-backed commercial paper 

programs. (a) An asset-backed commercial 

paper (ABCP) program means a program that 

primarily issues externally rated commercial 

paper backed by assets or other exposures 

held in a bankruptcy-remote, special purpose 

entity. 

(b) A bank that qualifies as a primary 

beneficiary and must consolidate an ABCP 

program that is defined as a variable interest 

entity under GAAP may exclude the 

consolidated ABCP program assets from riskweighted assets provided that the bank is the 

sponsor of the ABCP program. If a bank 

excludes such consolidated ABCP program 

assets, the bank must assess the appropriate 

risk-based capital charge against any 

exposures of the bank arising in connection 

with such ABCP programs, including direct 

credit substitutes, recourse obligations, 

residual interests, liquidity facilities, and 

loans, in accordance with sections II.B.5, II.C, 

and II.D of this appendix E. 

(c) If a bank has multiple overlapping 

exposures (such as a program-wide credit 

enhancement and multiple pool-specific 

liquidity facilities) to an ABCP program that 

is not consolidated for risk-based capital 

purposes, the bank is not required to hold 

capital under duplicative risk-based capital 

requirements under this appendix E against 

the overlapping position. Instead, the bank 

should apply to the overlapping position the 

applicable risk-based capital treatment that 

results in the highest capital charge. 

8. Securitizations of revolving credit with 

early amortization provisions. 

(a) Definitions. For purposes of this section 

II.B.8, the following definitions will apply: 

(i) 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 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). 

(ii) Excess spread means gross finance 

charge collections and other income received 

by a trust or special purpose entity minus 

interest paid to the investors in the 

securitization exposures, servicing fees, 

charge-offs, and other similar trust or special 

purpose entity expenses. 

(iii) Excess spread trapping point means 

the point at which the bank is required by 

the documentation governing a securitization 

to divert and hold excess spread in a spread 

or reserve account, expressed as a percent. 

(iv) Investors’ interest is the total 

securitization exposure represented by 

securities issued by a trust or special purpose 

entity to investors. 

(v) Revolving Credit means a line of credit 

where the borrower is permitted to vary both 

the drawn amount and the amount of 

repayment within an agreed limit. 

(b) Capital charge for revolving 

securitizations with an early amortizations 

trigger. A bank that securitizes revolving 

credits where the securitization structure 

contains an early amortization provision 

must maintain risk-based capital against the 

investors’ interest as required under this 

section. 

(c) Calculation. Capital for securitizations 

of revolving credit exposures that incorporate 

early-amortization provisions will be 

assessed based on a comparison of the 

securitizations’ three-month average excess 

spread against the excess spread trapping 

point. 

(i) To calculate the securitization’s excess 

spread trapping point ratio, a bank must first 

calculate the three-month average of: 

(A) The dollar amount of excess spread 

divided by 

(B) The outstanding principal balance of 

the underlying pool of exposures at the end 

of each of the prior three months. 

(ii) This annualized three-month average of 

excess spread is then divided by the excess 

spread trapping point that is required by the 

securitization structure. 

(iii) The excess spread trapping point ratio 

is compared to the ratios contained in Table 

E to determine the appropriate conversion 

factor to apply to the investors’ interest. 

(iv) The amount of investors’ interest after 

conversion is then assigned capital based on 

the underlying obligor, collateral, or 

guarantor. 

(d) Default for certain securitizations. For 

purposes of section II.B.8 of this appendix E, 

for securitizations that do not require excess 

spread to be trapped, or that specify the 

trapping points based primarily on the 

performance measures other than the threemonth average excess spread, the excess 

spread trapping point is 4.5. 

(e) Limit. For a bank subject to the early 

amortization requirements in this section 

II.B.8 of appendix E, the aggregate risk-based 

capital requirement for all of the bank’s 

exposures to a securitization of revolving 

credit is limited to the greater of the riskbased capital requirement for residual 

interests (as calculated under section II.B.5 of 

this appendix E); or the risk-based capital 

requirement for the underlying securitized 

assets calculated as if the bank continued to 

hold the assets on its balance sheet. 


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26 In addition, certain items receive a dollar-fordollar capital treatment under section II.B.5 of this 

appendix E. 

27A central government is defined to include 

departments and ministries, including the central 

bank, of the central government. The U.S. central 

bank includes the 12 Federal Reserve banks. The 

definition of central government does not include 

state, provincial or local governments or 

commercial enterprises owned by the central 

government. In addition, it does not include local 

government entities or commercial enterprises 

whose obligations are guaranteed by the central 

government. OECD central governments are defined 

as central governments of the OECD-based group of 

countries. Non-OECD central governments are 

defined as central governments of countries that do 

not belong to the OECD-based group of countries. 

28All other bullion holdings are to be assigned to 

the 100 percent risk weight category. 

29For purposes of determining the appropriate 

risk weights for this risk-based capital framework, 

the terms ‘‘claims’’ and ‘‘securities’’ refer to loans 

or other debt obligations of the entity on whom the 

claim is held. Investments in the form of stock or 

equity holdings in commercial or financial firms are 

generally assigned to the 100 percent risk category. 

30For risk-based capital purposes U.S. 

Government agency is defined as an instrumentality 

of the U.S. Government whose debt 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. These agencies 

include the Government National Mortgage 

Association (GNMA), the Veterans Administration 

(VA), the Federal Housing Administration (FHA), 

the Farmers Home Administration (FHA), the 

Export-Import Bank (Exim Bank), the Overseas 

Private Investment Corporation (OPIC), the 

Commodity Credit Corporation (CCC), and the 

Small Business Administration (SBA). U.S. 

Government agencies generally do not directly issue 

securities to the public; however, a number of U.S. 

Government agencies, such as GNMA, guarantee 

securities that are publicly held. 

31With regard to securities firms incorporated in 

the United States, qualifying securities firms are 

those securities firms that are broker-dealers 

registered with the Securities and Exchange 

Commission (SEC) and are in compliance with the 

SEC’s net capital rule, 17 CFR 240.15c3–1. With 

regard to securities firms incorporated in any other 

country in the OECD-based group of countries, 

qualifying securities firms are those securities firms 

that a bank is able to demonstrate are subject to 

consolidated supervision and regulation (covering 

their direct and indirect subsidiaries, but not 

necessarily their parent organizations) comparable 

to that imposed on banks in OECD countries. Such 

regulation must include risk-based capital 

requirements comparable to those applied to banks 

under the Accord on International Convergence of 

Capital Measurement and Capital Standards (1988, 

as amended in 1998) (Basel Accord). Claims on a 

qualifying securities firm that are instruments the 

firm, or its parent company, uses to satisfy its 

applicable capital requirements are not eligible for 

this risk weight and are generally assigned to at 

least a 100 percent risk weight. In addition, certain 

claims on qualifying securities firms are eligible for 

a zero percent risk weight if the claims are 

collateralized by cash on deposit in the lending 

bank or by securities issued or guaranteed by the 

United States (including U.S. government agencies), 

provided that a positive margin of collateral is 

required to be maintained on such a claim on a 

daily basis, taking into account any change in a 

bank’s exposure to the obligor or counterparty 

under the claim in relation to the market value of 

the collateral held in support of the claim. 

32Claims guaranteed by U.S. depository 

institutions include risk participations in both 

bankers acceptances and standby letters of credit, 

as well as participations in commitments, that are 

conveyed to other U.S. depository institutions. 

33U.S. depository institutions are defined to 

include branches (foreign and domestic) of federally 

insured banks and depository institutions chartered 

and headquartered in the 50 states of the United 

States, the District of Columbia, Puerto Rico, and 

U.S. territories and possessions. The definition 

encompasses banks, mutual or stock savings banks, 

savings or building and loan associations, 

cooperative banks, credit unions, international 

banking facilities of domestic depository 

institutions, and U.S.-chartered depository 

institutions owned by foreigners. However, this 

definition excludes branches and agencies of 

foreign banks located in the U.S. and bank holding 

companies. 

34Foreign banks are distinguished as either OECD 

banks or non-OECD banks. OECD banks include 

banks and their branches (foreign and domestic) 

organized under the laws of countries (other than 

the U.S.) that belong to the OECD-based group of 

countries. Non-OECD banks include banks and their 

branches (foreign and domestic) organized under 

the laws of countries that do not belong to the 

OECD-based group of countries. For risk-based 

capital purposes, a bank is defined as an institution 

that engages in the business of banking; is 

recognized as a bank by the bank supervisory or 

monetary authorities of the country of its 

organization or principal banking operations; 

receives deposits to a substantial extent in the 

regular course of business; and has the power to 

accept demand deposits. 

35Long-term claims on, or guaranteed by, nonOECD banks are assigned to the 100 percent risk 

weight category, as are holdings of bank-issued 

securities that qualify as capital of the issuing banks 

for risk-based capital purposes. 

36For risk-based capital purposes, U.S. 

Government-sponsored agencies are defined as 

agencies originally 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. These agencies include the 

Federal Home Loan Mortgage Corporation 

(FHLMC), the Federal National Mortgage 

Association (FNMA), the Farm Credit System, the 

Federal Home Loan Bank System, and the Student 

Loan Marketing Association (SLMA). For risk-based 

capital purposes, claims on U.S. Governmentsponsored agencies also include capital stock in a 

Federal Home Loan Bank that is held as a condition 

of membership in that bank. 

37For risk-based capital purposes, a conditional 

guarantee is deemed to exist if the validity of the 

TABLE E.—EARLY AMORTIZATION

CREDIT CONVERSION FACTORS

Excess spread trapping point 

ratio 

Credit conversion factor 

(CCF) 

(percent) 

133.33 percent of trapping 

point or more ......................... 0 

less than 133.33 percent to 100 

percent of trapping point ....... 5 

less than 100 percent to 75 

percent of trapping point ....... 15 

less than 75 percent to 50 percent of trapping point ............ 50 

Less than 50 percent of trapping point .............................. 100 

C. Risk Weights for Balance Sheet Assets (See 

Table J) 

The risk-based capital framework contains 

eight risk weight categories—0 percent, 20 

percent, 35 percent, 50 percent, 75 percent, 

100 percent, 150 percent, and 200 percent.26

In general, if a particular item can be placed 

in more than one risk category, it is assigned 

to the category that has the lowest risk 

weight. An explanation of the components of 

each category follows: 

1—Zero Percent Risk Weight 

(a) This category includes cash (domestic 

and foreign) owned and held in all offices of 

the bank or in transit; balances due from 

Federal Reserve banks and central banks in 

other OECD countries; 27 and gold bullion 

held in the bank’s own vaults or in another 

bank’s vaults on an allocated basis, to the 

extent it is offset by gold bullion liabilities.28

(b) The zero percent risk category also 

includes direct claims 29 (including 

securities, loans, and leases) on, and the 

portions of claims that are unconditionally 

guaranteed by the United States and U.S. 

Government agencies.30 Federal Reserve 

Bank stock also is included in this category. 

(c) This category also includes claims on, 

and claims guaranteed by, qualifying 

securities firms 31 incorporated in the United 

States or other members of the OECD-based 

group of countries that are collateralized by 

cash on deposit in the lending bank or by 

securities issued or guaranteed by the United 

States (including U.S. government Agencies) 

or OECD central governments, provided that 

a positive margin of collateral is required to 

be maintained on such a claim on a daily 

basis, taking into account any change in a 

bank’s exposure to the obligor or 

counterparty under the claim in relation to 

the market value of the collateral held in 

support of the claim. 

(d) As provided in sections II.B.3 and II.C.9 

of this appendix E, this category also 

includes securities issued by and other 

claims on a sovereign rated highest 

investment grade, e.g., AAA, by a NRSRO, in 

the case of long-term ratings, or highest rating 

category, e.g., A–1, P–1, in the case of shortterm ratings; and claims guaranteed by a 

sovereign rated highest investment grade by 

a NRSRO. 

2—20 Percent Risk Weight 

(a) This category includes short-term 

claims (including demand deposits) on, and 

portions of short-term claims that are 

guaranteed 32 by, U.S. depository 

institutions 33 and foreign banks; 34 portions 

of claims collateralized by cash held in a 

segregated deposit account of the lending 

bank; cash items in process of collection, 

both foreign and domestic; and long-term 

claims on, and portions of long-term claims 

guaranteed by, U.S. depository institutions 

and OECD banks.35

(b) This category also includes claims on, 

or portions of claims guaranteed by U.S. 

Government-sponsored agencies; 36 and 

portions of claims (including repurchase 

agreements) collateralized by securities 

issued or guaranteed by the United States, 

U.S. Government agencies, or U.S. 

Government-sponsored agencies. Also 

included in the 20 percent risk category are 

portions of claims that are conditionally 

guaranteed by U.S. Government agencies or 

U.S. Government-sponsored agencies.37


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guarantee by the U.S. Government agency is 

dependent upon some affirmative action (e.g., 

servicing requirements on the part of the 

beneficiary of the guarantee). Portions of claims that 

are unconditionally guaranteed by U.S. Government 

agencies are assigned to the zero percent risk 

category. 

38Claims on, or guaranteed by, states or other 

political subdivisions of countries that do not 

belong to the OECD-based group of countries are to 

be placed in the 100 percent risk weight category. 

39 In addition, such loans must have been 

approved in accordance with prudent underwriting 

standards, including standards relating to the loan 

amount as a percent of the appraised value of the 

property, and the loans must not be past due 90 

days or more or carried in nonaccrual status. The 

types of loans that qualify as loans secured by oneto-four family residential properties are listed in the 

instructions for preparation of the Consolidated 

Reports of Condition and Income. 

40The types of loans that qualify as loans secured 

by multifamily residential properties are listed in 

the instructions for preparation of the Consolidated 

Reports of Condition and Income. In addition, from 

the stand point of the selling bank, when a 

multifamily residential property loan is sold subject 

to a pro rata loss sharing arrangement which 

provides for the purchaser of the loan to share in 

any loss incurred on the loan on a pro rata basis 

with the selling bank when that portion of the loan 

is not subject to the risk-based capital standards. In 

connection with sales of multifamily residential 

property loans in which the purchaser of a loan 

shares in any loss incurred on the loan with the 

selling bank on other than a pro rata basis, the 

selling bank must treat these other loss sharing 

arrangements in accordance with section II.B.5 of 

this appendix E. 

41At the origination of a loan to purchase an 

existing property, the term ‘‘value’’ means the lesser 

of the actual acquisition cost or the estimate of 

value set forth in an appraisal or evaluation, 

whichever may be appropriate. 

42 In the case where the existing owner of a 

multifamily residential property refinances a loan 

Continued 

(c) General obligation claims on, or 

portions of claims guaranteed by, the full 

faith and credit of states or other political 

subdivisions of the United States or other 

countries of the OECD-based group are also 

assigned to this 20 percent risk category, as 

well as portions of claims guaranteed by such 

organizations or collateralized by their 

securities.38

(d) As provided in sections II.B.2 and II.B.5 

of this appendix E, this category also 

includes recourse obligations, direct credit 

substitutes, residual interests (other than a 

credit-enhancing interest-only strip) and 

asset- or mortgage-backed securities rated in 

the highest or second highest investment 

grade category, e.g., AAA, AA, in the case of 

long-term ratings, or the highest rating 

category, e.g., A–1, P–1, in the case of shortterm ratings. 

