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Preamble

Table of Contents
          - Introduction 
          - Scope 
          - Qualification 
          - Calculation of Tier 1 Capital and Total Qualifying Capital 
          - Calculation of Risk-Weighted Assets 
          - Operational Risk 
          - Disclosure 

List of Acronyms

Regulatory Flexibility Act Analysis

Paperwork Reduction Act

Plain Language

OCC Executive Order 12866

OTS Executive Order 12866 Determination

OCC Unfunded Mandates Reform Act of 1995 Determination

OTS Unfunded Mandates Reform Act of 1995 Determination

Proposed Regulatory Text

Table of Contents
        - Part I
        - General Provisions
        - Part II
        - Qualifying Capital
        - Part III
        - Qualification
        - Part IV
        - Risk-Weighted Assets for General Credit Risk
        - Part V 
        - Risk-Weighted Assets for Securitization Exposures
        - Part VI
        - Risk-Weighted Assets for Equity Exposures
        - Part VII
        - Risk-Weighted Assets for Operational Risk
        - Part VIII
        - Disclosure

List of Subjects

Authority and Issuance

OCC

Federal Reserve

FDIC

OTS

OCC

Federal Reserve

FDIC

OTS

Billing Codes

The proposed rule maintains the minimum risk-based capital ratio requirements    of 4.0 percent tier 1 capital to total risk-weighted assets and 8.0 percent    total qualifying capital to total risk-weighted assets. Under the proposed    rule, a bank's total qualifying capital is the sum of its tier 1 (core) capital    elements and tier 2 (supplemental) capital elements, subject to various limits    and restrictions, minus certain deductions (adjustments). The agencies are    not restating the elements of tier 1 and tier 2 capital in this proposed rule.    Those capital elements generally remain as they are currently in the general    risk-based capital rules.31    The agencies have provided proposed regulatory text for, and the following    discussion of, proposed adjustments to the capital elements for purposes of    the advanced approaches. 

The agencies are considering restating the elements of tier 1 and tier 2 capital,    with any necessary conforming and technical amendments, in any final rules    that are issued regarding this proposed framework so that a bank using the    advanced approaches would have a single, comprehensive regulatory text that    describes both the numerator and denominator of the bank's minimum risk-based    capital ratios. The agencies decided not to set forth the capital elements    in this proposed rule so that commenters would be able to focus attention    on the parts of the risk-based capital framework that the agencies propose    to amend. Question 21: Commenters are encouraged to provide views    on the proposed adjustments to the components of the risk-based capital numerator    as described below. Commenters also may provide views on numerator-related    issues that they believe would be useful to the agencies' consideration of    the proposed rule.

After identifying the elements of tier 1 and tier 2 capital, a bank would    make certain adjustments to determine its tier 1 capital and total qualifying    capital (that is, the numerator of the total risk-based capital ratio). Some    of these adjustments would be made only to the tier 1 portion of the capital    base. Other adjustments would be made 50 percent from tier 1 capital and 50 percent from tier 2 capital.32    Under the proposed rule, a bank must still have at least 50 percent of its    total qualifying capital in the form of tier 1 capital.

The bank would continue to deduct from tier 1 capital goodwill, other    intangible assets, and deferred tax assets to the same extent that those assets    are currently required to be deducted from tier 1 capital under the general    risk-based capital rules. Thus, all goodwill would be deducted from tier 1    capital. Qualifying intangible assets – including mortgage servicing    assets, non-mortgage servicing assets, and purchased credit card relationships    – that meet the conditions and limits in the general risk-based capital    rules would not have to be deducted from tier 1 capital. Likewise, deferred    tax assets that are dependent upon future taxable income and that meet the    valuation requirements and limits in the general risk-based capital rules    would not have to be deducted from tier 1 capital.33

Under the general risk-based capital rules, a bank also must deduct from its    tier 1 capital certain percentages of the adjusted carrying value of    its nonfinancial equity investments. An advanced approaches bank would no    longer be required to make this deduction. Instead, the bank's equity exposures    would be subject to the equity treatment in part VI of the proposed rule    and described in section V.F. of this preamble.34

Under the general risk-based capital rules, a bank is allowed to include in    tier 2 capital its ALLL up to 1.25 percent of risk-weighted assets (net of    certain deductions). Amounts of ALLL in excess of this limit, as well as allocated    transfer risk reserves, may be deducted from the gross amount of risk-weighted    assets.

