Federal Register / Vol. 60, No. 29 / Monday, February 13, 1995 / Rules and Regulations 8177

1The GAAP treatment focuses on the transfer of

benefits rather than the retention of risk and, thus,

allows a transfer of receivables with recourse to be

accounted for as a sale if the transferor: (1)

surrenders control of the future economic benefits

of the assets; (2) is able to reasonably estimate its

obligations under the recourse provision; and (3) is

not obligated to repurchase the assets except

pursuant to the recourse provision. In addition, the

Continued

(d) Within the scope of § 1751.101(d),

if the Plan Developer is the PUC, the

Modernization Plan shall name the

Telecommunications Providers in the

State, in addition to Borrowers, that are

covered by the Modernization Plan.

(e) The Modernization Plan must

require that the design of the network

provided by Telecommunications

Providers allow for the expeditious

deployment and integration of such

emerging technologies as may from time

to time become commercially feasible.

(f) The Modernization Plan must

provide guidelines to

Telecommunications Providers for the

development of affordable tariffs for

medical links and distance learning

services.

(g) With regard to the uniform

deployment requirement of the law

restated in paragraph (a)(5) of this

section, if services cannot be deployed

at the same time, only the minimum

feasible interval of time shall separate

availability of the services in rural and

nonrural areas.

(h) The Modernization Plan must

make provision for reliable powering of

ordinary voice telephone service

operating over those portions of the

telecommunications network which are

not network powered. In the event of

electric utility power outages, an

alternative source of power must be

available to ensure reliable voice

service.

(i) Short-term requirements. (1) The

‘‘short-term requirements start date’’ is

the date one year after the date RUS

approves the Modernization Plan for the

State.

(2) All New Facilities providing

Wireline Service after the short-term

requirements start date, even if the

construction began before such date,

shall be constructed so that:

(i) Every subscriber can be provided

1-party service.

(ii) The New Facilities are suitable, as

built or with additional equipment, to

provide transmission and reception of

data at a rate no lower than 1 Mb/sec.

(3) All switching equipment installed

by a Telecommunications Provider after

the short-term requirements start date

shall be capable of:

(i) Providing custom calling features.

At a minimum, custom calling features

must include call waiting, call

forwarding, abbreviated dialing, and

three-way calling; and

(ii) Providing E911 service for areas

served by the Telecommunication

Provider when requested by the

government responsible for this service.

(j) Medium-term requirements. (1) The

‘‘medium-term requirements start date’’

is the date six years after the date RUS

approves the Modernization Plan for the

State, or such earlier date as the

Modernization Plan shall provide.

(2) All New Facilities providing

Wireline Service after the medium-term

requirements start date, even if the

construction began before such date,

shall be capable, as built or with

additional equipment, of transmitting

video to a subscriber. The video must be

capable of depicting a reasonable

representation of motion. The frame

rate, resolution, and other measures of

audio and video quality shall be

determined by the Plan Developer.

(3) No later than the medium-term

requirements start date, all switching

equipment of Telecommunications

Providers covered by the Modernization

Plan must be capable of providing E911

service when requested by the

government responsible for this service.

(4) No later than five years after the

medium-term requirements start date,

one-party service must be provided

upon demand to any subscriber of a

Telecommunications Provider covered

by the Modernization Plan.

(k) Long-term goals. RUS suggests, but

does not require, that the provisions of

each Modernization Plan be consistent

with the accomplishment of the

following:

(1) The elimination of party line

service.

(2) For subscribers that desire the

service, universal availability of:

(i) digital voice and data service (56–

164 kb/sec).

(ii) service that provides transmission

and reception of high bit rate (no less

than 1 Mb/sec) data.

(iii) service that provides reception of

video as described in paragraph (j)(2) of

this section.

Dated: January 23, 1995.

Bob J. Nash,

Under Secretary, Rural Economic and

Community Development.

[FR Doc. 95–3414 Filed 2–10–95; 8:45 am]

BILLING CODE 3410–15–P

FEDERAL RESERVE SYSTEM

12 CFR Parts 208 and 225

[Regulations H and Y; Docket No. R–0835]

Capital; Capital Adequacy Guidelines

AGENCY: Board of Governors of the

Federal Reserve System.

ACTION: Final rule.

SUMMARY: The Board of Governors of the

Federal Reserve System (Board) is

amending its risk-based capital

guidelines for state member banks and

bank holding companies (banking

organizations) to implement section 350

of the Riegle Community Development

and Regulatory Improvement Act of

1994 (Riegle Act). Section 350 states

that the amount of risk-based capital

required to be maintained by any

insured depository institution, with

respect to assets transferred with

recourse, may not exceed the maximum

amount of recourse for which the

institution is contractually liable under

the recourse agreement. This rule will

have the effect of correcting the anomaly

that currently exists in the risk-based

capital treatment of recourse

transactions under which an institution

could be required to hold capital in

excess of the maximum amount of loss

possible under the contractual terms of

the recourse obligation.

