Proposed Rule2023-19200
Regulatory Capital Rule: Large Banking Organizations and Banking Organizations With Significant Trading Activity
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
September 18, 2023
Issuing agencies
Treasury DepartmentComptroller of the CurrencyFederal Reserve SystemFederal Deposit Insurance Corporation
Abstract
The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation are inviting public comment on a notice of proposed rulemaking (proposal) that would substantially revise the capital requirements applicable to large banking organizations and to banking organizations with significant trading activity. The revisions set forth in the proposal would improve the calculation of risk-based capital requirements to better reflect the risks of these banking organizations' exposures, reduce the complexity of the framework, enhance the consistency of requirements across these banking organizations, and facilitate more effective supervisory and market assessments of capital adequacy. The revisions would include replacing current requirements that include the use of banking organizations' internal models for credit risk and operational risk with standardized approaches and replacing the current market risk and credit valuation adjustment risk requirements with revised approaches. The proposed revisions would be generally consistent with recent changes to international capital standards issued by the Basel Committee on Banking Supervision. The proposal would not amend the capital requirements applicable to smaller, less complex banking organizations.
Full Text
<html>
<head>
<title>Federal Register, Volume 88 Issue 179 (Monday, September 18, 2023)</title>
</head>
<body><pre>
[Federal Register Volume 88, Number 179 (Monday, September 18, 2023)]
[Proposed Rules]
[Pages 64028-64343]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2023-19200]
[[Page 64027]]
Vol. 88
Monday,
No. 179
September 18, 2023
Part II
Department of the Treasury
-----------------------------------------------------------------------
Office of the Comptroller of the Currency
12 CFR Parts 3, 6, 32, et al.
Federal Reserve System
-----------------------------------------------------------------------
Federal Deposit Insurance Corporation
-----------------------------------------------------------------------
Regulatory Capital Rule: Large Banking Organizations and Banking
Organizations With Significant Trading Activity; Proposed Rule
Federal Register / Vol. 88, No. 179 / Monday, September 18, 2023 /
Proposed Rules
[[Page 64028]]
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Parts 3, 6, 32
[Docket ID OCC-2023-0008]
RIN 1557-AE78
FEDERAL RESERVE SYSTEM
12 CFR Parts 208, 217, 225, 238, 252
[Docket No. R-1813]
RIN 7100-AG64
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 324
RIN 3064-AF29
Regulatory Capital Rule: Large Banking Organizations and Banking
Organizations With Significant Trading Activity
AGENCY: Office of the Comptroller of the Currency, Treasury; the Board
of Governors of the Federal Reserve System; and the Federal Deposit
Insurance Corporation.
ACTION: Notice of proposed rulemaking.
-----------------------------------------------------------------------
SUMMARY: The Office of the Comptroller of the Currency, the Board of
Governors of the Federal Reserve System, and the Federal Deposit
Insurance Corporation are inviting public comment on a notice of
proposed rulemaking (proposal) that would substantially revise the
capital requirements applicable to large banking organizations and to
banking organizations with significant trading activity. The revisions
set forth in the proposal would improve the calculation of risk-based
capital requirements to better reflect the risks of these banking
organizations' exposures, reduce the complexity of the framework,
enhance the consistency of requirements across these banking
organizations, and facilitate more effective supervisory and market
assessments of capital adequacy. The revisions would include replacing
current requirements that include the use of banking organizations'
internal models for credit risk and operational risk with standardized
approaches and replacing the current market risk and credit valuation
adjustment risk requirements with revised approaches. The proposed
revisions would be generally consistent with recent changes to
international capital standards issued by the Basel Committee on
Banking Supervision. The proposal would not amend the capital
requirements applicable to smaller, less complex banking organizations.
DATES: Comments must be received by November 30, 2023.
ADDRESSES: Comments should be directed to:
OCC: Commenters are encouraged to submit comments through the
Federal eRulemaking Portal, if possible. Please use the title
``Regulatory capital rule: Amendments applicable to large banking
organizations and to banking organizations with significant trading
activity'' to facilitate the organization and distribution of the
comments. You may submit comments by any of the following methods:
<bullet> Federal eRulemaking Portal--<a href="http://Regulations.gov">Regulations.gov</a>:
Go to <a href="https://regulations.gov/">https://regulations.gov/</a>. Enter ``Docket ID OCC-2023-0008''
in the Search Box and click ``Search.'' Public comments can be
submitted via the ``Comment'' box below the displayed document
information or by clicking on the document title and then clicking the
``Comment'' box on the top-left side of the screen. For help with
submitting effective comments, please click on ``Commenter's
Checklist.'' For assistance with the <a href="http://Regulations.gov">Regulations.gov</a> site, please call
1-866-498-2945 (toll free) Monday-Friday, 9 a.m.-5 p.m. ET, or email
<a href="/cdn-cgi/l/email-protection#4b392e2c3e272a3f22242538232e273b2f2e38200b2c382a652c243d"><span class="__cf_email__" data-cfemail="a5d7c0c2d0c9c4d1cccacbd6cdc0c9d5c1c0d6cee5c2d6c48bc2cad3">[email protected]</span></a>.
<bullet> Mail: Chief Counsel's Office, Attention: Comment
Processing, Office of the Comptroller of the Currency, 400 7th Street
SW, Suite 3E-218, Washington, DC 20219.
<bullet> Hand Delivery/Courier: 400 7th Street SW, Suite 3E-218,
Washington, DC 20219.
Instructions: You must include ``OCC'' as the agency name and
``Docket ID OCC-2023-0008'' in your comment. In general, the OCC will
enter all comments received into the docket and publish the comments on
the <a href="http://Regulations.gov">Regulations.gov</a> website without change, including any business or
personal information provided such as name and address information,
email addresses, or phone numbers. Comments received, including
attachments and other supporting materials, are part of the public
record and subject to public disclosure. Do not include any information
in your comment or supporting materials that you consider confidential
or inappropriate for public disclosure.
You may review comments and other related materials that pertain to
this action by the following method:
<bullet> Viewing Comments Electronically--<a href="http://Regulations.gov">Regulations.gov</a>:
Go to <a href="https://regulations.gov/">https://regulations.gov/</a>. Enter ``Docket ID OCC-2023-0008''
in the Search Box and click ``Search.'' Click on the ``Dockets'' tab
and then the document's title. After clicking the document's title,
click the ``Browse All Comments'' tab. Comments can be viewed and
filtered by clicking on the ``Sort By'' drop-down on the right side of
the screen or the ``Refine Comments Results'' options on the left side
of the screen. Supporting materials can be viewed by clicking on the
``Browse Documents'' tab. Click on the ``Sort By'' drop-down on the
right side of the screen or the ``Refine Results'' options on the left
side of the screen checking the ``Supporting & Related Material''
checkbox. For assistance with the <a href="http://Regulations.gov">Regulations.gov</a> site, please call 1-
866-498-2945 (toll free) Monday-Friday, 9 a.m.-5 p.m. ET, or email
<a href="/cdn-cgi/l/email-protection#27554240524b46534e4849544f424b574342544c6740544609404851"><span class="__cf_email__" data-cfemail="74061113011815001d1b1a071c1118041011071f341307155a131b02">[email protected]</span></a>.
The docket may be viewed after the close of the comment period in
the same manner as during the comment period.
Board: You may submit comments, identified by Docket No. R-1813,
RIN 7100-AG64 by any of the following methods:
Agency Website: <a href="https://www.federalreserve.gov">https://www.federalreserve.gov</a>. Follow the
instructions for submitting comments at <a href="https://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm">https://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm</a>.
Federal eRulemaking Portal: <a href="https://www.regulations.gov">https://www.regulations.gov</a>. Follow the
instructions for submitting comments.
Email: <a href="/cdn-cgi/l/email-protection#b9cbdcdeca97dad6d4d4dcd7cdcaf9dfdcdddccbd8d5cbdccadccbcfdc97ded6cf"><span class="__cf_email__" data-cfemail="99ebfcfeeab7faf6f4f4fcf7edead9fffcfdfcebf8f5ebfceafcebeffcb7fef6ef">[email protected]</span></a>. Include the docket number
and RIN in the subject line of the message.
Fax: (202) 452-3819 or (202) 452-3102.
Mail: Ann E. Misback, Secretary, Board of Governors of the Federal
Reserve System, 20th Street and Constitution Avenue NW, Washington, DC
20551.
In general, all public comments will be made available on the
Board's website at <a href="http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm">www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm</a> as submitted, and will not be modified to remove
confidential, contact or any identifiable information. Public comments
may also be viewed electronically or in paper in Room M-4365A, 2001 C
St. NW, Washington, DC 20551, between 9 a.m. and 5 p.m. during Federal
business weekdays.
FDIC: The FDIC encourages interested parties to submit written
comments. Please include your name, affiliation, address, email
address, and telephone number(s) in your comment. You may submit
comments to the FDIC, identified by RIN 3064-AF29 by any of the
following methods:
Agency Website: https://www.fdic.gov/resources/regulations/
[[Page 64029]]
federal-register-publications. Follow instructions for submitting
comments on the FDIC's website.
Mail: James P. Sheesley, Assistant Executive Secretary, Attention:
Comments/Legal OES (RIN 3064-AF29), Federal Deposit Insurance
Corporation, 550 17th Street NW, Washington, DC 20429.
Hand Delivered/Courier: Comments may be hand-delivered to the guard
station at the rear of the 550 17th Street NW, building (located on F
Street NW) on business days between 7 a.m. and 5 p.m.
Email: <a href="/cdn-cgi/l/email-protection#d8bbb7b5b5bdb6acab989e9c919bf6bfb7ae"><span class="__cf_email__" data-cfemail="bad9d5d7d7dfd4cec9fafcfef3f994ddd5cc">[email protected]</span></a>. Include the RIN 3064-AF29 on the subject
line of the message.
Public Inspection: Comments received, including any personal
information provided, may be posted without change to <a href="https://www.fdic.gov/resources/regulations/federal-register-publications">https://www.fdic.gov/resources/regulations/federal-register-publications</a>.
Commenters should submit only information that the commenter wishes to
make available publicly. The FDIC may review, redact, or refrain from
posting all or any portion of any comment that it may deem to be
inappropriate for publication, such as irrelevant or obscene material.
The FDIC may post only a single representative example of identical or
substantially identical comments, and in such cases will generally
identify the number of identical or substantially identical comments
represented by the posted example. All comments that have been
redacted, as well as those that have not been posted, that contain
comments on the merits of this document will be retained in the public
comment file and will be considered as required under all applicable
laws. All comments may be accessible under the Freedom of Information
Act.
FOR FURTHER INFORMATION CONTACT:
OCC: Venus Fan, Risk Expert, Benjamin Pegg, Analyst, Andrew
Tschirhart, Risk Expert, or Diana Wei, Risk Expert, Capital Policy,
(202) 649-6370; Carl Kaminski, Assistant Director, Kevin Korzeniewski,
Counsel, Rima Kundnani, Counsel, Daniel Perez, Counsel, or Daniel
Sufranski, Senior Attorney, Chief Counsel's Office, (202) 649-5490,
Office of the Comptroller of the Currency, 400 7th Street SW,
Washington, DC 20219. If you are deaf, hard of hearing, or have a
speech disability, please dial 7-1-1 to access telecommunications relay
services.
Board: Anna Lee Hewko, Associate Director, (202) 530-6260; Brian
Chernoff, Manager, (202) 452-2952; Andrew Willis, Manager, (202) 912-
4323; Cecily Boggs, Lead Financial Institution Policy Analyst, (202)
530-6209; Marco Migueis, Principal Economist, (202) 452-6447; Diana
Iercosan, Principal Economist, (202) 912-4648; Nadya Zeltser, Senior
Financial Institution Policy Analyst, (202) 452-3164; Division of
Supervision and Regulation; or Jay Schwarz, Assistant General Counsel,
(202) 452-2970; Mark Buresh, Special Counsel, (202) 452-5270; Andrew
Hartlage, Special Counsel, (202) 452-6483; Gillian Burgess, Senior
Counsel, (202) 736-5564; Jonah Kind, Senior Counsel, (202) 452-2045,
Legal Division, Board of Governors of the Federal Reserve System, 20th
Street and Constitution Avenue NW, Washington, DC 20551. For users of
TTY-TRS, please call 711 from any telephone, anywhere in the United
States.
FDIC: Benedetto Bosco, Chief Capital Policy Section; Bob Charurat,
Corporate Expert; Irina Leonova, Corporate Expert; Andrew Carayiannis,
Chief, Policy and Risk Analytics Section; Brian Cox, Chief, Capital
Markets Strategies Section; Noah Cuttler, Senior Policy Analyst; David
Riley, Senior Policy Analyst; Michael Maloney, Senior Policy Analyst;
Richard Smith, Capital Markets Policy Analyst; Olga Lionakis, Capital
Markets Policy Analyst; Kyle McCormick, Senior Policy Analyst; Keith
Bergstresser, Senior Policy Analyst, Capital Markets and Accounting
Policy Branch, Division of Risk Management Supervision; Catherine Wood,
Counsel; Benjamin Klein, Counsel; Anjoly David, Honors Attorney, Legal
Division; <a href="/cdn-cgi/l/email-protection#35475052405954415a474c5654455c4154597553515c561b525a43"><span class="__cf_email__" data-cfemail="5b293e3c2e373a2f342922383a2b322f3a371b3d3f3238753c342d">[email protected]</span></a>, (202) 898-6888; Federal Deposit
Insurance Corporation, 550 17th Street NW, Washington, DC 20429.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
A. Overview of the Proposal
B. Use of Internal Models Under the Proposed Framework
II. Scope of Application
III. Proposed Changes to the Capital Rule
A. Calculation of Capital Ratios and Application of Buffer
Requirements
1. Standardized Output Floor
2. Stress Capital Buffer Requirement
B. Definition of Capital
1. Accumulated Other Comprehensive Income
2. Regulatory Capital Deductions
3. Additional Definition of Capital Adjustments
4. Changes to the Definition of Tier 2 Capital Applicable to
Large Banking Organizations
C. Credit Risk
1. Due Diligence
2. Proposed Risk Weights for Credit Risk
3. Off-Balance Sheet Exposures
4. Derivatives
5. Credit Risk Mitigation
D. Securitization Framework
1. Operational Requirements
2. Securitization Standardized Approach (SEC-SA)
3. Exceptions to the SEC-SA Risk-Based Capital Treatment for
Securitization Exposures
4. Credit Risk Mitigation for Securitization Exposures
E. Equity Exposures
1. Risk-Weighted Asset Amount
F. Operational Risk
1. Business Indicator
2. Business Indicator Component
3. Internal Loss Multiplier
4. Operational Risk Management and Data Collection Requirements
G. Disclosure Requirements
1. Proposed Disclosure Requirements
2. Specific Public Disclosure Requirements
H. Market Risk
1. Background
2. Scope and Application of the Proposed Rule
3. Market Risk Covered Position
4. Internal Risk Transfers
5. General Requirements for Market Risk
6. Measure for Market Risk
7. Standardized Measure for Market Risk
8. Models-Based Measure for Market Risk
9. Treatment of Certain Market Risk Covered Positions
10. Reporting and Disclosure Requirements
11. Technical Amendments
I. Credit Valuation Adjustment Risk
1. Background
2. Scope of Application
3. CVA Risk Covered Positions and CVA Hedges
4. General Risk Management Requirements
5. Measure for CVA Risk
IV. Transition Provisions
A. Transitions for Expanded Total Risk-Weighted Assets
B. AOCI Regulatory Capital Adjustments
V. Impact and Economic Analysis
A. Scope and Data
B. Impact on Risk-Weighted Assets and Capital Requirements
C. Economic Impact on Lending Activity
D. Economic Impact on Trading Activity
E. Additional Impact Considerations
VI. Technical Amendments to the Capital Rule
A. Additional OCC Technical Amendments
B. Additional FDIC Technical Amendments
VII. Proposed Amendments to Related Rules and Related Proposals
A. OCC Amendments
B. Board Amendments
C. Related Proposals
VIII. Administrative Law Matters
A. Paperwork Reduction Act
B. Regulatory Flexibility Act
C. Plain Language
D. Riegle Community Development and Regulatory Improvement Act
of 1994
E. OCC Unfunded Mandates Reform Act of 1995 Determination
F. Providing Accountability Through Transparency Act of 2023
I. Introduction
The Office of the Comptroller of the Currency (OCC), the Board of
Governors
[[Page 64030]]
of the Federal Reserve System (Board), and the Federal Deposit
Insurance Corporation (FDIC) (collectively, the agencies) are proposing
to modify the capital requirements applicable to banking organizations
\1\ with total assets of $100 billion or more and their subsidiary
depository institutions (large banking organizations) and to banking
organizations with significant trading activity. The revisions set
forth in the proposal would strengthen the calculation of risk-based
capital requirements to better reflect the risks of these banking
organizations' exposures. In addition, the proposed revisions would
enhance the consistency of requirements across large banking
organizations and facilitate more effective supervisory and market
assessments of capital adequacy.
---------------------------------------------------------------------------
\1\ The term ``banking organizations'' includes national banks,
state member banks, state nonmember banks, Federal savings
associations, state savings associations, top-tier bank holding
companies domiciled in the United States not subject to the Board's
Small Bank Holding Company and Savings and Loan Holding Company
Policy Statement (12 CFR part 225, appendix C), U.S. intermediate
holding companies of foreign banking organizations, and top-tier
savings and loan holding companies domiciled in the United States,
except for certain savings and loan holding companies that are
substantially engaged in insurance underwriting or commercial
activities and savings and loan holding companies that are subject
to the Small Bank Holding Company and Savings and Loan Holding
Company Policy Statement.
---------------------------------------------------------------------------
Following the 2007-09 financial crisis, the agencies adopted an
initial set of reforms to improve the effectiveness of and address
weaknesses in the regulatory capital framework. For example, in 2013,
the agencies adopted a final rule that increased the quantity and
quality of regulatory capital banking organizations must maintain.\2\
These changes were broadly consistent with an initial set of reforms
published by the Basel Committee on Banking Supervision (Basel
Committee) following the financial crisis.\3\ The Board also
implemented capital planning and stress testing requirements for large
bank holding companies and savings and loan holding companies \4\ and
an additional capital buffer requirement to mitigate the financial
stability risks posed by U.S. global systemically important banking
organizations (GSIBs),\5\ as well as other enhanced prudential
standards, consistent with the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (Dodd-Frank Act).\6\
---------------------------------------------------------------------------
\2\ The Board and the OCC issued a joint final rule on October
11, 2013 (78 FR 62018) and the FDIC issued a substantially identical
interim final rule on September 10, 2013 (78 FR 55340). In April
2014, the FDIC adopted the interim final rule as a final rule with
no substantive changes. 79 FR 20754 (April 14, 2014).
\3\ The Basel Committee is a committee composed of central banks
and banking supervisory authorities, which was established by the
central bank governors of the G-10 countries in 1975.
\4\ See 12 CFR 225.8; 12 CFR part 238, subparts N, O, P, R, S;
12 CFR part 252, subparts D, E, F, N, O.
\5\ 12 CFR part 217, subpart H.
\6\ See 12 CFR part 252; 12 U.S.C. 5365.