Under the proposed framework, as noted above, the ALLL is treated differently.    The proposed rule includes a methodology for adjusting risk-based capital    requirements based on a comparison of the bank's eligible credit reserves    to its ECL. The proposed rule defines eligible credit reserves as all general    allowances, including the ALLL, that have been established through a charge    against earnings to absorb credit losses associated with on- or off-balance    sheet wholesale and retail exposures. Eligible credit reserves would not include    allocated transfer risk reserves established pursuant to 12 U.S.C. 390435    and other specific reserves created against recognized losses.

The proposed rule defines a bank's total ECL as the sum of ECL for all wholesale    and retail exposures other than exposures to which the bank has applied the    double default treatment (described below). The bank's ECL for a wholesale    exposure to a non-defaulted obligor or a non-defaulted retail segment is the    product of PD, ELGD, and EAD for the exposure or segment. The bank's ECL for    a wholesale exposure to a defaulted obligor or a defaulted retail segment    is equal to the bank's impairment estimate for ALLL purposes for the exposure    or segment.

The proposed method of measuring ECL for non-defaulted exposures is different    than the proposed method of measuring ECL for defaulted exposures. For non-defaulted    exposures, ECL depends directly on ELGD and hence would reflect economic losses,    including the cost of carry and direct and indirect workout expenses. In contrast,    for defaulted exposures, ECL is based on accounting measures of credit loss    incorporated into a bank's charge-off and reserving practices.

The agencies believe that, for defaulted exposures, any difference between    a bank's best estimate of economic losses and its impairment estimate for    ALLL purposes is likely to be small. As a result, the agencies are proposing    to use a bank's ALLL impairment estimate in the determination of ECL for defaulted    exposures to reduce implementation burden for banks. The agencies recognize    that this proposed treatment would require a bank to specify how much of its    ALLL is attributable to defaulted exposures, and that a bank still would need    to capture all material economic losses on defaulted exposures when building    its databases for estimating ELGDs and LGDs for non-defaulted exposures. Question 22:    The agencies seek comment on the proposed ECL approach for defaulted exposures    as well as on an alternative treatment, under which ECL for a defaulted exposure    would be calculated as the bank's current carrying value of the exposure multiplied    by the bank's best estimate of the expected economic loss rate associated    with the exposure (measured relative to the current carrying value), that    would be more consistent with the proposed treatment of ECL for non-defaulted    exposures. The agencies also seek comment on whether these two approaches    would likely produce materially different ECL estimates for defaulted exposures.    In addition, the agencies seek comment on the appropriate measure of ECL for    assets held at fair value with gains and losses flowing through earnings. 

A bank must compare the total dollar amount of its ECL to its eligible credit    reserves. If there is a shortfall of eligible credit reserves compared to    total ECL, the bank would deduct 50 percent of the shortfall from tier 1    capital and 50 percent from tier 2 capital. If eligible credit reserves    exceed total ECL, the excess portion of eligible credit reserves may be included    in tier 2 capital up to 0.6 percent of credit-risk-weighted assets.    The proposed rule defines credit-risk-weighted assets as 1.06 multiplied    by the sum of total wholesale and retail risk-weighted assets, risk-weighted    assets for securitization exposures, and risk-weighted assets for equity exposures.

A bank must deduct from tier 1 capital any increase in the bank's equity    capital at the inception of a securitization transaction (gain-on-sale), other    than an increase in equity capital that results from the bank's receipt of    cash in connection with the securitization. The agencies have designed this    deduction to offset accounting treatments that produce an increase in a bank's    equity capital and tier 1 capital at the inception of a securitization    - for example, a gain attributable to a CEIO that results from Financial Accounting    Standard (FAS) 140 accounting treatment for the sale of underlying    exposures to a securitization special purpose entity (SPE). Over time,    as the bank, from an accounting perspective, realizes the increase in equity    capital and tier 1 capital that was booked at the inception of the securitization    through actual receipt of cash flows, the amount of the required deduction    would shrink accordingly.