EFFECTIVE DATE: March 22, 1995.

FOR FURTHER INFORMATION CONTACT:

Rhoger H Pugh, Assistant Director (202/

728–5883), Thomas R. Boemio,

Supervisory Financial Analyst (202/

452–2982), or David Elkes (202/452–

5218), Senior Financial Analyst, Policy

Development, Division of Banking

Supervision and Regulation. For the

hearing impaired only,

Telecommunication Device for the Deaf

(TDD), Dorothea Thompson (202/452–

3544), Board of Governors of the Federal

Reserve System, 20th and C Streets

NW., Washington, DC 20551.

SUPPLEMENTARY INFORMATION:

Background

The Board’s current regulatory capital

guidelines are intended to ensure that

banking organizations that transfer

assets and retain the credit risk inherent

in the assets maintain adequate capital

to support that risk. For banks, this is

generally accomplished by requiring

that assets transferred with recourse

continue to be reported on the balance

sheet in regulatory reports. These

amounts are thus included in the

calculation of banks’ risk-based and

leverage capital ratios. For bank holding

companies, transfers of assets with

recourse are reported in accordance

with generally accepted accounting

principles (GAAP), which treats most

such transactions as sales, allowing the

assets to be removed from the balance

sheet.1 For purposes of calculating bank
8178 Federal Register / Vol. 60, No. 29 / Monday, February 13, 1995 / Rules and Regulations

transferor must establish a separate liability account

equal to the estimated probable losses under the

recourse provision (GAAP recourse liability

account).

holding companies’ risk-based capital

ratios, however, assets sold with

recourse that have been removed from

the balance sheet in accordance with

GAAP are included in risk-weighted

assets. Consequently, both banks and

bank holding companies generally are

required to maintain capital against the

full risk-weighted amount of assets

transferred with recourse.

In cases where an institution retains

a low level of recourse, the amount of

capital required under the Board’s riskbased capital guidelines could exceed

the institution’s maximum contractual

liability under the recourse agreement.

This can occur in transactions in which

a banking organization contractually

limits its recourse exposure to less than

the full effective risk-based capital

requirement for the assets transferred—

generally, 4 percent for mortgage assets

and 8 percent for most other assets.

The Federal Reserve and the other

federal banking agencies have long

recognized this anomaly in the riskbased capital guidelines. On May 25,

1994, the banking agencies, under the

auspices of the Federal Financial

Institutions Examination Council

(FFIEC), issued a Notice of Proposed

Rulemaking (NPR) (59 FR 27116) that

was aimed principally at amending the

risk-based capital guidelines to limit the

capital charge in low level recourse

transactions to an institution’s

maximum contractual recourse liability.

The proposal for these types of

transactions would effectively result in

a dollar capital charge for each dollar of

low level recourse exposure, up to the

full effective risk-based capital

requirement on the underlying assets.

The proposal requested specific

comment on whether an institution

should be able to use the balance of the

GAAP recourse liability account to

reduce the dollar-for-dollar capital

charge for the recourse exposure on

assets transferred with low level

recourse in a transaction recognized as

a sale both under GAAP and for

regulatory reporting purposes. In

addition, the proposal indicated that the

capital requirement for an exposure to

low level recourse retained in a

transaction associated with a swap of

mortgage loans for mortgage-related

securities would be the lower of the

capital charge for the swapped

mortgages or the combined capital

charge for the low level recourse

exposure and the mortgage-related

securities, adjusted for any double

counting.

The NPR also addressed other issues

related to recourse transactions,

including equivalent capital treatment

of recourse arrangements and direct

credit substitutes that provide first

dollar loss protection and definitions for

‘‘recourse’’ and associated terms such as

‘‘standard representations and

warranties.’’ The NPR was issued in

conjunction with an Advance Notice of

Proposed Rulemaking (ANPR) that

outlined a possible alternative approach

to deal comprehensively with the

capital treatment of recourse

transactions and securitizations. The

comment period for the NPR and ANPR

ended on July 25, 1994.

During the agencies’ review of the

comments received, the Riegle Act was

signed into law on September 23, 1994.

Section 350 of the Act requires the

federal banking agencies to issue

regulations limiting, as of March 22,

1995, the amount of risk-based capital

an insured depository institution is

required to hold for assets transferred

with recourse to the maximum amount

of recourse for which the institution is

contractually liable. In order to meet the

statutory requirements of section 350,

the Federal Reserve is now issuing a

rule that puts into final form only those

portions of the NPR dealing with low

level recourse transactions.

Comments Received

In response to the NPR and ANPR, the

Federal Reserve Board received letters

from 36 public commenters. Of these

respondents, 27 addressed issues related

to the NPR’s proposed low level

recourse capital treatment. These

commenters included 13 banking

organizations, including 11

multinational and regional banking

organizations, one community banking

organization, and one foreign banking

organization; eight trade associations;

two law firms; one governmentsponsored agency; and three other

commenters. Of these 27 respondents,

23 specifically provided a favorable

overall assessment of the low level

recourse proposal. In general, these

respondents viewed the low level

proposal as a way of rationally

correcting an anomaly in the existing

risk-based capital rules so that

institutions would not be required to

hold capital in excess of their

contractual liability.

