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Proposed Rule2026-05959

Regulatory Capital Rule: Category I and II Banking Organizations, Banking Organizations With Significant Trading Activity, and Optional Adoption for Other Banking Organizations

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Published

March 27, 2026

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 proposing to modernize the capital requirements applicable to Category I and II depository institution holding companies and depository institutions, as well as revise the market risk capital framework for banking organizations with significant trading activity (the proposal). The proposal would improve the regulatory capital framework for covered banking organizations by enhancing its risk sensitivity and consistency and by simplifying core components of its design. The agencies expect the proposal would support the safety and soundness of covered banking organizations and U.S. financial stability while promoting lending and other financial intermediation activities in the banking system over a range of economic conditions.

Full Text

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[Federal Register Volume 91, Number 59 (Friday, March 27, 2026)]
[Proposed Rules]
[Pages 14952-15329]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2026-05959]

[[Page 14951]]

Vol. 91

Friday,

No. 59

March 27, 2026

Part III

Department of the Treasury

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Office of the Comptroller of the Currency

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12 CFR Parts 3, 6, and 32

Federal Reserve System

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12 CFR Parts 208, 217, et al.

Federal Deposit Insurance Corporation

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12 CFR Part 324

Regulatory Capital Rule: Category I and II Banking Organizations,
Banking Organizations With Significant Trading Activity, and Optional
Adoption for Other Banking Organizations; Proposed Rule

Federal Register / Vol. 91, No. 59 / Friday, March 27, 2026 /
Proposed Rules

[[Page 14952]]

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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Parts 3, 6, and 32

[Docket ID OCC-2026-0265]
RIN 1557-AF52

FEDERAL RESERVE SYSTEM

12 CFR Parts 208, 217, 225, 238, and 252

[Docket No. 1887]
RIN 7100-AH20

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 324

RIN 3064-AF29

Regulatory Capital Rule: Category I and II Banking Organizations,
Banking Organizations With Significant Trading Activity, and Optional
Adoption for Other Banking Organizations

AGENCY: Office of the Comptroller of the Currency (OCC), Treasury; the
Board of Governors of the Federal Reserve System (Board); and the
Federal Deposit Insurance Corporation (FDIC).

ACTION: Notice of proposed rulemaking.

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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 proposing to modernize the capital
requirements applicable to Category I and II depository institution
holding companies and depository institutions, as well as revise the
market risk capital framework for banking organizations with
significant trading activity (the proposal). The proposal would improve
the regulatory capital framework for covered banking organizations by
enhancing its risk sensitivity and consistency and by simplifying core
components of its design. The agencies expect the proposal would
support the safety and soundness of covered banking organizations and
U.S. financial stability while promoting lending and other financial
intermediation activities in the banking system over a range of
economic conditions.

DATES: Comments must be received by June 18, 2026.

ADDRESSES: Comments should be directed to:
<bullet> OCC: Commenters are encouraged to submit comments through
the Federal eRulemaking Portal, if possible. Please use the title
``Regulatory Capital Rule: Category I and II Banking Organizations,
Banking Organizations with Significant Trading Activity, and Optional
Adoption for Other Banking Organizations'' to facilitate the
organization and distribution of the comments and identify the number
of the specific question(s) to which you are responding. You may submit
comments by any of the following methods:
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-2026-0265''
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. EST, or email
<a href="/cdn-cgi/l/email-protection#4e3c2b293b222f3a2721203d262b223e2a2b3d250e293d2f60292138">[email&#160;protected]</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-2026-0265'' 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:
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-2026-0265''
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. EST, or email
<a href="/cdn-cgi/l/email-protection#65170002100904110c0a0b160d0009150100160e250216044b020a13">[email&#160;protected]</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-1887,
and RIN 7100-AH20 by any of the following methods:
<bullet> Agency website: <a href="https://www.federalreserve.gov/apps/proposals/">https://www.federalreserve.gov/apps/proposals/</a>. Follow the instructions for submitting comments, including
attachments. Preferred Method.
<bullet> Mail: Benjamin W. McDonough, Secretary, Board of Governors
of the Federal Reserve System, 20th Street and Constitution Avenue NW,
Washington, DC 20551.
<bullet> Hand Delivery/Courier: Same as mailing address.
<bullet> Other Means: <a href="/cdn-cgi/l/email-protection#b5c5c0d7d9dcd6d6dad8d8d0dbc1c6f5d3c7d79bd2dac3">[email&#160;protected]</a>. You must include the
docket number in the subject line of the message.
Comments received are subject to public disclosure. In general,
comments received will be made available on the Board's website at
<a href="https://www.federalreserve.gov/apps/proposals/">https://www.federalreserve.gov/apps/proposals/</a> without change and will
not be modified to remove personal or business information including
confidential, contact, or other identifying information. Comments
should not include any information such as confidential information
that would be not appropriate for public disclosure. Comments should
identify the number for the specific question(s) to which they respond.
Public comments may also be viewed electronically or in person in Room
M-4365A, 2001 C St. NW, Washington, DC 20551, between 9 a.m. and 5 p.m.
during Federal business weekdays.
FDIC: You may submit comments to the FDIC, identified by RIN 3064-
AF29 and identify the number for the specific question(s) to which you
are responding, by any of the following methods:
Agency website: <a href="https://www.fdic.gov/resources/regulations/federal-register-publications">https://www.fdic.gov/resources/regulations/federal-register-publications</a>. Follow instructions for submitting comments on
the FDIC's website.