---------------------------------------------------------------------------
The proposal would build on these initial reforms by making
additional changes developed in response to the 2007-09 financial
crisis and informed by experience since the crisis. Requirements under
the proposal would generally be consistent with international capital
standards issued by the Basel Committee, commonly known as the Basel
III reforms.\7\ Where appropriate, the proposal differs from the Basel
III reforms to reflect, for example, specific characteristics of U.S.
markets, requirements under U.S. generally accepted accounting
principles (GAAP),\8\ practices of U.S. banking organizations, and U.S.
legal requirements and policy objectives.
---------------------------------------------------------------------------
\7\ See the consolidated Basel Framework at <a href="https://www.bis.org/basel_framework/">https://www.bis.org/basel_framework/</a>.
\8\ GAAP often serve as a foundational measurement component for
U.S. capital requirements.
---------------------------------------------------------------------------
The proposal would strengthen risk-based capital requirements for
large banking organizations by improving their comprehensiveness and
risk sensitivity. These proposed revisions, including removal of
certain internal models, would increase capital requirements in the
aggregate, in particular for those banking organizations with
heightened risk profiles. Increased capital requirements can produce
both economic costs and benefits. The agencies assessed the likely
effect of the proposal on economic activity and resilience, and expect
that the benefits of strengthening capital requirements for large
banking organizations outweigh the costs.\9\
---------------------------------------------------------------------------
\9\ See the impact and economic analysis presented in section V
of this SUPPLEMENTARY INFORMATION.
---------------------------------------------------------------------------
Historical experience has demonstrated the impact individual
banking organizations can have on the stability of the U.S. banking
system, in particular banking organizations that would have been
subject to the proposal. Large banking organizations that experience an
increase in their capital requirements resulting from the proposal
would be expected to be able to absorb losses with reduced disruption
to financial intermediation in the U.S. economy. Enhanced resilience of
the banking sector supports more stable lending through the economic
cycle and diminishes the likelihood of financial crises and their
associated costs.
The agencies seek comment on all aspects of the proposal.
A. Overview of the Proposal
The proposal would improve the risk capture and consistency of
capital requirements across large banking organizations and reduce
complexity and operational costs through changes across multiple areas
of the agencies' risk-based capital framework. For most parts of the
framework, the proposal would eliminate the use of banking
organizations' internal models to set regulatory capital requirements
and in their place apply a simpler and more consistent standardized
framework. For market risk, the proposal would retain banking
organizations' ability to use internal models, with an improved models-
based measure for market risk that better accounts for potential
losses. The use of internal models would be subject to enhanced
requirements for model approval and performance and a new ``output
floor'' to limit the extent to which a banking organization's internal
models may reduce its overall capital requirement. The proposal would
also adopt new standardized approaches for market risk and credit
valuation adjustment (CVA) risk that better reflect the risks of
banking organizations' exposures.
This new framework for calculating risk-weighted assets (the
expanded risk-based approach) would apply to banking organizations with
total assets of $100 billion or more and their subsidiary depository
institutions. The revised requirements for market risk would also apply
to other banking organizations with $5 billion or more in trading
assets plus trading liabilities or for which trading assets plus
trading liabilities exceed 10 percent of total assets.
The expanded risk-based approach would be more risk-sensitive than
the current U.S. standardized approach by incorporating more credit-
risk drivers (for example, borrower and loan characteristics) and
explicitly differentiating between more types of risk (for example,
operational risk, credit valuation adjustment risk). In this manner,
the expanded risk-based approach would better account for key risks
faced by large banking organizations. The proposed changes would also
enhance the alignment of capital requirements to the risks of banking
organizations' exposures and increase incentives for prudent risk
management.
To ensure that large banking organizations would not have lower
capital requirements than smaller, less complex banking organizations,
the
[[Page 64031]]
proposal would maintain the capital rule's dual-requirement structure.
Under this structure, a large banking organization would be required to
calculate its risk-based capital ratios under both the new expanded
risk-based approach and the standardized approach (including market
risk, as applicable), and use the lower of the two for each risk-based
capital ratio.\10\ All capital buffer requirements, including the
stress capital buffer requirement, would apply regardless of whether
the expanded risk-based approach or the existing standardized approach
produces the lower ratio.
---------------------------------------------------------------------------
\10\ Banking organizations' risk-based capital ratios are the
common equity tier 1 capital ratio, tier 1 capital ratio, and total
capital ratio. See 12 CFR 3.10 (OCC), 12 CFR 217.10 (Board), and 12
CFR 324.10 (FDIC).
---------------------------------------------------------------------------
For banking organizations subject to Category III or IV capital
standards,\11\ the proposal would align the calculation of regulatory
capital--the numerator of the regulatory capital ratios--with the
calculation for banking organizations subject to Category I or II
capital standards, providing the same approach for all large banking
organizations. Banking organizations subject to Category III or IV
capital standards would be subject to the same treatment of accumulated
other comprehensive income (AOCI), capital deductions, and rules for
minority interest as banking organizations subject to Category I or II
capital standards. This change would help ensure that the regulatory
capital ratios of these banking organizations better reflect their
capacity to absorb losses, including by taking into account unrealized
losses or gains on securities positions reflected in AOCI.
---------------------------------------------------------------------------
\11\ In 2019, the agencies adopted rules establishing four
categories of capital standards for U.S. banking organizations with
$100 billion or more in total assets and foreign banking
organizations with $100 billion or more in combined U.S. assets.
Under this framework, Category I capital standards apply to U.S.
global systemically important bank holding companies and their
depository institution subsidiaries. Category II capital standards
apply to banking organizations with at least $700 billion in total
consolidated assets or at least $75 billion in cross-jurisdictional
activity and their depository institution subsidiaries. Category III
capital standards apply to banking organizations with total
consolidated assets of at least $250 billion or at least $75 billion
in weighted short-term wholesale funding, nonbank assets, or off-
balance sheet exposure and their depository institution
subsidiaries. Category IV capital standards apply to banking
organizations with total consolidated assets of at least $100
billion that do not meet the thresholds for a higher category and
their depository institution subsidiaries. See 12 CFR 3.2 (OCC), 12
CFR 252.5, 12 CFR 238.10 (Board), 12 CFR 324.2 (FDIC); ``Prudential
Standards for Large Bank Holding Companies, Savings and Loan Holding
Companies, and Foreign Banking Organizations,'' 84 FR 59032
(November 1, 2019); and ``Changes to Applicability Thresholds for
Regulatory Capital and Liquidity Requirements,'' 84 FR 59230
(November 1, 2019).
---------------------------------------------------------------------------
The proposal would expand application of the supplementary leverage
ratio and the countercyclical capital buffer to banking organizations
subject to Category IV capital standards. This change would bring
further alignment of capital requirements across large banking
organizations and is consistent with the proposal's goal of
strengthening the resilience of large banking organizations.
The proposal would also introduce enhanced disclosure requirements
to facilitate market participants' understanding of a banking
organization's financial condition and risk management practices. Also,
the proposal would align Federal Reserve's regulatory reporting
requirements with the changes to capital requirements. The agencies
anticipate that revisions to the reporting forms of the Federal
Financial Institutions Examination Council (FFIEC) applicable to large
banking organizations and to banking organizations with significant
trading activity will be proposed in the near future, which would align
with the proposed revisions to the capital rule.
The proposed changes would take effect subject to the transition
provisions described in section IV of this SUPPLEMENTARY INFORMATION.
The revisions introduced by the proposal would interact with
several Board rules, including by modifying the risk-weighted assets
used to calculate total loss-absorbing capacity requirements, long-term
debt requirements, and the short-term wholesale funding score included
in the GSIB surcharge method 2 score. Also, the proposal would revise
the calculation of single-counterparty credit limits by removing the
option of using a banking organization's internal models to calculate
derivatives exposure amounts and requiring the use of the standardized
approach for counterparty credit risk for this purpose. The proposal
would also remove the exemption from calculating risk-weighted assets
under subpart E of the capital rule currently available to U.S.
intermediate holding companies of foreign banking organizations under
the Board's enhanced prudential standards.
In parallel, the Board is issuing a notice of proposed rulemaking
revising the GSIB surcharge calculation applicable to GSIBs and the
systemic risk report applicable to large banking organizations.\12\
---------------------------------------------------------------------------
\12\ On October 24, 2019, the Board published in the Federal
Register a notice of proposed rulemaking inviting comment on a
proposal to establish risk-based capital requirements for depository
institution holding companies significantly engaged in insurance
activities. See 84 FR 57240 (October 24, 2019). The Board
anticipates that any final rule based on the proposal in this
Supplementary Information would include appropriate adjustments as
necessary to take into account any final insurance capital rule.
---------------------------------------------------------------------------
Question 1: The Board invites comment on the interaction of the
revisions under the proposal with other existing rules and with the
other notice of proposed rulemaking. In particular, comment is invited
on the impact of the proposal on the single-counterparty credit limit
framework. What are the advantages and disadvantages of the proposed
approach? Which alternatives, if any, should the Board consider and
why?
B. Use of Internal Models Under the Proposed Framework
The proposal would remove the use of internal models to set credit
risk and operational risk capital requirements (the so-called advanced
approaches) for banking organizations subject to Category I or II
capital standards. These internal models rely on a banking
organization's choice of modeling assumptions and supporting data. Such
model assumptions include a degree of subjectivity, which can result in
varying risk-based capital requirements for similar exposures.
Moreover, empirical verification of modeling choices can require many
years of historical experience because severe credit risk and
operational risk losses can occur infrequently. In the agencies'
previous observations, the advanced approaches have produced
unwarranted variability across banking organizations in requirements
for exposures with similar risks.\13\ This unwarranted variability,
combined with the complexity of these models-based approaches, can
reduce confidence in the validity of the modeled outputs, lessen the
transparency of the risk-based capital ratios, and challenge
comparisons of capital adequacy across banking organizations.
---------------------------------------------------------------------------
\13\ The Basel Committee has published analysis illustrating the
variability of credit-risk-weighted assets across banking
organizations. See <a href="https://www.bis.org/publ/bcbs256.pdf">https://www.bis.org/publ/bcbs256.pdf</a> and <a href="https://www.bis.org/bcbs/publ/d363.pdf">https://www.bis.org/bcbs/publ/d363.pdf</a>.
---------------------------------------------------------------------------
Standardization of credit and operational risk capital requirements
would improve the consistency of requirements. Standardized
requirements, together with robust public disclosure and reporting
requirements, would enhance the transparency of capital requirements
and the ability of supervisors and market participants to make
independent assessments of a banking
[[Page 64032]]
organization's capital adequacy, individually and relative to its
peers.
The use of robust, risk-sensitive standardized approaches for
credit and operational risk would also improve the efficiency of the
capital framework by reducing operational costs. Under the advanced
approaches, banking organizations subject to Category I or II capital
standards must develop and maintain internal modeling systems to
determine capital requirements, which may differ from the risk
measurement approaches they use to monitor risk for internal
assessments. Further, any material changes to a banking organization's
internal models must be fully documented and presented to the banking
organization's primary Federal supervisor for review.\14\ Replacing the
use of internal models with standardized approaches would reduce costs
associated with maintaining such modeling systems and eliminate the
associated submissions to the agencies.
---------------------------------------------------------------------------
\14\ See 12 CFR 3.123(a) (OCC); 12 CFR 217.123(a) (Board); 12
CFR 324.123(a) (FDIC).
---------------------------------------------------------------------------
Eliminating the use of internal models to set credit and
operational risk capital requirements would not reduce the overall risk
capture of the regulatory framework. In addition to the calculation of
expanded risk-based approach and standardized approach capital
requirements, a large banking organization would continue to be
required to maintain capital commensurate with the level and nature of
all risks to which the banking organization is exposed,\15\ to have a
process for assessing its overall capital adequacy in relation to its
risk profile and a comprehensive strategy for maintaining an
appropriate level of capital,\16\ and, where applicable, to conduct
internal stress tests.\17\ Also, holding companies subject to the
Board's capital plan rule would continue to be subject to a stress
capital buffer requirement that is based on a supervisory stress test
of the holding company's exposures.\18\ Although the proposal would
remove use of internal models for calculating capital requirements for
credit and operational risk, internal models can provide valuable
information to a banking organization's internal stress testing,
capital planning, and risk management functions. Large banking
organizations should employ internal modeling capabilities as
appropriate for the complexity of their activities.
---------------------------------------------------------------------------
\15\ See 12 CFR 3.10(e)(1) (OCC); 12 CFR 217.10(e)(1) (Board);
12 CFR 324.10(e)(1) (FDIC).
\16\ See 12 CFR 3.10(e)(2) (OCC); 12 CFR 217.10(e)(2) (Board);
12 CFR 324.10(e)(2) (FDIC).
\17\ See 12 CFR 46 (OCC); 12 CFR 252 subpart B and F (Board); 12
CFR 325 (FDIC).
\18\ See 12 CFR 225.8 and 12 CFR 238.170.
---------------------------------------------------------------------------
The proposal would continue to allow use of internal models to set
market risk capital requirements for portfolios where modeling can be
demonstrated to be appropriate. In addition, the proposal would provide
for conservative but risk-sensitive standardized alternatives where
modeling is not supported. In contrast to credit and operational risk,
market risk data allows for daily feedback on model performance to
support empirical verification. The proposal would limit the use of
models to only those trading desks for which a banking organization has
received approval from its primary Federal supervisor. Ongoing use of
such models would depend upon a banking organization's ability to
demonstrate through robust testing that the models are sufficiently
conservative and accurate for purposes of calculating market risk
capital requirements. In cases where a banking organization cannot
demonstrate acceptable performance of its internal models for a given
trading desk, the banking organization would be required to use the
standardized measure for market risk which acts as a risk-sensitive
alternative.
II. Scope of Application
The proposal's expanded risk-based approach would apply to banking
organizations with total assets of $100 billion or more and their
subsidiary depository institutions.\19\ These banking organizations are
large and exhibit heightened complexity. Application of the expanded
risk-based approach to large banking organizations would provide
granular, generally standardized requirements that result in robust
risk capture and appropriate risk sensitivity. By strengthening the
requirements that apply to large banking organizations, the proposal
would enhance their resilience and reduce risks to U.S. financial
stability and costs they may pose to the Federal Deposit Insurance Fund
in case of material distress or failure. Relative to smaller, less
complex banking organizations, these banking organizations have greater
operational capacity to apply more sophisticated requirements.
---------------------------------------------------------------------------
\19\ The proposal would also apply to depository institutions
with total assets of $100 billion or more that are not consolidated
subsidiaries of depository institution holding companies, and to
depository institutions with total assets of $100 billion or more
that are subsidiaries of depository institution holding companies
that are not assigned a category under the capital rule.
---------------------------------------------------------------------------
Previously, the agencies determined that the advanced approaches
requirements should not apply to banking organizations subject to
Category III or IV capital standards, as the agencies considered such
requirements to be overly complex and burdensome relative to the safety
and soundness benefits that they would provide for these banking
organizations.\20\ The expanded risk-based approach generally is based
on standardized requirements, which would be less complex and costly.
In addition, recent events demonstrate the impact banking organizations
subject to Category III or IV capital standards can have on financial
stability. While the recent failure of banking organizations subject to
Category IV capital standards may be attributed to a variety of
factors, the effect of these failures on financial stability supports
further alignment of the regulatory capital framework across large
banking organizations.
---------------------------------------------------------------------------
\20\ See ``Prudential Standards for Large Bank Holding
Companies, Savings and Loan Holding Companies, and Foreign Banking
Organizations,'' 84 FR 59032 (November 1, 2019).
---------------------------------------------------------------------------
Banking organizations with significant trading activities are
subject to substantial market risk and, therefore, would be subject to
market risk capital requirements. Recognizing that the dollar-based
threshold for the application of market risk requirements was
established in 1996, the proposal would increase this dollar-based
threshold from $1 billion to $5 billion of trading assets plus trading
liabilities. Banking organizations would also continue to be subject to
market risk requirements if their trading assets plus trading
liabilities represent 10 percent or more of total assets. The proposal
would revise the calculation of the dollar-based threshold amount to be
based on four-quarter averages of trading assets and trading
liabilities instead of point-in-time amounts. Banking organizations
that would no longer meet these minimum thresholds for being subject to
market risk capital requirements would calculate risk-weighted assets
for trading exposures under the standardized approach. Additionally,
under the proposal, large banking organizations would be subject to
market risk capital requirements regardless of trading activities.
The proposal would expand application of the countercyclical
capital buffer to banking organizations subject to Category IV capital
standards. The countercyclical capital buffer is a macroprudential tool
that can be used to increase the resilience of the financial system by
increasing capital requirements for large banking organizations during
a period of
[[Page 64033]]
elevated risk of above-normal losses. Failure or distress of a banking
organization with assets of $100 billion or more during a time of
elevated risk or stress can have significant destabilizing effects for
other banking organizations and the broader financial system--even if
the banking organization does not meet the criteria for being subject
to Category II or III capital standards. Applying the countercyclical
capital buffer to banking organizations subject to Category IV capital
standards would increase the resilience of these banking organizations
and, in turn, improve the resilience of the broader financial system.
The proposed approach also has the potential to moderate fluctuations
in the supply of credit over time. The proposal would also modify how
the countercyclical capital buffer amount is determined to reflect the
proposed changes to market risk capital requirements. Specifically, the
risk-weighted asset amount for private sector credit exposures that are
market risk covered positions under the proposal would be determined
using the standardized default risk capital requirement for such
positions rather than using the specific risk add-on of the current
rule.
The proposal also would expand application of the supplementary
leverage ratio requirement to banking organizations subject to Category
IV capital standards. In contrast to the risk-based capital
requirements, a leverage ratio does not differentiate the amount of
capital required by exposure type. Rather, a leverage ratio puts a
simple and transparent limit on banking organization leverage. Leverage
requirements protect against underestimation of risk both by banking
organizations and by risk-based capital requirements and serve as a
complement to risk-based capital requirements. The supplementary
leverage ratio measures tier 1 capital relative to total leverage
exposure, which includes on-balance sheet assets and certain off-
balance sheet exposures. The proposed change would ensure that all
large banking organizations are subject to a consistent and robust
leverage requirement that serves as a complement to risk-based capital
requirements and takes into account on- and off-balance sheet
exposures.
Question 2: What are the advantages and disadvantages of applying
the expanded risk-based approach to banking organizations subject to
Category III or IV capital standards? To what extent is the expanded
risk-based approach appropriate for banking organizations with
different risk profiles, including from a cost and operational burden
perspective? Are there specific areas, such as the market risk capital
framework, for which the agencies should consider a materiality
threshold to better balance cost and operational burden and risk
sensitivity, and if so what should that threshold be and why? What
would the appropriate exposure treatment be for banking organizations
with such exposures beneath any materiality threshold, and how would
that treatment be consistent with the overall calibration of the
expanded risk-based approach? What alternatives, if any, should the
agencies consider to help ensure that the risks of large banking
organizations are appropriately captured under minimum risk-based
capital requirements and why?
Question 3: What are the advantages and disadvantages of
harmonizing the calculation of regulatory capital across large banking
organizations? What are any unintended consequences of the proposal and
what steps should the agencies consider to mitigate those consequences?
What are the advantages and disadvantages of harmonizing the
calculation of regulatory capital across large banking organizations
and using different approaches (for example, the expanded risk-based
approach and the U.S. standardized approach) for the calculation of
risk-weighted assets?