Ten of the commenters stated that,

while the proposed low level recourse

capital treatment was a positive step, it

still would result in too high of a capital

requirement for assets sold with limited

recourse. These respondents, which

included eight of the thirteen banking

organizations and two of the eight trade

associations, expressed the view that the

banking agencies should adopt the

GAAP treatment of assets sold with

recourse for purposes of calculating the

regulatory capital ratios. These

commenters maintained that the GAAP

recourse liability account provides

adequate protection against the risk of

loss on assets sold with recourse,

obviating the need for additional

capital.

The NPR specifically sought comment

on five issues related to the proposed

capital treatment of low level recourse

transactions. Thirteen of the 27

respondents commented on the first

issue, which concerned the treatment of

the GAAP recourse liability account

established for assets sold with recourse

reported as sales for regulatory reporting

purposes. These 13 commenters favored

reducing the capital requirement for low

level recourse transactions by the

balance of its GAAP recourse liability

account—which would continue to be

excluded from an institution’s

regulatory capital. In their view, not

taking this account into consideration

would result in double coverage of the

portion of the risk provided for in that

account.

Fourteen commenters, including five

banking organizations and five trade

associations, responded to the second

issue, which sought comment on

whether a dollar-for-dollar capital

requirement would be too high for low

level recourse transactions. Eleven

commenters indicated that such a

capital charge would be too high since

it was unlikely that an institution would

incur losses up to its maximum

contractual liability. Two others

responded that whether the capital

treatment was too high depended upon

the credit quality of the underlying asset

pool and the structure of the

securitization. One commenter stated

that the dollar-for-dollar capital charge

would not be too onerous.

The third issue dealt with ways of

demonstrating that the dollar-for-dollar

capital requirement might be too high

and possible methods for reducing this

requirement without jeopardizing safety

and soundness. The eight commenters

on this issue indicated that historical

analysis, examiner review, and

‘‘depression scenario’’ stress testing

would show whether the capital

requirement would be too high relative

to historical losses.

The fourth issue concerned ways the

banking agencies could handle the

increased probability of loss to the

insurance fund if less than dollar-fordollar capital is maintained against low
Federal Register / Vol. 60, No. 29 / Monday, February 13, 1995 / Rules and Regulations 8179

2 In addition to amending the risk-based capital

guidelines to reduce the capital requirement for low

level recourse transactions (see paragraph g of

section III.D.1. of the guidelines), the Board is also

making some technical, nonsubstantive changes to

that section of the guidelines by identifying each

paragraph in the section with a letter designation.

level recourse transactions. The eight

commenters on this issue stated that as

long as the amount of required capital

held against the low level recourse

transactions was prudently assessed

based upon expected losses, actual

losses would seldom, if ever, exceed the

capital requirement. Thus, the insurance

funds would not likely experience

losses.

The fifth issue sought comment on

whether the proposed low level

recourse capital treatment would reduce

transaction costs or otherwise help to

facilitate the sale or securitization of

banking organizations’ assets. The eight

commenters that responded to this issue

were all of the opinion that the low

level capital treatment generally would

help lower transaction costs and help

facilitate securitization.

Final Rule

After consideration of the comments

received and further deliberation on the

issues involved, particularly the

requirements of section 350 of the

Riegle Act, the Board is adopting a final

rule amending the risk-based capital

guidelines with respect to the treatment

of low level recourse transactions.

Specifically, the final amendments

implement section 350 by reducing the

capital requirements for all recourse

transactions in which a state member

bank contractually limits its recourse

exposure to less than the full, effective

risk-based capital requirement for the

assets transferred. Although section 350

explicitly extends only to depository

institutions, the Board, consistent with

its proposal, is also issuing a parallel

final amendment to its risk-based

capital guidelines for bank holding

companies.2

The final rule applies to low level

recourse transactions involving all types

of assets, including small business

loans, commercial loans, and residential

mortgages. In this regard, the Board

notes that previously under the riskbased capital guidelines residential

mortgage loans transferred with

recourse were excluded from riskweighted assets if the institution did not

retain significant risk of loss. As

proposed, this treatment would no

longer apply and the low level recourse

capital treatment the Board is now

issuing would extend to these types of

mortgage loan transfers.

Under the low level recourse rule, a

banking organization that contractually

limits its maximum recourse obligation

to less than the full effective risk-based

capital requirement for the transferred

assets would be required to hold riskbased capital equal to the contractual

maximum amount of its recourse

obligation. This requirement limits to

one dollar the capital charge for each

dollar of low-level recourse exposure.