[[Page 14953]]

Mail: Jennifer M. Jones, Deputy 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#1b787476767e756f685b5d5f5258357c746d">[email&#160;protected]</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, Technical Expert, or
Diana Wei, Risk Expert, Capital Policy, (202) 649-6370; Carl Kaminski,
Assistant Director, Ron Shimabukuro, Senior Counsel, Kevin
Korzeniewski, Counsel, Daniel Perez, Counsel, Christopher Rafferty,
Counsel, or Joanne Phillips, Counsel, 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; Andrew
Willis, Manager, (202) 430-1667; Missaka Nuwan Warusawitharana,
Manager, (202) 452-3461; 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, Lead Financial Institution Policy Analyst, (202) 452-
3164; Division of Supervision and Regulation; or Jay Schwarz, Deputy
Associate General Counsel, (202) 452-2970; Mark Buresh, Senior Special
Counsel, (202) 452-5270; 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; Michael Maloney, Senior
Policy Analyst; Iris Li, Senior Policy Analyst; Olga Lionakis, Senior
Policy Analyst; Richard Smith, Capital Markets Policy Analyst; Ernest
Barkett, Financial Analyst; Kyle McCormick, Senior Policy Analyst;
Keith Bergstresser, Senior Policy Analyst; Lauren Brown, Senior Risk
and Policy Analyst; Rachel Romm-Nisson, Risk Analytics Specialist; Jim
Yu, Senior Policy Analyst, Peter Yen, Senior Policy Analyst; Huiyang
Zhou, Senior Quantitative Risk Specialist; Soo Jeong Kim, Capital
Markets Policy Analyst; Capital Markets and Accounting Policy Branch,
Division of Risk Management Supervision; Catherine Wood, Counsel;
Merritt Pardini, Counsel; Kevin Zhao, Senior Attorney; Nicholas Soyer,
Attorney, Michael Overmyer, Special Counsel, Legal Division;
<a href="/cdn-cgi/l/email-protection#1d6f787a68717c69726f647e7c6d74697c715d7b79747e337a726b">[email&#160;protected]</a>, (202) 898-6888; Federal Deposit Insurance
Corporation, 550 17th Street NW, Washington, DC 20429.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction
A. Statutory Authority
B. Objectives of the Proposal
C. Overview of the Proposal
II. Scope, Design, and Other Overarching Issues
A. Scope of Application
B. Single Set of Risk-Based Requirements
C. Removal of Internal Models for Credit and Operational Risk
D. Overlaps With the Stress Capital Buffer Requirement
E. Indexing of Thresholds
F. The Role of International Standards in Developing U.S.
Capital Requirements
G. Treatments Retained from the Current Standardized Approach
III. Definition of Capital
IV. Calculation of Risk-Weighted Assets Under the Expanded Risk-
Based Approach
A. Credit Risk
1. Exposure Amounts
2. Proposed Risk Weights for Credit Risk
3. Off-Balance Sheet Exposures
4. Counterparty Credit Risk-Related Exposures
5. Credit Risk Mitigation
B. Securitization Framework
1. Definitions
2. Operational Requirements
3. Exposure Amount of a Securitization Exposure
4. Securitization Standardized Approach (SEC-SA)
5. Exceptions to the SEC-SA Risk-Based Capital Treatment for
Securitization Exposures
6. Credit Risk Mitigation for Securitization Exposures
C. Equity Exposures
1. Adjusted Carrying Value
2. Simple Risk-Weight Approach (SRWA)
D. Operational Risk
1. Business Indicator
2. Business Indicator Component
3. Alternative Simple Approaches
4. Operational Risk Management
V. Calculation of Risk-Weighted Assets Under the Market Risk
Framework
A. Market Risk
1. Background
2. Scope and Application of the Proposed Rule
3. Measure for Market Risk
4. Market Risk Covered Position
5. Internal Risk Transfers
6. General Requirements for Market Risk
7. Standardized Non-Default Capital Requirement
8. Models-Based Non-Default Capital Requirement
9. Default Risk Capital Requirement
10. Treatment of Certain Market Risk Covered Positions
11. Reporting and Disclosure Requirements
12. Technical Amendments
B. 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
6. Reporting and Disclosure Requirements
VI. Disclosure Requirements
A. Proposed Disclosure Requirements
B. Specific Public Disclosure Requirements
VII. Estimated Impact on Capital Requirements
A. Standalone Effect of Proposed Capital Rule Changes
1. Impact on Other Banking Organizations
B. Cumulative Effect of Proposed Capital Rule Changes
1. Cumulative Impact of Recent Proposals on Capital Requirements
2. Cumulative Impact of Recent Proposals on Common Eequity Tier
1 Capital Requirements by Risk Type
C. Impact by Banking Activities
1. Impact on Risk-Weighted Assets by Banking Activity
2. Cumulative Impact of Recent Proposals on Common Equity Tier 1
Capital Requirements by Banking Activity
D. Data and Estimation Methodology