Question 4: What are the advantages and disadvantages of applying
the countercyclical capital buffer and supplementary leverage ratio to
banking organizations subject to Category IV capital standards?
III. Proposed Changes to the Capital Rule
A. Calculation of Capital Ratios and Application of Buffer Requirements
Under the proposal, large banking organizations would be required
to calculate total risk-weighted assets under two approaches: (1) the
expanded risk-based approach, and (2) the standardized approach. Total
risk-weighted assets under the expanded risk-based approach (expanded
total risk-weighted assets) would equal the sum of risk-weighted assets
for credit risk, equity risk, operational risk, market risk, and CVA
risk, as described in this proposal, minus any amount of the banking
organization's adjusted allowance for credit losses that is not
included in tier 2 capital and any amount of allocated transfer risk
reserves. For calculating standardized total risk-weighted assets, the
proposal would revise the methodology for determining market risk-
weighted assets and would require banking organizations subject to
Category III or IV capital standards to use the standardized approach
for counterparty credit risk (SA-CCR) for derivative exposures.\21\
---------------------------------------------------------------------------
\21\ The proposed methodology for determining market risk-
weighted assets, in certain instances, would require a banking
organization that is subject to subpart E to apply risk weights from
subpart D for purposes of determining its standardized total risk-
weighted assets and from subpart E for purposes of determining its
expanded total risk-weighted assets. This approach would apply in
the case of: (i) capital add-ons for re-designations, (ii) term
repo-style transactions the banking organization elects to include
in market risk, (iii) the standardized default risk capital
requirement for securitization positions non-CTP, and (iv) the
standardized default risk capital requirement for correlation
trading positions, each as discussed further below.
---------------------------------------------------------------------------
To determine its applicable risk-based capital ratios, a large
banking organization would calculate two sets of risk-based capital
ratios (common equity tier 1 capital ratio, tier 1 capital ratio, and
total capital ratio), one using expanded total risk-weighted assets and
one using standardized total risk-weighted assets. A banking
organization's common equity tier 1 capital ratio, tier 1 capital
ratio, and total capital ratio would be the lower of each ratio of the
two approaches.
The proposal would not change the minimum risk-based capital ratios
under the capital rule. Also, the capital conservation buffer would
continue to apply to risk-based capital ratios as under the capital
rule, except that the stress capital buffer requirement--a component of
the capital conservation buffer that is applicable to banking
organizations subject to the Board's capital plan rule--would apply to
a banking organization's risk-based capital ratios regardless of
whether the ratios result from the expanded risk-based approach or the
standardized approach.
Question 5: What are the advantages and disadvantages of banking
organizations being required to calculate risk-based capital ratios in
two different ways and what alternatives, such as a single calculation,
should the agencies consider and why? What modifications, if any, to
the proposed structure of the risk-based capital calculation should the
agencies consider?
1. Standardized Output Floor
To enhance the consistency of capital requirements and ensure that
the use of internal models for market risk does not result in
unwarranted reductions in capital requirements, the proposal would
introduce an ``output floor'' to the calculation of expanded total
risk-
[[Page 64034]]
weighted assets. This output floor would correspond to 72.5 percent of
the sum of a banking organization's credit risk-weighted assets, equity
risk-weighted assets, operational risk-weighted assets, and CVA risk-
weighted assets under the expanded risk-based approach and risk-
weighted assets calculated using the standardized measure for market
risk, minus any amount of the banking organization's adjusted allowance
for credit losses that is not included in tier 2 capital and any amount
of allocated transfer risk reserves.
The output floor would serve as a lower bound on the risk-weighted
assets under the expanded risk-based approach. In other words, if the
risk-weighted assets under the expanded risk-based approach were less
than the output floor, the output floor would have to be used as the
risk-weighted asset amount to determine the expanded risk-based
approach capital ratios.
The proposed calibration of the output floor aims to strike a
balance between allowing internal models to enhance the risk
sensitivity of market risk capital requirements and ensuring that these
models would not result in unwarranted reductions in capital
requirements. The output floor would be consistent with the Basel III
reforms, which would promote consistency in capital requirements for
large, complex, and internationally active banking organizations across
jurisdictions.
[GRAPHIC] [TIFF OMITTED] TP18SE23.000
Question 6: What are the advantages and disadvantages of the
proposed output floor?
2. Stress Capital Buffer Requirement
Under the current capital rule, each banking organization is
subject to one or more buffer requirements, and must maintain capital
ratios above the sum of its minimum requirements and buffer
requirements to avoid restrictions on capital distributions and certain
discretionary bonus payments.\22\ Banking organizations that are
subject to the Board's capital plan rule \23\ (bank holding companies,
U.S. intermediate holding companies, and savings and loan holding
companies that have over $100 billion or more in total consolidated
assets) are currently subject to a standardized approach capital
conservation buffer requirement, which is calculated as the sum of the
banking organization's stress capital buffer requirement, applicable
countercyclical capital buffer requirement, and applicable GSIB
surcharge. The standardized approach capital conservation buffer
requirement applies to a banking organization's standardized approach
risk-based capital ratios. In addition, banking organizations that are
subject to the capital plan rule and the advanced approaches
requirements are subject to an advanced approaches capital conservation
buffer requirement, which applies to their advanced approaches risk-
based capital ratios, and which is calculated in the same manner as the
standardized approach capital conservation buffer requirement, except
that the banking organization's stress capital buffer requirement is
replaced with a 2.5 percent buffer requirement.\24\
---------------------------------------------------------------------------
\22\ 12 CFR 3.11 (OCC); 12 CFR 217.11 (Board); 12 CFR 324.11
(FDIC).
\23\ 12 CFR 225.8 (bank holding companies and U.S. intermediate
holding companies of foreign banking organizations); 12 CFR 238.170
(savings and loan holding companies).
\24\ See 12 CFR 217.11(c).
---------------------------------------------------------------------------
The stress capital buffer requirement integrates the results of the
Board's supervisory stress tests with the risk-based requirements of
the capital rule to determine capital distribution limitations. As a
result, required capital levels for each banking organization more
closely align with the banking organization's risk profile and
projected losses as measured by the Board's stress test.\25\ The stress
capital buffer requirement is generally calculated as (1) the
difference between the banking organization's starting and minimum
projected common equity tier 1 capital ratios under the severely
adverse scenario in the supervisory stress test (stress test losses)
plus (2) the sum of the dollar amount of the banking organization's
planned common stock dividends for each of the fourth through seventh
quarters of the planning horizon as a percentage of risk-weighted
assets (dividend add-on).\26\ A banking organization's stress capital
buffer requirement cannot be less than 2.5 percent of standardized
total risk-weighted assets.
---------------------------------------------------------------------------
\25\ See 85 FR 15576 (March 18, 2020).
\26\ 12 CFR 225.8(f)(2); 12 CFR 238.170(f)(2).
---------------------------------------------------------------------------
Currently, the stress test losses and dividend add-on portion of
the stress capital buffer requirement are calculated using only the
standardized approach common equity tier 1 capital ratio. This is
consistent with the exclusion of the stress capital buffer requirement
from the advanced approaches capital conservation buffer requirement,
and with the Board's stress testing and capital plan rules, under which
banking organizations are not required to project capital ratios using
the advanced approaches.
The Board is proposing to amend its capital plan rule, stress
testing rule, and the buffer framework in its capital rule to take into
account capital ratios calculated under the expanded risk-based
approach, in addition to the standardized approach. Under the proposal,
banking organizations subject to the capital plan rule would be subject
to a single capital conservation buffer requirement, which would
include the stress capital buffer requirement, applicable
countercyclical capital buffer requirement, and applicable GSIB
surcharge, and would apply to the banking organization's risk-based
capital ratios, regardless of whether the ratios result from the
expanded risk-based approach or the standardized approach. In this
manner, the proposal would ensure that the stress capital buffer
requirement contributes to the robustness and risk-sensitivity of the
[[Page 64035]]
risk-based capital requirements of these banking organizations.
Application of the stress capital buffer requirement to the risk-based
capital ratios derived from the expanded risk-based approach would not
introduce complexity given the fixed balance sheet assumption currently
used in the Board stress tests and because the expanded risk-based
approach is based in mostly standardized requirements.\27\
---------------------------------------------------------------------------
\27\ Initially, the Board did not incorporate the stress capital
buffer requirement into the advanced approaches capital conservation
buffer requirement owing to the complexity involved in doing so.
---------------------------------------------------------------------------
Additionally, the proposal would revise the calculation of the
stress capital buffer requirement for large banking organizations.
Under the proposal, both the stress test losses and dividend add-on
components of the stress capital buffer requirement would be calculated
using the binding common equity tier 1 capital ratio, as of the final
quarter of the previous capital plan cycle, regardless of whether it
results from the expanded risk-based approach or the standardized
approach.\28\ The proposed calculation methodology would limit
complexity relative to potential alternatives, such as introducing two
stress capital buffer requirements for each banking organization (one
for each approach to calculating total risk-weighted assets). In
addition, the proposed approach recognizes that the binding approach
for a banking organization is unlikely to change within the period in
which a given stress capital buffer requirement is applicable.
---------------------------------------------------------------------------
\28\ The Board's Stress Testing Policy Statement includes an
assumption that the magnitude of a banking organization's balance
sheet will be fixed throughout the projection horizon under the
supervisory stress test. 12 CFR part 252, appendix B. Under this
assumption, because the denominators of the common equity tier 1
capital ratios as calculated under the standardized approach and the
expanded risk-based approach would remain the same throughout the
stress test, the approach under which the binding common equity tier
1 capital ratio is calculated would remain the same throughout the
final quarter of the previous capital plan cycle and the projection
horizon.
---------------------------------------------------------------------------
As part of the capital buffer framework, the stress capital buffer
requirement helps ensure that a banking organization can withstand
losses from a severely adverse scenario, while still meeting its
minimum regulatory capital requirements and thereby continuing to serve
as a viable financial intermediary. Because this proposal aims to
better reflect the risk of banking organizations' exposures in the
calculation of risk-weighted assets, without changing the targeted
level of conservatism of the minimum capital requirements, the Board is
not proposing associated changes to the targeted severity of the stress
capital buffer requirement. The Board evaluates the minimum risk-based
capital requirements, which are largely determined by risk-weighted
assets, and the stress capital buffer requirement individually for
their specific intended purposes in the capital framework, and
holistically as they determine the aggregate capital banking
organizations hold in the normal course of business.
In addition to revising the stress capital buffer requirement, the
proposal would amend the Board's stress testing and capital plan rules
to require banking organizations subject to Category I, II, or III
standards to project their risk-based capital ratios in their company-
run stress tests and capital plans using the calculation approach that
results in the binding ratios as of the start of the projection horizon
(generally, as of December 31 of a given year). Also, the proposal
would require banking organizations subject to Category IV standards to
project their risk-based capital ratios under baseline conditions in
their capital plans and FR Y-14A submissions using the risk-weighted
assets calculation approach that results in the binding ratios as of
the start of the projection horizon. The use of the binding approach to
calculating risk-based capital ratios aims to conform company-run
stress tests and capital plans with the binding risk-based capital
ratios in the proposed capital rule and promote simplicity relative to
possible alternatives (such as requiring that firms project ratios
under both the expanded risk-based approach and the standardized
approach).
Question 7: The Board invites comment on the appropriate level of
risk capture for the risk-weighted assets framework and the stress
capital buffer requirement, both for their respective roles in the
capital framework and for their joint determination of overall capital
requirements. How should the Board balance considerations of overall
capital requirements with the distinct roles of minimum requirements
and buffer requirements? What adjustments, if any, to either piece of
the framework should the Board consider? Which, if any, specific
portfolios or exposure classes merit particular attention and why?
Question 8: What are the advantages and disadvantages of applying
the same stress capital buffer requirement to a banking organization's
risk-based capital ratios regardless of whether they are determined
using the standardized or expanded risk-based approach? What would be
the advantages and disadvantages of applying different stress capital
buffer requirements for each set of risk-based capital ratios?
Question 9: What, if any, adjustments should the Board consider
with respect to the buffer requirements to account for the transitions
in this proposal, particularly related to expanded total risk-weighted
assets? For example, what would be the advantages and disadvantages of
the Board determining stress capital buffer requirements using fully
phased-in expanded total risk-weighted assets versus transitional
expanded total risk-weighted assets? What, if any, additional
adjustments to stress capital buffer requirements should the Board
consider during the expanded total risk-weighted assets transition?
B. Definition of Capital
The agencies regularly review their capital framework to help
ensure it is functioning as intended. Consistent with this ongoing
assessment, the agencies believe it is appropriate to align the
definition of capital for banking organizations subject to Category III
or IV capital standards with the definition currently applicable to
banking organizations subject to Category I or II capital standards.
The current definition of capital applicable to banking organizations
subject to Category I or II capital standards provides for risk
sensitivity and transparency that is commensurate with the size,
complexity, and risk profile of banking organizations subject to
Category III or IV capital standards. The proposed alignment of the
numerator and denominator of regulatory capital ratios of large banking
organizations would support the transparency of the capital rule as it
facilitates market participants' assessment of loss absorbency and
would promote consistency of requirements across large banking
organizations.
As described in more detail below, under the proposal, banking
organizations subject to Category III or IV capital standards would be
required to recognize most elements of AOCI in regulatory capital
consistent with the treatment for banking organizations subject to
Category I or II capital standards. Banking organizations subject to
Category III or IV capital standards would also apply the capital
deductions and minority interest treatments that are currently
applicable to banking organizations subject to Category I or II capital
standards. The proposal would also apply total loss absorbing capacity
(TLAC) holdings deduction treatments to banking organizations subject
to Category III or IV capital standards. The proposal
[[Page 64036]]
includes a three-year transition period for AOCI.
1. Accumulated Other Comprehensive Income
Under the current capital rule, banking organizations subject to
Category I or II capital standards are required to include most
elements of AOCI in regulatory capital; whereas all other banking
organizations including those subject to Category III or IV capital
standards were provided an opportunity to make a one-time election to
opt-out of recognizing most elements of AOCI and related deferred tax
assets (DTAs) and deferred tax liabilities within regulatory capital
(AOCI opt-out banking organizations).\29\ Under the proposal,
consistent with the treatment applicable to banking organizations
subject to Category I or II capital standards, banking organizations
subject to Category III or IV capital standards would be required to
include all AOCI components in common equity tier 1 capital, except
gains and losses on cash-flow hedges where the hedged item is not
recognized on a banking organization's balance sheet at fair value.
This would require all net unrealized holding gains and losses on
available-for-sale (AFS) debt securities \30\ from changes in fair
value to flow through to common equity tier 1 capital, including those
that result primarily from fluctuations in benchmark interest rates.
This treatment would better reflect the point in time loss-absorbing
capacity of banking organizations subject to Category III or IV capital
standards and would align with banking organizations subject to
Category I or II capital standards.
---------------------------------------------------------------------------
\29\ See 12 CFR 3.22(b) (OCC); 12 CFR 217.22(b) (Board); 12 CFR
324.22(b) (FDIC). A banking organization that made an opt-out
election is currently required to adjust common equity tier 1
capital as follows: subtract any net unrealized holding gains and
add any net unrealized holding losses on available-for-sale
securities; subtract any accumulated net gains and add any
accumulated net losses on cash flow hedges; subtract any amounts
recorded in AOCI attributed to defined benefit postretirement plans
resulting from the initial and subsequent application of the
relevant GAAP standards that pertain to such plans (excluding, at
the banking organization's option, the portion relating to pension
assets deducted under Sec. __.22(a)(5) of the current capital
rule); and, subtract any net unrealized holding gains and add any
net unrealized holding losses on held-to-maturity securities that
are included in AOCI.
\30\ AFS securities refers to debt securities. ASC Subtopic 321-
10 eliminated the classification of equity securities with readily
determinable fair values not held for trading as available-for-sale
and generally requires investments in equity securities to be
measured at fair value with changes in fair value recognized in net
income. Changes in the fair value of (i.e., the unrealized gains and
losses on) a banking organization's equity securities are recognized
through net income rather than other comprehensive income.
---------------------------------------------------------------------------
The agencies have previously observed that the requirement to
recognize elements of AOCI in regulatory capital has helped improve the
transparency of regulatory capital ratios, as it better reflects
banking organizations' actual loss-absorbing capacity at a specific
point in time, notwithstanding the potential volatility that such
recognition may pose for their regulatory capital ratios. The agencies
have also previously observed that AOCI is an important indicator used
by market participants to evaluate the capital strength of a banking
organization.\31\ More recently, the agencies have observed generally
higher levels of securities classified as held-to-maturity (HTM) among
banking organizations that recognize AOCI in regulatory capital.\32\
---------------------------------------------------------------------------
\31\ 84 FR 59230, 59249 (November 1, 2019).
\32\ GAAP set forth restrictions on the classification of a debt
security as HTM, circumstances not consistent with the HTM
classification, and situations that call into question or taint a
banking organization's intent to hold securities in the HTM
category.
---------------------------------------------------------------------------
Changes in interest rates have led to net unrealized losses for
banking organizations' investment portfolios and brought into focus the
importance of regulatory capital measures reflecting the loss absorbing
capacity of a banking organization. The agencies have observed that
adverse trends in a banking organization's GAAP equity can have
negative market perception and liquidity implications.\33\
Specifically, net unrealized losses on AFS securities included in AOCI
have reduced banking organizations' tangible book value and liquidity
buffers,\34\ which can adversely affect market participants'
assessments of capital adequacy and liquidity. Banking organizations
are often reluctant to sell these AFS securities as the unrealized
losses would become realized losses upon sale, thus reducing regulatory
capital. However, banking organizations may need to take such steps in
order to meet liquidity needs. Recognizing elements of AOCI in
regulatory capital thus achieves a better alignment of regulatory
capital with market participants' assessment of loss-absorbing
capacity.
---------------------------------------------------------------------------
\33\ See Board of Governors of the Federal Reserve System,
Supervision and Regulation Report, at 11 (November 2022); Office of
the Comptroller of the Currency, Semiannual Risk Perspective, at 22
(Fall 2022); Federal Deposit Insurance Corporation, Fourth Quarter
2022 Quarterly Banking Profile, at 5, 22 (February 2023), Managing
Sensitivity to Market Risk in a Challenging Interest Rate
Environment (FIL-46-2013, October 8, 2013).
\34\ See 12 CFR part 50 (OCC); 12 CFR part 249 (Board); 12 CFR
part 329 (FDIC).
---------------------------------------------------------------------------
Question 10: What complementary measures should the banking
agencies consider regarding the regulatory capital treatment for
securities held as HTM rather than AFS?
2. Regulatory Capital Deductions
The agencies have long limited the amount of intangible and higher-
risk assets, such as mortgage servicing assets (MSAs) and certain
temporary difference DTAs, included in regulatory capital and required
deduction of the amounts above the limits. This is due to the
relatively high level of uncertainty regarding the ability of banking
organizations to both accurately value and realize value from these
assets, especially under adverse financial conditions. The current
capital rule also limits the amount of investments in the capital
instruments of other banking organizations that can be reflected in
regulatory capital. Furthermore, the current capital rule limits the
inclusion of minority interest \35\ in regulatory capital in
recognition that minority interest is generally not available to absorb
losses at the banking organization's consolidated level and to prevent
highly capitalized subsidiaries from overstating the amount of capital
available to absorb losses at the consolidated organization.