Under this dollar-for-dollar capital

requirement, the capital charge for a 100

percent risk-weighted asset transferred

with 3 percent recourse would be 3

percent of the value of the transferred

assets, rather than the 8 percent

previously required. Thus, a banking

organization’s capital requirement on a

low level recourse transaction would

not exceed the contractual maximum

amount it could lose under the recourse

obligation.

Under the final rule, an institution

may reduce the dollar-for-dollar capital

charge held against the recourse

exposure on assets transferred with low

level recourse for a transaction

recognized as a sale under GAAP and

for regulatory reporting purposes by the

balance of any associated non-capital

GAAP recourse liability account. In

adopting this aspect of the final rule, the

Board concurs with commenters that

indicated that nonrecognition of the

liability account would result in double

coverage of the portion of the credit risk

provided for in that account.

In applying the final rule, the Board

will, as proposed, limit the capital

requirement for an exposure to low level

recourse retained in a transaction

associated with a swap of mortgage

loans for mortgage-related securities to

the lower of the capital charge for the

swapped mortgages or the combined

capital charge for the low level recourse

exposure and the mortgage-related

securities, adjusted for any double

counting.

In setting forth this final rule, the

Board has considered the arguments

that several commenters made for

adopting for regulatory capital purposes

the GAAP treatment for all assets sold

with recourse, including those sold with

low levels of recourse. Under such a

treatment, assets sold with recourse in

accordance with GAAP would have no

capital requirement, but the GAAP

recourse liability account would

provide some level of protection against

losses.

The Board continues to believe it

would not be appropriate to adopt for

regulatory capital purposes the GAAP

treatment of recourse transactions, even

if the transferring bank retains only a

low level of recourse. In the Board’s

view, the GAAP recourse liability

account would be an inadequate

substitute for maintaining capital at a

level commensurate with the risks. One

of the principal purposes of regulatory

capital is to provide a cushion against

unexpected losses. In contrast, the

GAAP recourse liability account is, in

effect, a specific reserve that is intended

to cover only an institution’s probable

expected losses under the recourse

provision. In this regard, the Board

notes that the capital guidelines

explicitly state that specific reserves

may not be included in regulatory

capital.

In addition, the amount of credit risk

that is typically retained in a recourse

transaction greatly exceeds the normal

expected losses associated with the

transferred assets. Thus, even though a

transferring institution may reduce its

exposure to potential catastrophic losses

by limiting the amount of recourse it

provides, it may still retain, in many

cases, the bulk of the risk inherent in

the assets. For example, an institution

transferring high quality assets with a

reasonably estimated expected loss rate

of one percent that retains ten percent

recourse in the normal course of

business will sustain the same amount

of losses it would have had the assets

not been transferred. This occurs

because the amount of exposure under

the recourse provision is very high

relative to the amount of expected

losses. The Board believes that in such

transactions the transferor has not

significantly reduced its risk for

purposes of assessing regulatory capital

and should continue to be assessed

regulatory capital as though the assets

had not been transferred.

The GAAP reliance on reasonable

estimates of all probable credit losses

over the life of the receivables

transferred poses additional concerns to

the Board. While it may be possible to

make such estimates for pools of

consumer loans or residential

mortgages, the Board is of the view that

it is currently difficult to do so for other

types of loans. Even if it is possible to

make a reasonable estimate of probable

credit losses at the time an asset or asset

pool is transferred, the ability of an

institution to make a reasonable

estimate may change over the life of the

transferred assets.

Finally, the Board is concerned that

an institution transferring assets with

recourse might estimate that it would

not have any losses under the recourse

provision, in which case it would not

establish any GAAP recourse liability

account for the exposure. If the

transferor recorded either no liability or

only a nominal liability in the GAAP
8180 Federal Register / Vol. 60, No. 29 / Monday, February 13, 1995 / Rules and Regulations

41Credit equivalent amounts of acquisitions of

risk participations are assigned to the risk category

appropriate to the account party obligor, or, if

relevant, the nature of the collateral or guarantees.

42That is, a participation in which the originating

bank remains liable to the beneficiary for the full

amount of the direct credit substitute if the party

that has acquired the participation fails to pay when

the instrument is drawn.

43Risk participations with a remaining maturity

of over one year that are conveyed to non-OECD

banks are to be assigned to the 100 percent risk

category, unless a lower risk category is appropriate

to the obligor, guarantor, or collateral.

44A risk participation in bankers acceptances

conveyed to other institutions is also assigned to

the risk category appropriate to the institution

acquiring the participation or, if relevant, the

guarantor or nature of the collateral.

recourse liability account for a

succession of asset transfers, it could

accumulate large amounts of credit risk

that would not be reflected, or would be

only partially reflected, on the balance

sheet.

The Board is issuing this final rule

now in order to implement section 350

of the Riegle Act in accordance with the

statutory deadline. Consequently, the

rule deals with only those portions of

the NPR concerned with low level

recourse transactions. The Board will

continue to consider, on an interagency

basis, the other aspects of the NPR, as

well as all aspects of the ANPR that was

issued in conjunction with the NPR.