(e) As provided in sections II.B.2, II.B.3, 

and II.C.9 of this appendix E, this category 

also includes securities issued by and other 

claims on a sovereign rated second-highest or 

third-highest investment grade by a NRSRO, 

e.g. AA or A, in the case of long-term ratings, 

or second-highest investment grade, e.g. A–

2, P–2, in the case of short-term ratings; 

claims guaranteed by a sovereign rated 

second-highest or third-highest investment 

grade by a NRSRO; and claims and portions 

of claims collateralized by securities issued 

by a sovereign rated second-highest or thirdhighest investment grade by a NRSRO, in the 

case of long-term ratings, or second-highest 

investment grade, in the case of short-term 

ratings. 

(f) As provided in sections II.B.2, II.B.3, 

and II.C.9 of this appendix E, this category 

also includes securities issued by and other 

claims on a non-sovereign rated highest or 

second-highest investment grade by a 

NRSRO, e.g. AAA or AA, in the case of longterm ratings, or highest investment grade, e.g. 

A–1, P–1, in the case of short-term ratings; 

claims guaranteed by a non-sovereign whose 

long-term senior debt is rated highest or 

second-highest investment grade by a 

NRSRO; and claims and portions of claims 

collateralized by securities issued by a nonsovereign rated highest or second-highest 

investment grade by a NRSRO, in the case of 

long-term ratings, or highest-investment 

grade, in the case of short-term ratings. 

(g) As provided in section II.C.9(b) of this 

appendix E, this category also includes 

certain one-to-four family residential 

mortgages. 

3—35 Percent Risk Weight 

(a) As provided in sections II.B.2 and II.B.5 

of this appendix E, this category includes 

recourse obligations, direct credit substitutes, 

residual interests (other than a creditenhancing interest-only strip) and asset- or 

mortgage-backed securities rated thirdhighest investment grade, e.g., A, in the case 

of long-term ratings, and second-highest 

investment grade, e.g. A–2, P–2, in the case 

of short-term ratings. 

(b) As provided in sections II.B.2, II.B.3, 

and II.C.9 of this appendix E, this category 

also includes securities issued by and other 

claims on a sovereign rated lowestinvestment grade plus by a NRSRO, e.g. 

BBB+, in the case of long-term ratings; claims 

guaranteed by a sovereign rated lowestinvestment grade plus by a NRSRO; and 

claims and portions of claims collateralized 

by securities issued by a sovereign rated 

lowest-investment grade plus by a NRSRO, in 

the case of long-term ratings. 

(c) As provided in sections II.B.2, II.B.3, 

and II.C.9 of this appendix E, this category 

also includes securities issued by and other 

claims on a non-sovereign rated third-highest 

investment grade by a NRSRO, e.g. A, in the 

case of long-term ratings, or second-highest 

investment grade, e.g. A–2, P–2, in the case 

of short-term ratings; claims guaranteed by a 

non-sovereign whose long-term senior debt is 

rated third-highest investment grade by a 

NRSRO; and claims and portions of claims 

collateralized by securities issued by a nonsovereign rated third-highest investment 

grade by a NRSRO, in the case of long-term 

ratings, or second-highest investment grade 

in the case of short-term ratings. 

(d) As provided in section II.C.9(b) of this 

appendix E, the 35 percent risk-weight 

category also includes certain one-to-four 

family residential mortgages. 

4—50 Percent Risk Weight 

(a) This category includes loans, secured 

by one-to-four family residential properties, 

to builders with substantial project equity for 

the construction of one-to-four family 

residences that have been presold under firm 

contracts to purchasers who have obtained 

firm commitments for permanent qualifying 

mortgage loans and have made substantial 

earnest money deposits.39 Such loans to 

builders will be considered prudently 

underwritten only if the bank has obtained 

sufficient documentation that the buyer of 

the home intends to purchase the home (i.e., 

has a legally binding written sales contract) 

and has the ability to obtain a mortgage loan 

sufficient to purchase the home (i.e., has a 

firm written commitment for permanent 

financing of the home upon completion), 

provided the following criteria are met: 

(i) The purchaser is an individual(s) who 

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 homes for speculative 

purposes; 

(ii) The builder must incur at least the first 

ten percent of the direct costs (i.e., actual 

costs of the land, labor, and material) before 

any drawdown is made under the 

construction loan and the construction loan 

may not exceed 80 percent of the sales price 

of the presold home; 

(iii) The purchaser has made a substantial 

‘‘earnest money deposit’’ of no less than three 

percent of the sales price of the home and the 

deposit must be subject to forfeiture if the 

purchaser terminates the sales contract; and 

(iv) The earnest money deposit must be 

held in escrow by the bank financing the 

builder or by an independent party in a 

fiduciary capacity and the escrow agreement 

must provide that, in the event of default 

arising from the cancellation of the sales 

contract by the buyer, the escrow funds must 

first be used to defray any costs incurred by 

the bank. 

(b) This category also includes loans fully 

secured by first liens on multifamily 

residential properties, 40 provided that: 

(i) The loan amount does not exceed 80 

percent of the value 41 of the property 

securing the loan as determined by the most 

current appraisal or evaluation, whichever 

may be appropriate (75 percent if the interest 

rate on the loan changes over the term of the 

loan); 

(ii) For the property’s most recent fiscal 

year, the ratio of annual net operating income 

generated by the property (before payment of 

any debt service on the loan) to annual debt 

service on the loan is not less than 120 

percent (115 percent if the interest rate on the 

loan changes over the term of the loan) or in 

the case of a property owned by a cooperative 

housing corporation or nonprofit 

organization, the property generates 

sufficient cash flow to provide comparable 

protection to the bank; 

(iii) Amortization of principal and interest 

on the loan occurs over a period of not more 

than 30 years; 

(iv) The minimum original maturity for 

repayment of principal on the loan is not less 

than seven years; 

(v) All principal and interest payments 

have been made on a timely basis in 

accordance with the terms of the loan for at 

least one year before the loan is placed in this 

category; 42


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on that 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 that loan for at least the preceding year. 

The new loan must meet all of the other eligiblity 

criteria in order to qualify for a 50 percent risk 

weight. 

43Such assets include all non-local currency 

claims on, and the portions of claims that are 

guaranteed by, non-OECD central governments that 

exceed the local currency liabilities held by the 

bank. 

44Customer liabilities on acceptances outstanding 

involving non-standard risk claims, such as claims 

on U.S. depository institutions, are assigned to the 

risk category appropriate to the identity of the 

obligor or, if relevant, the nature of the collateral 

or guarantees backing the claims. Portions of 

acceptances conveyed as risk participations to U.S. 

depository institutions or foreign banks are assigned 

to the 20 percent risk category appropriate to shortterm claims guaranteed by U.S. depository 

institutions and foreign banks. 

45This category includes one-to-four family 

residential pre-sold construction loans for a 

residence whose purchase contract is cancelled. 

(vi) The loan is not 90 days or more past 

due or carried in nonaccrual status; and 

(vii) The loan has been made in accordance 

with prudent underwriting standards. 

(c) This category also includes revenue 

(non-general obligation) bonds or similar 

obligations, including loans and leases, that 

are obligations of states or political 

subdivisions of the United States or other 

OECD countries, but for which the 

government entity is committed to repay the 

debt with revenues from the specific projects 

financed, rather than from general tax funds 

(e.g., municipal revenue bonds). 

(d) As provided in section II.B.2 and II.B.5 

of this appendix E, this category also 

includes recourse obligations, direct credit 

substitutes, residual interests (other than a 

credit-enhancing interest-only strip) and 

asset- or mortgage-backed securities rated 

lowest investment grade plus, e.g., BBB+, in 

the case of long-term ratings. 

(e) As provided in sections II.B.2, II.B.3, 

and II.C.9 of this appendix E, this category 

also includes securities issued by and other 

claims on a sovereign rated lowest 

investment grade naught by a NRSRO, e.g. 

BBB, in the case of long-term ratings, or 

lowest investment grade, e.g. A–3, P–3, in the 

case of short-term ratings; claims guaranteed 

by a sovereign rated lowest investment grade 

naught by a NRSRO; and claims and portions 

of claims collateralized by securities issued 

by a sovereign rated at least lowest 

investment grade naught by a NRSRO, in the 

case of long-term ratings, or lowest 

investment grade, in the case of short-term 

ratings. 

(f) As provided in sections II.B.2, II.B.3, 

and II.C.9 of this appendix E, this category 

also includes securities issued by and other 

claims on a non-sovereign rated lowest 

investment grade plus by a NRSRO, e.g. 

BBB+, in the case of long-term ratings; claims 

guaranteed by a non-sovereign whose longterm senior debt is rated lowest investment 

grade plus by a NRSRO; and claims and 

portions of claims collateralized by securities 

issued by a non-sovereign rated lowest 

investment grade plus by a NRSRO, in the 

case of long-term ratings. 

(g) As provided in section II.C.9(b) of this 

appendix E, the fifty percent risk-weight 

category also includes certain one-to-four 

family residential mortgages. 

5—75 Percent Risk Weight 

(a) As provided in section II.B.2 and II.B.5 

of this appendix E, this category also 

includes recourse obligations, direct credit 

substitutes, residual interests (other than a 

credit-enhancing interest-only strip) and 

asset- or mortgage-backed securities rated 

lowest investment grade naught, e.g., BBB, in 

the case of long-term ratings. 

(b) As provided in sections II.B.2, II.B.3, 

and II.C.9 of this appendix E, this category 

also includes securities issued by and other 

claims on a sovereign rated lowest 

investment grade negative or one category 

below investment grade plus and naught by 

a NRSRO, e.g. BBB-, BB+, or BB, in the case 

of long-term ratings; claims guaranteed by a 

sovereign rated lowest investment grade 

negative by a NRSRO, in the case of longterm ratings; and claims and portions of 

claims collateralized by securities issued by 

a sovereign rated lowest investment grade 

negative by a NRSRO, in the case of longterm ratings. 

(c) As provided in sections II.B.2, II.B.3, 

and II.C.9 of this appendix E, this category 

also includes certain securities issued by and 

other claims on a non-sovereign rated lowest 

investment grade naught by a NRSRO, e.g. 

BBB, in the case of long-term ratings, or 

lowest investment grade, A–3, P–3, in the 

case of short-term ratings; claims guaranteed 

by a non-sovereign whose long-term debt is 

rated lowest investment grade naught by a 

NRSRO; and claims and portions of claims 

collateralized by securities issued by a nonsovereign rated lowest investment grade 

naught by a NRSRO, in the case of long-term 

ratings, or lowest investment grade, in the 

case of short-term ratings. 

(d) As provided in section II.C.9(b), the 

seventy-five percent risk-weight category also 

includes certain one-to-four family 

residential mortgages. 

6—100 Percent Risk Weight 

(a) All assets not included in the above 

categories in section II.C of this appendix E, 

except the assets specifically included in the 

150 or 200 percent categories below in 

section II.C of this appendix E and the assets 

that are otherwise risk weighted in 

accordance with section II.B or II.C.9 of this 

appendix E, are assigned to this category, 

which comprises standard risk assets. 

(b) This category includes: 

(i) Long-term claims on, and the portions 

of long-term claims that are guaranteed by, 

non-OECD banks;43

(ii) Claims on commercial firms owned by 

the public sector; 

(iii) Customer liabilities to the bank on 

acceptances outstanding involving standard 

risk claims;44

(iv) Investments in fixed assets, premises, 

and other real estate owned; 

(v) Common and preferred stock of 

corporations, including stock acquired for 

debts previously contracted; 

(vi) Commercial and consumer loans 

(except rated loans, loans to sovereigns, and 

mortgage loans as provided under section 

II.C.9 of this appendix E and those loans 

assigned to lower risk categories due to 

recognized guarantees or collateral)45; 

(vii) As provided in sections II.B.2 and 

II.B.5 of this appendix E, recourse 

obligations, direct credit substitutes, residual 

interests (other than a credit-enhancing 

interest-only strip) and asset-or mortgagebacked securities rated lowest investment 

grade negative, e.g., BBB-, as well as certain 

positions (but not residual interests) which 

the bank rates pursuant to section II.B.5(g) of 

this appendix E; 

(viii) Industrial-development bonds and 

similar obligations issued under the auspices 

of states or political subdivisions of the 

OECD-based group of countries for the 

benefit of a private party or enterprise where 

that party or enterprise, not the government 

entity, is obligated to pay the principal and 

interest; and 

(ix) Stripped mortgage-backed securities 

and similar instruments, such as interestonly strips that are not credit-enhancing and 

principal-only strips. 

(x) Claims representing capital of a 

qualifying securities firm. 

(c) The following assets also are assigned 

a risk weight of 100 percent if they have not 

already been deducted from capital: 

investments in unconsolidated companies, 

joint ventures, or associated companies; 

instruments that qualify as capital issued by 

other banks; deferred tax assets; and 

mortgage servicing assets, nonmortgage 

servicing assets, and purchased credit card 

relationships. 

(d) As provided in sections II.B.2, II.B.3, 

and II.C.9 of this appendix E, this category 

also includes securities issued by and other 

claims on a sovereign rated at least one 

category below investment grade negative by 

a NRSRO, e.g. BB-, in the case of long-term 

ratings, or unrated, in the case of short-term 

ratings. 

(e) As provided in sections II.B.2, II.B.3, 

and II.C.9 of this appendix E, this category 

also includes certain securities issued by and 

other claims on a non-sovereign rated lowest 

investment grade negative by a NRSRO, e.g. 

BBB-, in the case of long-term ratings, or 

unrated, in the case of short-term ratings; 

claims guaranteed by a non-sovereign whose 

long-term debt is rated lowest investment 

grade negative by a NRSRO; and claims and 

portions of claims collateralized by securities 

issued by a non-sovereign rated lowest 

investment grade negative by a NRSRO, in 

the case of long-term ratings. 

(f) As provided in section II.C.9(b) of this 

appendix E, the 100 percent risk-weight 

category also includes certain one-to-four 

family residential mortgages. 

7—150 Percent Risk Weight 

(a) As provided in sections II.B.2, II.B.3, 

and II.C.9 of this appendix E, this category 

includes securities issued by and other 

claims on a sovereign rated two or more 

categories below investment grade by a 

NRSRO, e.g. B or CCC, in the case of longterm ratings. 

(b) As provided in sections II.B.2, II.B.3, 

and II.C.9 of this appendix E, this category 


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46Except for loans to sovereigns, loans that are 

not externally rated are risk weighted under section 

II.C to appendix A to part 325. 

47Qualifying one-to-four family residential presold construction loans are risk weighted at 50% 

under section II.C.4, unless the purchase contract is 

cancelled, in which case, they are risk weighted at 

100% under section II.C.6 of this appendix E. Loans 

that qualify as mortgages, including junior lien 

mortgages, that are secured by 1- to 4-family 

residential properties are listed in the instructions 

to the commercial bank Call Report. This section 

II.C.9(b) does not apply to transactions where a lien 

on a one-to-four family residential property has 

been taken as collateral solely through an 

abundance of caution and where, as a consequence, 

the terms have not been made more favorable than 

they would have been in the absence of the lien. 

In such as case, the loan would not be considered 

to be secured by real estate in the Call Reports. 

also includes certain securities issued by and 

other claims on a non-sovereign rated one 

category below investment grade plus and 

naught by a NRSRO, e.g. BB+ or BB, in the 

case of long-term ratings. 

(c) As provided in section II.C.9(b) of this 

appendix E, the 150 percent risk-weight 

category also includes certain one-to-four 

family residential mortgages. 