---------------------------------------------------------------------------
\35\ Minority interest, also referred to as non-controlling
interest, reflects investments in the capital instruments of
subsidiaries of banking organizations that are held by third
parties.
---------------------------------------------------------------------------
Under the current capital rule, banking organizations subject to
Category I or II capital standards must deduct from common equity tier
1 capital amounts of MSAs, temporary difference DTAs that the banking
organization could not realize through net operating loss carrybacks,
and significant investments in the capital of unconsolidated financial
institutions in the form of common stock \36\ (collectively, threshold
items) that individually exceed 10 percent of the banking
organization's common equity tier 1 capital minus certain deductions
and adjustments.\37\ Banking organizations subject to Category I or II
capital standards must also deduct from common equity tier 1 capital
the aggregate amount of threshold items not deducted under the 10
percent
[[Page 64037]]
threshold deduction but that nevertheless exceeds 15 percent of the
banking organization's common equity tier 1 capital minus certain
deductions and adjustments. Under the current capital rule, banking
organizations subject to Category III or IV capital standards are
required to deduct from common equity tier 1 capital any amount of
MSAs, temporary difference DTAs that the banking organization could not
realize through net operating loss carrybacks, and investments in the
capital of unconsolidated financial institutions \38\ that individually
exceed 25 percent of common equity tier 1 capital of the banking
organization minus certain deductions and adjustments.
---------------------------------------------------------------------------
\36\ A significant investment in the capital of an
unconsolidated financial institution is defined as an investment in
the capital of an unconsolidated financial institution where a
banking organization subject to Category I or II capital standards
owns more than 10 percent of the issued and outstanding common stock
of the unconsolidated financial institution. 12 CFR 3.2 (OCC); 12
CFR 217.2 (Board); 12 CFR 324.2 (FDIC).
\37\ See 12 CFR 3.22(c)(6), (d)(2) (OCC); 12 CFR 217.22(c)(6),
(d)(2) (Board); 12 CFR 324.22(c)(6), (d)(2) (FDIC).
\38\ For banking organizations that are not subject to Category
I or II capital standards, the current capital rule does not have
distinct treatments for significant and nonsignificant investments
in the capital of unconsolidated financial institutions. Rather, the
regulatory capital treatment for an investment in the capital of
unconsolidated financial institutions would be based on the type of
instrument underlying the investment.
---------------------------------------------------------------------------
Under the proposal, banking organizations subject to Category III
or IV capital standards would be required to deduct threshold items
from common equity tier 1 capital and apply other capital deductions
that are currently applicable to banking organizations subject to
Category I or II capital standards instead of the deductions applicable
to all other banking organizations, thereby creating alignment across
all banking organizations subject to the proposal.
In addition to deductions for the threshold items, the current
capital rule requires that a banking organization subject to Category I
or II capital standards deduct from regulatory capital any amount of
the banking organization's nonsignificant investments \39\ in the
capital of unconsolidated financial institutions that exceeds 10
percent of the banking organization's common equity tier 1 capital
minus certain deductions and adjustments.\40\ Further, significant
investments in the capital of unconsolidated financial institutions not
in the form of common stock must be deducted from regulatory capital in
their entirety.\41\ Under the proposal, banking organizations subject
to Category III or IV capital standards would be required to make these
deductions.
---------------------------------------------------------------------------
\39\ A non-significant investment in the capital of an
unconsolidated financial institution is defined as an investment in
the capital of an unconsolidated financial institution where a
banking organization subject to Category I or II capital standards
owns 10 percent or less of the issued and outstanding common stock
of the unconsolidated financial institution. 12 CFR 3.2 (OCC); 12
CFR 217.2 (Board); 12 CFR 324.2 (FDIC).
\40\ 12 CFR 3.22(c)(5) (OCC); 12 CFR 217.22(c)(5) (Board); 12
CFR 324.22(c)(5) (FDIC).
\41\ 12 CFR 3.22(c)(6) (OCC); 12 CFR 217.22(c)(6) (Board); 12
CFR 324.22(c)(6) (FDIC).
---------------------------------------------------------------------------
Similar to the deductions for investments in the capital of
unconsolidated financial institutions, the current capital rule
requires banking organizations subject to Category I or II capital
standards to deduct covered debt instruments from regulatory
capital.\42\ Under the proposal, banking organizations subject to
Category III or IV capital standards would be required to apply the
deduction requirements for certain investments in unsecured debt
instruments issued by U.S. or foreign GSIBs (covered debt instruments)
that currently apply to banking organizations subject to Category I or
II capital standards.\43\ The current capital rule generally treats
investments in unsecured debt instruments issued by U.S. or foreign
GSIBs as tier 2 capital instruments for purposes of applying deduction
requirements.
---------------------------------------------------------------------------
\42\ See 12 CFR 3.22(c) (OCC); 12 CFR 217.22(c) (Board); 12 CFR
324.22(c) (FDIC).
\43\ Similar to banking organizations subject to Category II
capital standards, the definition of excluded covered debt and the
applicable capital treatment, would not apply to banking
organizations subject to Category III and IV capital standards. See
12 CFR 3.2 (OCC); 12 CFR 217.2) (Board); 12 CFR 324.2 (FDIC).
---------------------------------------------------------------------------
The current capital rule also limits the amount of minority
interest that banking organizations subject to Category I or II capital
standards may include in regulatory capital based on the amount of
capital held by a consolidated subsidiary, relative to the amount of
capital the subsidiary would have had to maintain to avoid any
restrictions on capital distributions and discretionary bonus payments
under capital conservation buffer requirements.\44\ Under the current
capital rule, banking organizations subject to Category III or IV
capital standards are allowed to include: (i) common equity tier 1
minority interest comprising up to 10 percent of the parent banking
organization's common equity tier 1 capital; (ii) tier 1 minority
interest comprising up to 10 percent of the parent banking
organization's tier 1 capital; and (iii) total capital minority
interest comprising up to 10 percent of the parent banking
organization's total capital.\45\ Under the proposal, the limitations
on minority interests that apply to banking organizations subject to
Category I or II capital standards would also apply to banking
organizations subject to Category III or IV capital standards.
---------------------------------------------------------------------------
\44\ See 12 CFR 3.21(b) (OCC); 12 CFR 217.21(b) (Board); 12 CFR
324.21(b) (FDIC).
\45\ See 12 CFR 3.21(a) (OCC); 12 CFR 217.21(a) (Board); 12 CFR
324.21(a) (FDIC).
---------------------------------------------------------------------------
3. Additional Definition of Capital Adjustments
The current capital rule applies an additional capital eligibility
criterion to banking organizations subject to Category I or II capital
standards for their additional tier 1 and tier 2 capital instruments.
The criterion requires that the governing agreement, offering circular
or prospectus for the instrument must disclose that the holders of the
instrument may be fully subordinated to interests held by the U.S.
government in the event the banking organization enters into a
receivership, insolvency, liquidation, or similar proceeding. Under the
proposal, this eligibility criterion would also apply to instruments
issued after the date on which the issuer becomes subject to the
proposed rule, which generally would be the effective date of a final
rule for banking organizations subject to Category III or IV capital
standards. Instruments issued by banking organizations subject to
Category III or IV capital standards prior to the effective date of a
final rule that currently count as regulatory capital would continue to
count as regulatory capital as long as those instruments remain
outstanding.
4. Changes to the Definition of Tier 2 Capital Applicable to Large
Banking Organizations
The current capital rule defines an element of tier 2 capital to
include the allowance for loan and lease losses (ALLL) or the adjusted
allowance for credit losses (AACL), as applicable, up to 1.25 percent
of standardized total risk-weighted assets not including any amount of
the ALLL or AACL, as applicable (and excluding in the case of a banking
organization subject to market risk requirements, its standardized
market risk-weighted assets). Further, as part of its calculations for
determining its total capital ratio, a banking organization subject to
Category I or II standards must determine its advanced-approaches-
adjusted total capital by (1) deducting from its total capital any ALLL
or AACL, as applicable, included in its tier 2 capital and; (2) adding
to its total capital any eligible credit reserves that exceed the
banking organization's total expected credit losses to the extent that
the excess reserve amount does not exceed 0.6 percent of credit-risk-
weighted assets. Due to changes in GAAP, all large banking
organizations are no longer using ALLL and must use AACL. In addition,
the concept of eligible credit reserves is related to use
[[Page 64038]]
of the internal ratings-based approach, which the proposal would
eliminate. Therefore, under the proposal, a large banking organization
would determine its expanded risk-based approach-adjusted total capital
by (1) deducting from its total capital AACL included in its tier 2
capital and; (2) adding to its total capital any AACL up to 1.25
percent of total credit risk-weighted assets. The proposal would define
total credit risk-weighted assets as the sum of total risk-weighted
assets for: (1) general credit risk as calculated under Sec. __.110;
(2) cleared transactions and default fund contributions as calculated
under Sec. __.114; (3) unsettled transactions as calculated under
Sec. __.115; and (4) securitization exposures as calculated under
Sec. __.132.
Question 11: The agencies seek comment on the proposed definition
of total credit risk-weighted assets in connection with determining a
banking organization's total capital ratio. What, if any, modifications
should the agencies consider making to this definition and why?
C. Credit Risk
Credit risk arises from the possibility that an obligor, including
a borrower or counterparty, will fail to perform on an obligation.
While loans are a significant source of credit risk, other products,
activities, and services also expose banking organizations to credit
risk, including investments in debt securities and other credit
instruments, credit derivatives, and cash management services. Off-
balance sheet activities, such as letters of credit, unfunded loan
commitments, and the undrawn portion of lines of credit, also expose
banking organizations to credit risk.
In this section of the Supplementary Information, subsection
III.C.1. describes expectations for completing due diligence on a
banking organization's credit risk portfolio; subsection III.C.2.
describes the risk-weight treatment for on-balance sheet exposures
under the proposal; subsection III.C.3. describes the proposed approach
to determine the exposure amount for off-balance sheet exposures; and
subsections III.C.4.-5 provide the available approaches for recognizing
the benefits of credit risk mitigants including certain guarantees,
certain credit derivatives and financial collateral.
1. Due Diligence
Banking organizations must maintain capital commensurate with the
level and nature of the risks to which they are exposed.\46\ The
agencies' safety and soundness guidelines establish standards for
banking organizations to have an adequate understanding of the impact
of their lending decisions on the banking organization's credit
risk.\47\ A banking organization's performance of due diligence on
their credit portfolios is central to meeting both of these
obligations. For example, under the safety and soundness guidelines, a
banking organization is expected to have established effective internal
policies, processes, systems, and controls to ensure that the banking
organization's regulatory reporting is accurate and reflects
appropriate risk weights assigned to credit exposures.\48\
---------------------------------------------------------------------------
\46\ See 12 CFR 3.10(e) (OCC); 12 CFR 217.10(e) (Board); 12 CFR
324.10(e) (FDIC).
\47\ See 12 CFR part 30, appendix A (OCC); 12 CFR, appendix D-1
to part 208 (Board); 12 CFR, appendix A to part 364 (FDIC).
\48\ When performing due diligence, banking organizations must
adhere to the operational and managerial standards for loan
documentation and credit underwriting as set forth in the
Interagency Guidelines Establishing Standards for Safety and
Soundness (safety and soundness guidelines).
---------------------------------------------------------------------------
When properly performed, due diligence may lead a banking
organization to conclude that the minimum regulatory capital
requirements for certain exposures do not sufficiently account for
their potential credit risk. In such instances, the banking
organization should take appropriate risk mitigating measures such as
allocating additional capital, establishing larger credit loss
allowances, or requiring additional collateral. Adherence to due
diligence standards, as established through the agencies' safety and
soundness guidelines, directly supports and facilitates requirements
for banking organizations to maintain capital commensurate with the
level and nature of the risks to which they are exposed.
Question 12: The agencies seek comment on whether due diligence
requirements should be directly integrated into the text of the final
rule. What would be the advantages and disadvantages of specifying
increases in risk weights that would be required to the extent that due
diligence requirements are not met, similar to the proposed risk-weight
treatment for securitization exposures as described in section III.D of
this Supplementary Information?
2. Proposed Risk Weights for Credit Risk
The proposal would replace the use of internal models to set
regulatory capital requirements for credit risk as set out in subpart E
of the current capital rule with a new expanded risk-based approach for
credit risk applicable to large banking organizations. The proposed
expanded risk-based approach for credit risk would retain many of the
same definitions Sec. __.2 of the current capital rule including among
others a sovereign, a sovereign exposure, certain supranational
entities, a multilateral development bank, a public sector entity
(PSE), a government-sponsored enterprise (GSE), other assets, and a
commitment. Some elements of the proposed expanded risk-based approach
for credit risk would apply the same risk-weight treatment provided in
subpart D of the current capital rule (current standardized approach)
for on-balance sheet exposures, including exposures to sovereigns,
certain supranational entities and multilateral development banks,
government sponsored entities (GSEs) in the form of senior debt and
guaranteed exposures, Federal Home Loan Bank (FHLB) and Federal
Agricultural Mortgage Corporation (Farmer Mac) equity exposures,\49\
public sector entities (PSEs), and other assets. The proposal would
also apply the same risk-weight treatment provided in the current
standardized approach to the following real estate exposures: pre-sold
construction loans, statutory multifamily mortgages, and high-
volatility commercial real estate (HVCRE) exposures.
---------------------------------------------------------------------------
\49\ For treatment of other exposures to GSEs, see discussion
related to equity exposures in section III.E. and exposures to
subordinated debt instruments in section III.C.2.d. of this
Supplementary Information.
---------------------------------------------------------------------------
Relative to the internal models-based approaches in the advanced
approaches under the current capital rule, the proposed expanded risk-
based approach would result in more transparent capital requirements
for credit risk exposures across banking organizations. The proposal
would also facilitate comparisons of capital adequacy across banking
organizations by reducing excessive, unwarranted variability in risk-
weighted assets for similar exposures. Relative to the current
standardized approach, the proposal would incorporate more granular
risk factors to allow for a broader range of risk weights.
Specifically, the proposal would introduce the expanded risk-based
approach for exposures to depository institutions, foreign banks, and
credit unions; exposures to subordinated debt instruments, including
those to GSEs; and real estate, retail, and corporate exposures. The
proposal would also increase risk capture for certain off-balance sheet
exposures through a new exposure methodology for commitments without
pre-set limits and would
[[Page 64039]]
modify the credit conversion factors applicable to commitments.
Additionally, the proposal would introduce new definitions for
defaulted exposures and defaulted real estate exposures.
Under the proposal, a banking organization would determine the
risk-weighted asset amount for an on-balance sheet exposure by
multiplying the exposure amount by the applicable risk weight,
consistent with the method used under the current standardized
approach. The on-balance sheet exposure amount would generally be the
banking organization's carrying value \50\ of the exposure, consistent
with the value of the asset on the balance sheet as determined in
accordance with GAAP, which is the same as under the current capital
rule. For all assets other than AFS securities and purchased credit-
deteriorated assets, the carrying value is not reduced by any
associated credit loss allowance that is determined in accordance with
GAAP. Using the value of an asset under GAAP to determine a banking
organization's exposure amount would reduce burden and provide a
consistent framework that can be easily applied across all banking
organizations of the proposal because, in most cases, GAAP serve as the
basis for the information presented in financial statements and
regulatory reports.\51\
---------------------------------------------------------------------------
\50\ Carrying value under Sec. __. 2 of the current capital
rule means, with respect to an asset, the value of the asset on the
balance sheet of the banking organization as determined in
accordance with GAAP. For all assets other than available-for-sale
debt securities or purchased credit deteriorated assets, the
carrying value is not reduced by any associated credit loss
allowance that is determined in accordance with GAAP. See 12 CFR 3.2
(OCC); 12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC). The exposure
amount arising from an OTC derivative contract; a repo-style
transaction or an eligible margin loan; a cleared transaction; a
default fund contribution; or a securitization exposure would be
calculated in accordance with Sec. Sec. __.113, 121, or 131 of the
proposal, respectively, as described in sections III.C.4, II.C.5.b.,
and III.D. of this Supplementary Information.
\51\ See 12 U.S.C. 1831n.
---------------------------------------------------------------------------
The proposal would group credit risk exposures into the following
categories: sovereign exposures; exposures to certain supranational
entities and multilateral development banks; exposures to GSEs;
exposures to depository institutions, foreign banks, and credit unions;
exposures to PSEs; real estate exposures; retail exposures; corporate
exposures; defaulted exposures; exposures to subordinated debt
instruments; and off-balance sheet exposures.
The proposed categories with amended risk-weight treatments
relative to the current standardized approach include equity exposures
to GSEs and exposures to subordinated debt instruments issued by GSEs;
exposures to depository institutions, foreign banks, and credit unions;
exposures to subordinated debt instruments; real estate exposures;
retail exposures; corporate exposures; defaulted exposures; and some
off-balance sheet exposures such as commitments. The proposed risk
weight treatments for each of these categories are described in the
following sections of this Supplementary Information.
a. Defaulted Exposures
The proposal would introduce an enhanced definition of a defaulted
exposure that would be broader than the current capital rule's
definition of a defaulted exposure under subpart E. The proposed scope
and criteria of the defaulted exposure category is intended to
appropriately capture the elevated credit risk of exposures where the
banking organization's reasonable expectation of repayment has been
reduced, including exposures where the obligor is in default on an
unrelated obligation. Under the proposal, a defaulted exposure would be
any exposure that is a credit obligation and that meets the proposed
criteria related to reduced expectation of repayment, and that is not
an exposure to a sovereign entity,\52\ a real estate exposure,\53\ or a
policy loan.\54\ The proposal would define a credit obligation as any
exposure where the lender but not the obligor is exposed to credit
risk. In other words, for these exposures, the lender would have a
claim on the obligor that does not give rise to counterparty credit
risk \55\ and would exclude derivative contracts, cleared transactions,
default fund contributions, repo-style transactions, eligible margin
loans, equity exposures, and securitization exposures.
---------------------------------------------------------------------------
\52\ Under the proposal, the expanded risk-based approach would
rely on the treatment of sovereign default in the current
standardized approach in the capital rule. See 12 CFR 3.32(a)(6)
(OCC); 12 CFR 217.32(a)(6) (Board); 12 CFR 324.32 (a)(6) (FDIC).
\53\ For the treatment of defaulted real estate exposures, see
section III.C.2.e.vii of this Supplementary Information.
\54\ A policy loan is defined under Sec. __.2 of the current
capital rule to mean means a loan by an insurance company to a
policy holder pursuant to the provisions of an insurance contract
that is secured by the cash surrender value or collateral assignment
of the related policy or contract. A policy loan includes: (1) A
cash loan, including a loan resulting from early payment benefits or
accelerated payment benefits, on an insurance contract when the
terms of contract specify that the payment is a policy loan secured
by the policy; and (2) An automatic premium loan, which is a loan
that is made in accordance with policy provisions which provide that
delinquent premium payments are automatically paid from the cash
value at the end of the established grace period for premium
payments. See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2
(FDIC).
\55\ Counterparty credit risk is the risk that the counterparty
to a transaction could default before the final settlement of the
transaction where there is a bilateral risk of loss.