Regulatory Flexibility Act

The purpose of this final rule is to

reduce the risk-based capital

requirement on transfers of assets with

low levels of recourse. Therefore,

pursuant to section 605(b) of the

Regulatory Flexibility Act, the Board

hereby certifies that this rule will have

a beneficial economic impact on small

business entities (in this case, small

banking organizations) that sell assets

with low levels of recourse. The riskbased capital guidelines generally do

not apply to bank holding companies

with consolidated assets of less than

$150 million; thus, this rule will not

affect such companies.

Paperwork Reduction Act and

Regulatory Burden

The Board has determined that this

final rule will not increase the

regulatory paperwork burden of banking

organizations pursuant to the provisions

of the Paperwork Reduction Act (44

U.S.C. 3501 et seq.).

Section 302 requires that new

regulations take effect on the first day of

the calendar quarter following

publication of the rule, unless, inter

alia, the regulation, pursuant to any

other Act of Congress, is required to take

effect on a date other than the date

determined under section 302. Section

350 of the Riegle Act requires that

before the end of the 180-day period

beginning on the date of enactment of

the Act, or in this case no later than

March 22, 1995, the amount of riskbased capital required to be maintained,

under regulations prescribed by the

appropriate Federal banking agency, by

any insured depository institution

transferring assets with recourse be

limited to the maximum amount of

recourse for which such institution is

contractually liable under the recourse

agreement. Accordingly, the Board has

determined that an effective date of

March 22, 1995 is appropriate.

List of Subjects

12 CFR Part 208

Accounting, Agriculture, Banks,

banking, Confidential business

information, Crime, Currency, Federal

Reserve System, Mortgages, Reporting

and recordkeeping requirements,

Securities.

12 CFR Part 225

Administrative practice and

procedure, Banks, Banking, Federal

Reserve System, Holding companies,

Reporting and recordkeeping

requirements, Securities.

For the reasons set forth in the

preamble, the Board amends 12 CFR

parts 208 and 225 as set forth below:

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. 36, 248(a), 248(c),

321–338a, 371d, 461, 481–486, 601, 611,

1814, 1823(j), 1828(o), 1831o, 1831p–1, 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.

2. In Part 208, Appendix A, section

III.D.1. is revised to read as follows:

Appendix A to Part 208—Capital

Adequacy Guidelines for State Member

Banks: Risk-Based Measure

* * * * *

III. * * *

D. * * *

1. Items with a 100 percent conversion

factor.

a. A 100 percent conversion factor applies

to direct credit substitutes, which include

guarantees, or equivalent instruments,

backing financial claims, such as outstanding

securities, loans, and other financial

liabilities, or that back off-balance sheet

items that require capital under the riskbased capital framework. Direct credit

substitutes include, for example, financial

standby letters of credit, or other equivalent

irrevocable undertakings or surety

arrangements, that guarantee repayment of

financial obligations such as: commercial

paper, tax-exempt securities, commercial or

individual loans or debt obligations, or

standby or commercial letters of credit.

Direct credit substitutes also include the

acquisition of risk participations in bankers

acceptances and standby letters of credit,

since both of these transactions, in effect,

constitute a guarantee by the acquiring bank

that the underlying account party (obligor)

will repay its obligation to the originating, or

issuing, institution.41 (Standby letters of

credit that are performance-related are

discussed below and have a credit

conversion factor of 50 percent.)

b. The full amount of a direct credit

substitute is converted at 100 percent and the

resulting credit equivalent amount is

assigned to the risk category appropriate to

the obligor or, if relevant, the guarantor or the

nature of the collateral. In the case of a direct

credit substitute in which a risk

participation 42 has been conveyed, the full

amount is still converted at 100 percent.

However, the credit equivalent amount that

has been conveyed is assigned to whichever

risk category is lower: the risk category

appropriate to the obligor, after giving effect

to any relevant guarantees or collateral, or the

risk category appropriate to the institution

acquiring the participation. Any remainder is

assigned to the risk category appropriate to

the obligor, guarantor, or collateral. For

example, the portion of a direct credit

substitute conveyed as a risk participation to

a U.S. domestic depository institution or

foreign bank is assigned to the risk category

appropriate to claims guaranteed by those

institutions, that is, the 20 percent risk

category.43 This approach recognizes that

such conveyances replace the originating

bank’s exposure to the obligor with an

exposure to the institutions acquiring the risk

participations.44

c. In the case of direct credit substitutes

that take the form of a syndication as defined

in the instructions to the commercial bank

Call Report, that is, where each bank is

obligated only for its pro rata share of the

risk and there is no recourse to the

originating bank, each bank will only include

its pro rata share of the direct credit

substitute in its risk-based capital

calculation.

d. Financial standby letters of credit are

distinguished from loan commitments

(discussed below) in that standbys are

irrevocable obligations of the bank to pay a

third-party beneficiary when a customer

(account party) fails to repay an outstanding

loan or debt instrument (direct credit

substitute). 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 some other contractual nonfinancial obligation.

e. The distinguishing characteristic of a

standby letter of credit for risk-based capital

purposes is the combination of irrevocability

with the fact that funding is triggered by

some failure to repay or perform an

obligation. Thus, any commitment (by
Federal Register / Vol. 60, No. 29 / Monday, February 13, 1995 / Rules and Regulations 8181

45Forward forward deposits accepted are treated

as interest rate contracts.