Under the general risk-based capital rules,36    a bank must deduct CEIOs, whether purchased or retained, from tier 1    capital to the extent that the CEIOs exceed 25 percent of the bank's    tier 1 capital. Under the proposed rule, a bank must deduct CEIOs from    tier 1 capital to the extent they represent gain-on-sale, and must deduct    any remaining CEIOs 50 percent from tier 1 capital and 50 percent    from tier 2 capital.

Under the proposed rule, certain other securitization exposures also would    be deducted from tier 1 and tier 2 capital. These exposures include,    for example, securitization exposures that have an applicable external rating    (defined below) that is more than one category below investment grade (for    example, below BB) and most subordinated unrated securitization exposures.    When a bank must deduct a securitization exposure (other than gain-on-sale)    from regulatory capital, the bank must take the deduction 50 percent    from tier 1 capital and 50 percent from tier 2 capital. Moreover,    a bank may calculate any deductions from regulatory capital with respect to    a securitization exposure (including after-tax gain-on-sale) net of any deferred    tax liabilities associated with the exposure.

The proposed rule also requires a bank to deduct the bank's exposure on certain    unsettled and failed capital markets transactions 50 percent from tier 1    capital and 50 percent from tier 2 capital, as discussed in more    detail below in section V.D. of the preamble.

The agencies note that investments in unconsolidated banking and finance subsidiaries    and reciprocal holdings of bank capital instruments would continue to be deducted    from regulatory capital as described in the general risk-based capital rules.    Under the agencies' current rules, a national or state bank that controls    or holds an interest in a financial subsidiary does not consolidate the assets    and liabilities of the financial subsidiary with those of the bank for risk-based    capital purposes. In addition, the bank must deduct its equity investment    (including retained earnings) in the financial subsidiary from regulatory    capital – at least 50 percent from tier 1 capital and up to    50 percent from tier 2 capital.37    A BHC generally does not deconsolidate the assets and liabilities of the financial    subsidiaries of the BHC's subsidiary banks and does not deduct from its regulatory    capital the equity investments of its subsidiary banks in financial subsidiaries.    Rather, a BHC generally fully consolidates the financial subsidiaries of its    subsidiary banks. These treatments would continue under the proposed rule.

For BHCs with consolidated insurance underwriting subsidiaries that are functionally    regulated (or subject to comparable supervision and minimum regulatory capital    requirements in their home jurisdiction), the following treatment would apply.    The assets and liabilities of the subsidiary would be consolidated for purposes    of determining the BHC's risk-weighted assets. However, the BHC must deduct    from tier 1 capital an amount equal to the insurance underwriting subsidiary's    minimum regulatory capital requirement as determined by its functional (or    equivalent) regulator. For U.S. regulated insurance subsidiaries, this amount    generally would be 200 percent of the subsidiary's Authorized Control Level    as established by the appropriate state insurance regulator.

This approach with respect to functionally-regulated consolidated insurance    underwriting subsidiaries is different from the New Accord, which broadly    endorses a deconsolidation and deduction approach for insurance subsidiaries.    The Board believes a full deconsolidation and deduction approach does not    fully capture the risk in insurance underwriting subsidiaries at the consolidated    BHC level and, thus, has proposed the consolidation and deduction approach    described above. Question 23: The Board seeks comment on this proposed    treatment and in particular on how a minimum insurance regulatory capital    proxy for tier 1 deduction purposes should be determined for insurance    underwriting subsidiaries that are not subject to U.S. functional regulation.

A March 10, 2005, final rule issued by the Board defined restricted core capital    elements for BHCs and generally limited restricted core capital elements for    internationally active banking organizations to 15 percent of the sum    of all core capital elements net of goodwill less any associated deferred    tax liability.38    Restricted core capital elements are defined as qualifying cumulative perpetual    preferred stock (and related surplus), minority interest related to qualifying    cumulative perpetual preferred stock directly issued by a consolidated DI    or foreign bank subsidiary, minority interest related to qualifying common    or qualifying perpetual preferred stock issued by a consolidated subsidiary    that is neither a DI nor a foreign bank, and qualifying trust preferred securities.    The final rule defined an internationally active banking organization to be    a BHC that (i) as of its most recent year-end FR Y-9C reports total    consolidated assets equal to $250 billion or more or (ii) on a consolidated    basis, reports total on-balance sheet foreign exposure of $10 billion    or more in its filing of the most recent year-end FFIEC 009 Country Exposure    Report. The Board intends to change the definition of an internationally active    banking organization in the Board's capital adequacy guidelines for BHCs to    make it consistent with the definition of a core bank. This change would be    less restrictive on BHCs because the BHC threshold in this proposed rule uses    total consolidated assets excluding insurance rather than total consolidated    assets including insurance.