8—200 Percent Risk Weight 

This category includes: 

(a) As provided in sections II.B.2 and II.B.5 

of this appendix E, recourse obligations, 

direct credit substitutes, residual interests 

(other than a credit-enhancing interest-only 

strip) and asset-or mortgage-backed securities 

rated one category below investment grade 

plus, naught, and negative, e.g. BB+, BB, or 

BB-, in the case of long-term ratings. 

(b) As provided in sections II.B.2, II.B.3, 

and II.C.9 of this appendix E, this category 

also includes securities issued by and other 

claims on an unrated sovereign. 

(c) As provided in sections II.B.2, II.B.3, 

and II.C.9 of this appendix E, this category 

also includes certain securities issued by and 

other claims on a non-sovereign rated one 

category below investment grade and below 

by a NRSRO, e.g. BB+, BB, BB-, B, CCC, and 

unrated, in the case of long-term ratings. 

(d) A position (but not a residual interest) 

in a securitization or structured finance 

program that is not rated by an NRSRO for 

which the bank determines that the credit 

risk is equivalent to one category below 

investment grade, e.g., BB, to the extent 

permitted in section II.B.5(g) of this appendix 

E. 

9—Risk Weights for Certain Externally Rated 

Exposures and Certain Residential Mortgages 

(a) Externally Rated Exposures. (i) Banks 

must assign an exposure to a sovereign or 

non-sovereign to the appropriate risk weight 

category in accordance with Tables F1 and 

F2 of this appendix E. Such exposures 

include but are not limited to: sovereign 

bonds (which may be based on the external 

rating of the issuing country or of the issued 

bond); all loans to sovereigns, including 

unrated loans; securities issued by 

multilateral lending institutions or regional 

development banks; corporate debt 

obligations (senior and subordinated); rated 

loans 46; and commercial paper. 

(ii) If a claim or exposure has two or more 

external ratings, the bank must use the lowest 

assigned external rating to risk weight the 

claim in accordance with Tables F1 and F2 

of this appendix E, and that external rating 

must apply to the claim or exposure in its 

entirety. Thus, for banks that hold split or 

partially-rated instruments, the risk weight 

that corresponds to the lowest component 

rating will apply to the entire exposure. For 

example, a purchased subordinated security 

where the principal component is rated BBB, 

but the interest component is rated B, will be 

subject to the gross-up treatment accorded to 

residual interests rated B or lower. Similarly, 

if a portion of an instrument is unrated, the 

entire exposure will be treated as if it were 

unrated. 

(iii) For exposures to sovereigns, the bank 

must first look to the rating (if any) on the 

issue to risk weight the claim. If the issue is 

unrated, the bank must use the issuer rating 

to determine the appropriate risk weight. 

(iv) The FDIC reserves the authority to 

override the use of certain external ratings or 

the external ratings on certain instruments, 

either on a case-by-case basis or through 

broader supervisory policy, if necessary or 

appropriate to address the risk that an 

instrument or issuer poses to banks. 

TABLE F1.—RISK WEIGHTS BASED ON LONG-TERM EXTERNAL RATINGS

Long-term rating category Examples 

Non-sovereign 

risk weight 

(percent) 

Sovereign risk 

weight 

(percent) 

Highest investment grade rating 1 ............................................................................................. AAA .................. 20 0 

Second-highest investment grade rating .................................................................................. AA ..................... 20 20 

Third-highest investment grade rating ...................................................................................... A ....................... 35 20 

Lowest-investment grade rating—plus ..................................................................................... BBB+ ................ 50 35 

Lowest-investment grade rating—naught ................................................................................. BBB .................. 75 50 

Lowest-investment grade rating—negative .............................................................................. BBB¥ ............... 100 75 

One category below investment grade—plus & naught ........................................................... BB+, BB ............ 150 75 

One category below investment grade—negative ................................................................... BB¥ ................. 200 100 

Two or more categories below investment grade .................................................................... B, CCC ............. 200 150 

Unrated (excludes unrated loans to non-sovereigns) 2 ............................................................ n/a .................... 200 200 

1 Long-term claims collateralized by AAA-rated sovereign debt would be assigned to the 20 percent risk weight category. 

2 Unrated loans to non-sovereigns are risk weighted in accordance with section II.C of appendix A to part 325. 

TABLE F2.—RISK WEIGHTS BASED ON SHORT-TERM EXTERNAL RATINGS

Short-term rating category Examples 

Non-sovereign 

risk weight 

(percent) 

Sovereign risk 

weight 

(percent) 

Highest investment grade rating 1 ............................................................................................. A–1, P–1 .......... 20 0 

Second-highest investment grade rating .................................................................................. A–2, P–2 ........... 35 20 

Lowest investment grade rating ............................................................................................... A–3, P–3 ........... 75 50 

Unrated ..................................................................................................................................... n/a.

1Short-term claims collateralized by A1/P1 rated sovereign debt would be assigned to the 20 percent risk weight category. 

(b) Residential Mortgages. (i) This section 

II.C.9(b) (including Tables G1, G2, and G3) 

applies to all residential mortgages secured 

by a lien on a one-to-four family residential 

property, except for certain one-to-four 

family residential pre-sold construction 

loans, and certain one-to-four family 

residential pre-sold construction loans for 

residences for which the purchase contract is 

cancelled.47 The risk weights described in 

Tables G1 and G2 of this section II.C.9(b) are 

minimum risk weights. For a mortgage to 

qualify for these risk weights, it must meet 

certain minimum criteria: Be fully secured by 

a lien on a one-to four-family residential 


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48For purposes of this section II.C.9(b), the value 

of the property equals the lower of the purchase 

price for the property or the value at origination. 

The value of the property must be based on an 

appraisal or evaluation of the property in 

conformance with the FDIC’s appraisal regulations 

and real estate lending guidelines. See 12 CFR part 

323, 12 CFR part 365. 

49The CLTV represents the aggregate principle 

outstanding on a first lien mortgage and all 

applicable junior lien mortgages divided by the 

appraised value of the property at origination of the 

first lien. 

50See 12 CFR part 323, 12 CFR part 365. 

51As the loan balance increases through negative 

amortization, the bank must recalculate the 

outstanding loan amount using the original loan 

amount plus any increases to the loan amount due 

to negative amortization. 

52See footnote 48. 

53The sufficiency of collateral and guarantees for 

off-balance-sheet items is determined by the market 

value of the collateral or the amount of the 

guarantee in relation to the face amount of the item, 

except for derivative contracts, for which this 

determination is generally made in relation to the 

credit equivalent amount. Collateral and guarantees 

are subject to the same provisions noted under 

section II.B of this appendix E. 

54Forward forward deposits accepted are treated 

as interest rate contracts. 

property, either owner-occupied or rented, be 

prudently underwritten, and not be 90 days 

or more past due or carried in nonaccrual 

status. Mortgages that do not meet these 

criteria will be risk weighted in accordance 

with Table G3 of this appendix E. 

(ii) Mortgages subject to this section are 

risk weighted based on their loan-to-value 

(LTV) ratio 48 or combined loan-to-value 

(CLTV) ratio 49 and in accordance with Table 

G1, Table G2, or Table G3 of this appendix 

E, as applicable, after consideration of any 

loan level private mortgage insurance (loan 

level PMI). To calculate the CLTV on a junior 

lien mortgage, a bank must divide the 

aggregate principle amount outstanding for 

the first and junior lien(s) by the appraised 

value of the property at origination of the 

first lien. LTV ratios can only be adjusted 

through loan amortization, except for a loan 

refinancing where the bank extends 

additional funds. However, for purposes of 

calculating the CLTV, banks may adjust the 

appraised value of the property, as 

determined at the time of origination of the 

first lien, based on a new appraisal or 

evaluation in accordance with the FDIC’s 

appraisal regulations and real estate lending 

guidelines.50

(A) Mortgage loans secured by first liens on 

one-to four-family residential properties. 

Mortgage loans secured by first liens on oneto four-family residential properties (first lien 

mortgages) must be risk-weighted in 

accordance with Table G1 of this appendix 

E. If a bank holds both the first and junior 

lien(s) on a residential property and no other 

party holds an intervening lien, the 

transaction is treated as a first lien mortgage 

for purposes of determining the loan-to-value 

ratio and assigning a risk weight. 

TABLE G1.—RISK WEIGHTS FOR FIRST

LIEN ONE- TO FOUR-FAMILY RESIDENTIAL MORTGAGES

Loan-to-Value ratio 

(percent) 

Risk weight 

(percent) 

Up to 60 .................................... 20 

>60 and up to 80 ...................... 35 

>80 and up to 85 ...................... 50 

>85 and up to 90 ...................... 75 

>90 and up to 95 ...................... 100 

>95 ............................................ 150 

(B) Stand-Alone Junior Liens. Stand-alone 

junior liens on one- to four-family residential 

mortgages, including structured mortgages 

and the on-balance sheet portion of home 

equity lines of credit, must be risk weighted 

using the CLTV of the stand-alone junior and 

all senior liens in accordance with Table G2 

of this appendix E. The CLTV of the standalone junior and all senior liens, where any 

of the senior liens has a negative 

amortization feature, must reflect the 

maximum contractual loan amount under the 

terms of these liens if they were to fully 

negatively amortize under the applicable 

contract. 

TABLE G2.—RISK WEIGHTS FOR

STAND-ALONE JUNIOR LIEN 1–4 

FAMILY RESIDENTIAL MORTGAGES

Combined loan to value ratio 

(percent) 

Risk weight 

(percent) 

Up to 60 .................................... 75 

>60 and up to 90 ...................... 100 

>90 ............................................ 150 

TABLE G3.—RISK WEIGHTS FOR

MORTGAGES NOT MEETING MINIMUM

CRITERIA

Risk weight under Table G1 or 

G2 1

Risk weight 

(percent) 

20%, 35%, 50%, 75%, or 100% 100 

150% ......................................... 150 

1This column represents the risk weight a 

mortgage would have received under Table 

G1 or G2 if it had met the minimum criteria required by this section II.C.9(b). 

(C) One- to Four-Family Residential 

Mortgages With Negative Amortization 

Features. First lien mortgages with negative 

amortization features are risk weighted in 

accordance with Table G1 of this appendix 

E. For loans with negative amortization 

features, the LTV of the loans must be 

adjusted quarterly to include the amount of 

any negative amortization. Any remaining 

potential increase in the mortgage’s principal 

balance permitted through negative 

amortization is to be treated as a long-term 

commitment and converted to an on-balance 

sheet equivalent amount as set forth in 

section II.D. of this Appendix E. The credit 

equivalent amount of the commitment is then 

risk-weighted according to Table G1 based on 

the loan’s ‘‘highest contractual LTV ratio.’’

The highest contractual LTV ratio of a first 

lien mortgage equals the current outstanding 

principal balance of the loan, 51 plus the 

credit equivalent amount of the remaining 

negative amortization commitment, minus 

the amount covered by any loan-level PMI 

divided by the value of the property.52

(iii) Transitional Rule for Residential 

Mortgage Exposures. A bank may continue to 

use appendix A to risk weight those mortgage 

loans that it owns before it elects to use this 

appendix E. However, the bank must use 

appendix A to risk weight all such mortgage 

loans. Mortgage loans approved, acquired, or 

originated after a bank elects to use appendix 

E must be risk weighted under this appendix 

E. A bank may only rely on this subsection 

II.C.9(b)(iii) the first time it elects to use this 

appendix E. 

D. Conversion Factors for Off-Balance Sheet 

Items (see Table H) 

The face amount of an off-balance sheet 

item is generally incorporated into the riskweighted assets in two steps. The face 

amount is first multiplied by a credit 

conversion factor, except as otherwise 

specified in section II.B.5 of this appendix E 

for direct credit substitutes and recourse 

obligations. The resultant credit equivalent 

amount is assigned to the appropriate risk 

category according to the obligor or, if 

relevant, the guarantor, the nature of any 

collateral, or external credit ratings. 53

1. Items With a 100 Percent Conversion 

Factor. (a) Except as otherwise provided in 

section II.B.5 of this appendix E, the full 

amount of an asset or transaction supported, 

in whole or in part, by a direct credit 

substitute or a recourse obligation. Direct 

credit substitutes and recourse obligations 

are defined in section II.B.5 of this appendix 

E. 

(b) Sale and repurchase agreements, if not 

already included on the balance sheet, and 

forward agreements. Forward agreements are 

legally binding contractual obligations to 

purchase assets with drawdown which is 

certain at a specified future date. Such 

obligations include forward purchases, 

forward forward deposits placed,54 and 

partly-paid shares and securities; they do not 

include commitments to make residential 

mortgage loans or forward foreign exchange 

contracts. 

(c) Securities lent by a bank are treated in 

one of two ways, depending upon whether 

the lender is exposed to risk of loss. If a bank, 

as agent for a customer, lends the customer’s 

securities and does not indemnify the 

customer against loss, then the securities 

transaction is excluded from the risk-based 

capital calculation. On the other hand, if a 

bank lends its own securities or, acting as 

agent for customer, lends the customer’s 

securities and indemnifies the customer 

against loss, the transaction is converted at 

100 percent and assigned to the risk weight 

category appropriate to the obligor or, if 

applicable, to the collateral delivered to the 

lending bank or the independent custodian 

acting on the lending bank’s behalf. 

2. Items With a 50 Percent Conversion 

Factor. (a) Transaction-related contingencies 

are to be converted at 50 percent. Such 

contingencies include bid bonds, 

performance bonds, warranties, and 

performance standby letters of credit related 

to particular transactions, as well as 

acquisitions of risk participations in 


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55 In the case of home equity or mortgage lines of 

credit secured by liens on one- to four-family 

residential properties, a bank is deemed able to 

unconditionally cancel the commitment if, at its 

option, it can prohibit additional extensions of 

credit, reduce the credit line, and terminate the 

commitment to the full extent permitted by relevant 

federal law. 

56Short-term commitments to originate one- to 

four-family residential mortgage loans, other than a 

derivative contract, will continue to be converted to 

an on-balance-sheet credit equivalent amount using 

the zero percent conversion factor. 

performance standby letters of credits. 

Performance standby letters of credit 

(performance bonds) are irrevocable 

obligations of the bank to pay a third-party 

beneficiary when a customer (account party) 

fails to perform on some contractual 

nonfinancial obligation. Thus, performance 

standby letters of credit represent obligations 

backing the performance of nonfinancial or 

commercial contracts or undertakings. 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. 

(b) The unused portion of commitments 

with an original maturity exceeding one year. 

including underwriting commitments and 

commercial and consumer credit 

commitments, also are to be converted at 50 

percent. Original maturity is defined as the 

length of time between the date the 

commitment is issued and the earliest date 

on which: The bank can at its option, 

unconditionally (without cause) cancel the 

commitment,55 and the bank is scheduled to 

(and as a normal practice actually does) 

review the facility to determine whether or 

not it should be extended and, on at least an 

annual basis, continues to regularly review 

the facility. Facilities that are 

unconditionally cancelable (without cause) at 

any time by the bank are not deemed to be 

commitments, provided the bank makes a 

separate credit decision before each drawing 

under the facility. 