44Credit equivalent amounts of acquisitions of

risk participations are assigned to the risk category

appropriate to the account party obligor, or, if

relevant, the nature of the collateral or guarantees.

45That is, a participation in which the originating

banking organization remains liable to the

beneficiary for the full amount of the direct credit

substitute if the party that has acquired the

participation fails to pay when the instrument is

drawn.

46Risk participations with a remaining maturity

of over one year that are conveyed to non-OECD

banks are to be assigned to the 100 percent risk

category, unless a lower risk category is appropriate

to the obligor, guarantor, or collateral.

47A risk participation in bankers acceptances

conveyed to other institutions is also assigned to

the risk category appropriate to the institution

acquiring the participation or, if relevant, the

guarantor or nature of the collateral.

whatever name) that involves an irrevocable

obligation to make a payment to the customer

or to a third party in the event the customer

fails to repay an outstanding debt obligation

or fails to perform a contractual obligation is

treated, for risk-based capital purposes, as

respectively, a financial guarantee standby

letter of credit or a performance standby.

f. A loan commitment, on the other hand,

involves an obligation (with or without a

material adverse change or similar clause) of

the bank to fund its customer in the normal

course of business should the customer seek

to draw down the commitment.

g. Sale and repurchase agreements and

asset sales with recourse (to the extent not

included on the balance sheet) and forward

agreements also are converted at 100 percent.

The risk-based capital definition of the sale

of assets with recourse, including the sale of

1- to 4-family residential mortgages, is the

same as the definition contained in the

instructions to the commercial bank Call

Report. Accordingly, the entire amount of

any assets transferred with recourse that are

not already included on the balance sheet,

including pools of 1- to 4-family residential

mortgages, are to be converted at 100 percent

and assigned to the risk weight appropriate

to the obligor, or if relevant, the nature of any

collateral or guarantees. The terms of a

transfer of assets with recourse may

contractually limit the amount of the

institution’s liability to an amount less than

the effective risk-based capital requirement

for the assets being transferred with recourse.

If such a transaction (including one that is

reported as a financing, i.e., the assets are not

removed from the balance sheet) meets the

criteria for sales treatment under GAAP, the

amount of total capital required is equal to

the maximum amount of loss possible under

the recourse provision. If the transaction is

also treated as a sale for regulatory reporting

purposes, then the required amount of capital

may be reduced by the balance of any

associated non-capital liability account

established pursuant to GAAP to cover

estimated probable losses under the recourse

provision. So-called ‘‘loan strips’’ (that is,

short-term advances sold under long-term

commitments without direct recourse) are

defined in the instructions to the commercial

bank Call Report and for risk-based capital

purposes as assets sold with recourse.

h. Forward agreements are legally binding

contractual obligations to purchase assets

with certain drawdown at a specified future

date. Such obligations include forward

purchases, forward forward deposits

placed,45 and partly-paid shares and

securities; they do not include commitments

to make residential mortgage loans or

forward foreign exchange contracts.

i. Securities lent by a bank are treated in

one of two ways, depending upon whether

the lender is at 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 transaction is

excluded from the risk-based capital

calculation. If, alternatively, a bank lends its

own securities or, acting as agent for a

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, to any collateral

delivered to the lending bank, or, if

applicable, to the independent custodian

acting on the lender’s behalf. Where a bank

is acting as agent for a customer in a

transaction involving the lending or sale of

securities that is collateralized by cash

delivered to the bank, the transaction is

deemed to be collateralized by cash on

deposit in the bank for purposes of

determining the appropriate risk-weight

category, provided that any indemnification

is limited to no more than the difference

between the market value of the securities

and the cash collateral received and any

reinvestment risk associated with that cash

collateral is borne by the customer.

* * * * *

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,

1831i, 1831p–1, 1843(c)(8), 1844(b), 1972(l),

3106, 3108, 3310, 3331–3351, 3907, and

3909.

2. In Part 225, Appendix A, section

III.D.1. is revised to read as follows:

Appendix A to Part 225—Capital

Adequacy Guidelines for Bank Holding

Companies: Risked-Based Measure

* * * * *

III. * * *

D. * * *

1. Items with a 100 percent conversion

factor.

a. A 100 percent conversion factor applies

to direct credit substitutes, which include

guarantees, or equivalent instruments,

backing financial claims, such as outstanding

securities, loans, and other financial

liabilities, or that back off-balance sheet

items that require capital under the riskbased capital framework. Direct credit

substitutes include, for example, financial

standby letters of credit, or other equivalent

irrevocable undertakings or surety

arrangements, that guarantee repayment of

financial obligations such as: commercial

paper, tax-exempt securities, commercial or

individual loans or debt obligations, or

standby or commercial letters of credit.