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1. Estimation of Risk-Weighted Assets Under the Proposed
Expanded Risk-Based Approach
2. Extrapolation of Estimates to Other Time Periods and Banking
Organizations
3. Attribution of Risk-Weighted Assets to Banking Activities
4. Estimation of Capital Requirements
5. Attribution of Stress Capital Buffer Requirement to Risk
Categories
VIII. Economic Analysis
A. Overview of the Baseline
1. Capital Ratios of Category I and II Banking Organizations--
Cross Section
2. Capital Ratios of Banking Organizations--Time Series
3. Portfolio Characteristics of Category I and II Banking
Organizations--by Revenue
4. Portfolio Characteristics of Category I and II Banking
Organizations--by Broad Asset Class
5. Dependency of the U.S. Economy on the Banking System
6. Nonbank Financial Intermediaries
B. Reasonable Alternatives
1. Alternative 1: Dual Calculation Implementation
2. Alternative 2: BCBS Models-Based Implementation
3. Alternative 3: BCBS Standardized Implementation
4. Quantitative Estimates and Discussion
C. Macroeconomic Effects and the Analysis of the Proposal With
Respect to Estimates of Optimal Capital Levels
1. Impact of the Proposals
2. Development of the Literature on the Optimal Level of Capital
in the Banking System
3. General Equilibrium Models of Optimal Capital Levels
4. Limitations of Applying the Academic Studies on Optimal
Capital Levels To Evaluating the Proposals
5. Differences Across U.S. Households
6. Benefits From Improved Risks Measurement
7. Microprudential Consequences of the Proposals
D. Effects on Lending (Including Credit Cards, Residential
Mortgages, and Business Lending)
1. Credit Cards
2. Residential Mortgages
3. Corporate Loans
E. Effects on Trading
1. Changes in Capital Requirements Across Different Trading
Activities
2. Impact on Banking Organizations
3. Impacts on Markets
F. Effect on Competitiveness
1. On Internationally Active Banks
2. On Smaller Banks
3. On Nonbank Financial Intermediaries
4. On Consumer Welfare and Barriers to Entry
G. Conclusion
IX. Technical Amendments to the Capital Rule
A. Additional OCC Technical Amendments
B. Additional FDIC Technical Amendments
X. Related Proposals and Proposed Amendments to Related Rules
A. Related Proposals
B. OCC Amendments
C. Board Amendments
XI. 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. Executive Orders 12866, 13563, and 14192
G. Providing Accountability Through Transparency Act of 2023

I. Introduction

The Office of the Comptroller of the Currency (OCC), the Board of
Governors of the Federal Reserve System (Board), and the Federal
Deposit Insurance Corporation (FDIC) (collectively, the agencies) are
proposing to modernize the capital requirements applicable to Category
I and II depository institution holding companies and depository
institutions (henceforth Category I and II banking organizations) and
the market risk capital framework applicable to banking organizations
with significant trading activity.\1\ The proposal would improve the
regulatory capital framework for covered banking organizations by
enhancing its risk sensitivity and consistency, as well as by
simplifying core components of its design.\2\ Improving the risk
sensitivity of the regulatory capital framework would mean that a
banking organization's capital requirements more readily increase or
decrease due to changes in the risk of its business activities.
Improving the consistency of the regulatory capital framework would
mean that the regulatory capital framework would apply similar capital
requirements to exposures with similar risks across different banking
organizations.
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\1\ In 2019, the agencies adopted rules establishing four
categories of capital standards for U.S. banking organizations with
$100 billion or more in total consolidated assets and foreign
banking organizations with $100 billion or more in combined U.S.
assets. Under this framework, Category I standards apply to U.S.-
domiciled bank holding companies identified as global systemically
important BHCs and their depository institution subsidiaries.
Category II 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 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 exposures and their depository
institution subsidiaries. Category IV 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 217.400, 238.10, 252.5, (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 (Nov. 1, 2019); ``Changes to Applicability Thresholds for
Regulatory Capital and Liquidity Requirements,'' 84 FR 59230 (Nov.
1, 2019).
\2\ The term covered banking organizations refers to Category I
and II banking organizations, banking organizations with significant
trading activity, and banking organizations that elect to use the
expanded risk-based approach (as discussed further below).
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Elements of the proposal would address comments received from the
Economic Growth and Regulatory Paperwork Reduction Act (EGRPRA) public
notices.\3\ Consistent with other recent efforts to modify the
regulatory capital framework, the agencies expect the proposal would
support the safety and soundness of covered banking organizations and
U.S. financial stability while promoting lending and other financial
intermediation activities by covered banking organizations over a range
of economic conditions.\4\
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\3\ The agencies, together with the Federal Financial
Institutions Examination Council, commenced a review under the
Economic Growth and Regulatory Paperwork Reduction Act of 1996 in
2024 to identify outdated or otherwise unnecessary regulatory
requirements. The agencies will continue reviewing and considering
these comments as part of any final rulemaking. Public Law 104-208,
Div. A, Title II, section 2222, 110 Stat. 3009-414, (1996) (codified
at 12 U.S.C. 3311). See also Regulatory Publication and Review Under
the Economic Growth and Regulatory Paperwork Reduction Act of 1996,
90 FR. 35241 (Jul. 25, 2025).
\4\ Other recent initiatives to modernize the capital framework
include the finalized changes to the enhanced supplementary leverage
ratio standards, which would reinforce the role of leverage
requirements as a backstop to risk-based capital requirements and
address unintended incentive effects (see 90 FR 55248 (Dec. 1,
2025); the community bank leverage ratio proposal, which would
reduce regulatory burden while continuing to ensure the safety and
soundness of community banks (see 90 FR 55048 (Dec. 1, 2025); and
recent proposals to revise the Board's stress testing framework,
which would improve its transparency and reduce excess volatility in
the stress capital buffer requirement (see 90 FR 16843 (Apr. 22,
2025) and 90 FR 51856 (Nov. 18, 2025)).
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Requirements under the proposal would generally be consistent with
international capital standards issued by the Basel Committee on
Banking Supervision (Basel Committee).\5\ Where appropriate, however,
the proposal may differ from the standards published by the Basel
Committee (Basel standards) to reflect specific characteristics of U.S.
markets, requirements under U.S. generally accepted accounting