(c)(i) Commitments are defined as any 

legally binding arrangements that obligate a 

bank to extend credit in the form of loans or 

lease financing receivables; to purchase 

loans, securities, or other assets; or to 

participate in loans and leases. Commitments 

also include overdraft facilities, revolving 

credit, home equity and mortgage lines of 

credit, eligible ABCP liquidity facilities, and 

similar transactions. Normally, commitments 

involve a written contract or agreement and 

a commitment fee, or some other form of 

consideration. Commitments are included in 

weighted-risk assets regardless of whether 

they contain material adverse change clauses 

or other provisions that are intended to 

relieve the issuer of its funding obligation 

under certain conditions. In the case of 

commitments structured as syndications, 

where the bank is obligated solely for its pro 

rata share, only the bank’s proportional share 

of the syndicated commitment is taken into 

account in calculating the risk-based capital 

ratio. 

(ii) Banks that are subject to the market risk 

rules in appendix C to part 325 are required 

to convert the notional amount of eligible 

ABCP liquidity facilities, in form or in 

substance, with an original maturity of over 

one year that are carried in the trading 

account at 50 percent to determine the 

appropriate credit equivalent amount even 

though those facilities are structured or 

characterized as derivatives or other trading 

book assets. Liquidity facilities that support 

ABCP, in form or in substance, (including 

those positions to which the market risk rules 

may not be applied as set forth in section 2(a) 

of appendix C of this part) that are not 

eligible ABCP liquidity facilities are to be 

considered recourse obligations or direct 

credit substitutes, and assessed the 

appropriate risk-based capital treatment in 

accordance with section II.B.5 of this 

appendix E. 

(d) In the case of commitments structured 

as syndications where the bank is obligated 

only for its pro rata share, the risk-based 

capital framework includes only the bank’s 

proportional share of such commitments. 

Thus, after a commitment has been converted 

at 50 percent, portions of commitments that 

have been conveyed to other U.S. depository 

institutions or OECD banks, but for which the 

originating bank retains the full obligation to 

the borrower if the participating bank fails to 

pay when the commitment is drawn upon, 

will be assigned to the 20 percent risk 

category. The acquisition of such a 

participation in a commitment would be 

converted at 50 percent and the credit 

equivalent amount would be assigned to the 

risk category that is appropriate for the 

account party obligor or, if relevant, to the 

nature of the collateral or guarantees. 

(e) Revolving underwriting facilities 

(RUFs), note issuance facilities (NIFs), and 

other similar arrangements also are converted 

at 50 percent. These are facilities under 

which a borrower can issue on a revolving 

basis short-term notes in its own name, but 

for which the underwriting banks have a 

legally binding commitment either to 

purchase any notes the borrower is unable to 

sell by the rollover date or to advance funds 

to the borrower. 

3. Items With a 20 Percent Conversion 

Factor. Short-term, self-liquidating, traderelated contingencies which arise from the 

movement of goods are converted at 20 

percent. Such contingencies include 

commercial letters of credit and other 

documentary letters of credit collateralized 

by the underlying shipments. 

4. Items With a 10 Percent Conversion 

Factor. (a) Unused portions of commitments 

with an original maturity of one year or less 

are converted using the 10 percent 

conversion factor.56 Unused portions of 

eligible ABCP liquidity facilities with an 

original maturity of one year or less that 

provide liquidity support to ABCP also are 

converted at 10 percent. 

(b) Banks that are subject to the market risk 

rules in appendix C to part 325 are required 

to convert the notional amount of eligible 

ABCP liquidity facilities, in form or in 

substance, with an original maturity of one 

year or less that are carried in the trading 

account at 10 percent to determine the 

appropriate credit equivalent amount even 

through those facilities are structured or 

characterized as derivatives or other trading 

book assets. Liquidity facilities that provide 

liquidity support to ABCP, in form or in 

substance, (including those positions to 

which the market risk rules may not be 

applied as set forth in section 2(a) of 

appendix C of this part) that are not eligible 

ABCP liquidity facilities are to be considered 

recourse obligations or direct credit 

substitutes and assessed the appropriate riskbased capital requirement in accordance with 

section II.B.5 of this appendix. 

5. Items with a Zero Percent Conversion 

Factor. These include unused portions of 

retail credit card lines and related plans are 

deemed to be short-term commitments if the 

bank, in accordance with applicable law, has 

the unconditional option to cancel the credit 

line at any time. 

6. Derivative Contracts. The creditequivalent amount for a derivative contract, 

or group of derivative contracts subject to a 

qualifying bilateral netting contract, is 

assigned to the risk weight category 

appropriate to the underlying obligor 

regardless of the type of transaction. 

E. Derivative Contracts (Interest Rate, 

Exchange Rate, Commodity (Including 

Precious Metal) and Equity Derivative 

Contracts) 

1. Credit equivalent amounts are computed 

for each of the following off-balance-sheet 

derivative contracts: 

(a) Interest Rate Contracts 

(i) Single currency interest rate swaps. 

(ii) Basis swaps. 

(iii) Forward rate agreements. 

(iv) Interest rate options purchased 

(including caps, collars, and floors 

purchased). 

(v) Any other instrument linked to interest 

rates that gives rise to similar credit risks 

(including when-issued securities and 

forward deposits accepted). 

(b) Exchange Rate Contracts 

(i) Cross-currency interest rate swaps. 

(ii) Forward foreign exchange contracts. 

(iii) Currency options purchased. 

(iv) Any other instrument linked to 

exchange rates that gives rise to similar credit 

risks. 

(c) Commodity (including precious metal) 

or Equity Derivative Contracts 

(i) Commodity-or equity-linked swaps. 

(ii) Commodity-or equity-linked options 

purchased. 

(iii) Forward commodity-or equity-linked 

contracts. 

(iv) Any other instrument linked to 

commodities or equities that gives rise to 

similar credit risks. 

2. Exchange rate contracts with an original 

maturity of 14 calendar days or less and 

derivative contracts traded on exchanges that 

require daily receipt and payment of cash 

variation margin may be excluded from the 

risk-based ratio calculation. Gold contracts 

are accorded the same treatment as exchange 

rate contracts except gold contracts with an 

original maturity of 14 calendar days or less 

are included in the risk-based calculation. 

Over-the-counter options purchased are 

included and treated in the same way as 

other derivative contracts. 

3. Credit Equivalent Amounts for 

Derivative Contracts. (a) The credit 


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57Mark-to-market values are measured in dollars, 

regardless of the currency or currencies specified in 

the contract and should reflect changes in both 

underlying rates, prices and indices, and 

counterparty credit quality. 

58For purposes of this section, a walkaway clause 

means a provision in a netting contract that permits 

a non-defaulting counterparty to make lower 

payments than it would make otherwise under the 

contract, or no payment at all, to a defaulter or to 

the estate of a defaulter, even if a defaulter or the 

estate of a defaulter is a net creditor under the 

contract. 

59For purposes of calculating potential future 

credit exposure for foreign exchange contracts and 

other similar contracts in which notional principal 

is equivalent to cash flows, total notional principal 

is defined as the net receipts to each party falling 

due on each value date in each currency. 

equivalent amount of a derivative contract 

that is not subject to a qualifying bilateral 

netting contract in accordance with section 

II.E.5 of this appendix E is equal to the sum 

of: 

(i) The current exposure (which is equal to 

the mark-to-market value, 57 if positive, and 

is sometimes referred to as the replacement 

cost) of the contract; and 

(ii) An estimate of the potential future 

credit exposure. 

(b) The current exposure is determined by 

the mark-to-market value of the contract. If 

the mark-to-market value is positive, then the 

current exposure is equal to that mark-tomarket value. If the mark-to-market value is 

zero or negative, then the current exposure is 

zero. 

(c) The potential future credit exposure of 

a contract, including a contract with a 

negative mark-to-market value, is estimated 

by multiplying the notional principal amount 

of the contract by a credit conversion factor. 

Banks should, subject to examiner review, 

use the effective rather than the apparent or 

stated notional amount in this calculation. 

The credit conversion factors are: 

TABLE H.—CONVERSION FACTOR MATRIX

Remaining maturity Interest rate 

(percent) 

Exchange rate 

and gold 

(percent) 

Equity 

(percent) 

Precious metals, except 

gold 

(percent) 

Other commodities 

(percent) 

One year or less .................................................................. 0.0 1.0 6.0 7.0 10.0 

More than one year to five years ........................................ 0.5 5.0 8.0 7.0 12.0 

More than five years ............................................................ 1.5 7.5 10.0 8.0 15.0 

(d) For contracts that are structured to 

settle outstanding exposure on specified 

dates and where the terms are reset such that 

the market value of the contract is zero on 

these specified dates, the remaining maturity 

is equal to the time until the next reset date. 

For interest rate contracts with remaining 

maturities of more than one year and that 

meet these criteria, the conversion factor is 

subject to a minimum value of 0.5 percent. 

(e) For contracts with multiple exchanges 

of principal, the conversion factors are to be 

multiplied by the number of remaining 

payments in the contract. Derivative 

contracts not explicitly covered by any of the 

columns of the conversion factor matrix are 

to be treated as ‘‘other commodities.’’

(f) No potential future exposure is 

calculated for single currency interest rate 

swaps in which payments are made based 

upon two floating rate indices (so called 

floating/floating or basis swaps); the credit 

exposure on these contracts is evaluated 

solely on the basis of their mark-to-market 

values. 

4. Risk Weights and Avoidance of Double 

Counting. (a) Once the credit equivalent 

amount for a derivative contract, or a group 

of derivative contracts subject to a qualifying 

bilateral netting agreement, has been 

determined, that amount is assigned to the 

risk category appropriate to the counterparty, 

or, if relevant, the guarantor or the nature of 

any collateral. However, the maximum 

weight that will be applied to the credit 

equivalent amount of such contracts is 50 

percent. 

(b) In certain cases, credit exposures 

arising from the derivative contracts covered 

by these guidelines may already be reflected, 

in part, on the balance sheet. To avoid double 

counting such exposures in the assessment of 

capital adequacy and, perhaps, assigning 

inappropriate risk weights, counterparty 

credit exposures arising from the types of 

instruments covered by these guidelines may 

need to be excluded from balance sheet 

assets in calculating a bank’s risk-based 

capital ratio. 

(c) The FDIC notes that the conversion 

factors set forth in section II.E.3 of appendix 

E, which are based on observed volatilities of 

the particular types of instruments, are 

subject to review and modification in light of 

changing volatilities or market conditions. 

(d) Examples of the calculation of credit 

equivalent amounts for these types of 

contracts are contained in Table H of this 

appendix E. 

5. Netting. (a) For purposes of this 

appendix E, netting refers to the offsetting of 

positive and negative mark-to-market values 

when determining a current exposure to be 

used in the calculation of a credit equivalent 

amount. Any legally enforceable form of 

bilateral netting (that is, netting with a single 

counterparty) of derivative contracts is 

recognized for purposes of calculating the 

credit equivalent amount provided that: 

(i) The netting is accomplished under a 

written netting contract that creates a single 

legal obligation, covering all included 

individual contracts, with the effect that the 

bank would have a claim or obligation to 

receive or pay, respectively, only the net 

amount of the sum of the positive and 

negative mark-to-market values on included 

individual contracts in the event that a 

counterparty, or a counterparty to whom the 

contract has been validly assigned, fails to 

perform due to default, bankruptcy, 

liquidation, or similar circumstances; 

(ii) The bank obtains a written and 

reasoned legal opinion(s) representing that in 

the event of a legal challenge, including one 

resulting from default, insolvency, 

bankruptcy or similar circumstances, the 

relevant court and administrative authorities 

would find the bank’s exposure to be such a 

net amount under: 

(A) The law of the jurisdiction in which 

the counterparty is chartered or the 

equivalent location in the case of 

noncorporate entities and, if a branch of the 

counterparty is involved, then also under the 

law of the jurisdiction in which the branch 

is located; 

(B) The law that governs the individual 

contracts covered by the netting contract; and 

(C) The law that governs the netting 

contract. 

(iii) The bank establishes and maintains 

procedures to ensure that the legal 

characteristics of netting contracts are kept 

under review in the light of possible changes 

in relevant law; and 

(iv) The bank maintains in its file 

documentation adequate to support the 

netting of derivative contracts, including a 

copy of the bilateral netting contract and 

necessary legal opinions. 

(b) A contract containing a walkaway 

clause is not eligible for netting for purposes 

of calculating the credit equivalent 

amount.58

(c) By netting individual contracts for the 

purpose of calculating its credit equivalent 

amount, a bank represents that it has met the 

requirements of this appendix E and all the 

appropriate documents are in the bank’s files 

and available for inspection by the FDIC. 

Upon determination by the FDIC that a 

bank’s files are inadequate or that a netting 

contract may not be legally enforceable under 

any one of the bodies of law described in 

paragraphs (ii)(1) through (3) of section 

II.E.5(a) of this appendix E, underlying 

individual contracts may be treated as though 

they were not subject to the netting contract. 

(d) The credit equivalent amount of 

derivative contracts that are subject to a 

qualifying bilateral netting contract is 

calculated by adding: 

(i) The net current exposure of the netting 

contract; and 

(ii) The sum of the estimates of potential 

future exposure for all individual contractors 

subject to the netting contract, adjusted to 

take into account the effects of the netting 

contract.59


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(e) The net current exposure is the sum of 

all positive and negative mark-to-market 

values of the individual contracts subject to 

the netting contract. If the net sum of the 

mark-to-market values is positive, then the 

net current exposure is equal to that sum. If 

the net sum of the mark-to-market values is 

zero or negative, then the net current 

exposure is zero. 

(f) The effects of the bilateral netting 

contract on the gross potential future 

exposure are recognized through application 

of a formula, resulting in an adjusted add-on 

amount (Anet). The formula, which employs 

the ratio of net current exposure to gross 

current exposure (NGR) is expressed as: 

Anet = (0.4 × Agross) + 0.6(NGR × Agross) 

The effect of this formula is that Anet is the 

weighted average of Agross, and Agross adjusted 

by the NGR. 

(g) The NGR may be calculated in either 

one of two ways—referred to as the 

counterparty-by-counterparty approach and 

the aggregate approach. 

(i) Under the counterparty-by-counterparty 

approach, the NGR is the ratio of the net 

current exposure of the netting contract to 

the gross current exposure of the netting 

contract. The gross current exposure is the 

sum of the current exposure of all individual 

contracts subject to the netting contract 

calculated in accordance with section II.E of 

this appendix E. 

(ii) Under the aggregate approach, the NGR 

is the ratio of the sum of all of the net current 

exposures for qualifying bilateral netting 

contracts to the sum of all of the gross current 

exposures for those netting contracts (each 

gross current exposure is calculated in the 

same manner as in section II.E.5(g)(i) of this 

appendix E). Net negative mark-to-market 

values to individual counterparties cannot be 

used to offset net positive current exposures 

to other counterparties. 

(iii) A bank must use consistently either 

the counterparty-by-counterparty approach 

or the aggregate approach to calculate the 

NGR. Regardless of the approach used, the 

NGR should be applied individually to each 

qualifying bilateral netting contract to 

determine the adjusted add-on for that 

netting contract. 

III. Minimum Risk-Based Capital Ratio 

Subject to section II.B.5 of this appendix E, 

banks generally will be expected to meet a 

minimum ratio of qualifying total capital to 

risk-weighted assets of 8 percent, of which at 

least 4 percentage points should be in the 

form of core capital (Tier 1). Any bank that 

does not meet the minimum risk-based 

capital ratio, or whose capital is otherwise 

considered inadequate, generally will be 

expected to develop and implement a capital 

plan for achieving an adequate level of 

capital, consistent with the provisions of this 

risk-based capital framework and § 325.104, 

the specific circumstances affecting the 

individual bank, and the requirements of any 

related agreements between the bank and the 

FDIC. 

