Mortgage-Related Assets: Capital Requirements Vary Depending on Type of Asset
Released: 2016-12-15T00:00:00

Letter

Background

Bank capital performs several important functions. Among other things, capital acts as a financial cushion to absorb unexpected losses, promotes public confidence in the solvency of the institution and the stability of the banking sector, and provides protection to depositors and deposit insurance funds. Because of capital’s role in absorbing losses, promoting confidence, and protecting depositors, federal banking regulations require banking organizations to maintain adequate capital, and regulators set minimum capital levels to help ensure that institutions do so, including a target total minimum risk-based capital ratio—that is, the ratio of capital to risk-weighted assets. Federal law authorizes banking regulators to take a variety of actions to ensure capital adequacy, including informal and formal enforcement actions. Federal banking regulators generally expect institutions to hold capital at levels higher than regulatory minimums.

Capital rules in the United States generally follow a framework of measures adopted by the Basel Committee. U.S. federal banking regulators have adopted various risk-based capital regimes over the past decades. Under these frameworks, assets and off-balance-sheet exposures are assigned to one of several broad risk categories according to the obligor (for example, the person or legal entity contractually obligated on an exposure), or if relevant, the guarantor or the nature of the collateral. Banking organizations multiply the aggregate dollar amount or exposure amount in each risk category by the risk weight associated with that category. The resulting risk-weighted amounts from each of the risk categories are added together, and generally this sum is the banking organization’s total risk-weighted assets, which comprises the denominator of the risk-based capital ratio. For example, a $1,000 on- balance-sheet asset at a 20 percent risk weight would equal $200 in risk- weighted assets. An additional $1,000 on-balance-sheet asset at a 50 percent risk weight would equal $500 in risk-weighted assets, for a total of $700 in risk-weighted assets (compared to the $2,000 in total assets). The risk weights enable one to calculate the amount of capital a banking organization would need to hold for a given asset—its “capital charge”—in order to meet the minimum risk-based capital ratio requirements. To meet an 8 percent minimum total capital ratio requirement, the organization with the $700 in risk-weighted assets in the previous example would need to hold $56 in capital ($700×0.08). The minimum total capital charge for the $1,000 on-balance-sheet asset that was risk-weighted at 20 percent would be $16 ($1,000×0.2×0.08), while the minimum capital charge for the $1,000 on-balance-sheet asset that was risk-weighted at 50 percent would be $40 ($1,000×0.5×0.08).

Risk weights for mortgages and other mortgage-related assets have been included in a number of these regulatory capital frameworks over the years, including the following:

The Basel Capital Accord (Basel I), which was adopted in 1988 and implemented in the United States in the early 1990s, established a system of generally applicable risk weights for specific assets (including mortgage-related assets) to calculate total risk-weighted assets and defined a minimum total risk-based capital ratio (the ratio of regulatory capital to risk-weighted assets) of 8 percent with limited exceptions. Under this system, all assets of a certain category—for example, commercial loans—were assigned a flat risk weight without regard for differences in credit quality among the assets in that category (simple risk-bucket approach). Asset categories were classified into one of four risk-weight buckets—0 percent, 20 percent, 50 percent, or 100 percent.

Amendments to the U.S. federal banking regulators’ rules adopted in 2001 implemented a multilevel, ratings-based approach to assess capital requirements on asset securitizations— including mortgage- backed securities (MBS)—based on their relative exposure to credit risk. The approach used credit ratings from nationally recognized statistical rating organizations (NRSRO) to measure relative exposure to credit risk and determine the associated risk-based capital requirement.

In 2007, U.S. federal banking regulators adopted capital rules for large internationally active banking organizations that were based on a revised framework published by the Basel Committee in 2006 (Basel II). Only large, internationally active banks—banks with consolidated total assets (excluding assets held by an insurance underwriting subsidiary of a bank holding company) of $250 billion or more or with consolidated total on-balance-sheet foreign exposure of $10 billion or more—were required to adopt the advanced approaches for measuring risk (including mortgage-related credit risk) established in the Basel II-based rules. Under these rules, the advanced internal ratings-based approach used risk parameters determined by a bank’s internal systems as inputs into a formula developed by supervisors for calculating minimum regulatory capital and expanded the use of credit ratings to measure credit risk.