Direct credit substitutes also include the

acquisition of risk participations in bankers

acceptances and standby letters of credit,

since both of these transactions, in effect,

constitute a guarantee by the acquiring

banking organization that the underlying

account party (obligor) will repay its

obligation to the originating, or issuing,

institution.44 (Standby letters of credit that

are performance-related are discussed below

and have a credit conversion factor of 50

percent.)

b. The full amount of a direct credit

substitute is converted at 100 percent and the

resulting credit equivalent amount is

assigned to the risk category appropriate to

the obligor or, if relevant, the guarantor or the

nature of the collateral. In the case of a direct

credit substitute in which a risk

participation 45 has been conveyed, the full

amount is still converted at 100 percent.

However, the credit equivalent amount that

has been conveyed is assigned to whichever

risk category is lower: the risk category

appropriate to the obligor, after giving effect

to any relevant guarantees or collateral, or the

risk category appropriate to the institution

acquiring the participation. Any remainder is

assigned to the risk category appropriate to

the obligor, guarantor, or collateral. For

example, the portion of a direct credit

substitute conveyed as a risk participation to

a U.S. domestic depository institution or

foreign bank is assigned to the risk category

appropriate to claims guaranteed by those

institutions, that is, the 20 percent risk

category.46 This approach recognizes that

such conveyances replace the originating

banking organization’s exposure to the

obligor with an exposure to the institutions

acquiring the risk participations.47

c. In the case of direct credit substitutes

that take the form of a syndication, that is,

where each banking organization if obligated

only for its pro rata share of the risk and

there is no recourse to the originating

banking organization, each banking

organization will only include its pro rata

share of the direct credit substitute in its riskbased capital calculation.

d. Financial standby letters of credit are

distinguished from loan commitments

(discussed below) in that standbys are

irrevocable obligations of the banking

organization to pay a third-party beneficiary

when a customer (account party) fails to

repay an outstanding loan or debt instrument

(direct credit substitute). Performance

standby letters of credit (performance bonds)

are irrevocable obligations of the banking

organization to pay a third-party beneficiary

when a customer (account party) fails to

perform some other contractual non-financial

obligation.

e. The distinguishing characteristic of a

standby letter of credit for risk-based capital

purposes is the combination of irrevocability

with the fact that funding is triggered by

some failure to repay or perform an

obligation. Thus, any commitment (by

whatever name) that involves an irrevocable
8182 Federal Register / Vol. 60, No. 29 / Monday, February 13, 1995 / Rules and Regulations

48 In regulatory reports and under GAAP, bank

holding companies are permitted to treat some asset

sales with recourse as ‘‘true’’ sales. For risk-based

capital purposes, however, such assets sold with

recourse and reported as ‘‘true’’ sales by bank

holding companies are converted at 100 percent

and assigned to the risk category appropriate to the

underlying obligor or, if relevant, the guarantor or

nature of the collateral, provided that the

transactions meet the definition of assets sold with

recourse (including assets sold subject to pro rata

and other loss sharing arrangements), that is

contained in the instructions to the commercial

bank Consolidated Reports of Condition and

Income (Call Report). This treatment applies to any

assets, including the sale of 1- to 4-family and

multifamily residential mortgages, sold with

recourse. Accordingly, the entire amount of any

assets transferred with recourse that are not already

included on the balance sheet, including pools of

1- to 4-family residential mortgages, are to be

converted at 100 percent and assigned to the risk

category appropriate to the obligor, or if relevant,

the nature of any collateral or guarantees. The terms

of a transfer of assets with recourse may

contractually limit the amount of the institution’s

liability to an amount less than the effective riskbased capital requirement for the assets being

transferred with recourse. If such a transaction is

recognized as a sale under GAAP, the amount of

total capital required is equal to the maximum

amount of loss possible under the recourse

provision, less any amount held in an associated

non-capital liability account established pursuant to

GAAP to cover estimated probable losses under the

recourse provision.