[[Page 14955]]

principles (GAAP),\6\ practices of U.S. banking organizations, and U.S.
statutory mandates and policy objectives. For example, the proposal
would remove the current requirement to deduct mortgage servicing
assets (MSAs) from regulatory capital and instead subject all MSAs to a
250 percent risk weight. This aspect of the proposal is intended to
remove a regulatory disincentive for residential mortgage servicing and
origination, reducing impacts on broader policy objectives regarding
the U.S. housing market.
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\5\ 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. The
consolidated Basel framework is available at <a href="https://www.bis.org/basel_framework/">https://www.bis.org/basel_framework/</a>. For additional discussion of the revisions to the
Basel framework with which this proposal would align, see also
<a href="https://www.bis.org/bcbs/publ/d424.htm">https://www.bis.org/bcbs/publ/d424.htm</a>, <a href="https://www.bis.org/bcbs/publ/d457.htm">https://www.bis.org/bcbs/publ/d457.htm</a>, and <a href="https://www.bis.org/bcbs/publ/d507.htm">https://www.bis.org/bcbs/publ/d507.htm</a>.
\6\ GAAP often serve as a foundational measurement component for
U.S. capital requirements. See also 12 U.S.C. 1831n (generally
requiring that financial reports required by the agencies from
banking organizations use U.S. GAAP).
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The agencies expect that the proposal would increase the common
equity tier 1 capital requirements of Category I and II holding
companies by about 1.2 percent, while decreasing corresponding
requirements for Category I and II subsidiary depository institutions
by 5.1 percent.\7\ Together with the GSIB surcharge proposal and the
stress testing changes proposed in October 2025,\8\ the Board expects
that the common equity tier 1 capital requirements for Category I and
II holding companies would decline by 5.0 percent (see section VII for
additional discussion of capital impact).\9\ The agencies performed
extensive economic analysis to assess the potential effects of the
proposal, including together with related proposals (see section VIII).
The improvements in risk sensitivity, simplicity, transparency and
consistency of risk-based capital requirements expected to result from
the proposal justify its expected costs.
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\7\ The revisions introduced by the proposal to the calculation
of risk-weighted assets would also modify Category I bank holding
companies' total loss-absorbing capacity (TLAC) requirements and
long-term debt requirements.
\8\ See 90 FR 51856 (Nov. 18, 2025).
\9\ A banking organization for which the Board is the primary
Federal supervisor must maintain capital ratios above the sum of its
minimum requirements and buffer requirements to avoid restrictions
on capital distributions and discretionary bonus payments.
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The agencies seek comment on all aspects of the proposal.\10\
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\10\ In 2023, the agencies published a proposal to revise the
capital rule based on the Basel Committee framework. 88 FR 64028
(Sept. 18, 2023). The agencies are rescinding the 2023 proposal.
Members of the public that seek to submit comments on the current
proposal must submit comments in line with the procedures described
in this proposal.
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A. Statutory Authority