TABLE I.—DEFINITION OF QUALIFYING CAPITAL

Components Minimum requirements 

(1) Core Capital (Tier 1) ........................................................................... Must equal or exceed 4% of risk-weighted assets. 

(a) Common stockholders’ equity ............................................................. No limit.1

(b) Noncumulative perpetual preferred stock and any related surplus .... No limit.1

(c) Minority interest in equity accounts of consolidated ........................... No limit.1

(d) Less: All intangible assets other than certain mortgage servicing assets, nonmortgage servicing assets and purchased credit card relationships.(2) 

(e) Less: Certain credit-enhancing interest only strips and nonfinancial 

equity investments required to be deducted from capital.

(3) 

(f) Less: Certain deferred tax assets. ....................................................... (4) 

(2) Supplementary Capital (Tier 2) ........................................................... Total of tier 2 is limited to 100% of tier 1.5

(a) Allowance for loan and lease losses .................................................. Limited to 1.25% of weighted-risk assets.5

(b) Unrealized gains on certain equity securities 6 ................................... Limited to 45% of pretax net unrealized gains.6

(c) Cumulative perpetual and long-term preferred stock (original maturity of 20 years or more) and any related surplus..No limit within tier 2; long-term preferred is amortized for capital purposes as it approaches maturity. 

(d) Auction rate and similar preferred stock (both cumulative and noncumulative)..No limit within tier 2. 

(e) Hybrid capital instruments (including mandatory convertible debt securities)..No limit within tier 2. 

(f) Term subordinated debt and intermediate-term preferred stock (original weighted average maturity of five years or more)..Term subordinated debt and intermediate-term preferred stock are limited to 50% of Tier 1 5 and amortized for capital purposes as they 

approach maturity. 

(3) Deductions (from the sum of tier 1 and tier 2).

(a) Investments in banking and finance subsidiaries that are not consolidated for regulatory capital purposes..

(b) Intentional, reciprocal cross-holdings of capital securities issued by 

banks..

(c) Other deductions (such as investment in other subsidiaries or joint 

ventures) as determined by supervisory authority..

On a case-by-case basis or as a matter of policy after formal consideration of relevant issues. 

(4) Total Capital ........................................................................................ Must equal or exceed 8% of weighted-risk assets. 

1 No express limits are placed on the amounts of nonvoting common, noncumulative perpetual preferred stock, and minority interests that may 

be recognized as part of Tier 1 capital. However, voting common stockholders’ equity capital generally will be expected to be the dominant form 

of Tier 1 capital and banks should avoid undue reliance on other Tier 1 capital elements. 2The amounts of mortgage servicing assets, nonmortgage servicing assets and purchased credit card relationships that can be recognized for 

purposes of calculating Tier 1 capital are subject to the limitations set forth in § 325.5(f). All deductions are for capital purposes only; deductions 

would not affect accounting treatment. 3The amounts of credit-enhancing interest-only strips that can be recognized for purposes of calculating Tier 1 capital are subject to the limitations set forth in § 325.5(f). The amounts of nonfinancial equity investments that must be deducted for purposes of calculating Tier 1 capital are 

set forth in section II.B.6 of appendix E to part 325. 4 Deferred tax assets are subject to the capital limitations set forth in § 325.5(g). 5Amounts in excess of limitations are permitted but do not qualify as capital. 

6 Unrealized gains on equity securities are subject to the capital limitations set forth in paragraph I–2.A.2.(f) of appendix E to part 325. 


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60For the purpose of calculating the risk-based 

capital ratio, a U.S. Government agency is defined 

as an instrumentality of the U.S. Government whose 

obligations are fully and explicitly guaranteed as to 

the timely repayment of principal and interest by 

the full faith and credit of the U.S. Government. 

61For the purpose of calculating the risk-based 

capital ratio, a U.S. Government agency is defined 

as an instrumentality of the U.S. Government whose 

obligations are fully and explicitly guaranteed as to 

the timely repayment of principal and interest by 

the full faith and credit of the U.S. Government. 

62For the purpose of calculating the risk-based 

capital ratio, a U.S. Government-sponsored agency 

is defined as an agency originally established or 

chartered to serve public purposes specified by the 

U.S. Congress but whose obligations are not 

explicitly guaranteed by the full faith and credit of 

the U.S. Government. 

63 Degree of collateralization is determined by 

current market value. 

IV. Calculation of the Risk-Based Capital 

Ratio 

1. When calculating the risk-based capital 

ratio under the framework set forth in this 

statement of policy, qualifying total capital 

(the numerator) is divided by risk-weighted 

assets (the denominator). The process of 

determining the numerator for the ratio is 

summarized in Table I. The calculation of the 

denominator is based on the risk weights and 

conversion factors that are summarized in 

Tables II and III. 

2. When determining the amount of riskweighted assets, balance sheet assets are 

assigned an appropriate risk weight (see 

Table J) and off-balance sheet items are first 

converted to a credit equivalent amount (see 

Table H) and then assigned to one of the risk 

weight categories set forth in Table J. 

3. The balance sheet assets and the credit 

equivalent amount of off-balance sheet items 

are then multiplied by the appropriate risk 

weight percentages and the sum of these riskweighted amounts is the gross risk-weighted 

asset figure used in determining the 

denominator of the risk-based capital ratio. 

Any items deducted from capital when 

computing the amount of qualifying capital 

may also be excluded from risk-weighted 

assets when calculating the denominator for 

the risk-based capital ratio. 

Table J—Summary of Risk Weights and Risk 

Categories 

Category 1—Zero Percent Risk Weight 

(1) Cash (domestic and foreign). 

(2) Balances due from Federal Reserve 

banks. 

(3) Direct claims on, and portions of claims 

unconditionally guaranteed by, the U.S. 

Treasury and U.S. Government agencies.60

(4) Gold bullion held in the bank’s own 

vaults or in another bank’s vaults on an 

allocated basis, to the extent that it is offset 

by gold bullion liabilities. 

(5) Federal Reserve Bank stock. 

(6) Claims on, or guaranteed by, qualifying 

securities firms incorporated in the United 

States or other members of the OECD-based 

group of countries that are collateralized by 

cash on deposit in the lending bank or by 

securities issued or guaranteed by the United 

States (including U.S. government agencies) 

or OECD central governments, provided that 

a positive margin of collateral is required to 

be maintained on such a claim on a daily 

basis, taking into account any change in a 

bank’s exposure to the obligor or 

counterparty under the claim in relation to 

the market value of the collateral held in 

support of the claim. 

(7) Certain externally rated exposures as 

provided under section II.C.9 of this 

appendix E. 

Category 2—20 Percent Risk Weight 

(1) Cash items in the process of collection. 

(2) All claims (long- and short-term) on, 

and portions of claims (long- and short-term) 

guaranteed by, U.S. depository institutions 

and OECD banks. 

(3) Short-term (remaining maturity of one 

year or less) claims on, and portions of shortterm claims guaranteed by, non-OECD banks. 

(4) Portions of loans and other claims 

conditionally guaranteed by the U.S. 

Treasury or U.S. Government agencies.61

(5) Securities and other claims on, and 

portions of claims guaranteed by, U.S. 

Government-sponsored agencies.62

(6) Portions of loans and other claims 

(including repurchase agreements) 

collateralized by securities issued or 

guaranteed by the U.S. Treasury, U.S. 

Government agencies, or U.S. Governmentsponsored agencies. 

(7) Portions of loans and other claims 

collateralized 63 by cash on deposit in the 

lending bank. 

(8) General obligation claims on, and 

portions of claims guaranteed by, the full 

faith and credit of states or other political 

subdivisions of OECD countries, including 

U.S. state and local governments. 

(9) Investments in shares of mutual funds 

whose portfolios are permitted to hold only 

assets that qualify for the zero or 20 percent 

risk categories. 

(10) Recourse obligations, direct credit 

substitutes, residual interests (other than 

credit-enhancing interest-only strips) and 

asset-or mortgage-backed securities rated in 

either of the two highest investment grade 

categories, e.g., AAA or AA, in the case of 

long-term ratings, or the highest rating 

category, e.g., A–1, P–1, in the case of shortterm ratings. 

(11) Certain externally rated exposures as 

provided under section II.C.9 of this 

appendix E. 

(12) Certain one-to-four family residential 

mortgages as provided under section II.C.9 of 

this appendix E. 

Category 3—35 Percent Risk Weight 

(1) Recourse obligations, direct credit 

substitutes, residual interests (other than 

credit-enhancing interest-only strips) and 

asset-or mortgage-backed securities rated in 

the third-highest investment grade category, 

e.g., A, in the case of long-term ratings, or the 

second highest rating category, e.g., A–2, P–

2, in the case of short-term ratings. 

(2) Certain externally rated exposures as 

provided under section II.C.9 of this 

appendix E. 

(3) Certain one-to-four family residential 

mortgages as provided under section II.C.9 of 

this appendix E. 

Category 4—50 Percent Risk Weight 

(1) Certain presold residential construction 

loans, provided that the loans were approved 

in accordance with prudent underwriting 

standards and are not past due 90 days or 

more or carried on a nonaccrual status. 

(2) Loans fully secured by first liens on 

multifamily residential properties that have 

been prudently underwritten and meet 

specified requirements with respect to loanto-value ration, level of annual net operating 

income to required debt service, maximum 

amortization period, minimum original 

maturity, and demonstrated timely 

repayment performance. 

(3) Recourse obligations, direct credit 

substitutes, residual interests (other than 

credit-enhancing interest-only strips) and 

asset-or mortgage-backed securities rated in 

the lowest-highest investment grade category 

plus, e.g., BBB+, in the case of long-term 

ratings. 

(4) Revenue bonds or similar obligations, 

including loans and leases, that are 

obligations of U.S. state or political 

subdivisions of the United States or other 

OECD countries but for which the 

government entity is committed to repay the 

debt only out of revenues from the specific 

projects financed. 

(5) Certain externally rated exposures as 

provided under section II.C.9 of this 

appendix E. 

(6) Certain one-to-four family residential 

mortgages as provided under section II.C.9 of 

this appendix E. 

Category 5—75 Percent Risk Weight 

(1) Recourse obligations, direct credit 

substitutes, residual interests (other than 

credit-enhancing interest-only strips) and 

asset-or mortgage-backed securities rated in 

the lowest highest investment grade category 

naught, e.g., BBB, in the case of long-term 

ratings, or the lowest highest rating category, 

e.g., A–3, P–3, in the case of short-term 

ratings. 

(2) Certain externally rated exposures as 

provided under section II.C.9 of this 

appendix E. 

(3) Certain one-to-four family residential 

mortgages as provided under section II.C.9 of 

this appendix E. 

Category 6—100 Percent Risk Weight 

(1) All other claims on private obligors. 

(2) Obligations issued by U.S. state or local 

governments or other OECD local 

governments (including industrial 

development authorities and similar entities) 

that are repayable solely by a private party 

or enterprise. 

(3) Premises, plant, and equipment; other 

fixed assets; and other real estate owned. 

(4) Investments in any unconsolidated 

subsidiaries, joint ventures, or associated 

companies—if not deducted from capital. 

(5) Instruments issued by other banking 

organizations that qualify as capital. 

(6) Claims on commercial firms owned by 

the U.S. Government or foreign governments. 

(7) Recourse obligations, direct credit 

substitutes, residual interests (other than 

credit-enhancing interest-only strips) and 

asset-or mortgage-backed securities rated in 

the lowest investment grade category 

negative, e.g., BBB¥, as well as certain 


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64 In general for each off-balance sheet item, a 

conversion factor (see Table H) must be applied to 

determine the ‘‘credit equivalent amount’’ prior to 

assigning the off-balance sheet item to a risk weight 

category. 

positions (but not residual interests) which 

the bank rates pursuant to section II.B.5(g) of 

this appendix E. 

(8) Other assets, including any intangible 

assets that are not deducted from capital, and 

the credit equivalent amounts 64 of offbalance sheet items not assigned to a 

different risk category, except for certain 

externally rated exposures and certain oneto-four family residential mortgages as 

provided under section II.C.9 of this 

appendix E. 

Category 7—150 Percent Risk Weight 

(1) Certain externally rated exposures as 

provided under section II.C.9 of this 

appendix E. 

(2) Certain one-to-four family residential 

mortgages as provided under section II.C.9 of 

this appendix E. 

Category 8—200 Percent Risk Weight 

(1) Externally rated recourse obligations, 

direct credit substitutes, residual interests 

(other than credit-enhancing interest-only 

strips), and asset- and mortgage-backed 

securities that are rated one category below 

the lowest investment grade category—

negative, e.g., BB, to the extent permitted in 

section II.B.5(d) of this appendix E. 

(2) A position (but not a residual interest) 

extended in connection with a securitization 

or structured financing program that is not 

rated by an NRSRO for which the bank 

determines that the credit risk is equivalent 

to one category below investment grade, e.g., 

BB, to the extent permitted in section 

II.B.5(g) of this appendix E. 

(3) Certain externally rated exposures as 

provided under section II.C.9 of this 

appendix E. 

Department of the Treasury 

Office of Thrift Supervision 

12 CFR Chapter V. 

Authority and Issuance 

For the reasons stated in the common 

preamble, the Office of Thrift Supervision 

proposes to amend part 567 of chapter V of 

title 12 of the Code of Federal Regulations as 

follows: 

PART 567—CAPITAL 

1. The authority citation for part 567 

continues to read as follows: 

Authority: 12 U.S.C. 1462, 1462a, 1463, 

1464, 1467a, 1828 (note). 

2. In § 567.1, revise the definition of 

risk-weighted assets to read as follows: 

§ 567.1. Definitions. 

* * * * * 

Risk-weighted assets. Risk-weighted 

assets means risk-weighted assets 

computed under § 567.6 or § 567.7 of 

this part. 

* * * * * 

3. Revise paragraph (a)(1)(i) of § 567.2 

to read as follows: 

§ 567.2 Minimum regulatory capital 

requirement. 

(a) * * * 

(1) * * * 

(i) Risk-based capital requirement. A 

savings association’s minimum riskbased capital requirement shall be an 

amount equal to 8 percent of its riskweighted assets. 

* * * * * 

4. Revise the section heading and add 

a new introductory paragraph to § 567.6 

to read as follows: 

§ 567.6 Risk-weighted assets. 

Unless the savings association uses 12 

CFR part 566, Appendix A or elects to 

use § 567.7 of this part, a savings 

association must compute risk-weighted 

assets as described in this section. 

* * * * * 

5. Add a new § 567.7 to read as 

follows: 

§ 567.7 Alternate computation of riskweighted assets. 

(a) Opt-in. (1) Any savings 

association, other than a savings 

association that uses 12 CFR part 566, 

Appendix A, may elect to compute riskweighted assets under this section 

rather than § 567.6 of this part. If a 

savings association elects to apply this 

section, it must apply all of the 

requirements of this section. 

(2) To elect to apply this section, a 

savings association must notify OTS. 

The election will remain in effect until 

the savings association withdraws the 

election by notifying OTS. 