49Forward forward deposits accepted are treated

as interest rate contracts.

obligation to make a payment to the customer

or to a third party in the event the customer

fails to repay an outstanding debt obligation

or fails to perform a contractual obligation is

treated, for risk-based capital purposes, as

respectively, a financial guarantee standby

letter of credit or a performance standby.

f. A loan commitment, on the other hand,

involves an obligation (with or without a

material adverse change or similar clause) of

the banking organization to fund its customer

in the normal course of business should the

customer seek to draw down the

commitment.

g. Sale and repurchase agreements and

asset sales with recourse (to the extent not

included on the balance sheet) and forward

agreements also are converted at 100

percent.48 So-called ‘‘loan strips’’ (that is,

short-term advances sold under long-term

commitments without direct recourse) are

treated for risk-based capital purposes as

assets sold with recourse and, accordingly,

are also converted at 100 percent.

h. Forward agreements are legally binding

contractual obligations to purchase assets

with certain drawdown at a specified future

date. Such obligations include forward

purchases, forward forward deposits

placed,49 and partly-paid shares and

securities; they do not include commitments

to make residential mortgage loans or

forward foreign exchange contracts.

i. Securities lent by a banking organization

are treated in one of two ways, depending

upon whether the lender is at risk of loss. If

a banking organization, as agent for a

customer, lends the customer’s securities and

does not indemnify the customer against loss,

then the transaction is excluded from the

risk-based capital calculation. If,

alternatively, a banking organization lends its

own securities or, acting as agent for a

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, to any collateral

delivered to the lending banking

organization, or, if applicable, to the

independent custodian acting on the lender’s

behalf. Where a banking organization is

acting as agent for a customer in a transaction

involving the lending or sale of securities

that is collateralized by cash delivered to the

banking organization, the transaction is

deemed to be collateralized by cash on

deposit in a subsidiary lending institution for

purposes of determining the appropriate riskweight category, provided that any

indemnification is limited to no more than

the difference between the market value of

the securities and the cash collateral received

and any reinvestment risk associated with

that cash collateral is borne by the customer.

* * * * *

By order of the Board of Governors of the

Federal By Reserve System, February 7, 1995.

William W. Wiles,

Secretary of the Board.

[FR Doc. 95–3469 Filed 2–10–95; 8:45 am]

BILLING CODE 6210–01–P

FEDERAL DEPOSIT INSURANCE

CORPORATION

12 CFR Part 325

RIN 3064–AB20

Capital Maintenance

AGENCY: Federal Deposit Insurance

Corporation (FDIC).

ACTION: Final rule.

SUMMARY: The FDIC is amending its

capital standards for insured state

nonmember banks to establish a

limitation on the amount of certain

deferred tax assets that may be included

in (that is, not deducted from) Tier 1

capital for risk-based and leverage

capital purposes. Under the final rule,

deferred tax assets that can be realized

through carrybacks to taxes paid on

income earned in prior periods

generally will not be subject to

limitation for regulatory capital

purposes. On the other hand, deferred

tax assets that can only be realized if an

institution earns sufficient taxable

income in the future will be limited for

regulatory capital purposes to the

amount that the institution is expected

to realize within one year of the most

recent calendar quarter-end date, based

on the institution’s projection of taxable

income for that year, or ten percent of

Tier 1 capital, whichever is less.

Deferred tax assets in excess of these

limitations will be deducted from Tier

1 capital and from assets for purposes of

calculating both the risk-based and

leverage capital ratios.

This regulatory capital limit was

developed on a consistent basis by the

FDIC, the Board of Governors of the

Federal Reserve System (FRB), the

Office of the Comptroller of the

Currency (OCC), and the Office of Thrift

Supervision (OTS) (hereafter, the federal

banking agencies or the agencies) in

response to the issuance by the

Financial Accounting Standards Board

(FASB) of Statement No. 109,

‘‘Accounting for Income Taxes’’ (FASB

109), in February 1992.

The capital limitation is intended to

balance the FDIC’s continued concerns

about deferred tax assets that are

dependent upon future taxable income

against the fact that such assets will, in

many cases, be realized. The limitation

also ensures that state nonmember

banks do not place excessive reliance on

deferred tax assets to satisfy the

minimum capital standards.

EFFECTIVE DATE: April 1, 1995.

FOR FURTHER INFORMATION CONTACT:

Robert F. Storch, Chief, Accounting

Section, Division of Supervision, (202)

898–8906, or Joseph A. DiNuzzo,

Counsel, Legal Division, (202) 898–

7349, Federal Deposit Insurance

Corporation, 550 17th Street NW.,

Washington, D.C. 20429.

SUPPLEMENTARY INFORMATION:

I. Background

Characteristics of Deferred Tax Assets

Deferred tax assets are assets that

reflect, for financial reporting purposes,

amounts that will be realized as

reductions of future taxes or as future

receivables from a taxing authority.

Deferred tax assets may arise because of

specific limitations under tax laws of

different tax jurisdictions that require

that certain net operating losses (i.e.,

when, for tax purposes, expenses exceed

revenues) or tax credits be carried

forward if they cannot be used to

recover taxes previously paid. These

‘‘tax carryforwards’’ are realized only if

the institution generates sufficient

future taxable income during the

carryforward period.

Deferred tax assets may also arise

from the tax effects of certain events that

have been recognized in one period for

financial statement purposes but will

result in deductible amounts in a future

period for tax purposes, i.e., the tax

effects of ‘‘deductible temporary

differences.’’ For example, many

depository institutions may report

higher income to taxing authorities than