Congress has authorized the agencies to establish risk-based
capital requirements and standards for banking organizations subject to
this proposal. Section 165 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (Dodd-Frank Act),\11\ as amended by section 401
of the Economic Growth, Regulatory Relief, and Consumer Protection
Act,\12\ requires the Board to establish enhanced prudential standards
that include risk-based capital requirements for bank holding companies
with $250 billion or more in total consolidated assets.\13\ The prompt
corrective action framework in section 38 of the Federal Deposit
Insurance Act (FDI Act) requires the agencies to prescribe capital
standards for insured depository institutions that include a risk-based
capital requirement and provides that the agencies may establish any
additional relevant capital measures to carry out the purpose of that
section.\14\ Various other statutory authorities provide the agencies
with broad discretionary authority to set capital requirements and
standards for banking organizations supervised by the agencies,
including national banking associations, state-chartered banks, savings
associations, and depository institution holding companies.\15\
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\11\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Public Law 111-203, 124 Stat. 1376 (2010).
\12\ Economic Growth, Regulatory Relief, and Consumer Protection
Act, Public Law 115-174, 132 Stat. 1296 (2018).
\13\ See 12 U.S.C. 5365(a)(1), (b)(1)(A)(i). Section 165 of the
Dodd-Frank Act also provides that the Board may apply any prudential
standard established under section 165 to any bank holding company
with $100 billion or more in total consolidated assets to which the
prudential standard does not otherwise apply, under certain
circumstances. 12 U.S.C. 5365(a)(2)(C). Section 165, in relevant
part, also applies to foreign banks or companies that are treated as
a bank holding company for purposes of the Bank Holding Company Act.
See 12 U.S.C. 3106(a), 5311(a)(1). See also section 401(g) of the
Economic Growth, Regulatory Relief, and Consumer Protection Act
(regarding the Board's authority to establish enhanced prudential
standards for foreign banking organizations with total consolidated
assets of $100 billion or more). 12 U.S.C. 5365 note.
\14\ See 12 U.S.C. 1831o(c)(1)(A), (c)(1)(B)(i).
\15\ See 12 U.S.C. 93a (national banking associations); 12
U.S.C. 248(i), 324, 327, 329 (state member banks); 12 U.S.C. 1463
(savings associations); 12 U.S.C. 1467a(g)(1) (savings and loan
holding companies); 12 U.S.C. 1844(b) (bank holding companies); 12
U.S.C. 3106 (certain U.S. operations of foreign banking
organizations); 12 U.S.C. 3902(1)-(2), 3907(a), 3909(a), (c)(1)-(2)
(depository institutions; affiliates of depository institutions,
including holding companies; and certain U.S. operations of foreign
banking organizations); 12 U.S.C. 5371 (insured depository
institutions, depository institution holding companies, and nonbank
financial companies supervised by the Board). Additional statutory
authorities relevant to the agencies' capital rule can be found in
the authority citations in the capital rule. See 12 CFR part 3
(OCC); 12 CFR part 217 (Board); 12 CFR part 324 (FDIC).
---------------------------------------------------------------------------

B. Objectives of the Proposal

The proposal aims to improve the capital framework for covered
banking organizations by enhancing its risk sensitivity, reducing
complexity, and improving transparency and consistency.
Risk sensitivity is a core feature of risk-based capital
requirements. The proposed framework aims to improve the alignment of
regulatory capital requirements with the risks presented by banking
organizations' exposures. Such alignment could help promote safe and
sound banking organizations that can lend through a range of economic
conditions.
To further improve the capital framework, the proposal seeks to
reduce complexity by simplifying its overall design. Redundant or
unnecessarily complex requirements, such as multiple risk-based capital
frameworks applying to the same banking organization, add costs that
outweigh any incremental benefits presented by such an approach,
whereas a simpler framework reduces compliance burden and strengthens
transparency. Clear and transparent requirements support safety and
soundness by making it easier for supervisors, investors, and other
stakeholders to assess the financial condition of banking
organizations. A central element of the proposal's effort to reduce
redundancy is better integration with the Board's stress testing
framework, which is achieved by considering jointly the calibrations of
this proposal and the proposed stress test model changes that would
inform stress capital buffer requirements.
The proposal would also promote consistency. Consistent capital
requirements hold banking organizations with similar risk profiles to
similar standards, thereby reducing unwarranted divergence. Consistency
is also valuable internationally. The proposal is generally aligned
with the Basel standards, with some differences as discussed in section
II.F of this Supplementary Information. Broadly consistent regulatory
frameworks should reduce complexity and compliance costs for banking
organizations with cross-border operations, including both U.S. banking
organizations operating abroad and foreign banking organizations
operating in the United States.
By improving risk-based capital requirements, the proposal would
bolster the role of large U.S. banking organizations in supporting the
broader economy. The reforms that followed the 2007-09 financial crisis
substantially increased the resilience of the U.S.