U.S. federal banking regulators promulgated a final rule in 2013 to incorporate many of the changes included in the Basel III framework. Among other changes, the final rule includes a new standardized approach for credit risk to replace the Basel I generally applicable risk-based capital rule. The final rule also removed references to credit ratings that were in the Basel I generally applicable rule and the advanced internal ratings-based approach, consistent with requirements in Section 939A of the Dodd-Frank Act.

Other entities that hold mortgages and mortgage-related assets have different capital requirements. For example, in 1992 the Office of Federal Housing Enterprise Oversight, which at the time was the regulator for the enterprises, adopted minimum capital requirements based on the enterprises’ on-balance-sheet assets and off-balance-sheet obligations. Nonbank financial institutions that service mortgages for the enterprises and Ginnie Mae must comply with minimum capital and net worth requirements those entities have issued.

The Basel III-Based Final Rule Changes the Risk Weights for Some Mortgage- Related Assets

The Basel III final rule adopted in 2013 by the U.S. federal banking regulators and generally effective as of January 2015 incorporates higher risk weights for certain mortgage-related exposures while leaving others unchanged (see table 1). For example, the risk weights for most single- family residential mortgages are largely unchanged by the final rule. However, the final rule changed the risk weights for some mortgage- related securitization exposures and for mortgage servicing assets.

Overall Risk Weights for Mortgages Remain Largely Unchanged

Risk weights for residential first-lien mortgages on one-to-four family properties that are held in banks’ portfolios have remained largely unchanged since the adoption of the Basel I-based rules. Under the standardized approach outlined in the Basel III-based final rule, the portions of mortgages that are conditionally guaranteed by U.S. government agencies, such as the Federal Housing Administration or the Department of Veterans Affairs, are assigned 20 percent risk weights under the standardized approach—essentially unchanged since Basel I. Other mortgages—and the portions of mortgages not guaranteed by U.S. government agencies—secured by one-to-four family residential properties are assigned a 50 percent risk weight, provided that such loans are: secured by a property that is either owner-occupied or rented; made in accordance with prudent underwriting standards, including standards relating to the loan amount as a percentage of the appraised value of the property; not 90 days or more past due or carried in nonaccrual status; and not restructured or modified (other than through the Department of the Treasury’s Home Affordable Modification Program).

Also, if a banking organization holds the first-lien and junior-lien residential mortgage exposures, and no other party holds an intervening lien, the institution must combine the exposures and treat them as a single loan secured by a first lien to determine the loan-to-value ratio and assign a risk weight. Banking organizations are required to assign a 100 percent risk weight to a first-lien residential mortgage exposure that does not meet the criteria previously listed and to junior-lien residential mortgage exposures if the banking organization does not hold the first lien on the property.

The advanced internal ratings-based approach requires banking organizations to use a formula defined in regulation to determine the capital requirements for residential mortgage exposures, which are grouped into segments that have similar (homogeneous) risk characteristics. The formula for the capital charge for nondefaulted residential mortgage exposures uses values for the probability of default and loss given default that each bank derives from its internal systems (see app. I). For example, applying a probability of default of 3 percent and losses given default of 20 percent to a segment of nondefaulted residential mortgages would result in a risk weight of about 50 percent using this formula. This formula is unchanged since it went into effect in 2008.

Under this advanced approach, defaulted residential mortgage exposures that are covered by an eligible U.S. government guarantee have a capital charge of 1.6 percent for the portion that is covered by the guarantee—an implicit 20 percent risk weight (0.016 ÷ 0.08 = 0.2). The previous rules did not include a separate provision for defaulted residential mortgage exposures covered by a government guarantee. Defaulted residential mortgage exposures not covered by an eligible U.S. government guarantee have a capital charge of 8 percent, which implies a risk weight of 100 percent.

The standardized approach and the advanced approach both assign a risk weight of 50 percent to pre-sold construction loans with a legally binding sales contract unless the purchase contract is cancelled, in which case a banking organization must assign a 100 percent risk weight.

Some Risk Weights for Mortgage-Related Securitization Exposures Changed under the Final Rule

The Basel III-based final rule keeps the risk weights for government- and enterprise-guaranteed MBS outlined under the previous rules but changes how the risk weights for private-label securities are calculated. Under the standardized approach, residential MBS guaranteed by Ginnie Mae have a risk weight of 0 percent, while residential MBS issued and guaranteed by Fannie Mae and Freddie Mac have a risk weight of 20 percent—unchanged since Basel I. As shown previously in table 1, risk weights for other MBS that qualify as securitization exposures can range from 20 percent to 1,250 percent under either the standardized or the advanced approaches. Previously, risk weights for securitization exposures could be as low as 7 percent under the advanced approach. Under the current rules, banks using the advanced internal-ratings based approach must also apply the standardized approach. If banks are unable to use the formulas and approaches defined in the final rule for the standardized and advanced approaches—for example, because they do not have data to calculate all the inputs—they must apply the 1,250 percent risk weight to their securitization exposures.