---------------------------------------------------------------------------
For all other exposure categories (excluding an exposure to a
sovereign entity, real estate exposure, a retail exposure, or a policy
loan), the proposed definition of defaulted exposure would look to the
performance of the borrower with respect to credit obligations to any
creditor. Specifically, if the banking organization determines that an
obligor meets any of the of the defaulted criteria for exposures that
are not retail exposures, described further below, the proposal would
require the banking organization to treat all exposures that are credit
obligations of that obligor as defaulted exposures. Additionally, the
proposal would differentiate the criteria for determining whether an
exposure is a defaulted exposure between exposures that are retail
exposures and those that are not.
Retail exposures are originated to individuals or small- and
medium-sized businesses. Evaluating whether a retail borrower has other
exposures that are in default as defined by the proposal may be
difficult to operationalize for banking organizations given many unique
obligors. For other types of exposures that are not retail exposures,
evaluating default at the obligor level is appropriate because those
obligors are more likely to have additional credit obligations that are
large and held by multiple banking organizations. Default on one of
those credit obligations would be indicative of increased riskiness of
the exposure held by a banking organization, and hence a banking
organization should account for this in evaluating the risk profile of
the borrower.
Under the proposal, for a retail exposure, a credit obligation
would be considered a defaulted exposure if any of the following has
occurred: (1) the exposure is 90 days past due or in nonaccrual status;
(2) the banking organization has taken a partial charge-off, write-down
of principal, or negative fair value adjustment on the exposure for
credit-related reasons, until the banking organization has reasonable
assurance of repayment and performance for all contractual principal
and interest payments on the exposure; or (3) a distressed
restructuring of the exposure was agreed to by the banking
organization, until the banking organization has reasonable assurance
of repayment and performance for all contractual principal and interest
payments on the exposure as demonstrated by a
[[Page 64040]]
sustained period of repayment performance, provided that a distressed
restructuring includes the following made for credit-related reasons:
forgiveness or postponement of principal, interest, or fees, term
extension, or an interest rate reduction. A sustained period of
repayment performance by the borrower is generally a minimum of six
months in accordance with the contractual terms of the restructured
exposure.
For exposures that are not retail exposures (excluding an exposure
to a sovereign entity, a real estate exposure, or a policy loan), a
credit obligation would be considered a defaulted exposure if either of
the following has occurred: (1) the obligor has a credit obligation to
the banking organization that is 90 days or more past due \56\ or in
nonaccrual status; or (2) the banking organization determines that,
based on ongoing credit monitoring, the obligor is unlikely to pay its
credit obligations to the banking organization in full, without
recourse by the banking organization. If a banking organization
determines that an obligor meets these proposed criteria, the proposal
would require the banking organization to treat all exposures that are
credit obligations of that obligor as defaulted exposures.
---------------------------------------------------------------------------
\56\ Overdrafts are past due and are considered defaulted
exposures once the obligor has breached an advised limit or been
advised of a limit smaller than the current outstanding balance.
---------------------------------------------------------------------------
For purposes of the second criterion, the proposal would require a
banking organization to consider an obligor as unlikely to pay its
credit obligations if any of the following criteria apply: (1) the
obligor has any credit obligation that is 90 days or more past due or
in nonaccrual status with any creditor; (2) any credit obligation of
the obligor has been sold at a credit-related loss; (3) a distressed
restructuring of any credit obligation of the obligor was agreed to by
any creditor, provided that a distressed restructuring includes the
following made for credit-related reasons: forgiveness or postponement
of principal, interest, or fees, term extension or an interest rate
reduction; (4) the obligor is subject to a pending or active bankruptcy
proceeding; or (5) any creditor has taken a full or partial charge-off,
write-down of principal, or negative fair value adjustment on a credit
obligation of the obligor for credit-related reasons. Under the
proposal, banking organizations are expected to conduct ongoing credit
monitoring regarding relevant obligors. The proposal would require
banking organizations to continue to treat an exposure as a defaulted
exposure until the exposure no longer meets the definition or until the
banking organization determines that the obligor meets the definition
of investment grade \57\ or the proposed definition of speculative
grade.\58\ The proposal would revise the definition of speculative
grade, consistent with the current definition of investment grade, to
allow the definition to apply to entities to which the banking
organization is exposed through a loan or security. In addition, the
proposal would make the same revision to the definition of sub-
speculative grade.
---------------------------------------------------------------------------
\57\ Under Sec. __.2 of the current capital rule, investment
grade means that the entity to which the banking organization is
exposed through a loan or security, or the reference entity with
respect to a credit derivative, has adequate capacity to meet
financial commitments for the projected life of the asset or
exposure. Such an entity or reference entity has adequate capacity
to meet financial commitments if the risk of its default is low and
the full and timely repayment of principal and interest is expected.
See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC).
\58\ The proposal would revise the definition of speculative
grade to mean that the entity to which a banking organization is
exposed through a loan or security, or the reference entity with
respect to a credit derivative, has adequate capacity to meet
financial commitments in the near term, but is vulnerable to adverse
economic conditions, such that should economic conditions
deteriorate, the issuer or the reference entity would present an
elevated default risk.
---------------------------------------------------------------------------
A banking organization would assign a 150 percent risk weight to a
defaulted exposure including any exposure amount remaining on the
balance sheet following a charge-off, and any other non-retail exposure
to the same obligor, to reflect the increased uncertainty as to the
recovery of the remaining carrying value. The proposed risk weight is
intended to reflect the impaired credit quality of defaulted exposures
and to help ensure that banking organizations maintain sufficient
regulatory capital for the increased probability of losses on these
exposures. A banking organization may apply a risk weight to the
guaranteed or secured portion of a defaulted exposure based on (1) the
risk weight under Sec. __.120 of the proposal if the guarantee or
credit derivative meets the applicable requirements or (2) the risk
weight under Sec. __.121 of the proposal if the collateral meets the
applicable requirements.
Question 13: How does the defaulted exposure definition compare
with banking organizations' existing policies relating to the
determination of the credit risk of a defaulted exposure and the
creditworthiness of a defaulted obligor? What additional clarifications
are necessary to determine the point at which retail and non-retail
exposures should no longer be treated as defaulted exposures?
Question 14: What operational challenges, if any, would a banking
organization face in identifying which exposures meet the proposed
definition of defaulted exposure? In particular, the agencies seek
comment on the ability of a banking organization to obtain the
necessary information to assess whether the credit obligations of a
borrower to creditors other than the banking organization would meet
the proposed criteria? What operational challenges, if any, would a
banking organization face in identifying whether obligors on non-retail
credit obligations are subject to a pending or active bankruptcy
proceeding?
Question 15: For the purposes of retail credit obligations, the
agencies invite comment on the appropriateness of including a
borrower's bankruptcy as a criterion for a defaulted exposure. What
operational challenges, if any, would a banking organization face in
identifying whether obligors on retail credit obligations are subject
to a pending or active bankruptcy proceeding? To what extent would
criteria (1) through (3) in the proposed defaulted exposure definition
for retail exposures sufficiently capture the risk of a borrower
involved in a bankruptcy proceeding?
Question 16: What alternatives to the proposed treatment should the
agencies consider while maintaining a risk-sensitive treatment for
credit risk of a defaulted borrower? For example, what would be the
advantages and disadvantages of limiting the defaulted borrower scope
to obligations of the borrower with the banking organization?
b. Exposures to Government-Sponsored Enterprises
The proposal would assign a 20 percent risk weight to GSE \59\
exposures that are not equity exposures, securitization exposures or
exposures to a subordinated debt instrument issued by a GSE, consistent
with the current standardized approach.\60\ Under the proposal, an
exposure to the common stock issued by a GSE would be an
[[Page 64041]]
equity exposure. An exposure to the preferred stock issued by a GSE
would be an equity exposure or an exposure to a subordinated debt
instrument, depending on the contractual terms of the preferred stock
instrument. Equity exposures to a GSE must be assigned a risk-weighted
asset amount as calculated under Sec. Sec. __.140 through __.142 of
subpart E. An exposure to a subordinated debt instrument issued by a
GSE must be assigned a 150 percent risk weight, unless issued by a FHLB
or Farmer Mac. As discussed later in sections III.E. and III.C.2.d. of
this Supplementary Information, equity exposures and exposures to
subordinated debt instruments would generally be subject to an
increased risk-based capital requirement to reflect their heightened
risk relative to exposures to senior debt.
---------------------------------------------------------------------------
\59\ Government-sponsored enterprise (GSE) under Sec. __. 2 of
the current capital rule means an entity established or chartered by
the U.S. government to serve public purposes specified by the U.S.
Congress but whose debt obligations are not explicitly guaranteed by
the full faith and credit of the U.S. government. See 12 CFR 3.2
(OCC); 12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC).
\60\ Similar to the treatment of senior debt exposures to GSEs
and GSE exposures that are not equity exposures or exposures to a
subordinated debt instrument issued by a GSE, the proposal would
apply the same 20 percent risk weight to all exposures to FHLB or
Farmer Mac, including equity exposures and exposures to subordinated
debt instruments, which continues the treatment under the current
standardized approach.
---------------------------------------------------------------------------
c. Exposures to Depository Institutions, Foreign Banks, and Credit
Unions
The proposal would define the scope of exposures to depository
institutions, foreign banks, and credit unions in a manner that is
consistent with the definitions and scope of exposures covered under
the current capital rule. Under the proposal, a bank exposure would
mean an exposure (such as a receivable, guarantee, letter of credit,
loan, OTC derivative contract, or senior debt instrument) to any
depository institution, foreign bank, or credit union.\61\
---------------------------------------------------------------------------
\61\ Under Sec. __.2 of the current capital rule, a depository
institution means a depository institution as defined in section 3
of the Federal Deposit Insurance Act, a foreign bank means a foreign
bank as defined in section 211.2 of the Federal Reserve Board's
Regulation K (12 CFR 211.2) (other than a depository institution),
and a credit union means an insured credit union as defined under
the Federal Credit Union Act (12 U.S.C. 1751 et seq.). See 12 CFR
3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC). Exposures to
other financial institutions, such as bank holding companies,
savings and loans holding companies, and securities firms, generally
would be considered corporate exposures. See 78 FR 62087 (October
11, 2013).
---------------------------------------------------------------------------
The proposed treatment for bank exposures supports the simplicity,
transparency, and consistency objectives of the proposal in a manner
that is appropriately risk sensitive. The proposal would provide three
categories for bank exposures that are ranked from the highest to the
lowest in terms of creditworthiness: Grade A, Grade B, and Grade C. The
assignment of the bank exposure category would be based on the obligor
depository institution, foreign bank, or credit union. As outlined
below, the proposal would rely on the current capital rule's definition
of investment grade and the proposed definition of speculative grade
for differentiating the credit risk of bank exposures. In addition, the
proposal would incorporate publicly disclosed capital levels to
differentiate the financial strength of a depository institution,
foreign bank, or credit union in a manner that is both objective and
transparent to supervisors and the public.
More specifically, a Grade A bank exposure would mean a bank
exposure for which the obligor depository institution, foreign bank, or
credit union (1) is investment grade, and (2) whose most recent
publicly disclosed capital ratios meet or exceed the higher of: (a) the
minimum capital requirements and any additional amounts necessary to
not be subject to limitations on distributions and discretionary bonus
payments under the capital rules established by the prudential
supervisor of the depository institution, foreign bank, or credit
union, and (b) if applicable, the capital ratio requirements for the
well-capitalized category under the agencies' prompt corrective action
framework,\62\ or under similar rules of the National Credit Union
Administration.\63\ For example, an exposure to an investment grade
depository institution could qualify as a Grade A bank exposure if the
depository institution was not subject to limitations on distributions
and discretionary bonus payments under the capital rules and had risk-
based capital ratios that met the well capitalized thresholds under the
agencies' prompt corrective action framework. Further, a bank exposure
to a depository institution that had opted into the community bank
leverage ratio (CBLR) framework and is investment grade would be
considered to be a Grade A bank exposure, even if the obligor
depository institution were in the grace period under the CBLR
framework.\64\ Under the proposal, a depository institution that uses
the CBLR framework would not be required to calculate or disclose risk-
based capital ratios for purposes of qualifying as a Grade A bank
exposure.
---------------------------------------------------------------------------
\62\ The capital ratios used for this determination are the
ratios on the depository institution's most recent quarterly
Consolidated Report of Condition and Income (Call Report).
\63\ See 12 CFR part 702 (National Credit Union Administration).
\64\ See 12 CFR 3.12(a)(1) (OCC); 12 CFR 217.12(a)(1) (Board);
12 CFR 324.12(a)(1) (FDIC).
---------------------------------------------------------------------------
A Grade B bank exposure would mean a bank exposure that is not a
Grade A bank exposure and for which the obligor depository institution,
foreign bank, or credit union (1) is speculative grade or investment
grade, and (2) whose most recent publicly disclosed capital ratios meet
or exceed the higher of: (a) the applicable minimum capital
requirements under capital rules established by the prudential
supervisor of the depository institution, foreign bank, or credit
union, and (b) if applicable, the capital ratio requirements for the
adequately-capitalized category \65\ under the agencies' prompt
corrective action framework,\66\ or under similar rules of the National
Credit Union Administration.\67\
---------------------------------------------------------------------------
\65\ See 12 CFR 6.4(b)(2) (OCC); 12 CFR 208.43(b)(2) (Board); 12
CFR 324.403(b)(2) (FDIC).
\66\ The capital ratios used for this determination are the
ratios on the depository institution's most recent quarterly Call
Report.
\67\ See 12 CFR part 702 (National Credit Union Administration).
---------------------------------------------------------------------------
For a foreign bank to qualify as a Grade A or Grade B bank
exposure, the proposal would require the applicable capital standards
imposed by the home country supervisor to be consistent with
international capital standards issued by the Basel Committee.
A Grade C bank exposure would mean a bank exposure that does not
qualify as a Grade A or Grade B bank exposure. For example, a bank
exposure would be a Grade C bank exposure if the obligor depository
institution, foreign bank, or credit union has not publicly disclosed
its capital ratios within the last six months. In addition, an exposure
would be a Grade C bank exposure if the external auditor of the
depository institution, foreign bank, or credit union has issued an
adverse audit opinion or has expressed substantial doubt about the
ability of the depository institution, foreign bank, or credit union to
continue as a going concern within the previous 12 months.
Under the proposal, a foreign bank exposure that is a Grade A or
Grade B bank exposure and is a self-liquidating, trade-related
contingent item that arises from the movement of goods and that has a
maturity of three months or less may be assigned a risk weight that is
lower than the risk weight applicable to other exposures to the same
foreign bank. The proposed approach to providing a preferential risk
weight for short-term self-liquidating, trade-related contingent items
would be consistent with the current standardized approach.
The proposal would also address the risk that capital and foreign
exchange controls imposed by a sovereign entity in which a foreign bank
is located could prevent or materially impede the ability of the
foreign bank to convert its currency to meet its obligations or
transfer funds. The proposal would, therefore, provide a risk weight
floor for foreign bank exposures based on the risk weight applicable to
a sovereign
[[Page 64042]]
exposure for the jurisdiction where the foreign bank is incorporated
when (1) the exposure is not in the local currency of the jurisdiction
where the foreign bank is incorporated; or (2) the exposure to a
foreign bank branch that is not in the local currency of the
jurisdiction in which the foreign branch operates (sovereign risk-
weight floor).\68\ The risk weight floor would not apply to short-term
self-liquidating, trade-related contingent items that arise from the
movement of goods.
---------------------------------------------------------------------------
\68\ See Sec. __.111 for the proposed sovereign risk-weight
table, which is identical to Table 1 to Sec. __.32 in the current
capital rule.
---------------------------------------------------------------------------
As provided in Table 1, the proposed risk weights for bank
exposures generally would range from 40 percent to 150 percent.
[GRAPHIC] [TIFF OMITTED] TP18SE23.001
Question 17: What are the advantages and disadvantages of assigning
a range of risk weights based on the bank's creditworthiness? What
alternatives, if any, should the agencies consider, including to
address potential concerns around procyclicality?
Question 18: What are the advantages and disadvantages of
incorporating specific capital levels in the determination of each of
the three categories of bank exposures? What, if any, other risk
factors should the banking agencies consider to differentiate the
credit risk of bank exposures? What concerns, if any, could limitations
on available information about foreign banks raise in the context of
determining the appropriate risk weights for exposures to such banks
and how should the agencies consider addressing such concerns?
Question 19: What is the impact of limiting the lower risk weight
for self-liquidating, trade-related contingent items that arise from
the movement of goods to those with a maturity of three months or less?
What would be the advantages and disadvantages of expanding this risk
weight treatment to include such exposures with a maturity of six
months or less? What would be the advantages and disadvantages of
limiting this reduced risk weight treatment to only foreign banks whose
home country has an Organization for Economic Cooperation and
Development (OECD) Country Risk Classification (CRC) \69\ of 0, 1, 2,
or 3, or is an OECD member with no CRC, consistent with the current
standardized approach? \70\
---------------------------------------------------------------------------
\69\ Under Sec. __. 2 of the current capital rule, a Country
Risk Classification (CRC) for a sovereign means the most recent
consensus CRC published by the Organization for Economic Cooperation
and Development (OECD) as of December 31st of the prior calendar
year that provides a view of the likelihood that the sovereign will
service its external debt. See 12 CFR 3.2 (OCC); 12 CFR 217.2
(Board); 12 CFR 324.2 (FDIC). For more information on the OECD
country risk classification methodology, see OECD, ``Country Risk
Classification,'' available at <a href="https://www.oecd.org/trade/topics/export-credits/arrangement-and-sector-understandings/financing-terms-and-conditions/country-risk-classification/">https://www.oecd.org/trade/topics/export-credits/arrangement-and-sector-understandings/financing-terms-and-conditions/country-risk-classification/</a>.
\70\ The CRCs reflect an assessment of country risk, used to set
interest rate charges for transactions covered by the OECD
arrangement on export credits. The CRC methodology classifies
countries into one of eight risk categories (0-7), with countries
assigned to the zero category having the lowest possible risk
assessment and countries assigned to the 7 category having the
highest possible risk assessment. See 78 FR 62088 (October 11,
2018).
---------------------------------------------------------------------------
d. Subordinated Debt Instruments
The proposal would introduce a definition and an explicit risk
weight treatment for exposures in the form of subordinated debt
instruments. The proposed definition of a subordinated debt instrument
would capture exposures that are financial instruments and present
heightened credit risk but are not equity exposures, including: (1) any
preferred stock that does not meet the definition of an equity
exposure, (2) any covered debt instrument, including a TLAC debt
instrument, that is not deducted from regulatory capital, and (3) any
debt instrument that qualifies as tier 2 capital under the current
capital rule or that would otherwise be treated as regulatory capital
by the primary Federal supervisor of the issuer and that is not
deducted from regulatory capital.
The proposal would define a subordinated debt instrument as (1) a
debt security that is a corporate exposure, a bank exposure, or an
exposure to a GSE, including a note, bond, debenture, similar
instrument, or other debt instrument as determined by the primary
Federal supervisor, that is subordinated by its terms, or separate
intercreditor agreement, to any creditor of the obligor, or (2)
preferred stock that is not an equity exposure. For these purposes, a
debt security would be subordinated if the documentation creating or
evidencing such indebtedness (or a separate intercreditor agreement)
provides for any of the issuer's other creditors to rank senior to the
payment of such indebtedness in the event the issuer becomes the
subject of a bankruptcy or other insolvency proceeding, with the scope
of applicable bankruptcy or other insolvency proceedings being defined
in the applicable documentation. The scope of the definition of a
subordinated debt instrument is meant to capture the types of entities
that issue subordinated debt instruments and for which the level of
subordination is a meaningful determinant of the credit risk of the
instrument.