[[Page 14956]]

banking system. However, in some cases, these post-crisis reforms have
imposed burdens that contributed to the migration of some activities,
such as mortgage origination and servicing, outside of the regulated
banking sector.\16\ Revising the regulatory capital framework to better
align requirements with risks--and in so doing easing requirements on
some lower-risk, traditional banking activities--would contribute to
U.S. banking organizations becoming better positioned to support the
economy.
---------------------------------------------------------------------------

\16\ According to the 2024 Financial Stability Oversight Council
report on nonbank mortgage servicing, nonbank mortgage companies
originated approximately two-thirds of mortgages in the United
States and owned the servicing rights on 54 percent of mortgage
balances in 2022. In 2008, nonbank mortgage companies only accounted
for 39 percent of mortgage originations and owned the servicing
rights on 4 percent of mortgage balances. See page 3 FSOC Report on
Nonbank Mortgage Servicing 2024 at <a href="https://home.treasury.gov/system/files/261/FSOC-2024-Nonbank-Mortgage-Servicing-Report.pdf">https://home.treasury.gov/system/files/261/FSOC-2024-Nonbank-Mortgage-Servicing-Report.pdf</a>.
---------------------------------------------------------------------------

C. Overview of the Proposal

The proposal would streamline the risk-based capital requirements
applicable to Category I and II banking organizations. Currently, these
banking organizations are subject to two sets of risk-based capital
ratio requirements: one based on the standardized approach (which also
generally applies to other banking organizations) and the other based
on an internal models framework, the advanced approaches.\17\ Under the
proposal, Category I and II banking organizations would be subject to a
single set of risk-based capital ratio requirements based on the
``expanded risk-based approach''--which would include requirements for
credit risk, equity risk, and operational risk--and the revised market
risk framework.\18\ The standardized approach would no longer apply to
these banking organizations, and the advanced approaches would be
removed from the regulatory capital framework. As discussed further
below, other banking organizations could choose to adopt the expanded
risk-based approach that would be required for Category I and II
banking organizations.
---------------------------------------------------------------------------

\17\ See 12 CFR part 3, subparts D and E (OCC); 12 CFR part 217,
subparts D and E (Board); 12 CFR part 324, subparts D and E (FDIC).
\18\ For purposes of this discussion, unless otherwise noted,
the revised market risk framework is inclusive of requirements for
credit valuation adjustment risk, as applicable.
---------------------------------------------------------------------------

The expanded risk-based approach is a standardized framework that
would promote the simplicity, risk sensitivity, transparency, and
consistency objectives of the proposal. This approach would improve
risk sensitivity relative to the current standardized approach by
varying capital requirements according to several new risk factors,
such as loan-to-value ratios for real estate exposures, repayment
history for retail exposures, and assessed creditworthiness for
corporate exposures. Unlike the current standardized approach, the
expanded risk-based approach would include a specific operational risk
capital requirement. This difference, in part, supports the different
calibration of credit risk weights under the expanded risk-based
approach relative to the risk weights under the standardized approach.
The proposal would also revise the market risk framework, which
would be applicable to Category I and II depository institution holding
companies and to other banking organizations with significant trading
activity. Significant trading activity would be defined to mean (1)
more than $5 billion in trading activity or (2) trading activity equal
to or higher than 10 percent of the banking organization's total
assets. The new framework would improve risk sensitivity and
consistency by revising the models-based approach for market risk and
introducing a standardized approach for market risk. To reduce burden
without a meaningful loss in resilience, the proposal would raise the
threshold for applicability of the market risk framework from having
trading activity of at least $1 billion to having trading activity of
at least $5 billion.
As part of the revised market risk framework, the proposal would
include a risk-sensitive and consistent framework for capturing the
risks associated with credit valuation adjustment risk for derivative
exposures.\19\ This framework would apply to (1) Category I and II
depository institution holding companies, (2) depository institutions
that are subsidiaries of Category I or II depository institution
holding companies and have significant trading activity, and (3) other
banking organizations with significant trading activity that also have
at least $1 trillion in notional derivative exposure.
---------------------------------------------------------------------------

\19\ Credit valuation adjustment risk is the exposure to changes
in the valuation of derivative contracts driven by changes in
counterparty credit risk.
---------------------------------------------------------------------------

The proposal would retain banking organizations' ability to use
internal models, with supervisory approval, to calculate market risk
capital requirements. Market risk is more effectively modeled than
credit and operational risk because relevant data is observed at a much
higher frequency and depth, providing the basis for both model
calibration and empirical verification of model appropriateness.
The agencies consider the proposed requirements under the expanded
risk-based approach to be appropriate for Category I and II banking
organizations given their risk profiles, complexity, risk management
resources, and international activities. The agencies recognize that
the risk-sensitive requirements under the expanded risk-based approach
may appeal to other banking organizations with certain business models
and risk management systems. Therefore, the proposal would allow other
banking organizations to elect to use the expanded risk-based approach.
Banking organizations that choose this option would also be subject to
the definition of capital that applies to Category I and II banking
organizations.\20\
---------------------------------------------------------------------------