 

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    -  See  12 CFR part 3, Appendix A,       § 2 (national banks); 12 CFR part 208, Appendix A,       § II (state member banks); 12 CFR part 225, Appendix A,       § II (bank holding companies); 12 CFR part 325, Appendix A       (state nonmember banks); and 12 CFR 567.5 (savings associations).   Return to text
    -  If the amount deductible from tier 2 capital       exceeds the bank's actual tier 2 capital, however, the bank must deduct       the shortfall amount from tier 1 capital.   Return to text
    -  See  12 CFR part 3, § 2       (national banks); 12 CFR part 208, Appendix A, § II       (state member banks); 12 CFR part 225, Appendix A, § II       (bank holding companies); 12 CFR part 325, Appendix A, § II       (state nonmember banks). OTS existing rules are formulated differently,       but include similar deductions. Under OTS rules, for example, goodwill       is included within the definition of "intangible assets" and       is deducted from tier 1 (core) capital along with other intangible       assets.  See  12 CFR 567.1 and 567.5(a)(2)(i). Similarly,       purchased credit card relationships and mortgage and non-mortgage servicing       assets are included in capital to the same extent as the other agencies'       rules.  See  12 CFR 567.5(a)(2)(ii) and 567.12. The       deduction of deferred tax assets is discussed in Thrift Bulletin 56.   Return to text
    -  By contrast, OTS rules require the deduction       of equity investments from total capital. 12 CFR 567.5(c)(2)(ii).       "Equity investments" are defined to include (i) investments       in equity securities (other than investments in subsidiaries, equity investments       that are permissible for national banks, indirect ownership interests in       certain pools of assets (for example, mutual funds), Federal Home Loan       Bank stock and Federal Reserve Bank stock); and (ii) investments in       certain real property. 12 CFR 567.1. Savings associations applying       the proposed rule would not be required to deduct investments in equity       securities. Instead, such investments would be subject to the equity treatment       in part VI of the proposed rule. Equity investments in real estate       would continue to be deducted to the same extent as under the current rules.   Return to text
    -  12 U.S.C. 3904 does not apply to savings       associations regulated by the OTS. As a result, the OTS rule will not refer       to allocated transfer risk reserves.   Return to text
    -  See  12 CFR part 3, Appendix A,       § 2(c)(4) (national banks); 12 CFR part 208, Appendix A,       § I.B.1.c. (state member banks); 12 CFR part 225, Appendix A,       § I.B.1.c. (bank holding companies); 12 CFR part 325,       Appendix A, § I.B.5. (state nonmember banks); 12 CFR 567.5(a)(2)(iii)       (savings associations).   Return to text
    -  See  12 CFR 5.39(h)(1) (national       banks); 12 CFR 208.73(a) (state member banks); 12 CFR part 325,       Appendix A, § I.B.2. (state nonmember banks). Again, OTS       rules are formulated differently. For example, OTS rules do not use the       terms "unconsolidated banking and finance subsidiary" or "financial       subsidiary." Rather, as required by section 5(t)(5) of the Home       Owners' Loan Act (HOLA), equity and debt investments in non-includable       subsidiaries (generally subsidiaries that are engaged in activities that       are not permissible for a national bank) are deducted from assets and tier 1       (core) capital. 12 CFR 567.5(a)(2)(iv) and (v). As required       by HOLA, OTS will continue to deduct non-includable subsidiaries. Reciprocal       holdings of bank capital instruments are deducted from a savings association's       total capital under 12 CFR 567.5(c)(2).   Return to text
    -  70 FR 11827 (Mar. 10, 2005). The final rule also       allowed internationally active banking organizations to include restricted       core capital elements in their tier 1 capital up to 25 percent       of the sum of all core capital elements net of goodwill less associated       deferred tax liability so long as any amounts of restricted core capital       elements in excess of the 15 percent limit were in the form of mandatory       convertible preferred securities.   Return to text

Basel II Capital AccordNotice of Proposed Rulemaking (NPR)

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