[[Page 64043]]
In addition, even though the provision of collateral typically
reduces the risk of loss on indebtedness, the proposal includes secured
as well as unsecured subordinated debt securities in the scope of
subordinated debt instruments, since the effect of subordination may
result in the collateral providing little or no real value to the
subordinated debt holder in the event the issuer becomes to subject of
a bankruptcy or other insolvency proceeding. A subordinated debt
instrument would not include any loan, including a syndicated loan, a
debt security issued by a sovereign, public sector entity, multilateral
development bank, or supranational entity, or a security that would be
captured under the securitization framework. Due to the contractual
obligations and structures associated with subordinated debt
instruments, such exposures generally pose increased risk relative to a
senior loan, including a syndicated loan, or a senior debt security to
the same entity because investments in subordinated debt instruments
are usually considered junior creditors and subordinate to obligations
specified in the definition of senior debt in the document governing
the junior creditors' obligations.
The proposal generally would apply a 150 percent risk weight for
exposures that meet the definition of a subordinated debt instrument,
including any preferred stock that is not an equity exposure, and any
tier 2 instrument or covered debt instrument that is not deducted from
regulatory capital, including TLAC debt instruments, and any debt
instrument that would otherwise be treated as regulatory capital by the
primary Federal supervisor of the issuer and that is not deducted from
regulatory capital.\71\
---------------------------------------------------------------------------
\71\ Covered debt instruments are subject to deduction by
banking organizations subject to Category I or II capital standards
similar to the deduction framework for exposures to capital
instruments. See 12 CFR 3.22(c) (OCC); 12 CFR 217.22(c) (Board); 12
CFR 324.22(c) (FDIC). As noted in section III.B.3. of this
Supplementary Information, under the proposal, this deduction
framework will be expanded to banking organizations subject to
Category III or IV capital standards. As discussed in section
III.C.2.b. above, exposures to subordinated debt instruments issued
by an FHLB or by Farmer Mac would be assigned a 20 percent risk
weight.
---------------------------------------------------------------------------
The instruments included in the scope of subordinated debt
instruments present a greater risk of loss to an investing banking
organization relative to more senior debt exposures to the same issuer
because subordinated debt instruments have a lower priority of
repayment in the event of default. As a result, the proposal would
apply an increased risk weight to recognize this increase in loss given
default. Since a covered debt instrument that qualifies as a TLAC debt
instrument shares similar risk characteristics with a subordinated debt
instrument, the proposal would require banking organizations to apply
the same 150 percent risk weight to any such exposures that are not
otherwise deducted from regulatory capital.
Question 20: The agencies seek comment on the scope of the proposed
definition of a subordinated debt instrument. What, if any, operational
challenges might the proposed definition pose for banking
organizations, such as identifying the level of subordination in debt
securities or similar instruments, and how should the agencies consider
addressing such challenges?
Question 21: Would expanding the definition of a subordinated debt
instrument to include loans that are not securities more appropriately
capture the types of exposures that pose elevated risk and, if so, why?
Question 22: The agencies seek comment on applying a heightened 150
percent risk weight to exposures to subordinated debt instruments
issued by GSEs. What would be the advantages and disadvantages of this
proposed regulatory capital requirement? Would there be any challenges
for banking organizations to be able to identify which GSE exposures
would be subject to the 150 percent risk weight? Please provide
specific examples of any challenges and supporting data.
e. Real Estate Exposures
The proposal would define a real estate exposure as an exposure
that is neither a sovereign exposure nor an exposure to a PSE and that
is (1) a residential mortgage exposure, (2) secured by collateral in
the form of real estate,\72\ (3) a pre-sold construction loan,\73\ (4)
a statutory multifamily mortgage,\74\ (5) a high volatility commercial
real estate (HVCRE) exposure,\75\ or (6) an acquisition, development,
or construction (ADC) exposure. A pre-sold construction loan, a
statutory multifamily mortgage, and an HVCRE exposure are collectively
referred to as statutory real estate exposures for purposes of this
Supplementary Information. Under the proposal, the risk weight
treatment for statutory real estate exposures that are not defaulted
real estate exposures would be consistent with the current standardized
approach.
---------------------------------------------------------------------------
\72\ For purposes of the proposal, ``secured by collateral in
the form of real estate'' should be interpreted in a manner that is
consistent with the current definition for ``a loan secured by real
estate'' in the Call Report and Consolidated Financial Statements
for Holding Companies (FR Y-9C) instructions.
\73\ The Resolution Trust Corporation Refinancing,
Restructuring, and Improvement Act of 1991 (RTCRRI Act) mandates
that each agency provide in its capital regulations (i) a 50 percent
risk weight for certain one-to-four-family residential pre-sold
construction loans that meet specific statutory criteria in the
RTCRRI Act and any other underwriting criteria imposed by the
agencies, and (ii) a 100 percent risk weight for one-to-four-family
residential pre-sold construction loans for residences for which the
purchase contract is cancelled. See 12 U.S.C. 1831n, note.
\74\ The RTCRRI Act mandates that each agency provide in its
capital regulations a 50 percent risk weight for certain multifamily
residential loans that meet specific statutory criteria in the
RTCRRI Act and any other underwriting criteria imposed by the
agencies. See 12 U.S.C. 1831n, note.
\75\ Section 214 of the Economic Growth, Regulatory Relief, and
Consumer Protection Act imposes certain requirements on high
volatility commercial real estate acquisition, development, or
construction loans. Section 214 of Public Law 115-174, 132 Stat.
1296 (2018). See 12 U.S.C. 1831bb.
---------------------------------------------------------------------------
The proposal would differentiate the credit risk of real estate
exposures that are not statutory real estate exposures by introducing
the following categories: regulatory residential real estate exposures,
regulatory commercial real estate exposures, ADC exposures, and other
real estate exposures. The applicable risk weight for these non-
statutory real estate exposures would depend on (1) whether the real
estate exposure meets the definitions of regulatory residential real
estate exposure, regulatory commercial real estate exposure, ADC
exposure, or other real estate exposure, described below; (2) whether
the repayment of such exposures is dependent on the cash flows
generated by the underlying real estate (such as rental properties,
leased properties, hotels); and (3) in the case of regulatory
residential or regulatory commercial real estate exposures, the loan-
to-value (LTV) ratio of the exposure.
These proposed criteria for differentiating the credit risk of real
estate exposures would be based on information already collected and
maintained by a banking organization as part of its mortgage lending
activities and underwriting practices. Under the proposal, regulatory
residential and regulatory commercial real estate exposures would be
required to meet prudential criteria that are intended to reduce the
likelihood of default relative to other real estate exposures. The
criteria in these definitions generally align with existing Interagency
Guidelines for Real Estate Lending Policies (real estate lending
[[Page 64044]]
guidelines).\76\ Real estate loans in which repayment is dependent on
the cash flows generated by the real estate can expose a banking
organization to elevated credit risk relative to comparable exposures
\77\ as the borrower may be unable to meet its financial commitments
when cash flows from the property decrease, such as when tenants
default or properties are unexpectedly vacant.\78\ In addition, LTV
ratios can be a useful risk indicator because the amount of a
borrower's equity in a real estate property correlates inversely with
default risk and provides banking organizations with a degree of
protection against losses.\79\ Therefore, exposures with lower LTV
ratios generally would receive a lower risk weight than comparable real
estate exposures with higher LTV ratios under the proposal.\80\ The
following chart illustrates how the proposal would require a banking
organization to assign risk weights to various real estate exposures,
as described in more detail below:
---------------------------------------------------------------------------
\76\ See 12 CFR part 34, appendix A to subpart D (OCC); 12 CFR
part 208, appendix C (Board); 12 CFR part 365, appendix A (FDIC).
\77\ Comparable exposures include loans secured by real estate
where the repayment of the loan depends on non-real estate cash
flows such as owner-occupied properties, revenue from manufacturing
or retail sales.
\78\ See Board of Governors of the Federal Reserve System,
Financial Stability Report (November 2020), <a href="https://www.federalreserve.gov/publications/files/financial-stability-report-20201109.pdf">https://www.federalreserve.gov/publications/files/financial-stability-report-20201109.pdf</a>.
\79\ Id., at 30.
\80\ The proposed LTV criterion measures the borrower's use of
debt (leverage) to finance a real estate purchase, with higher LTV
reflecting greater leverage and thus higher credit risk.
---------------------------------------------------------------------------
BILLING CODE 6210-01-P; 6714-01-P; 4810-33-P
[[Page 64045]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.002
BILLING CODE 6210-01-C; 6714-01-C; 4810-33-C
i. Regulatory Residential Real Estate Exposures
Under the proposal, a regulatory residential real estate exposure
would be defined as a first-lien residential mortgage exposure (as
defined in Sec. __.2) that is not a defaulted real estate exposure (as
defined in Sec. __. 101), an ADC exposure, a pre-sold construction
loan, a statutory multifamily mortgage, or an HVCRE exposure, provided
the exposure meets certain prudential criteria.\81\ First, the loan
would be required to be secured by a property that is either owner-
occupied or rented. Second, the exposure would be required to be made
in accordance with prudent underwriting standards, including standards
relating to the loan amount as a percent of the value of the
[[Page 64046]]
property.\82\ Third, during the underwriting process, the banking
organization would be required to apply underwriting policies that
account for the ability of the borrower to repay based on clear and
measurable underwriting standards that enable the banking organization
to evaluate these credit factors. The agencies would expect these
underwriting standards to be consistent with the agencies' safety and
soundness and real estate lending guidelines.\83\ Fourth, the property
must be valued in accordance with the proposed requirements included in
the proposed LTV ratio calculation, as discussed below.
---------------------------------------------------------------------------
\81\ Consistent with the standardized approach in the capital
rule, under the proposal, when a banking organization holds the
first-lien and junior-lien(s) residential mortgage exposures and no
other party holds an intervening lien, the banking organization must
combine the exposures and treat them as a single first-lien
regulatory residential real estate exposure, if the first-lien meets
all of the criteria for a regulatory residential real estate
exposure.
\82\ For more information on value of the property, see section
III.C.2.e.iv of this Supplementary Information.
\83\ See 12 CFR part 30, appendix A (OCC); 12 CFR part 208,
appendix C (Board); 12 CFR parts 364 and 365 (FDIC).
---------------------------------------------------------------------------
ii. Regulatory Commercial Real Estate Exposures
The proposal would define a regulatory commercial real estate
exposure as a real estate exposure that is not a regulatory residential
real estate exposure, a defaulted real estate exposure, an ADC
exposure, a pre-sold construction loan, a statutory multifamily
mortgage, or an HVCRE exposure, provided the exposure meets several
prudential criteria. First, the exposure must be primarily secured by
fully completed real estate. Second, the banking organization must hold
a first priority security interest in the property that is legally
enforceable in all relevant jurisdictions.\84\ Third, the exposure must
be made in accordance with prudent underwriting standards, including
standards relating to the loan amount as a percent of the value of the
property. Fourth, during the underwriting process, the banking
organization must apply underwriting policies that account for the
ability of the borrower to repay in a timely manner based on clear and
measurable underwriting standards that enable the banking organization
to evaluate these credit factors. The agencies would expect that these
underwriting standards would be consistent with the agencies' safety
and soundness and real estate lending guidelines. Finally, the property
must be valued in accordance with the proposed requirements included in
the proposed LTV ratio calculation, as discussed below.
---------------------------------------------------------------------------
\84\ When the banking organization also holds a junior security
interest in the same property and no other party holds an
intervening security interest, the banking organization must treat
the exposures as a single first-lien regulatory commercial real
estate exposure, if the first-lien meets all of the criteria for a
regulatory commercial real estate exposure.
---------------------------------------------------------------------------
Question 23: The agencies seek comment on the application of
prudent underwriting standards in the proposed definitions of
regulatory residential and regulatory commercial real estate exposures,
including standards relating to the loan amount as a percent of the
value of the property. What, if any, further clarity is needed and why?
iii. Exposures That Are Dependent on the Cash Flows Generated by the
Real Estate
As noted above, the proposal would differentiate the risk weight of
regulatory residential, regulatory commercial, and other real estate
exposures based on whether the borrower's ability to service the loan
is dependent on cash flows generated by the real estate. Exposures that
are dependent on the cash flows generated by real estate to repay the
loan can be affected by local market conditions and present elevated
credit risk relative to exposures that are serviceable by the income,
cash, or other assets of the borrower. For example, an increase in the
supply of competitive rental property can lower demand and suppress
cash flows needed to support repayment of the loan.
If the underwriting process at origination of the real estate
exposure considers any cash flows generated by the real estate securing
the loan, such as from lease or rental payments or from the sale of the
real estate as a source of repayment, then the exposure would meet the
proposal's definition of dependent on the cash flows generated by the
real estate. Evaluating whether repayment of the exposure is dependent
on cash flows generated from the real estate is a conservative and
straightforward approach for differentiating the credit risk of real
estate exposures. Given their increased credit risk, the proposal would
assign relatively higher risk weights to exposures that are dependent
on any proceeds or income generated from the real estate itself to
service the debt.
Under the proposal, additional loan characteristics can affect
whether an exposure would be considered dependent on cash flows from
the real estate. The proposal's definition of dependence on the cash
flows generated by the real estate would exclude any residential
mortgage exposure that is secured by the borrower's principal residence
as such mortgage exposures present reduced credit risk relative to real
estate exposures that are secured by the borrower's non-principal
residence.\85\ For residential properties that are not the borrower's
principal residence, including vacation homes and other second homes,
such properties would be considered dependent on the cash flows
generated by the real estate unless the banking organization has relied
solely on the borrower's personal income and resources, rather than
rental income (or resale or refinance of the property), to repay the
loan.
---------------------------------------------------------------------------
\85\ For example, if (1) a borrower purchases a two-unit
property with the intention of making one unit their principal
residence, (2) the borrower intends to rent out the second unit to a
third party, and (3) the banking organization considered the cash
flows from the rental unit as a source of repayment, the exposure
would not meet the proposal's definition of dependent on the cash
flows generated by the real estate because the property securing the
exposure is the borrower's principal residence.
---------------------------------------------------------------------------
For regulatory commercial real estate exposures, the applicable
risk weights similarly would be determined based on whether repayment
is dependent on the cash flows generated by the real estate. For
example, the agencies would expect that rental office buildings,
hotels, and shopping centers leased to tenants are dependent on the
cash flows generated by the real estate for repayment of the loan. In
the case of a loan to a borrower to purchase or refinance real estate
where the borrower will operate a business such as a retail store or
factory and rely solely on the revenues from the business or resources
of the borrower other than rental, resale, or other income from the
real estate for repayment, the exposure would not be considered
dependent on the cash flows generated by the real estate under the
proposal. Similarly, a loan to the owner-operator of a farm would not
be considered dependent on the cash flows generated by the real estate
under the proposal if the borrower will rely solely on the sale of
products from the farm or other resources of the borrower other than
rental, resale, or other income from the real estate for repayment.
Question 24: What, if any, alternative quantitative threshold
should the agencies consider in determining whether a real estate
exposure is dependent on cash flows from the real estate (for example,
a threshold between 5 and 50 percent of the income)? Further, if the
agencies decide to adopt an alternative quantitative threshold, either
for regulatory residential or regulatory commercial real estate
exposures, how should it be calibrated for regulatory residential and
separately for regulatory commercial real estate exposures and what
would be the appropriate calibration levels for each? Please provide
specific examples of any
[[Page 64047]]
alternatives, including calculations and supporting data.
Question 25: The agencies seek feedback on the proposed treatment
of exposures secured by second homes, including vacation homes where
repayment of the loan is not dependent on cash flows. What are the
advantages and disadvantages of treating such exposures as regulatory
residential real estate exposures? Would a different category be more
appropriate for these exposures given their risk profile, and if so,
describe which other category(s) of real estate exposures would be most
similar and why. Please provide supporting data in your responses.\86\
---------------------------------------------------------------------------
\86\ See Garcia, Daniel (2019). ``Second Home Buyers and the
Housing Boom and Bust,'' Finance and Economics Discussion Series
2019-029. Washington: Board of Governors of the Federal Reserve
System, <a href="https://www.federalreserve.gov/econres/feds/files/2019029pap.pdf">https://www.federalreserve.gov/econres/feds/files/2019029pap.pdf</a>.
---------------------------------------------------------------------------
Question 26: The agencies seek comment on the treatment of
residential mortgage exposures where repayment is dependent on cash
flows from overnight or short-term rentals, as such cash flows may not
be as reliable as a source of repayment as cash flows from long-term
rental contracts or the borrower's other income sources. What would be
the advantages or disadvantages of treating residential real estate
exposures dependent on cash flows from short-term rentals similar to
commercial real estate exposures dependent on cash flows?
iv. Calculating the Loan-To-Value Ratio
The proposal would require a banking organization also to use LTV
ratios to assign a risk weight to a regulatory residential or
regulatory commercial real estate exposure. Under the proposal, LTV
ratio would be calculated as the extension of credit divided by the
value of the property. The proposed calculation of LTV ratio would be
generally consistent with the real estate lending guidelines except
with respect to the recognition of private mortgage insurance, as
described below.
The extension of credit would mean the total outstanding amount of
the loan including any undrawn committed amount of the loan. The total
outstanding amount of the loan would reflect the current amortized
balance as the loan pays down, which may allow a banking organization
to assign a lower risk weight during the life of the loan. Similarly,
if a loan balance increases, a banking organization would need to
increase the risk weight if the increased LTV would result in a higher
risk weight. For purposes of the LTV ratio calculation, a banking
organization would calculate the loan amount without making any
adjustments for credit loss provisions or private mortgage insurance.
Not recognizing private mortgage insurance would be consistent with the
current capital rule's definition of eligible guarantor, which does not
recognize an insurance company engaged predominately in the business of
providing credit protection (such as a monoline bond insurer or re-
insurer) and also reflects the performance of private mortgage
insurance during times of stress in the housing market. The agencies do
not intend the proposed risk weights to be applied to LTVs that include
private mortgage insurance.
The value of the property would mean the value at the time of
origination of all real estate properties securing or being improved by
the extension of credit, plus the fair value of any readily marketable
collateral and other acceptable collateral, as defined in the real
estate lending guidelines, that secures the extension of credit.
For exposures subject to the Real Estate Lending, Appraisal
Standards, and Minimum Requirements for Appraisal Management Companies
or Appraisal Standards for Federally Related Transactions (combined,
the appraisal rule),\87\ the market value of real estate would be a
valuation that meets all requirements of that rule. For exposures not
subject to the appraisal rule, the proposal would require that (1) the
market value of real estate be obtained from an independent valuation
of the property using prudently conservative valuation criteria and (2)
the valuation be done independently from the banking organization's
origination and underwriting process. Most real estate exposures held
by insured depository institutions are subject to the agencies'
appraisal rule, which also provides for evaluations in some cases, and
provides for certain exceptions, such as where a lien on real estate is
taken as an abundance of caution. To help ensure that the value of the
real estate is determined in a prudently conservative manner, the
proposal would also provide that, for exposures not subject to the
appraisal rule, the valuations of the real estate properties would need
to exclude expectations of price increases and be adjusted downward to
take into account the potential for the current market prices to be
significantly above the values that would be sustainable over the life
of the loan.