Securitization Exposure Calculations under the Standardized Approach

The Basel III final rule establishes two methods for calculating risk weights for securitization exposures under the standardized approach:

The simplified supervisory formula approach relies on objective inputs to calculate risk weights for securitization exposures using a formula. To use this approach, a bank needs to know the performance of the underlying assets.

The “gross-up” approach involves calculating an amount of capital for the bank’s exposure as well as for the portion of more senior exposures (that is, the least risky tranches, which are given priority for repayment), if any, for which the bank’s exposure provides support. If a bank does not have access to the inputs required to calculate the simplified supervisory formula approach, or prefers a simpler approach, the gross-up approach can be applied.

Banks that are subject to another rule, the market risk rule, must use the simplified supervisory formula approach. Banks that are not subject to this other rule may choose to use either method but must use the same method across all exposures.

The simplified supervisory formula approach takes into account the weighted average capital charge for the underlying exposures, delinquency level of the underlying collateral, and the relative size and seniority of the security in the securitization structure (see app. II for the details of the formula). The current balances of all the underlying exposures in the securitization structure are used to calculate the attachment and detachment points for each level, or tranche, of the structure. Losses are first borne by the lowest tranches. Once a tranche experiences a total loss, the next tranche immediately senior to it begins to bear any additional losses.

The following hypothetical securitization structure illustrates the simplified supervisory formula approach for a securitization backed by a pool of residential mortgages that would be risk-weighted at 50 percent. For such a securitization, the typical capital charge of the underlying mortgage pool is 4 percent (50 percent risk weight multiplied by 8 percent minimum risk- based capital ratio). Assuming that 5 percent of the mortgages in the pool are delinquent and have a risk weight of 100 percent (for an 8 percent capital charge), the weighted average capital charge of the mortgage pool would be 4.2 percent. The risk weights for each of the tranches can be calculated using the formula outlined in the final rule and described in appendix II. The risk-weight results for a pool that does not involve resecuritizations are shown in table 2. If 10 percent of the underlying mortgage pool is delinquent, the weighted average capital charge would be 4.4 percent, and the tranche risk weights for the lower (more risky) tranches would increase, reflecting the increased likelihood of losses on these tranches. In both scenarios, the most senior tranches would have risk weights of 20 percent.

Risk weights for other securitization exposures, such as real estate mortgage investment conduits, can also be calculated using the simplified supervisory formula approach. Similarly, the credit risk transfer transactions the enterprises have engaged in with various investors would be treated as securitization exposures for banks that hold these notes. In most cases, these notes would have risk weights at or near 1,250 percent due to the holders of the notes being in or near the first-loss position.

Previously, under the Basel I-based rules that most banks were subject to through 2014, some private-label securitization exposures were assigned general risk weights while others were given risk weights based on credit ratings. For example, privately issued MBS backed by mortgages that would qualify for the 50 percent risk weight would receive a 50 percent risk weight, subject to certain conditions. Mortgage securitization exposures—including direct credit substitutes, recourse, and residual interests—that were externally rated were assigned risk weights between 20 percent (for long-term credit ratings of AAA or AA) and 200 percent (for BB ratings, which indicate higher risk).

The gross-up approach in the Basel III-based rule is the same as an approach that was available under the previous rules. To calculate risk- weighted assets under the gross-up approach, a banking organization determines three inputs along with the exposure amount: the pro rata share, the enhanced amount, and the applicable risk weight.

The pro rata share is the par value of the banking organization’s exposure as a percentage of the par value of the tranche in which the securitization exposure resides—for example, a $5,000 exposure in a $10,000 junior tranche of one-to-four family residential mortgages would be a 50 percent pro rata share.

The enhanced amount is the par value of all tranches that are more senior to the tranche in which the exposure resides. These more senior tranches are “enhanced”—that is, their credit profiles are improved by—the subordinated tranches. If the total securitization in the previous example is $100,000, the par value of all tranches that are more senior to the tranche in which the bank has an interest is $90,000.