(b) Definitions. The following 

definitions apply to this section: 

(1) External rating. (i) An external 

rating is a credit rating assigned by a 

NRSRO that: 

(A) Fully reflects the entire amount of 

the credit risk with regard to all 

payments owed on the claim (that is, the 

rating must fully reflect the credit risk 

associated with timely repayment of 

principal and interest); 

(B) Is published in an accessible 

public form; 

(C) Is monitored by the issuing 

NRSRO; and 

(D) Is, or will be, included in the 

issuing NRSRO’s publicly available 

transition matrix, which tracks the 

performance and stability (or rating 

migration) of an NRSRO’s issued 

external ratings for the specific type of 

claim (for example, corporate debt). 

(ii) If an exposure has two or more 

external ratings, the external rating is 

the lowest assigned rating. If an 

exposure has components that are 

assigned different external ratings, the 

savings association must assign the 

lowest component rating to the entire 

exposure. If an exposure has a 

component that is not externally rated, 

the exposure is not externally rated. 

(2) Non-sovereign. A non-sovereign 

includes a securities firm, insurance 

company, bank holding company, 

savings and loan holding company, 

multi-lateral lending and regional 

development institution, partnership, 

limited liability company, business 

trust, special purpose entity, 

association, and similar organization. 

(3) Public-sector entity. A publicsector entity means a state, local 

authority or governmental subdivision 

below the central government level in 

an OECD country. In the United States, 

this definition encompasses a state, 

county, city, town, or other municipal 

corporation, a public authority, and 

generally any publicly-owned entity 

that is an instrumentality of a state or 

municipal corporation. This definition 

does not include commercial companies 

owned by a public-sector entity. 

(4) Sovereign. Sovereign means a 

central government or an agency, 

department, ministry, or central bank of 

a central government. It does not 

include state, provincial or local 

governments, or commercial enterprises 

owned by a central government. 

(c) Computation. Under this section, 

risk-weighted assets equal risk-weighted 

on-balance sheet assets computed under 

paragraph (d) of this section, plus riskweighted off-balance sheet items 

computed under paragraph (e) of this 

section, plus risk-weighted recourse 

obligations, direct credit substitutes and 

certain other positions computed under 

paragraph (f) of this section. Assets not 

included (i.e., deducted from capital) for 

the purposes of calculating capital 

under § 567.5 are not included in 

calculating risk-weighted assets. 

(d) On-balance sheet assets. Except as 

provided in paragraph (f) of this section, 

risk-weighted on-balance sheet assets 

are computed by multiplying the onbalance sheet asset amounts times the 

appropriate risk weight categories 

described in this section. 

(1) The risk weight categories are: 

(i) Zero percent risk weight. 

(A) Cash, including domestic and 

foreign currency owned and held in all 

offices of a savings association or in 

transit. Any foreign currency held by a 

savings association must be converted 

into U.S. dollar equivalents; 

(B) Securities issued by and other 

direct claims on the United States 

Government or its agencies (to the 

extent such securities or claims are 

unconditionally backed by the full faith 


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and credit of the United States 

Government); 

(C) Notes and obligations issued by 

either the Federal Savings and Loan 

Insurance Corporation or the Federal 

Deposit Insurance Corporation and 

backed by the full faith and credit of the 

United States Government; 

(D) Deposit reserves at, claims on, and 

balances due from Federal Reserve 

Banks; 

(E) The book value of paid-in Federal 

Reserve Bank stock; 

(F) That portion of assets that is fully 

covered against capital loss or yield 

maintenance agreements by the Federal 

Savings and Loan Insurance Corporation 

or any successor agency; 

(G) That portion of assets directly and 

unconditionally guaranteed by the 

United States Government or its 

agencies; 

(H) Claims on, and claims guaranteed 

by, a qualifying securities firm that are 

collateralized by cash on deposit in the 

savings association or by securities 

issued or guaranteed by the United 

States Government or its agencies or the 

central government of an OECD country. 

To be eligible for this risk weight, the 

savings association must maintain a 

positive margin of collateral on the 

claim on a daily basis, taking into 

account any change in a savings 

association’s exposure to the obligor or 

counterparty under the claim in relation 

to the market value of the collateral held 

in support of the claim; 

(I) Debt securities issued by, other 

claims on, and that portion of assets 

backed by an eligible guarantee of, a 

sovereign that receive a zero percent 

risk weight, as provided in paragraphs 

(d)(3) and (5) of this section. 

(ii) 20 percent risk weight. 

(A) Cash items in the process of 

collection; 

(B) That portion of assets 

collateralized by the current market 

value of securities issued or guaranteed 

by the United States Government or its 

agencies; 

(C) That portion of assets 

conditionally guaranteed by the United 

States Government or its agencies; 

(D) Securities (not including equity 

securities) issued by and other claims 

on the U.S. Government or its agencies 

that are not backed by the full faith and 

credit of the United States Government; 

(E) Securities (not including equity 

securities) issued by, or other direct 

claims on, United States Governmentsponsored agencies; 

(F) That portion of assets guaranteed 

by United States Government-sponsored 

agencies; 

(G) That portion of assets 

collateralized by the current market 

value of securities issued or guaranteed 

by United States Government-sponsored 

agencies; 

(H) Loans that are not externally rated 

that are issued to a qualifying securities 

firm, subject to the conditions set forth 

below. Externally rated loans to, debt 

securities of, claims collateralized by 

claims on, and guarantees by a 

qualifying securities firm are subject to 

paragraphs (d)(1)(i)(H), and (d)(3) 

through (5) of this section. 

(1) A qualifying securities firm must 

have a long-term issuer credit rating, or 

a rating on at least one issue of longterm unsecured debt, from a NRSRO. 

The rating must be in one of the three 

highest investment grade categories 

used by the NRSRO. If two or more 

NRSROs assign ratings to the qualifying 

securities firm, the savings association 

must use the lowest rating to determine 

whether the rating requirement of this 

paragraph is met. A qualifying securities 

firm may rely on the rating of its parent 

consolidated company, if the parent 

consolidated company guarantees the 

claim. 

(2) A collateralized claim on a 

qualifying securities firm does not have 

to comply with the rating requirements 

under paragraph (d)(1)(ii)(H)(1) of this 

section if the claim arises under a 

contract that: 

(i) Is a reverse repurchase/repurchase 

agreement or securities lending/ 

borrowing transaction executed using 

standard industry documentation; 

(ii) Is collateralized by debt or equity 

securities that are liquid and readily 

marketable; 

(iii) Is marked-to-market daily; 

(iv) Is subject to a daily margin 

maintenance requirement under the 

standard industry documentation; and 

(v) Can be liquidated, terminated or 

accelerated immediately in bankruptcy 

or similar proceeding, and the security 

or collateral agreement will not be 

stayed or avoided under applicable law 

of the relevant jurisdiction. For 

example, a claim is exempt from the 

automatic stay in bankruptcy in the 

United States if it arises under a 

securities contract or a repurchase 

agreement subject to section 555 or 559 

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 (12 U.S.C. 

1821(e)(8)), or a netting contract 

between or among financial institutions 

under sections 401–407 of the Federal 

Deposit Insurance Corporation 

Improvement Act of 1991 (12 U.S.C. 

4401–4407), or Regulation EE (12 CFR 

part 231). 

(3) If the securities firm uses the claim 

to satisfy its applicable capital 

requirements, the claim is not eligible 

for a risk weight under this paragraph 

(d)(1)(ii)(H); 

(I) Claims representing general 

obligations of any public-sector entity in 

an OECD country, and that portion of 

any claims guaranteed by any such 

public-sector entity; 

(J) Bonds issued by the Financing 

Corporation or the Resolution Funding 

Corporation; 

(K) Balances due from and all claims 

on domestic depository institutions. 

This includes demand deposits and 

other transaction accounts, savings 

deposits and time certificates of deposit, 

federal funds sold, loans to other 

depository institutions, including 

overdrafts and term federal funds, 

holdings of the savings association’s 

own discounted acceptances for which 

the account party is a depository 

institution, holdings of bankers 

acceptances of other institutions and 

securities issued by depository 

institutions, except those that qualify as 

capital; 

(L) The book value of paid-in Federal 

Home Loan Bank stock; 

(M) Deposit reserves at, claims on and 

balances due from the Federal Home 

Loan Banks; 

(N) Assets collateralized by cash held 

in a segregated deposit account by the 

reporting savings association; 

(O) Loans that are not externally rated 

that are issued to official multilateral 

lending institutions or regional 

development institutions in which the 

United States Government is a 

shareholder or contributing member. 

Externally rated loans to, debt securities 

of, claims collateralized by claims on, 

and guarantees by such official 

multilateral lending institutions, or 

regional development institutions are 

subject to paragraph (d)(3) through (5) of 

this section; 

(P) All claims on depository 

institutions incorporated in an OECD 

country, and all assets backed by the 

full faith and credit of depository 

institutions incorporated in an OECD 

country. This includes the credit 

equivalent amount of participations in 

commitments and standby letters of 

credit sold to other depository 

institutions incorporated in an OECD 

country, but only if the originating bank 

remains liable to the customer or 

beneficiary for the full amount of the 

commitment or standby letter of credit. 

Also included in this category are the 

credit equivalent amounts of risk 

participations in bankers’ acceptances 

conveyed to other depository 

institutions incorporated in an OECD 

country. However, bank-issued 

securities that qualify as capital of the 


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issuing bank are not included in this 

risk category; 

(Q) Claims on, or guaranteed by 

depository institutions other than the 

central bank, incorporated in a nonOECD country, with a remaining 

maturity of one year or less; 

(R) Debt securities issued by, other 

claims on, and that portion of assets 

backed by an eligible guarantee of, a 

sovereign that receive a 20 percent risk 

weight under paragraphs (d)(3) and (5) 

of this section; 

(S) Debt securities issued by, certain 

other externally rated claims on, and 

that portion of assets backed by an 

eligible guarantee of, a non-sovereign 

that receive a 20 percent risk weight 

under paragraphs (d)(3) and (5) of this 

section; 

(T) Recourse obligations, direct credit 

substitutes, residual interests (other 

than credit-enhancing interest-only 

strips), and asset-or mortgage-backed 

securities with long-term external 

ratings in the highest or second highest 

investment grade category or short-term 

external ratings in the highest 

investment rating category, as provided 

under paragraph (f) of this section; 

(U) Assets collateralized by exposures 

that receive a 20 percent risk weight 

under paragraph (d)(4) of this section; 

(V) Certain mortgage loans secured by 

liens on one-to four-family residential 

properties that receive a 20 percent risk 

weight under paragraph (d)(2) of this 

section. 

(iii) 35 percent risk weight. 

(A) Debt securities issued by, other 

claims on, and that portion of assets 

backed by an eligible guarantee of, a 

sovereign that receive a 35 percent risk 

weight under paragraphs (d)(3) and (5) 

of this section; 

(B) Debt securities issued by, certain 

other externally rated claims on, and 

that portion of assets backed by an 

eligible guarantee of, a non-sovereign 

that receive a 35 percent risk weight 

under paragraphs (d)(3) and (5) of this 

section; 

(C) Recourse obligations, direct credit 

substitutes, residual interests (other 

than credit-enhancing interest-only 

strips), and asset-or mortgage-backed 

securities with long-term external 

ratings in the third highest investment 

grade category or short-term external 

ratings in the second highest investment 

rating category, as provided under 

paragraph (f) of this section; 

(D) Assets collateralized by exposures 

that receive a 35 percent risk weight 

under paragraph (d)(4) of this section; 

(E) Certain mortgage loans secured by 

liens on one-to four-family residential 

properties that receive a 35 percent risk 

weight under paragraph (d)(2) of this 

section. 

(iv) 50 percent risk weight. 

(A) Revenue bonds issued by any 

public-sector entity in an OECD 

country, for which the underlying 

obligor is a public-sector entity, but 

which are repayable solely from the 

revenues generated from the project 

financed through the issuance of the 

obligations; 

(B) Qualifying multifamily mortgage 

loans; 

(C) Privately-issued mortgage-backed 

securities (i.e., those that do not carry 

the guarantee of a government or 

government-sponsored agency) 

representing an interest in qualifying 

mortgage loans or qualifying 

multifamily mortgage loans. If the 

security is backed by qualifying 

multifamily mortgage loans, the savings 

association must receive timely 

payments of principal and interest in 

accordance with the terms of the 

security. Payments will generally be 

considered timely if they are not 30 

days past due; 

(D) Qualifying residential 

construction loans; 

(E) Debt securities issued by, other 

claims on, and that portion of assets 

backed by an eligible guarantee of, a 

sovereign that receive a 50 percent risk 

weight under paragraphs (d)(3) and (5) 

of this section; 

(F) Debt securities issued by, certain 

other externally rated claims on, and 

that portion of assets backed by an 

eligible guarantee of, a non-sovereign 

that receive a 50 percent risk weight 

under paragraphs (d)(3) and (5) of this 

section; 

(G) Recourse obligations, direct credit 

substitutes, residual interests (other 

than credit-enhancing interest-only 

strips), and asset-or mortgage-backed 

securities with long-term external 

ratings in the lowest investment ‘‘ plus 

grade category, as provided under 

paragraph (f) of this section; 

(H) Assets collateralized by exposures 

that receive a 50 percent risk weight 

under paragraph (d)(4) of this section; 

(I) Certain mortgage loans secured by 

liens on one-to four-family residential 

properties that receive a 50 percent risk 

weight under paragraph (d)(2) of this 

section. 

(v) 75 percent risk weight. 

(A) Debt securities issued by, other 

claims on, and that portion of assets 

backed by an eligible guarantee of, a 

sovereign that receive a 75 percent risk 

weight under paragraphs (d)(3) and (5) 

of this section; 

(B) Debt securities issued by, certain 

other externally rated claims on, and 

that portion of assets backed by an 

eligible guarantee of, a non-sovereign 

that receive a 75 percent risk weight 

under paragraphs (d)(3) and (5) of this 

section; 

(C) Recourse obligations, direct credit 

substitutes, residual interests (other 

than credit-enhancing interest-only 

strips), and asset-or mortgage-backed 

securities with long-term external 

ratings in the lowest investment grade ‘‘

naught category or short-term external 

ratings in the lowest investment rating 

category, as provided under paragraph 

(f) of this section; 

(D) Assets collateralized by exposures 

that receive a 75 percent risk weight 

under paragraph (d)(4) of this section; 

(E) Certain mortgage loans secured by 

liens on one-to four-family residential 

properties that receive a 75 percent risk 

weight under paragraph (d)(2) of this 

section. 