---------------------------------------------------------------------------
\87\ See 12 CFR part 34, subpart C or subpart G (OCC); 12 CFR
part 208, subpart E or 12 CFR part 225, subpart G (Board); 12 CFR
part 323 (FDIC).
---------------------------------------------------------------------------
In addition, when the real estate exposure finances the purchase of
the property, the value would be the lower of (1) the actual
acquisition cost of the property and (2) the market value obtained from
either (i) the valuation requirements under the appraisal rule (if
applicable) or (ii) as described above, an independent valuation using
prudently conservative valuation criteria that is separate from the
banking organization's origination and underwriting process.
Supervisory experience has shown that market values of real estate
properties can be temporarily impacted by local market forces and using
a value figure including such volatility would not reflect the long-
term value of the real estate. Therefore, the proposal would require
that the value used for the LTV calculation be an amount that is more
conservative than the market value of the property.
Using the value of the property at origination when calculating the
LTV ratio protects against volatility risk or short-term market price
inflation. For purposes of the LTV ratio calculation, the proposal
would require banking organizations to use the value of the property at
the time of origination, except under the following circumstances: (1)
the banking organization's primary Federal supervisor requires the
banking organization to revise the property value downward; (2) an
extraordinary event occurs resulting in a permanent reduction of the
property value (for example, a natural disaster); or (3) modifications
are made to the property that increase its market value and are
supported by an appraisal or independent evaluation using prudently
conservative criteria. These proposed exceptions are intended to
constrain the use of values other than the value of the property at
loan origination only to exceptional circumstances that are
sufficiently material to warrant use of a revised valuation.
For purposes of determining the value of the property, the proposal
would use the definition of readily marketable collateral and other
acceptable collateral consistent with the real estate lending
guidelines. Therefore, readily marketable collateral would mean insured
deposits, financial instruments, and bullion in which the banking
organization has a perfected security interest. Financial instruments
and bullion would need to be salable under ordinary circumstances with
reasonable promptness at a fair market value determined by quotations
based on actual transactions, on an auction or similarly available
daily bid and ask price market. Readily marketable
[[Page 64048]]
collateral should be appropriately discounted by the banking
organization consistent with the banking organization's usual practices
for making loans secured by such collateral. Other acceptable
collateral would mean any collateral in which the banking organization
has a perfected security interest that has a quantifiable value and is
accepted by the banking organization in accordance with safe and sound
lending practices. Other acceptable collateral should be appropriately
discounted by the banking organization consistent with the banking
organization's usual practices for making loans secured by such
collateral. Under the proposal, other acceptable collateral would
include, among other items, unconditional irrevocable standby letters
of credit for the benefit of the banking organization. The
reasonableness of a banking organization's underwriting criteria would
be reviewed through the examination and supervisory process to help
ensure its real estate lending policies are consistent with safe and
sound banking practices.
Question 27: What are the benefits and drawbacks of allowing
readily marketable collateral and other acceptable collateral to be
included in the value for purposes of calculating the LTV ratio? What
are the advantages and disadvantages of providing specific discount
factors to the value of acceptable collateral for purposes of
calculating the LTV ratio such as the standard supervisory market price
volatility haircuts contained in Sec. __.121 of the proposed rule?
What alternatives should the agencies consider? Please provide specific
examples and supporting data.
v. Risk Weights for Regulatory Residential Real Estate Exposures
Under the proposal, a banking organization would assign a risk
weight to a regulatory residential real estate exposure based on the
exposure's LTV ratio and whether the exposure is dependent on the cash
flows generated by the real estate, as reflected in Tables 2 and 3
below. LTV ratios and dependence on cash flows generated by the real
estate would factor into the risk-weight treatment for real estate
exposures under the proposal because these risk factors can be
determinants of credit risk for real estate exposures. The proposed
corresponding risk weights in each LTV ratio category are intended to
appropriately reflect differences in the credit risk of these
exposures. The risk weights that would apply under the proposal are
provided below.\88\
---------------------------------------------------------------------------
\88\ The risk weight assigned to loans does not impact the
appropriate treatment of loans under the agencies' other regulations
and guidance, such as the supervisory LTV limits under the real
estate lending guidelines.
[GRAPHIC] [TIFF OMITTED] TP18SE23.003
[GRAPHIC] [TIFF OMITTED] TP18SE23.004
While LTV ratios and dependency upon cash flows of the real estate
are useful risk indicators, the agencies recognize that banking
organizations consider a variety of factors when underwriting a
residential real estate exposure and assessing a borrower's ability to
repay. For example, a banking organization may consider a borrower's
current and expected income, current and expected cash flows, net
worth, other relevant financial resources, current financial
obligations, employment status, credit history, or other relevant
factors during the underwriting process. The agencies are supportive of
home ownership and do not intend the proposal to diminish home
affordability or homeownership opportunities, including for low- and
moderate-income (LMI) home buyers or other historically underserved
markets. The agencies are particularly interested in whether the
proposed framework for regulatory residential real estate exposures
should be modified in any way to avoid unintended impacts on the
ability of otherwise credit-worthy borrowers who make a smaller down
payment to purchase a home. For example, the agencies are considering
whether a 50 percent risk weight would be appropriate for these loans,
to the extent they are originated in accordance with prudent
underwriting standards and originated through a home ownership program
that the primary Federal regulatory agency determines provides a public
benefit and includes risk mitigation features such as credit counseling
and consideration of repayment ability.
Question 28: The agencies seek comment on how the proposed
treatment of regulatory residential real estate exposures will impact
home affordability and home ownership opportunities, particularly for
LMI borrowers or other historically underserved markets. What are the
advantages and disadvantages of an alternative treatment that would
assign a 50 percent risk weight to mortgage loans originated in
accordance with
[[Page 64049]]
prudent underwriting standards and originated through a home ownership
program that the primary Federal regulatory agency determines provides
a public benefit and includes risk mitigation features such as credit
counseling and consideration of repayment ability? What, if any,
additional or alternative risk indicators should the agencies consider,
besides loan-to-value or dependency upon cash flow for risk-weighting
regulatory residential real estate exposures? Please provide specific
examples of mortgage lending programs where such factors were the basis
for underwriting the loans and the historical repayment performance of
the loans in such programs. Please comment on whether these risk
indicators are already collected and maintained by banking
organizations as part of their mortgage lending activities and
underwriting practices.
In addition, the agencies considered adopting an alternative risk-
based capital treatment in subpart E that does not rely on loan-to-
value ratios or dependency upon cash flow generated by the real estate.
One such alternative would be to incorporate the same treatment for
residential mortgage exposures as found in the current U.S.
standardized risk-based capital framework. Under this alternative, the
risk-based capital treatment for residential mortgage exposures in
subpart D of the capital rule would be incorporated into the proposed
subpart E. First-lien residential mortgage exposures that are prudently
underwritten would receive a 50 percent risk weight consistent with the
treatment contained in the U.S. standardized risk-based capital
framework. Such an approach would allow banking organizations to
continue to offer prudently underwritten products through lending
programs with the flexibility to meet the needs of their communities
without additional regulatory capital implications. The agencies note
that current mortgage rules promulgated since the global financial
crisis require lenders to consider each borrower's ability to
repay.\89\
---------------------------------------------------------------------------
\89\ See 12 CFR part 1026.
---------------------------------------------------------------------------
As in subpart D, residential mortgage exposures that do not meet
the requirements necessary to receive a 50 percent risk weight would
receive a 100 percent risk weight. While such an approach would not use
loan-to-value or dependency upon cash flow generated by the real estate
to assign a risk-weight, it would provide for a simpler framework where
all prudently underwritten first-lien residential mortgage exposures
would receive the same risk-based capital treatment. Lastly and
consistent with the treatment in subpart D, if a banking organization
holds the first and junior lien(s) on a regulatory residential real
estate exposure and no other party holds an intervening lien, the
banking organization would be required to treat the combined exposure
as a single loan secured by a first lien for purposes of assigning a
risk weight.
Question 29: The agencies seek comment on assigning risk weights to
residential mortgage exposures, consistent with the current U.S.
standardized risk-based capital framework. What are the pros and cons
of this alternative treatment?
vi. Risk Weights for Regulatory Commercial Real Estate Exposures
In a manner similar to regulatory residential real estate exposure,
the proposal would require a banking organization to assign a risk
weight to a regulatory commercial real estate exposure based on the
exposure's LTV ratio and whether the exposure is dependent on the cash
flows generated by the real estate, as reflected in Tables 4 and 5
below. For regulatory commercial real estate exposures that are not
dependent on cash flows for repayment, the main driver of risk to the
banking organization is whether the commercial borrower would generate
sufficient revenue through its non-real estate business activities to
repay the loan to the banking organization. For this reason, under
Table 4 the proposed risk weight for the exposure would be dependent on
the risk weight assigned to the borrower. For the purposes of Table 4,
if the LTV ratio of the exposures is greater than 60 percent, and the
banking organization does not have sufficient information about the
exposure to determine what the risk weight applicable to the borrower
would be, the banking organization would be required to assign a 100
percent risk weight to the exposure.
[GRAPHIC] [TIFF OMITTED] TP18SE23.005
[GRAPHIC] [TIFF OMITTED] TP18SE23.006
Question 30: What, if any, market effects could the proposed
treatment have on residential and commercial real estate mortgage
lending and why? What alternatives to the proposed treatment or
calibration should the agencies consider? Please provide supporting
data.
vii. Defaulted Real Estate Exposures
The proposal would require banking organizations to apply an
elevated risk weight to defaulted real estate
[[Page 64050]]
exposures, consistent with the approach to defaulted exposures
described in section III.C.2.a. of this Supplementary Information. The
proposal would introduce a definition of defaulted real estate exposure
that would provide new criteria for determining whether a residential
mortgage exposure or a non-residential mortgage exposure is in default.
These new criteria are indicative of a credit-related default for such
exposures. For residential mortgage exposures, the definition of
defaulted real estate exposure would require the banking organization
to evaluate default at the exposure level. For other real estate
exposures that are not residential mortgage exposures, the definition
of defaulted real estate exposure would require the banking
organization to evaluate default at the obligor level, consistent with
the approach describe above for non-retail defaulted exposures.
Since residential mortgage exposures are primarily originated to
individuals for the purchase or refinancing of their primary residence,
most obligors of residential real estate exposures do not have
additional real estate exposures. Therefore, determining default at the
exposure level would account for the material default risk of most
residential mortgage exposures. Additionally, evaluating defaulted
residential mortgage exposures at the obligor level may be difficult
for banking organizations to operationalize, for example, if there are
challenges collecting information on the payment status of other
obligations of individual borrowers.
In contrast, for other types of real estate exposures, such as
regulatory commercial real estate and ADC exposures, evaluating default
at the obligor level would be more appropriate and less challenging as
those obligors frequently have other credit obligations that are large
in value and potentially held by multiple banking organizations.
Default by an obligor on other credit obligations, which a banking
organization should account for when evaluating the risk profile of the
borrower, would indicate increased credit risk of the exposure held by
a banking organization.
A defaulted real estate exposure that is a residential mortgage
exposure would include an exposure (1) that is 90 days or more past due
or in nonaccrual status; (2) where the banking organization has taken a
partial charge-off, write-down of principal, or negative fair value
adjustment on the exposure for credit-related reasons, until the
banking organization has reasonable assurance of repayment and
performance for all contractual principal and interest payments on the
exposure; or (3) where the banking organization agreed to a distressed
restructuring that includes the following credit-related reasons:
forgiveness or postponement of principal, interest, or fees; term
extension; or an interest rate reduction. Distressed restructuring
would not include a loan modified or restructured solely pursuant to
the U.S. Treasury's Home Affordable Mortgage Program.\90\
---------------------------------------------------------------------------
\90\ The U.S. Treasury's Home Affordable Mortgage Program was
created under the Troubled Asset Relief Program in response to the
subprime mortgage crisis of 2008. See Emergency Economic
Stabilization Act, Public Law 110-343, 122 Stat. 3765 (2008).
---------------------------------------------------------------------------
To determine if a non-residential mortgage exposure would be a
defaulted real estate exposure, banking organizations would apply the
same criteria as described above in section III.C.2.a. of this
Supplementary Information that are used to determine if a non-retail
exposure is a defaulted exposure. Banking organizations are expected to
conduct ongoing credit reviews of relevant obligors. The proposal would
require banking organizations to continue to treat non-residential real
estate exposures that meet this definition as defaulted real estate
exposures until the non-residential real estate exposure no longer
meets the definition or until the banking organization determines that
the obligor meets the definition of investment grade or speculative
grade.
Under the proposal, a defaulted real estate exposure that is a
residential mortgage exposure not dependent on the cash flows generated
by the real estate would receive a risk weight of 100 percent,
regardless of whether the exposure qualifies as a regulatory real
estate exposure, unless a portion of the real estate exposure is
guaranteed under Sec. __.120 of the proposal. This treatment is
consistent with the risk weight for past due residential mortgage
exposures under the current standardized approach. Additionally, a
residential mortgage guaranteed by the Federal Government through the
Federal Housing Administration (FHA) or the Department of Veterans
Affairs (VA) generally will be risk-weighted at 20 percent under the
proposal, including a residential mortgage guaranteed by FHA or VA that
meets the defaulted real estate exposure definition.
Any other defaulted real estate exposure would receive a risk
weight of 150 percent, including any other non-residential real estate
exposure to the same obligor, consistent with the proposed risk weight
of other defaulted exposures described in section II.C.2.a. of this
Supplementary Information. A banking organization may apply a risk
weight to the guaranteed portion of defaulted real estate exposures
based on the risk weight that applies under Sec. __.120 of the
proposal if the guarantee or credit derivative meets the applicable
requirements.
Question 31: How does the defaulted real estate exposure definition
compare with banking organizations' existing policies relating to the
determination of the credit risk of defaulted real estate exposures and
the creditworthiness of defaulted real estate obligors? What, if any,
additional clarifications are necessary to determine the point at which
residential and non-residential mortgages should no longer be treated
as defaulted exposures? Please provide specific examples and supporting
data.
Question 32: For purposes of commercial real estate exposures, the
agencies invite comment on the extent to which obligors have
outstanding other exposures with multiple banking organizations and
other creditors. What would be the advantages and disadvantages of
considering both the obligor and the parent company or other entity or
individual that owns or controls the obligor when determining if the
exposure meets the criteria for ``defaulted real estate exposure''?
Question 33: For purposes of residential mortgage exposures, the
agencies invite comment on the appropriateness of including a
borrower's bankruptcy as a criterion for defaulted real estate
exposure. Would criteria (1)(i) through (1)(iii) in the proposed
defaulted real estate definition for residential mortgages sufficiently
capture the risk of a borrower involved in a bankruptcy proceeding?
viii. ADC Exposures That Are Not HVCRE Exposures
Under the proposal, the agencies would define an ADC exposure as an
exposure secured by real estate for the purpose of acquiring,
developing, or constructing residential or commercial real estate
properties, as well as all land development loans, and all other land
loans. Some ADC exposures meet the definition of HVCRE exposure in
Sec. __.2 of the capital rule and would be assigned a 150 percent risk
weight.\91\ Real estate exposures that meet the
[[Page 64051]]
definition of ADC exposure but do not meet the criteria of an HVCRE
exposure or a defaulted real estate exposure would be assigned a 100
percent risk weight under the proposal. The proposed regulatory
treatment for ADC exposures would not take into consideration cash flow
dependency or LTV ratio criteria. ADC exposures are mostly short-term
or bridge loans to cover construction or development, or lease up or
sales phases of a real estate project, rather than an amortizing
permanent loan for completed residential or commercial real estate.
Supervisory experience has shown that ADC exposures have heightened
risk compared to permanent commercial real estate exposures, and these
exposures generally have been subject to a risk weight of 100 percent
or more under the current standardized approach. Repayment of ADC loans
is often based on the expected completion of the construction or
development of the property, which can be delayed or interrupted by
many factors such as changes in market condition or financial
difficulty of the obligor.
---------------------------------------------------------------------------
\91\ Section 214 of the Economic Growth, Regulatory Relief, and
Consumer Protection Act (EGRRCPA) imposes certain requirements on
high volatility commercial real estate acquisition, development, or
construction loans. Section 214 of Public Law 115-174, 132 Stat.
1296 (2018); 12 U.S.C. 1831bb.
---------------------------------------------------------------------------
ix. Other Real Estate Exposures
The proposal would define other real estate exposures as real
estate exposures that are not defaulted real estate exposures,
regulatory commercial real estate exposures, regulatory residential
real estate exposures, ADC exposures, or any of the statutory real
estate exposures.
An exposure meeting the proposed definition of other real estate
exposure poses heightened credit risk as a result of not meeting the
proposed prudential underwriting criteria included in the definitions
of regulatory residential and regulatory commercial real estate,
respectively, and accordingly would be assigned a higher risk weight.
Specifically, the proposal would require a banking organization to
assign a 150 percent risk weight to an other real estate exposure,
unless the exposure is a residential mortgage exposure that is not
dependent on the cash flows generated by the real estate, which must be
assigned a 100 percent risk weight.
For example, a banking organization would assign a 150 percent risk
weight to real estate exposures that are dependent on the cash flows
generated by the underlying real estate, such as a rental property, and
that do not meet the regulatory residential or regulatory commercial
real estate exposure definitions. Loans for the purpose of acquiring
real estate and reselling it at higher value that do not qualify as ADC
loans and do not meet the definition of regulatory residential real
estate exposures would be assigned a 150 percent risk weight as other
real estate exposures. The proposed 150 percent risk weight also would
provide a regulatory capital incentive for banking organizations to
originate real estate exposures in accordance with the prudential
qualification requirements for regulatory residential and commercial
real estate exposures, respectively.
In other cases, if a banking organization does not adequately
evaluate the creditworthiness of a borrower for an owner-occupied
residential mortgage exposure, or if the borrower has inadequate
creditworthiness or capacity to repay the loan, the exposure would not
be considered prudently underwritten and would be assigned a 100
percent risk weight instead of the lower risk weights included in Table
2 for regulatory residential mortgage exposures not dependent on the
cash flows generated by the real estate. The 100 percent risk weight
would also apply to junior lien home equity lines of credit and other
second mortgages given the elevated risk of these loans when compared
to similar senior lien loans.
f. Retail Exposures
Relative to the current standardized approach, and as described in
more detail below, the proposal would increase the credit risk-
sensitivity of the capital requirements applicable to retail exposures
by assigning risk weights that would vary depending on product type and
the degree of portfolio diversification. The proposal would introduce a
new definition of retail exposure, which would include an exposure to a
natural person or persons, or an exposure to a small or medium-sized
entity (SME) \92\ that meets the proposed definition of a regulatory
retail exposure described below. Including an exposure to an SME in the
definition of a retail exposure provides a benefit for small companies,
such as smaller limited liability companies, which may have
characteristics more similar to those of a natural person than of a
larger corporation. The proposed definition of a retail exposure would
be narrower in scope than the current capital rule's existing
definition of a retail exposure under subpart E, which includes a
broader range of exposures, including real estate-related exposures.