The applicable risk weight is the weighted-average risk weight of the underlying exposures in the securitization as calculated under the standardized approach. For mortgages not guaranteed by the federal government (as in the previous example), the underlying exposures can have risk weights of either 50 percent or 100 percent. The weighted-average risk weight would be 75 percent if half of the total amount of underlying mortgages had a risk weight of 50 percent and the remaining underlying exposures had a risk weight of 100 percent.

For the previous example, assume the weighted-average risk weight of the underlying exposures is 50 percent (that is, all the mortgages meet all of the requirements discussed previously, such as not 90 days past due and not restructured or modified). The risk weight would then be applied to the bank’s interest—$5,000—plus the pro rata share of the more senior tranches—50 percent of $90,000. In other words, $50,000 ($5,000 plus $45,000) would be multiplied by the 50 percent risk weight. The result, $25,000, is equivalent to a 500 percent risk weight on the bank’s $5,000 exposure. The bank would then multiply the $25,000 by the minimum capital requirement of 8 percent to determine that the capital requirement for the $5,000 exposure is $2,000.

Securitization Calculations under the Advanced Internal Ratings-Based Approach

For the advanced internal ratings-based approach, the Basel III-based final rule eliminates the credit ratings-based approach that had been the primary method for determining risk weights for securitization exposures under the previous rules. The credit ratings-based approach assigned risk weights to securitization exposures based on their seniority in the securitization structure and the effective number of exposures (as determined by a formula), as well as their external ratings from one or more NRSROs or inferred ratings. These risk weights ranged from 7–20 percent for the highest investment grade (long-term) securitization exposures (e.g., AAA) to 35–100 percent for the lowest investment grade exposures (e.g., BBB+, BBB, BBB-) to 250–650 percent for exposures one category below investment grade (e.g., BB+, BB, BB-).

The primary method for banks using the advanced internal ratings-based approach to calculate capital requirements for securitization exposures is the supervisory formula approach. The supervisory formula approach was an alternative method banks could use under the Basel II-based rules for securitization exposures for which there was no applicable external or inferred credit rating. It has remained largely unchanged from the Basel II- based rules with one significant exception: a 20 percent risk-weight floor, rather than a 7 percent risk-weight floor, now applies to all securitization exposures. The supervisory formula approach requires banks to calculate several input parameters on an ongoing basis. These include the exposure’s credit enhancement level and thickness; the exposure-weighted average loss given default for the underlying exposures to the securitization transaction and the effective number of underlying exposures (both determined by formulas specified in the final rule); and the capital requirements for the underlying exposures, such as those for residential mortgage exposures described earlier.

If banks using the advanced internal ratings-based approach are unable to calculate the inputs for the supervisory formula approach, they may use the simplified supervisory formula approach described earlier.

Risk Weights for Mortgage Servicing Assets Will Increase

The Basel III-based final rule changes the treatment of mortgage servicing assets by (1) lowering the cap on the amount of mortgage servicing assets that can be included in capital calculations, which reflects, in part, the uncertainty regarding the ability of banking institutions to realize value from these assets, especially under adverse financial conditions, and (2) increasing the risk weights. Mortgage servicing assets are the contractual rights owned by a banking organization to service (for a fee) mortgage loans that are owned by others. Under previous rules, banks included up to 90 percent of fair value or 100 percent of book value of mortgage servicing assets in their capital calculations, whichever was lower, and mortgage servicing assets were subject to 100 percent risk weight. In contrast, the final rule caps the recognition of mortgage servicing assets at 10 percent of the common equity component of tier 1 capital. Mortgage servicing assets exceeding the 10 percent threshold must be deducted from common equity. Deductions from common equity reduce the numerator in banks’ calculations of their risk-based capital ratios. Mortgage servicing asset amounts that are not deducted from common equity are currently subject to a 100 percent risk weight, and that risk weight will increase to 250 percent beginning January 1, 2018, when the phase-in period ends. The future increase in the risk weight will increase risk-weighted assets, the denominator for banks’ risk-based capital ratios. As a result, both the stricter cap and higher risk weight on mortgage servicing assets will reduce banks’ risk-based capital ratios, making the required minimum level more difficult to maintain.