(vi) 100 percent risk weight. All assets 

not otherwise specified in this section 

or deducted from calculations of capital 

under to § 567.5 of this part, including, 

but not limited to: 

(A) Consumer loans; 

(B) Commercial loans that are not 

externally rated; 

(C) Non-qualifying multifamily 

mortgage loans; 

(D) Residential construction loans; 

(E) Land loans; 

(F) Nonresidential construction loans; 

(G) Obligations issued by any publicsector entity in an OECD country, for 

the benefit of a private party or 

enterprise provided that the party or 

enterprise, rather than the issuing 

public-sector entity, is responsible for 

the timely payment of principal and 

interest on the obligations, e.g., 

industrial development bonds; 

(H) Investments in fixed assets and 

premises; 

(I) Certain nonsecurity financial 

instruments including servicing assets 

and intangible assets includable in core 

capital under § 567.12 of this part; 

(J) That portion of equity investments 

not deducted pursuant to § 567.5 of this 

part; 

(K) The prorated assets of subsidiaries 

(except for the assets of includable, fully 

consolidated subsidiaries) to the extent 

such assets are included in adjusted 

total assets; 

(L) All repossessed assets or assets 

(other than mortgage loans secured by 

liens on one-to four-family residential 

properties) that are more than 90 days 

past due; 

(M) Equity investments that the Office 

determines have the same risk 

characteristics as foreclosed real estate 

by the savings association; 

(N) Equity investments permissible 

for a national bank; 


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77514 Federal Register / Vol. 71, No. 247 / Tuesday, December 26, 2006 / Proposed Rules 

(O) Debt securities issued by, other 

claims on, and that portion of assets 

backed by an eligible guarantee of, a 

sovereign that receive a 100 percent risk 

weight under paragraphs (d)(3) and (5) 

of this section; 

(P) Debt securities issued by, certain 

other rated claims on, and that portion 

of assets backed by an eligible guarantee 

of, non-sovereign that receive a 100 

percent risk weight under paragraphs 

(d)(3) and (5) of this section; 

(Q) Recourse obligations, direct credit 

substitutes, residual interests (other 

than credit-enhancing interest-only 

strips), and asset- or mortgage-backed 

securities with long-term external 

ratings in the lowest investment grade—

negative category, as provided under 

paragraph (f) of this section; 

(R) Assets collateralized by exposures 

that receive a 100 percent risk weight 

under paragraph (d)(4) of this section; 

(S) Certain mortgage loans secured by 

liens on one-to four-family residential 

properties that receive a 100 percent 

risk weight under paragraph (d)(2) of 

this section. 

(vii) 150 percent risk weight. 

(A) Debt securities issued by, certain 

other rated claims on, and that portion 

of assets backed by an eligible guarantee 

of a non-sovereign that receive a 150 

percent risk weight under paragraphs 

(d)(3) and (5) of this section; 

(B) Assets collateralized by exposures 

that receive a 150 percent risk weight 

under paragraph (d)(4) of this section; 

(C) Certain mortgage loans secured by 

liens on one-to four-family residential 

properties that receive a 150 percent 

risk weight under paragraph (d)(2) of 

this section. 

(viii) 200 percent risk weight. 

(A) Debt securities issued by, other 

claims on, and that portion of assets 

backed by an eligible guarantee of, a 

sovereign that receive a 200 percent risk 

weight under paragraphs (d)(3) and (5) 

of this section; 

(B) Debt securities issued by, certain 

other rated claims on, and that portion 

of assets backed by an eligible guarantee 

of, a non-sovereign that receive a 200 

percent risk weight under paragraphs 

(d)(3) and (5) of this section; 

(C) Recourse obligations, direct credit 

substitutes, residual interests (other 

than credit-enhancing interest-only 

strips), and asset-or mortgage-backed 

securities with long-term external 

ratings one category below investment 

grade, as provided under paragraph (f) 

of this section; 

(D) Assets collateralized by exposures 

that receive a 200 percent risk weight 

under paragraph (d)(4) of this section. 

(2) Mortgage loans secured by a lien 

on one-to four-family residential 

property. A savings association must 

risk-weight mortgage loans secured by 

liens on one-to four-family residential 

properties under this paragraph (d)(2). 

(i) First liens. A savings association 

must apply the risk weight in Table 1 

that corresponds to the loan-to-value 

(LTV) ratio of a mortgage loan secured 

by a first lien on one-to four-family 

residential property. If a loan is not 

prudently underwritten, is not 

performing, or is more than 90 days past 

due, the savings association must apply 

a risk weight of 150 percent if the loan 

has an LTV that is greater than 95 

percent, and must apply a risk weight of 

100 percent to all other loans. 

TABLE 1.—RISK WEIGHTS FOR MORTGAGE LOANS SECURED BY FIRST

LIENS ON ONE-TO FOUR-FAMILY

RESIDENTIAL PROPERTIES

Loan-to-Value ratio Risk weight 

(percent) 

60% or less ............................... 20 

Greater than 60% and less 

than or equal to 80% ............ 35 

Greater than 80% and less 

than or equal to 85% ............ 50 

Greater than 85% and less 

than or equal to 90% ............ 75 

Greater than 90% and less 

than or equal to 95% ............ 100 

Greater than 95% ..................... 150 

(ii) Junior liens. 

(A) If a savings association holds the 

first lien and a junior lien on a one-to 

four family residential property and no 

other party holds an intervening lien, 

the savings association must treat the 

two loans as a single loan secured by a 

first lien and risk-weight the loans 

under paragraph (d)(2)(i) of this section. 

(B) If a third party holds a senior or 

intervening lien, the savings association 

must apply the risk weight in Table 2 

that corresponds the LTV ratio of the 

loan. If a loan is not prudently 

underwritten, is not performing, or is 

more than 90 days past due, the savings 

association must apply a risk weight of 

150 percent if the loan has an LTV that 

is greater than 90 percent, and must 

apply a risk weight of 100 percent to all 

other loans. 

TABLE 2.—RISK WEIGHTS FOR MORTGAGE LOANS SECURED BY JUNIOR

LIENS ON ONE-TO FOUR-FAMILY

RESIDENTIAL PROPERTIES

Loan-to-Value ratio Risk weight 

60% or less ............................... 75 

Greater than 60% and less 

than or equal to 90% ............ 100 

Greater than 90% ..................... 150 

(iii) LTV computation. To compute 

the LTV ratio under this paragraph 

(d)(2): 

(A) The loan amount is the original 

principal amount of the loan and of all 

senior loans, subject to the following 

adjustments: 

(1) If a loan has positively amortized, 

the savings association may adjust the 

original principal amount of the loan 

quarterly to reflect the positive 

amortization. 

(2) If a loan has a negative 

amortization feature, the savings 

association must adjust the original 

principal amount of the loan quarterly 

to include amount of the negative 

amortization. If a third party holds a 

senior or intervening lien with a 

negative amortization feature, the 

savings association must adjust the 

original principal amount of the senior 

or intervening loan to reflect the amount 

of that loan if it were to fully negatively 

amortize under the applicable contract. 

(3) If a loan is a home equity line of 

credit, the savings association must 

adjust the original principal amount of 

the loan quarterly to reflect the current 

funded amount of the line of credit. 

(B) At the origination of the loan, the 

value of the property is the lower of the 

purchase price or the estimate of the 

property’s value. The savings 

association may update the value of the 

property only when it extends 

additional funds in connection with 

refinancing the loan or originating 

another loan secured by a junior lien 

that is treated as a single loan under 

paragraph (d)(2)(ii)(A) of this section, 

and it obtains a new appraisal or 

evaluation of the value of the property 

as a part of that transaction. All 

estimates of the property’s value must 

be based on an appraisal or evaluation 

of the property in conformance with 12 

CFR part 564 and 12 CFR 560.100–

560.101. 

(C) The savings association may 

compute the LTV ratio after 

consideration of loan level private 

mortgage insurance (PMI) provided by 

non-affiliated insurer with long-term 

senior debt (without credit 

enhancement) that is externally-rated at 

least the third highest investment grade. 

Loan level PMI is insurance that 

protects a mortgage lender in the event 

of borrower default up to a 

predetermined portion of the value of a 

one-to four-family residential property 

and that has no pool-level cap that 

would effectively reduce coverage 

below the predetermined portion of the 

value of the property. An affiliated 

company is any company that controls, 

is controlled by, or is in common 

control with the savings association. A 


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company or person controls a company 

if it owns, controls, or holds with power 

to vote 25 percent or more of a class of 

voting securities of the company, or 

consolidates the company for financial 

reporting purposes. 

(iv) Negatively amortizing loans and 

home equity lines of credit. This 

paragraph (d)(2) applies to the funded 

portions of negatively amortizing loans 

and home equity lines of credit that are 

secured by a first or junior lien on oneto four-family residential property. The 

unfunded portions of these loans are 

addressed at paragraph (e)(2) of this 

section. 

(v) Construction loans. This paragraph 

(d)(2) applies to a mortgage loan to an 

individual borrower that is secured by 

a lien on land to be used for the 

construction of the borrower’s home. It 

does not apply to ‘‘qualifying residential 

construction loans,’’ as defined in 

§ 567.1, which are addressed under 

paragraph (d)(1)(iv)(D) of this section or 

other residential construction loans, 

which are addressed under paragraph 

(d)(1)(vi)(D) of this section. 

(vi) Transition provision. If a savings 

association owns a mortgage loan 

secured by a lien on one-to four-family 

residential property on the date that it 

elects to opt-in under paragraph (a) of 

this section, it may apply a 50 percent 

risk weight if the mortgage loan is a 

‘‘qualifying mortgage loan’’ as defined 

in § 567.1, and apply a 100 percent risk 

weight if the mortgage loan is not a 

qualifying mortgage loan. If the savings 

association elects to apply this 

paragraph (d)(2)(vi), it must apply this 

transitional risk-weight treatment to all 

mortgage loans that it owns on the date 

that it elects to opt-in under paragraph 

(a). A savings association may only rely 

on this transitional provision the first 

time it elects to compute risk-weights 

under this § 567.7. 

(3) Direct claims—ratings-based 

approach. (i) A savings association must 

risk-weight claims described in 

paragraph (d)(3)(ii) of this section using 

the risk weights indicated on Table 3 

(claims with an original maturity of one 

year or more) or Table 4 (claims with an 

original maturity of less than one year). 

To determine the applicable risk weight 

for a claim, the savings association must 

use the external rating for the claim. If 

a sovereign exposure has no external 

rating, the exposure is deemed to have 

an external rating equal to the 

sovereign’s issuer rating assigned by an 

NRSRO. 

(ii)(A) This paragraph (d)(3) applies to 

claims on sovereigns, other than the 

United States Government and its 

agencies. Claims on the United States 

Government and its agencies are riskweighted under paragraph (d)(1) of this 

section. 

(B) This paragraph (d)(3) also applies 

to all claims on non-sovereigns, other 

than loans that are not externally rated 

and claims on United States 

Government-sponsored agencies, 

public-sector entities in OECD 

countries, and depository institutions. 

Loans to non-sovereigns that are not 

externally rated and claims on United 

States Government-sponsored agencies, 

public sector entities in OECD countries 

and depository institutions are riskweighted under paragraph (d)(1) of this 

section. 

(C) This paragraph (d)(3) does not 

apply to recourse obligations, direct 

credit substitutes, and other positions 

that are subject to paragraph (f) of this 

section. 

(D) This paragraph (d)(3) also does not 

apply to OTC derivative counter-party 

risk. OTC derivative counter-party risk 

is addressed in paragraph (e) of this 

section. 

TABLE 3.—RISK WEIGHTS BASED ON RATINGS FOR LONG-TERM EXPOSURES

Long-term rating category Example 

Sovereign risk 

weight 

(percent) 

Non-Sovereign 

risk weight 

(percent) 

Highest investment grade rating ............................................................................................... AAA 0 20 

Second-highest investment grade rating .................................................................................. AA 20 20 

Third-highest investment grade rating ...................................................................................... A 20 35 

Lowest-investment grade rating—plus ..................................................................................... BBB+ 35 50 

Lowest-investment grade rating ............................................................................................... BBB 50 75 

Lowest-investment grade rating—minus .................................................................................. BBB¥ 75 100 

One category below investment grade ..................................................................................... BB+, BB 75 150 

One category below investment grade—minus ....................................................................... BB¥ 100 200 

Two or more categories below investment grade .................................................................... B, CCC 150 200

Unrated ..................................................................................................................................... n/a 200 2001

TABLE 4.—RISK WEIGHTS BASED ON RATINGS FOR SHORT-TERM EXPOSURES

Short-term rating category Example Sovereign risk 

weight 

Non-Sovereign 

risk weight 

Highest investment grade rating ............................................................................................... A–1, P–1 0 20 

Second-highest investment grade rating .................................................................................. A–2, P–2 20 35 

Lowest investment grade rating ............................................................................................... A–3, P–3 50 75 

Unrated ..................................................................................................................................... n/a 100 1001

1Unrated debt securities issued by non-sovereigns receive the risk-weight indicated. Unrated loans to non-sovereigns are risk-weighted under 

paragraph (d)(1) of this section. 

(4) Claims collateralized by certain 

debt securities or asset-backed or 

mortgage-backed securities. (i) In 

addition to collateralized claims 

addressed in paragraph (d)(1) of this 

section, a savings association may riskweight a claim that is collateralized by: 

(A) A debt security that may be riskweighted under paragraph (d)(3) of this 

section, by applying the risk-weight that 

would be assigned directly to the debt 

security under that paragraph. The 

minimum risk-weight that may be 

assigned to an asset collateralized by a 

debt security that is issued by a 

sovereign is 20 percent; 

(B) A debt security backed by a 

guarantee of a sovereign (other than the 

United States and its agencies) that may 

be risk-weighted under paragraph (d)(5) 

of this section, by applying the riskVerDate Aug<31>2005 16:17 Dec 22, 2006 Jkt 211001 PO 00000 Frm 00071 Fmt 4701 Sfmt 4702 E:\FR\FM\26DEP2.SGM 26DEP2

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weight that would be assigned directly 

to the debt security under that 

paragraph. The minimum risk-weight 

that may be assigned to an asset 

collateralized by a debt security that is 

guaranteed by a sovereign is 20 percent; 

or 

(C) A security that may be riskweighted under Table A or B of 

paragraph (f) of this section, by applying 

the risk-weight that would be assigned 

directly to the security under paragraph 

(f). 

(ii) To be eligible for risk-weighting 

under this paragraph (d)(4), the 

collateral must be liquid and readily 

marketable and must have an external 

rating (or, if applicable, a sovereign 

issuer rating assigned by an NRSRO) of 

at least investment grade. 

(iii) If an asset is partially 

collateralized, only that portion of the 

asset that is collateralized by the market 

value of the collateral may be riskweighted under this paragraph (d)(4). 

(5) Guaranteed assets or claims. (i) A 

savings association may risk-weight a 

claim that is backed by an eligible 

guarantee by applying the risk-weight 

indicated in Table 3 of this section. To 

determine the applicable risk weight for 

an exposure, the savings association 

must use the external rating assigned to 

the guarantor’s long-term senior debt 

(without credit enhancement) or, if the 

guarantor is a sovereign, an external 

rating that is equal to the sovereign’s 

issuer rating assigned by an NRSRO. 

The applicable external rating must be 

at least investment grade. 

(ii) This paragraph (d)(5) applies to 

eligible guarantees of: 

(A) Sovereigns, other than the United 

States Government and its agencies. 

Guarantees of the United States 

Government and its agencies are riskweighted under paragraph (d)(1) of this 

section; and 

(B) Non-sovereigns, other than United 

States Government-sponsored agencies, 

public-sector entities in OECD 

countries, and depository institutions. 

Guarantees of United States 

Government-sponsored agencies, 

public-sector entities in OECD 

countries, and depository institutions 

are risk-weighted under paragraph (d)(1) 

of this section. 

(iii) To be an eligible guarantee, the 

guarantee must be issued by a third 

party guarantor and must: 

(A) Be written and unconditional and, 

for a sovereign guarantee, be backed by 

the full faith and credit of the sovereign; 

(B) Cover all or a pro rata portion of 

contractual payments of the obligor on 

the reference asset or claim. If an asset 

or claim is partially guaranteed, only the 

pro rata portion of the asset or claim 

that is guaranteed may be assigned a 

risk-weight under this paragraph (d)(5); 

(C) Give the beneficiary a direct claim 

against the protection provider; 

(D) Be non-cancelable by the 

protection provider for reasons other 

than the breach of the contract by the 

beneficiary; 

(E) Be 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; 

and 

(F) Require the protection provider to 

make payment to the beneficiary on the 

occurrence of a default of the obligor on 

the reference asset or claim without first 

requiring the beneficiary to demand 

payment from the obligor. 