Because the proposal would include separate risk-weight treatments for
real estate exposures that account for the underlying collateral, the
proposed definition of a retail exposure would only apply to a retail
exposure that would not otherwise be a real estate exposure.\93\
---------------------------------------------------------------------------
\92\ An SME would mean an entity in which the reported annual
revenues or sales for the consolidated group of which the entity is
a part are less than or equal to $50 million for the most recent
fiscal year. This scope is generally consistent with the definition
of an SME under the Basel III reforms and also corresponds with the
maximum receipts-based size standard for small businesses set by the
Small Business Administration, which varies by industry and does not
exceed $47 million per year. See 13 CFR part 121.
\93\ For an exposure that qualifies as a real estate exposure
and also meets conditions (1) and (2) of the definition of a retail
exposure, the proposal would require a banking organization to treat
the exposure as a real estate exposure and calculate risk-based
requirements for the exposure as described in section III.C.2.e of
this Supplementary Information.
---------------------------------------------------------------------------
The proposal would differentiate the risk-weight treatment for
retail exposures based on whether (1) the exposure qualifies as a
regulatory retail exposure, (2) further qualifies as a transactor
exposure; or (3) does not qualify for either of the previous categories
and is treated as an other retail exposure. The proposed definitions of
a regulatory retail exposure and a transactor exposure outlined below
include key criteria for broadly categorizing the relative credit risk
of retail exposures.
To qualify as a regulatory retail exposure, the proposal would
require the exposure to be in the form of any of the following credit
products: a revolving credit or line of credit (such as a credit card,
charge card, or overdraft) or a term loan or lease (such as an
installment loan, auto loan or lease, or student or educational loan)
(collectively, eligible products). In addition, under the proposal, the
amount of retail exposures that a banking organization could treat as
regulatory retail exposures would be limited on an aggregate and
granular basis. A banking organization would include all outstanding
and committed but unfunded regulatory retail exposures accounting for
any applicable credit conversion factor when aggregating the retail
exposures. Specifically, the regulatory retail exposure category would
exclude any retail exposure to a single obligor and its affiliates
that, in the aggregate with any other retail exposures to that obligor
or its affiliates, including both on- and off-balance sheet exposures,
exceeds a combined total of $1 million (aggregate limit).
In addition, for any single retail exposure, only the portion up to
0.2 percent of the banking organization's total retail exposures that
are eligible products (granularity limit) would be considered a
regulatory retail exposure.
[[Page 64052]]
The portion of any single retail exposure that exceeds the granularity
limit would not qualify as a regulatory retail exposure. For purposes
of calculating the 0.2 percent granularity limit for a regulatory
retail exposure, off-balance sheet exposures would be subject to the
applicable credit conversion factors, as discussed in Sec. __.112(b),
and defaulted exposures, as discussed in Sec. __.101(b) of the
proposal, would be excluded. Under the proposal, if an exposure to an
SME does not meet criteria (1) through (3) of the definition of a
regulatory retail exposure, then none of the exposures to that SME
would qualify as retail exposures and all of the exposures to that SME
would be treated as corporate exposures.
The proposal would define a transactor exposure as a regulatory
retail exposure that is a credit facility where the balance has been
repaid in full at each scheduled repayment date for the previous twelve
months or an overdraft facility where there has been no drawdown over
the previous twelve months. If a single obligor had both a credit
facility and an overdraft facility from the same banking organization,
the banking organization would separately evaluate each facility to
determine whether each facility would meet the definition of a
transactor exposure to be categorized as a transactor exposure.
Under the proposal, a banking organization would assign a risk
weight of 55 percent to a regulatory retail exposure that is a
transactor exposure and an 85 percent risk weight to a regulatory
retail exposure that is not a transactor exposure. All other retail
exposures would be assigned a 110 percent risk weight. The proposed 55
percent risk weight for a transactor exposure is appropriate because
obligors that demonstrate a historical repayment capacity generally
exhibit less credit risk relative to other retail obligors. A
regulatory retail exposure that is not a transactor exposure warrants
the proposed 85 percent risk weight, which would be lower than the
proposed 110 percent risk weight for all other retail exposures, due to
mitigating factors related to size or concentration risk. The aggregate
limit and granularity limit are intended to ensure that the regulatory
retail portfolio consists of a set of small exposures to a diversified
group of obligors, which would reduce credit risk to the banking
organization. Conversely, banking organizations with a high aggregate
amount of retail exposures to a single obligor, or exposures exceeding
the granularity limit, have a heightened concentration of retail
exposures. This concentration of retail exposures increases the level
of credit risk the banking organization has to a single obligor, and
the likelihood that the banking organization could face material losses
if the obligor misses a payment or defaults. Therefore, any retail
exposure that would not qualify as a regulatory retail or a transactor
exposure warrants a risk weight of 110 percent.
The following example describes how a banking organization would
identify the amount of retail exposures that could be treated as
regulatory retail exposures. First, a banking organization would
identify the amount of credit exposures that meet the eligible products
criterion within the definition of a regulatory retail exposure. Assume
a banking organization has $100 million in total retail exposures that
meet the eligible regulatory retail product criterion described above.
Next, for this set of exposures, the banking organization would
identify any amounts to a single obligor and its affiliates that exceed
$1 million. The banking organization in this example determines that a
single obligor and its affiliates account for an aggregate of $20
million of the banking organization's total retail exposures. Because
this $20 million exceeds the $1 million threshold for amounts to a
single obligor and its affiliates, this $20 million would be retail
exposures that are not regulatory retail exposures and subject to a 110
percent risk weight, leaving $80 million that could be categorized as
regulatory retail exposures.
Also, assume that of the $80 million, $1 million of the exposures
are considered defaulted exposures. This $1 million in defaulted
exposures would be subtracted from the $80 million. The banking
organization would multiply the remaining $79 million by the 0.2
percent granularity limit, with the resulting $158,000 representing the
dollar amount equivalent of the granularity limit for this banking
organization's retail portfolio. Therefore, of the remaining $79
million, the portion of those retail exposures to a single obligor and
its affiliates that do not exceed $158,000 would be considered
regulatory retail exposures. Of the regulatory retail exposures, the
portion of the exposure that would qualify as a transactor exposure
would receive a 55 percent risk weight and the remaining portion would
receive an 85 percent risk weight. Under the proposal, a banking
organization would assign a 110 percent risk weight to the portion of a
retail exposure that exceeds the granularity limit. Thus, the total
amount of retail exposures to a single obligor exceeding $158,000 in
this example would receive a 110 percent risk weight as other retail
exposures. This example is also illustrated in the following decision
tree.
[[Page 64053]]
[GRAPHIC] [TIFF OMITTED] TP18SE23.007
Question 34: What, if any, additional criteria or alternatives
should the agencies consider to help ensure that the regulatory retail
treatment is limited to a group of diversified retail obligors? What
alternative thresholds or calibrations should the agencies consider for
purposes of retail exposures? Please provide supporting data in your
response.
Question 35: What simplifications, if any, to the calculation
described above for a regulatory retail exposure should the agencies
consider to reduce operational complexity for banking organizations?
For example, what operational challenges would arise from assigning
differing risk weights to portions of retail exposures based on the
regulatory retail eligibility criteria?
Question 36: Is the requirement for repayment of a credit facility
in full at each scheduled repayment date for the previous twelve months
or lack of overdraft history an appropriate criterion to distinguish
the credit risk of a transactor exposure from other retail exposures,
and if not, what would be more appropriate and why? Is twelve months of
full repayment history a sufficient amount of time to demonstrate a
consistent repayment history of the credit or overdraft facility to
meet the definition of a transactor and if not, what would be an
appropriate amount of time?
g. Risk-Weight Multiplier for Certain Retail and Residential Mortgage
Exposures With Currency Mismatch
The proposal would introduce a new requirement for banking
organizations to apply a multiplier to the applicable risk weight
assigned to certain exposures that contain currency mismatches between
the banking organization's lending currency and the borrower's source
of repayment. The multiplier would reflect the borrower's increased
risk of default due to the borrower's exposure to foreign exchange
risk. The multiplier would apply to exposure types where the borrower
generally does not manage or hedge its foreign exchange risk. Exposures
with such currency mismatches pose increased credit risk to the banking
organization as the borrower's repayment ability could be affected by
exchange rate fluctuations.
To capture this increased risk, the proposal would require banking
organizations to apply a 1.5 multiplier to the applicable risk weight,
subject to a maximum risk weight of 150 percent, for retail and
residential mortgage exposures to a borrower that does not have a
source of repayment in the currency of the loan equal to at least 90
percent of the annual payment from either income generated through
ordinary business activities or from a contract with a financial
institution that provides funds denominated in the currency of the
loan, such as a forward exchange contract. Other types of exposures
generally account for foreign exchange risk through hedging or other
risk mitigants and would not be subject to the proposed multiplier. The
proposed risk weight ceiling of 150 percent aligns with the maximum
risk weight for credit exposures under the proposal.
Question 37: What, if any, additional or alternative criteria of
the proposed multiplier should the agencies consider and why?
h. Corporate Exposures
A corporate exposure under the proposal would be an exposure to a
company that does not fall under any other exposure category under the
proposal. This scope would be consistent with the definition found in
Sec. __.2 of the current capital rule. For example, an exposure to a
corporation that also meets the proposed definition of a real estate
exposure would be a real estate exposure rather than a corporate
exposure for purposes of the proposal.
As described in more detail below, the proposal would differentiate
the risk weights of corporate exposures based on credit risk by
considering such factors as a corporate exposure's investment quality
and the general creditworthiness of the borrower, level of
subordination, as well as the nature and substance of the lending
arrangement, and the degree of reliance on the borrower's independent
capacity for repayment of the obligation, or reliance on the income
that the borrowing entity is expected to generate from the asset(s) or
a project being financed. First, a banking organization would assign a
65 percent risk weight to a corporate exposure that is an exposure to a
company that is investment grade, and that has a publicly traded
security outstanding or that is controlled by a company that has
[[Page 64054]]
a publicly traded security outstanding.\94\ Second, consistent with the
current standardized approach, a banking organization would assign risk
weights of 2 percent or 4 percent to certain exposures to a qualifying
central counterparty.\95\ Third, as discussed further below, a banking
organization would assign a 130 percent risk weight to a project
finance exposure that is not a project finance operational phase
exposure. Fourth, a banking organization would assign a 150 percent
risk weight to a corporate exposure that is an exposure to a
subordinated debt instrument or an exposure to a covered debt
instrument unless a deduction treatment is provided as described in
section III.C.2.d. of this Supplementary Information.
---------------------------------------------------------------------------
\94\ Under Sec. __.2 of the current capital rule, a person or
company controls a company if it: (1) owns, controls, or holds with
power to vote 25 percent or more of a class of voting securities of
the company; or (2) consolidates the company for financial reporting
purposes. See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2
(FDIC).
\95\ See 12 CFR 3.32(f)(2) and (3) (OCC); 12 CFR 217.32(f)(2)
and (3) (Board); 12 CFR 324.32(f)(2) and (3) (FDIC).
---------------------------------------------------------------------------
Finally, a banking organization would assign a 100 percent risk
weight to all other corporate exposures. Assigning a 100 percent risk
weight to all other corporate exposures appropriately reflects the
relative risk of such corporate exposures, as the repayment methods for
these exposures pose greater risks than those of publicly-traded
corporate exposures that are deemed investment grade. A banking
organization would also assign a 100 percent risk weight to corporate
exposures that finance income-producing assets or projects that engage
in non-real estate activities where the obligor has no independent
capacity to repay the loan. For example, corporate exposures subject to
the 100 percent risk weight would include exposures (i) for the purpose
of acquiring or financing equipment where repayment of the exposure is
dependent on the cash flows generated by either the equipment being
financed or acquired, (ii) for the purpose of acquiring or financing
physical commodities where repayment of the exposure is dependent on
the proceeds from the sale of the physical commodities, and (iii)
project finance operational phase exposures, as further discussed
below.
i. Investment Grade Companies With Publicly Traded Securities
Outstanding
Under the proposal, a banking organization would assign a 65
percent risk weight to a corporate exposure that is both (1) an
exposure to a company that is investment grade, and (2) where that
company, or a parent that controls that company, has publicly traded
securities outstanding.\96\ This two-pronged test would serve as a
reasonable basis for banking organizations to identify exposures to
obligors of sufficient creditworthiness to be eligible for a reduced
risk weight. The definition of investment grade directly addresses the
credit quality of the exposure by requiring that the entity or
reference entity have adequate capacity to meet financial commitments,
which means that the risk of its default is low and the full and timely
repayment of principal and interest is expected. A banking
organization's investment grade analysis is dependent upon the banking
organization's underwriting criteria, judgment, and assumptions.
---------------------------------------------------------------------------
\96\ Under Sec. __.2 of the current capital rule, publicly-
traded means traded on: (1) any exchange registered with the SEC as
a national securities exchange under section 6 of the Securities
Exchange Act; or (2) any non-U.S.-based securities exchange that:
(i) is registered with, or approved by, a national securities
regulatory authority; and (ii) provides a liquid, two-way market for
the instrument in question. See 12 CFR 3.2 (OCC); 12 CFR 217.2
(Board); 12 CFR 324.2 (FDIC).
---------------------------------------------------------------------------
The proposed requirement that the company or its parent company
have securities outstanding that are publicly traded, in contrast,
would be a simple, objective criterion that would provide a degree of
consistency across banking organizations. Further, publicly-traded
corporate entities are subject to enhanced transparency and market
discipline as a result of being listed publicly on an exchange. A
banking organization would use these simple criteria, which complement
a banking organization's due diligence and internal credit analysis, to
determine whether a corporate exposure qualifies as an investment grade
exposure.
Question 38: What, if any, alternative criteria should the agencies
consider to identify corporate exposures that would warrant a risk
weight of 65 percent or a risk weight between 65 percent and 100
percent?
Question 39: For what reasons, if any, should the agencies consider
applying a lower risk weight than 100 percent to exposures to companies
that are not publicly traded but are companies that are ``highly
regulated?'' What, if any, criteria should the agencies consider to
identify companies that are ``highly regulated?'' Alternatively, what
are the advantages and disadvantages of assigning lower risk weights to
highly regulated entities (such as open-ended mutual funds, mutual
insurance companies, pension funds, or registered investment
companies)?
Question 40: What are the advantages and disadvantages of applying
a lower risk weight (such as between 85 and 100 percent), to entities
based on size, such as companies with reported annual sales of less
than or equal to $50 million for the most recent financial year? What
alternative criteria, if any, should the agencies consider to identify
small or medium-sized entities that present lower credit risk? For
example, should the agencies consider asset size or number of employees
to identify small or medium-sized entities? Please provide supporting
data.
Question 41: What criteria, if any, should the agencies consider to
further differentiate corporate exposures according to their risk
profiles and what implications would such criteria have for the risk
weighting of these exposures and why?
ii. Project Finance Exposures
The proposal would define a project finance exposure as a corporate
exposure for which the banking organization relies on the revenues
generated by a single project (typically a large and complex
installation, such as power plants, manufacturing plants,
transportation infrastructure, telecommunications, or other similar
installations), both as the source of repayment and as security for the
loan. For example, a project finance exposure could take the form of
financing the construction of a new installation, or a refinancing of
an existing installation, with or without improvements. The primary
determinant of credit risk for a project finance exposure is the
variability of the cash flows expected to be generated by the project
being financed rather than the general creditworthiness of the obligor
or the market value or sale of the project or the real estate on which
the project sits.\97\ A project finance exposure also would be required
to meet the following criteria: (1) the exposure would need to be to a
borrowing entity that was created specifically to finance the project,
operate the physical assets of the project, or do both, and (2) the
borrowing entity would need to have an immaterial amount of assets,
activities, or sources of income apart from revenues from the
activities of the project being financed. Under the proposal, an
exposure that is deemed secured by real estate,\98\ would not be
[[Page 64055]]
considered a project finance exposure and would be assigned a risk
weight as described in section III.C.2.e. of this Supplementary
Information.
---------------------------------------------------------------------------
\97\ Exposures that are guaranteed by the government or
considered a general obligation or revenue obligation exposure to a
PSE would not qualify as a project finance exposure.
\98\ Although it is common for the banking organization to take
a mortgage over the real property and a lien against other assets of
the project for security and lender control purposes, a project
finance exposure would not be considered a real estate exposure
because the banking organization does not rely on real estate
collateral to grant credit. As noted in section III.C.2.e of this
Supplementary Information, for purposes of the proposal, ``secured
by collateral in the form of real estate'' in the context of the
proposed real estate exposure definition should be interpreted in a
manner that is consistent with the current definition for ``a loan
secured by real estate'' in the Call Report and FR Y-9C
instructions.
---------------------------------------------------------------------------
Under the proposal, a project finance exposure would receive a 130
percent risk weight during the pre-operational phase and a 100 percent
risk weight during the operational phase. The proposal would define a
project finance operational phase exposure as a project finance
exposure where the project has a positive net cash flow that is
sufficient to support the debt service and expenses of the project and
any other remaining contractual obligation, in accordance with the
banking organization's applicable loan underwriting criteria for
permanent financings, and where the outstanding long-term debt of the
project is declining. Prior to the operational phase classification, a
banking organization would be required to treat a project finance
exposure as being in the pre-operational phase and assign a 130 percent
risk weight to the exposure. The pre-operational phase would be the
period between the origination of the loan and the time at which the
banking organization determines that the project has entered the
operational phase. Relative to the operational phase, the pre-
operational phase presents increased uncertainty that the project will
be completed in a timely and cost-effective manner, which warrants the
application of a higher risk weight. For example, market conditions
could change significantly between commencement and completion of the
project. In addition, unanticipated supply shortages could disrupt
timely completion of the project and the expected timing of the
transition to the operational phase. These unanticipated changes could
disrupt the completion of the project and delay it becoming
operational, and thus impact the ability of the project to generate
cash flows as projected and to repay creditors.
Question 42: What additional exposures, if any, should be captured
by the proposed definition of a project finance exposure? What
exposures, if any, captured by the proposed definition of a project
finance exposure should be excluded from the definition?
Question 43: What clarifications or changes, if any, should the
agencies consider to differentiate project finance exposures from
exposures secured by real estate? What, if any, capital market effects
would the proposed treatment of project finance exposures have and why
and what, if any, modifications should the agencies consider to address
such effects? How material for banking organizations are project
finance exposures that are not based on the creditworthiness of a
Federal, state or local government?
3. Off-Balance Sheet Exposures
In addition to on-balance sheet exposures, banking organizations
are exposed to credit risk associated with off-balance sheet exposures.
Banking organizations often enter into contractual arrangements with
borrowers or counterparties to provide credit or other support. Such
arrangements generally are not recorded on-balance sheet under GAAP.
These off-balance sheet exposures often include commitments, contingent
items, guarantees, certain repo-style transactions, financial standby
letters of credit, and forward agreements.
The proposal would introduce a few updated credit conversion
factors that a banking organization would apply to an off-balance sheet
item's notional amount (typically, the contractual amount) in order to
calculate the exposure amount for an off-balance sheet exposure. Under
the proposal, the credit conversion factors, which would range from 10
percent to 100 percent, would reflect the expected proportion of the
off-balance sheet item that would become an on-balance sheet credit
expos
[…truncated; see source link]Indexed from Federal Register on September 18, 2023.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.