The Enterprises and Nonbank Financial Institutions Are Not Subject to the Final Rule or Capital Requirements That Involve Risk Weights

The final rule does not apply to the enterprises or nonbank financial institutions. The enterprises’ previous regulator, the Office of Federal Housing Enterprise Oversight, established risk-based capital requirements that were defined by stress test scenarios rather than fixed risk weights. A simulated stress test was used to project the enterprises’ financial performance over a 10 year period and measure capital adequacy, or the amount of capital required to survive a prolonged period of economic stress without new business or active risk management action. When the enterprises were placed in conservatorship in 2008, their new regulator, the Federal Housing Finance Agency, suspended the enterprises’ capital requirements.

Nonbank financial institutions such as nonbank mortgage servicers follow capital requirements established by Ginnie Mae and the enterprises in order to service loans these entities guaranteed, but these requirements do not involve risk weights. The minimum capital requirements that are currently in place or that have been proposed are shown in table 3.

Effects of Changes to Capital Requirements on Holdings of Mortgage- Related Assets Are Uncertain

The full impact of the changes to capital requirements for holdings of mortgage-related assets remains uncertain because insufficient time has passed since these changes took effect for both banks and nonbank mortgage servicers, and for some assets the changes have not yet been fully phased in. However, our past work suggested that—based on analysis of data included in banks’ Consolidated Reports of Condition and Income (commonly referred to as Call Reports) and Credit Union 5300 Call Reports—many lenders generally appeared to be participating in residential mortgage lending much as they had in the past. In addition, data on mortgage debt outstanding published by the Federal Reserve indicate that holdings of mortgage debt for one-to-four family properties have remained consistent with trends that predate the 2014–2015 changes in risk weights (see fig. 1): (1) mortgage debt held or guaranteed by the enterprises holding steady, (2) mortgage debt held by depository institutions also holding steady, (3) mortgage debt held or guaranteed by Ginnie Mae continuing to increase slightly, and (4) mortgage debt backing private-label securities continuing its steady decline.

But increased risk weights for some mortgage-related assets, among other factors, can have potential implications for banks’ decisions about securitizing and servicing mortgages and investing in MBS. Securitizing mortgages creates exposures that may carry increased risk weights for banks. These exposures can include mortgage servicing assets, recourse obligations, and residual interests.

As discussed previously, the cap on the amount of mortgage servicing assets that can be included in capital calculations is now lower than it previously was—10 percent of common equity rather than either 90 percent of fair value or 100 percent of book value. Banks that exceed the cap may need to hold more capital for these assets. In addition, mortgage servicing assets will have a higher risk weight under the final rule beginning in 2018, which will also increase the capital required for these assets. Fewer banks may want to retain these servicing rights and instead may seek to sell them to nonbank financial institutions that are not subject to the final rule. The total amount of mortgage servicing assets held by banks peaked in 2009 and generally has been decreasing in subsequent years, according to data compiled by SNL Financial. In 2016 reports on mortgage servicing and nonbank servicers, we found that the share of U.S. residential mortgages serviced by nonbank servicers increased from approximately 6.8 percent in the first quarter of 2012 to approximately 24.2 percent in the second quarter of 2015, while the share serviced by the largest nationwide, regional, and other banks decreased from about 75.4 percent to about 58.6 percent over the same period.

Banking organizations may face recourse obligations (for example, to repurchase mortgages they have sold to others) when loans default within a certain period after the sale. Banks reported a decreasing amount of residential mortgages serviced for others with recourse, according to data compiled by SNL Financial, but this trend predates the Basel III-based final rule.

Under current credit risk retention rules, banks must retain an interest equal to at least 5 percent of the credit risk for mortgage-backed securities they sponsor unless the security qualifies for an applicable exemption, including being exclusively backed by mortgages that meet the definition of a “qualified mortgage.” These residual interests are included in risk-weighted assets and may carry higher risk weights under the Basel III-based rules than under the previous rules, depending on how they are structured. Residual interests that are structured as a vertical slice of the securitization structure (meaning the sponsor retains a 5 percent interest in each tranche) would have a lower risk weight than residual interests that are structured as a horizontal slice of the securitization (meaning the sponsor retains the most junior 5 percent interest in the securitization structure). Few transactions involving the securitization of mortgages that do not meet the qualified mortgage definition have been completed since the rule went into effect. Instead, banks may be electing to hold these mortgages in their portfolios or to originate loans that meet the qualified mortgage definition, including those that can be sold to the enterprises. The increase in banks’ holdings of securities backed by the enterprises could be evidence of this latter scenario, as banks often deliver loans to the enterprises in exchange for enterprise MBS. Holdings of enterprise MBS would have lower risk weights than holding whole loans in portfolio (whether or not they meet the qualified mortgage definition).