\20\ This definition of capital would include the requirement to
reflect accumulated other comprehensive income in regulatory capital
and to use the deductions framework that applies to Category I and
II banking organizations.
---------------------------------------------------------------------------

In addition to the changes to the calculation of risk-weighted
assets, the proposal would change the definition of regulatory capital
applicable to Category I and II banking organizations by removing the
threshold-based deduction for mortgage servicing assets. Thus, all
mortgage servicing assets would receive a 250 percent risk weight under
the proposal, consistent with the risk weight in the current capital
rule for MSAs that do not exceed the deduction thresholds. This
proposed revision would eliminate a strong disincentive for mortgage
origination and mortgage servicing by banking organizations.
The proposal would also amend certain dollar-based regulatory
thresholds, where appropriate, to reflect inflation and ensure that
such thresholds preserve their intended application in real terms over
time.\21\ Consistent with this proposal, the agencies are reviewing
other thresholds throughout out the regulatory framework.
---------------------------------------------------------------------------

\21\ Certain thresholds in FDIC regulations are also indexed to
reflect inflation. See 90 FR 55789 (Dec. 1, 2025).
---------------------------------------------------------------------------

Finally, the proposal would revise disclosure requirements to
facilitate market participants' understanding of the financial
condition and risk management practices of banking organizations
subject to the expanded risk-based approach.\22\ In addition, to align
with these revisions, the agencies anticipate proposing revisions to
the

[[Page 14957]]

reporting forms of the Federal Financial Institutions Examination
Council (FFIEC) that would apply to covered banking organizations.
---------------------------------------------------------------------------

\22\ The disclosure requirements would only apply to the top
tier of a consolidated banking organization.
---------------------------------------------------------------------------

In a separate rulemaking, the agencies are proposing modifications
to the standardized approach risk-based capital requirements
(standardized approach proposal), which would apply to banking
organizations that do not use the expanded risk-based approach. Also,
the Board is separately issuing a notice of proposed rulemaking that
would revise the U.S. global systemically important banking holding
company (GSIB) surcharge calculation applicable to Category I bank
holding companies and the systemic risk report applicable to large
holding companies (GSIB surcharge proposal).
Question 1: The agencies invite comment on the interaction of the
revisions in the proposal with other existing rules and with other
notices of proposed rulemaking.
Question 2: What would be an appropriate amount of time between the
publication of any final rule and its effective date, and why?

II. Scope, Design, and Other Overarching Issues

A. Scope of Application

The proposal would require Category I and II banking organizations
to use the expanded risk-based approach. These banking organizations
present substantial systemic risks due to their size, complexity,
interconnectedness, and cross-jurisdictional activity. Application of
the expanded risk-based approach to them would provide granular, risk-
sensitive, and standardized requirements that align with international
standards.
While the expanded risk-based approach was designed for application
to banking organizations that operate globally across multiple business
lines, such as Category I and II banking organizations, the agencies
are aware that the more differentiated treatments for traditional
banking exposures such as mortgage, corporate, and retail exposures may
appeal to certain smaller banking organizations. Therefore, the
proposal would provide all banking organizations subject to the capital
rule with the option of adopting the expanded risk-based approach in
its entirety.
Under the proposal, a banking organization that chooses to adopt
the expanded risk-based approach would become subject to the same
definition of capital as Category I and II banking organizations and,
therefore, be required to reflect most elements of accumulated other
comprehensive income in regulatory capital even if it subsequently
changes to the standardized approach. This is consistent with the one-
time election to recognize accumulated other comprehensive income in
regulatory capital in the current standardized approach and avoids
changes in accumulated other comprehensive income recognition based on
interest rate cycles. For a banking organization that chooses to adopt
the proposed expanded risk-based approach, the inclusion of most
elements of other accumulated other comprehensive income in regulatory
capital would be subject to a transition period of five years from the
effective date of any final rule.\23\
---------------------------------------------------------------------------

\23\ This transition period would mirror the transition period
under the standardized approach proposal provided to Category III
and IV banking organizations that do not currently recognize
accumulated other comprehensive income in regulatory capital.
---------------------------------------------------------------------------