(6) Indirect ownership interests in 

pools of assets. Assets representing an 

indirect holding of a pool of assets, e.g., 

mutual funds, are assigned to riskweight categories based upon the risk 

weight that would be assigned to the 

assets in the portfolio of the pool. An 

investment in shares of a mutual fund 

whose portfolio consists primarily of 

various securities or money market 

instruments that, if held separately, 

would be assigned to different riskweight categories, generally is assigned 

to the risk-weight category appropriate 

to the highest risk-weighted asset that 

the fund is permitted to hold in 

accordance with the investment 

objectives set forth in its prospectus. 

The savings association may, at its 

option, assign the investment on a pro 

rata basis to different risk-weight 

categories according to the investment 

limits in its prospectus. In no case will 

an investment in shares in any such 

fund be assigned to a total risk weight 

less than 20 percent. If the savings 

association chooses to assign 

investments on a pro rata basis, and the 

sum of the investment limits of assets in 

the fund’s prospectus exceeds 100 

percent, the savings association must 

assign the highest pro rata amounts of 

its total investment to the higher risk 

categories. If, in order to maintain a 

necessary degree of short-term liquidity, 

a fund is permitted to hold an 

insignificant amount of its assets in 

short-term, highly liquid securities of 

superior credit quality that do not 

qualify for a preferential risk weight, 

such securities will generally be 

disregarded in determining the riskweight category into which the savings 

association’s holding in the overall fund 

should be assigned. The prudent use of 

hedging instruments by a mutual fund 

to reduce the risk of its assets will not 

increase the risk-weighting of the 

mutual fund investment. For example, 

the use of hedging instruments by a 

mutual fund to reduce the interest rate 

risk of its government bond portfolio 

will not increase the risk weight of that 

fund above the 20 percent category. 

Nonetheless, if the fund engages in any 

activities that appear speculative in 

nature or has any other characteristics 

that are inconsistent with the 

preferential risk-weighting assigned to 

the fund’s assets, holdings in the fund 

will be assigned to the 100 percent riskweight category. 

(e) Off balance sheet items. A savings 

association must calculate the riskweighted off-balance sheet items as 

described at § 567.6 of this part, with 

the following modifications: 

(1) Short-term commitments. A 

savings association must apply the 

following credit conversion factors to 

the unused portion of commitments 

with an original maturity of one year or 

less: 

(i) Zero percent for commitments that 

are unconditionally cancelable and 

commitments to originate a loan secured 

by a lien on one- to four-family 

residential property; and 

(ii) 10 percent for all other short-term 

commitments. 

(2) Unfunded amount of negatively 

amortizing mortgage loans and home 

equity lines of credit. If a mortgage loan 

secured by a lien on one- to four-family 

residential property may negatively 

amortize or is a home equity line of 

credit, a savings association must 

calculate the risk-weighted asset amount 

for the unfunded amount of the loan by 

multiplying the amount of the offbalance sheet exposure times the 

applicable credit conversion factor 

times the applicable risk weight. For the 

purposes of this paragraph (e)(2): 

(i) The amount of the off-balance 

sheet exposure is the unfunded amount 

of the loan if it were to fully negatively 

amortize under the applicable contract 

or the maximum unfunded amount of 

the home equity line of credit; and 

(ii) The applicable risk weight is the 

risk weight prescribed in paragraph 

(d)(2) of this section using an LTV 

computed under that paragraph, except 

that the loan amount must include an 

additional amount equal to the 

unfunded amount of the loan if it were 

to fully negative amortize under the 

applicable contract or equal to the 

maximum unfunded amount of the 

home equity line of credit. 

(3) Risk weight for derivatives. A 

savings association must calculate the 

risk-weighted asset amount for offbalance sheet derivative contracts 

without reference to the 50 percent 

maximum risk-weight cap described at 

12 CFR 567.6(a)(2). 


sroberts on PROD1PC70 with PROPOSALS
Federal Register / Vol. 71, No. 247 / Tuesday, December 26, 2006 / Proposed Rules 77517 

(f) Ratings-based approach for 

recourse obligations, direct credit 

substitutes and certain other positions. 

(1) General. A savings association must 

apply § 567.6(b) of this part to 

determine the risk weights for recourse 

obligations, direct credit substitutes, 

and other described positions, except 

the savings association must calculate 

risk-weights for recourse obligations, 

direct credit substitutes, residual 

interests (other than credit enhancing 

interest-on strips) described in 

§ 567.6(b)(3) by referring to the 

exposure’s external rating and using the 

following tables: 

TABLE 5 

Long-term external rating category Example Risk weight 

(percent) 

Highest investment grade rating ........................................................................................................................... AAA 20 

Second-highest investment grade rating .............................................................................................................. AA 20 

Third-highest investment grade rating .................................................................................................................. A 35 

Lowest-investment grade rating—plus ................................................................................................................. BBB+ 50 

Lowest-investment grade rating—naught ............................................................................................................. BBB 75 

Lowest-investment grade rating—negative .......................................................................................................... BBB¥ 100 

One category below investment grade—plus & naught ....................................................................................... BB+, BB 200 

One category below investment grade—negative ............................................................................................... BB¥ 200 

TABLE 6 

Short-term external rating category Example Risk weight 

(percent) 

Highest investment grade rating ........................................................................................................................... A–1, P–1 20 

Second-highest investment grade rating .............................................................................................................. A–2, P–2 35 

Lowest investment grade rating ........................................................................................................................... A–3, P–3 75 

(2) Securitizations of revolving credit 

with early amortization provisions. 

(i) A savings association must riskweight the off-balance sheet amount of 

the investor’s interest in a securitization 

if: 

(A) The savings association 

securitizes revolving credits in the 

securitization. A revolving credit is a 

line of credit where the borrower is 

permitted to vary the drawn amount and 

the amount of repayment within an 

agreed limit; and 

(B) The securitization structure 

includes an early amortization 

provision. An early amortization 

provision is 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. An early 

amortization provision does not include 

a provision that is triggered solely by 

events that are not directly related to the 

performance of the underlying 

exposures or the originating savings 

association (such as material changes in 

tax laws or regulations). 

(ii) The risk-based asset amount for 

the investors’ interest in a securitization 

described in this paragraph (f)(2) is 

equal to the off-balance sheet investors’

interest times the applicable credit 

conversion factor times the risk-weight 

applicable to the underlying obligor, 

collateral or guarantor. For the purposes 

of this paragraph (f)(2): 

(A) The off-balance sheet investors’

interest is the total amount of the 

securitization exposures issued by a 

trust or a special purpose entity to 

investors. 

(B) The applicable credit conversion 

factor is determined by reference to 

Table 5, which is based upon a 

comparison of the securitization’s 

annualized three month average excess 

spread against the excess spread 

trapping point. This excess spread 

trapping ratio is computed as follows: 

(1) The savings association must 

calculate the three-month average of the 

dollar amount of excess spread divided 

by the outstanding principal balance of 

the underlying pool of exposures at the 

end of each month. Excess spread is 

equal to the gross finance charge 

collections (including market 

interchange fees) and other income 

received by a trust or special purpose 

entity minus interest paid to the 

investors in the securitization 

exposures, servicing fees, charge-offs, 

and other trust or special purpose entity 

expenses. 

(2) The three-month average excess 

spread is converted to a compound 

annual rate and is then divided by the 

excess spread trapping point. The 

excess spread trapping point is the point 

at which the savings association is 

required by the documentation for the 

securitization to divert and hold excess 

spread in spread or reserve account, 

expressed as a percentage. The excess 

spread trapping point is 4.5 percent for 

securitizations that do not require 

excess spread to be trapped or that 

specify a trapping point that is based 

primarily on performance features other 

than the three-month average excess 

spread. 

(iii) If the aggregate risk-based capital 

requirement for all of a savings 

association’s exposures to a 

securitization (including the risk-based 

capital requirements for residual 

interests, recourse obligations, direct 

credit substitutes, the investor’s interest 

computed under this paragraph (f)(2), 

and other securitization exposures) 

exceeds the risk-based capital 

requirement for the underlying 

securitized assets, the aggregate riskbased capital for all of the exposures is 

the greater of the risk-based capital 

requirement for: 

(A) The residual interest; or 

(B) The underlying securitized assets 

calculated as if the savings association 

continued to hold the assets on its 

balance sheet. 

TABLE 7.—EARLY AMORTIZATION

CREDIT CONVERSION FACTORS

Excess spread trapping point 

ratio 

CCF 

(percent) 

133.33 percent of trapping 

point or more ......................... 0 

Less than 133.33 percent to 

100 percent of trapping point 5 

Less than 100 percent to 75 

percent of trapping point ....... 15 


sroberts on PROD1PC70 with PROPOSALS
77518 Federal Register / Vol. 71, No. 247 / Tuesday, December 26, 2006 / Proposed Rules 

1As used in this notice, the term ‘‘bank’’ includes 

banks, savings associations, and bank holding 

companies. 

TABLE 7.—EARLY AMORTIZATION

CREDIT CONVERSION FACTORS—

Continued 

Excess spread trapping point 

ratio 

CCF 

(percent) 

Less than 75 percent to 50 percent of trapping point ............ 50 

Less than 50 percent of trapping point .............................. 100 

6. In § 567.11, revise paragraph (c)(2), 

redesignate paragraph (c)(3) as 

paragraph (c)(4) and add new paragraph 

(c)(3) to read as follows: 

§ 567.11 Reservation of authority. 

* * * * * 

(c) * * * 

(2) Notwithstanding §§ 567.6 and 

567.7 of this part, OTS will look to the 

substance of a transaction and may find 

that the assigned risk-weight for any 

asset, or credit equivalent amount or 

credit conversion factor for any offbalance sheet item does not 

appropriately reflect the risks imposed 

on the savings association. OTS may 

require the savings association to apply 

another risk weight, credit equivalent 

amount, or credit conversion factor that 

the OTS deems appropriate. Similarly, 

OTS may override the use of certain 

ratings or ratings on certain instruments, 

if necessary or appropriate to reflect the 

risk that that an instrument poses to a 

savings association. 

(3) OTS may require a savings 

association to use § 567.6 or § 567.7 of 

this part to compute risk-weighted 

assets, if OTS determines that the riskweighted capital requirement computed 

under that section is more appropriate 

for the risk profile of the savings 

association or would otherwise enhance 

the safety and soundness of the savings 

association. In making a determination 

under this paragraph (c)(3), OTS will 

apply notice and response procedures in 

the same manner and to the same extent 

as the notice procedures in 12 CFR 

567.3(d). 

* * * * * 

Dated: December 12, 2006. 

John C. Dugan, 

Comptroller of the Currency. 

By order of the Board of Governors of the 

Federal Reserve System, December 8, 2006. 

Jennifer J. Johnson, 

Secretary of the Board. 

Dated at Washington, D.C., this 5th Day of 

December, 2006. 

By order of the Board of Directors. 

Federal Deposit Insurance Corporation. 

Valerie J. Best, 

Assistant Executive Secretary. 

Dated: December, 11, 2006. 

By the Office of Thrift Supervision 

John Reich, 

Director. 

[FR Doc. 06–9738 Filed 12–22–06; 8:45 am] 

BILLING CODE 4810–33–P(25%); 6210–01–P(25%); 6714–

01–P(25%); 6720–01–P(25%) 

DEPARTMENT OF THE TREASURY 

Office of the Comptroller of the 

Currency 

12 CFR Part 3 

[Docket No. 06–09] 

RIN 1557–AC91 

FEDERAL RESERVE SYSTEM 

12 CFR Parts 208 and 225 

[Regulations H and Y; Docket No. R–1261] 

FEDERAL DEPOSIT INSURANCE 

CORPORATION 

12 CFR Part 325 

RIN 3064–AC73 

DEPARTMENT OF THE TREASURY 

Office of Thrift Supervision 

12 CFR Part 566 

[Docket No. 2006–33] 

RIN 1550–AB56 

Risk-Based Capital Standards: 

Advanced Capital Adequacy 

Framework 

AGENCIES: Office of the Comptroller of 

the Currency, Treasury; Board of 

Governors of the Federal Reserve 

System; Federal Deposit Insurance 

Corporation; and Office of Thrift 

Supervision, Treasury. 

ACTION: Joint notice of proposed 

rulemaking; extension of comment 

period. 

SUMMARY: On September 25, 2006, the 

Office of the Comptroller of the 

Currency (OCC), the Board of Governors 

of the Federal Reserve System (Board), 

the Federal Deposit Insurance 

Corporation (FDIC), and the Office of 

Thrift Supervision (OTS) (collectively, 

the agencies) issued a joint notice of 

proposed rulemaking for public 

comment that proposed a new riskbased capital adequacy framework 

(Basel II NPR). The Basel II NPR would 

require some and permit other 

qualifying banks 1 to use an internal 

ratings-based approach to calculate 

regulatory credit risk capital 

requirements and advanced 

measurement approaches to calculate 

regulatory operational risk capital 

requirements. The Basel II NPR 

describes the qualifying criteria for 

banks required or seeking to operate 

under the proposed framework and the 

applicable risk-based capital 

requirements for banks that operate 

under the framework. The Basel II NPR 

comment period will end on January 23, 

2007. 

In today’s issue of the Federal 

Register, the agencies are proposing 

revisions to the existing risk-based 

capital framework that would apply to 

banks that do not use the Basel II NPR 

(Basel IA NPR). The agencies have 

determined that an extension of the 

Basel II NPR comment period is 

appropriate to allow interested parties 

additional time to compare the riskbased capital requirements as proposed 

in the Basel II NPR with the risk-based 

capital requirements as proposed in the 

Basel IA NPR. 

DATES: The comment period for the 

proposed rule published at 71 FR 55830 

(Sept. 25, 2006) is extended until March 

26, 2007. 

ADDRESSES: You may submit comments 

by any of the methods identified in the 

Basel II NPR (See 71 FR 55830, 

September 25, 2006.) 

FOR FURTHER INFORMATION CONTACT: 

OCC: Roger Tufts, Senior Economic 

Advisor, Capital Policy (202–874–4925) 

or Ron Shimabukuro, Special Counsel, 

Legislative and Regulatory Activities 

Division (202–874–5090). Office of the 

Comptroller of the Currency, 250 E 

Street, SW., Washington, DC 20219. 

Board: Barbara Bouchard, Deputy 

Associate Director (202–452–3072 or 

barbara.bouchard@frb.gov) or Anna Lee 

Hewko, Senior Supervisory Financial 

Analyst (202–530–6260 or 

anna.hewko@frb.gov), Division of 

Banking Supervision and Regulation; or 

Mark E. Van Der Weide, Senior Counsel 

(202–452–2263 or 

mark.vanderweide@frb.gov), Legal 

Division. For users of 

Telecommunications Device for the Deaf 

(‘‘TDD’’) only, contact 202–263–4869. 

FDIC: Jason C. Cave, Associate 

Director, Capital Markets Branch, (202) 

898–3548, Bobby R. Bean, Chief, Policy 

Section, Capital Markets Branch, (202) 

898–3575, Kenton Fox, Senior Capital 

Markets Specialist, Capital Markets 


sroberts on PROD1PC70 with PROPOSALS