Finally, the Basel III-based final rule largely left unchanged the historically lower risk weights of MBS guaranteed by the enterprises vis-à-vis other mortgage-related assets, which can influence the demand for these securities relative to whole loans and privately issued MBS. While holdings of MBS guaranteed by Ginnie Mae retain a 0 percent risk weight and holdings of MBS guaranteed by the enterprises retain a 20 percent risk weight under the standardized approach (and their treatment under the advanced approach has not changed), holdings of privately issued MBS may face higher risk weights than under the prior rules. For privately issued MBS that have an external credit rating, the minimum weight increased from 7 percent to 20 percent for banks subject to the advanced approach, and the junior tranches of these MBS are likely subject to higher risk weights in part because credit ratings can no longer be used to calculate risk weights. According to data compiled by SNL Financial, banks’ holdings of MBS guaranteed by Ginnie Mae and the enterprises have been increasing while their holdings of other residential MBS have been decreasing, but these trends predate the changes to risk weights for privately issued MBS.

Agency Comments

We sought and received technical comments on a draft of this report from the Board of Governors of the Federal Reserve System, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation and incorporated their comments and feedback into the final report.

We are sending copies of this report to the appropriate congressional committees and other interested parties. In addition, the report is available at no charge on the GAO website at http://www.gao.gov.

If you or your staff have any questions about this report, please contact me at (202) 512-8678 or evansl@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix III.

Appendix I: Calculation of Risk-Weighted Assets for Retail Exposures under the Advanced Internal Ratings-Based Approach

Under the advanced internal ratings-based approach, residential mortgages are included in retail exposures. Generally, a banking organization must calculate retail risk-weighted asset amounts in four distinct phases: 1. Phase 1 – Categorization of exposures During this phase, the banking organization determines which of its exposures are wholesale exposures, retail exposures, securitization exposures, or equity exposures. Retail exposures are further categorized as residential mortgage exposures, qualifying revolving exposures, or other retail exposures. 2. Phase 2 – Segmentation of retail exposures During the second phase, a banking organization must group the retail exposures in each retail subcategory into segments that have homogeneous risk characteristics. A banking organization must also segment defaulted retail exposures separately from nondefaulted retail exposures. 3. Phase 3 – Assignment of risk parameters to segments of retail exposures During phase 3, the banking organization must associate a probability of default (PD), a loss given default (LGD), and an exposure at default (EAD) to each segment of retail exposures such as residential mortgages.

𝐾𝐾=𝐿𝐿𝐿𝐿𝐿𝐿 ×𝑁𝑁�𝑁𝑁−1(𝑃𝑃𝐿𝐿)+√R×𝑁𝑁−1(0.999) �−(𝐿𝐿𝐿𝐿𝐿𝐿×𝑃𝑃𝐿𝐿) where K represents the capital charge; N(.) means the cumulative distribution function for a standard normal random variable; N-1(.) means the inverse cumulative distribution function for a standard normal random variable; and R is the non-defaulted exposures correlation factor. For residential mortgage exposures, R is set equal to 0.15 in the Basel III- based final rule.

𝐾𝐾=0.2 ×𝑁𝑁�𝑁𝑁−1(0.03)+√0.15×𝑁𝑁−1(0.999) √0.85 𝑁𝑁−1(0.03)=−1.88079 𝑁𝑁−1(0.999)=3.09023 𝐾𝐾=0.2 ×𝑁𝑁�−1.88079+0.3873×3.09023 0.92195 𝐾𝐾=0.2 ×𝑁𝑁(−0.74185)−(0.006) 𝑁𝑁(−0.74185)=0.22909 𝐾𝐾=0.2 ×0.22909−(0.006) 𝐾𝐾=.03982,or approximately 4% �−(0.2×0.03) �−(0.006)

The capital charge, K, reflects the risk weight multiplied by the minimum capital requirement. Therefore, dividing the capital charge of approximately 4 percent by the minimum capital requirement of 8 percent produces a risk weight of about 50 percent.

Appendix II: Specification of the Simplified Supervisory Formula Approach

−22.3214(0.0604−0.0104) −22.3214(0.0304−0)

GAO Contact

Staff Acknowledgments

In addition to the contact named above, Karen Tremba (Assistant Director), Don Brown (Analyst-in-Charge), M’Baye Diagne, Rachel DeMarcus, Marc Molino, Jennifer Schwartz, and Tyler Spunaugle made significant contributions to this report.