To align with a banking organization's annual capital planning
processes, any change in election between the expanded risk-based
approach and the standardized approach would take effect 12 months
after the date on which the banking organization provides written
notice of the change in election to its primary Federal supervisor.
This requirement would help ensure that any change in election reflects
structural balance sheet considerations and not short-term capital
reductions.
Banking organizations with significant trading activities face an
elevated level of market risk and, therefore, would continue to be
subject to the market risk framework. The proposal would increase the
current dollar-based threshold for the application of market risk
capital requirements from $1 billion to $5 billion or more of trading
assets and trading liabilities. The proposal would also 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 would continue to be
subject to market risk capital requirements if their trading assets and
trading liabilities represent 10 percent or more of total assets.
Banking organizations that do not meet the thresholds for being subject
to market risk capital requirements would calculate risk-weighted
assets for trading exposures under the standardized approach or the
expanded risk-based approach, as applicable. Additionally, under the
proposal, Category I and II depository institution holding companies
would be subject to market risk capital requirements regardless of the
amount of their trading activities.
The proposal would apply capital requirements for credit valuation
adjustment risk to all Category I and II depository institution holding
companies, as well as to their subsidiary depository institutions that
are subject to the market risk framework. In addition, capital
requirements for credit valuation adjustment risk would apply to other
banking organizations subject to the market risk framework that have
over-the-counter derivative notional amounts of $1 trillion or more.
Due to their substantial derivative portfolios, these banking
organizations have meaningful exposure to losses resulting from changes
to their credit valuation adjustment accounting reserve. This threshold
aims to balance coverage of credit valuation adjustment risk and
burden. According to data reported in the FR Y-9C form, depository
institution holding companies above this threshold accounted for over
98 percent of the over-the-counter derivative exposures of depository
institution holding companies as of 2025Q2.
Question 3: What are the advantages and disadvantages of the
proposed scope of application of the expanded risk-based approach?
Question 4: What are the advantages and disadvantages of allowing
all banking organizations to adopt the expanded risk-based approach?
What are the challenges associated with adopting the expanded risk-
based approach for Category III, IV, and smaller banking organizations?
To what extent would this optionality limit the transparency and
consistency of the risk-based capital requirements? What limitations or
restrictions on how frequently a banking organization could switch from
the expanded risk-based approach to the standardized approach and vice
versa should the agencies include and why?

B. Single Set of Risk-Based Requirements

Under the proposal, banking organizations would be subject to a
single set of risk-based capital ratio requirements.\24\ This contrasts
with the current framework, which requires Category I and II banking
organizations to calculate two sets of risk-based capital ratios: one
using the standardized approach and the other

[[Page 14958]]

using the internal models-based advanced approaches. By employing risk-
sensitive, simplified, consistent, and transparent requirements,
aligned with international standards, the expanded risk-based approach
would result in an appropriate stand-alone requirement.
---------------------------------------------------------------------------

\24\ This revision would be consistent with comments received
under EGRPRA as commenters requested that banking organizations be
required to calculate risk-weighted assets under a single approach.
---------------------------------------------------------------------------

The capital conservation buffer requirement would apply to the
risk-based capital ratios of Category I and II banking organizations in
the same manner as it currently applies to the standardized approach
ratios. For Category I depository institution holding companies, the
capital conservation buffer requirement would continue to consist of
the stress capital buffer requirement, the countercyclical capital
buffer (if activated), and the GSIB surcharge. For Category II
depository institution holding companies, the capital conservation
buffer would continue to consist of the stress capital buffer
requirement plus the countercyclical capital buffer (if activated). For
the subsidiary depository institutions of Category I or II depository
institution holding companies, the capital conservation buffer
requirement would continue to equal 2.5 percent plus the
countercyclical capital buffer requirement (if activated).

C. Removal of Internal Models for Credit and Operational Risk

The proposal would eliminate the advanced approaches framework and
introduce in its place the expanded risk-based approach to improve the
consistency and transparency of the risk-based capital requirements
applicable to Category I and II banking organizations. This approach
would help address many of the challenges associated with the use of
internal models to calculate risk-based capital requirements for credit
risk and operational risk.
In 2007, the agencies jointly issued a final rule requiring large,
internationally active banking organizations to calculate risk-based
capital requirements for credit risk and operational risk under the
advanced approaches.\25\ In seeking to ensure that these banking
organizations are adequately capitalized, the advanced approaches
require banking organizations to estimate their exposure to severe
unexpected losses.\26\ However, available information since adoption of
this rule suggests that the advanced approaches do not always result in
consistent minimum requirements across U.S. banking organizations with
similar risk profiles.\27\ While internal models to calculate risk-
based capital requirements for credit risk and operational risk do
provide valuable information and may be more accurate in some cases
than standardized approaches, as discussed below the severity of the
outcomes the advanced approaches rule requires banking organizations to
model coupled with data limitations and the subjectivity embedded in
modeling assumptions has presented substantial challenges.
---------------------------------------------------------------------------

\25\ See Risk-Based Capital Standards: Advanced Capital Adequacy
Framework--Basel II, 72 FR 69288 (Dec. 7, 2007). The agencies
subsequently revised certain aspects of the advanced approaches
framework in the rulemakings that established the current capital
rule. See 78 FR 62018 (Oct. 11, 2013).
\26\ For both credit risk and operational risk, the advanced
approaches capital requirements aimed to cover the risk of loss over
a one-year window at the 99.9th percentile level. See 72 FR 69288
(Dec. 7, 2007); 12 CFR part 3 (OCC); part 217 (Board); part 324
(FDIC).
\27\ See, e.g., Tobias Berg, and Philipp Koziol ``An analysis of
the consistency of banks' internal ratings,'' Journal of Banking and
Finance 78, 27-41 (2017), <a href="https://dx.doi.org/10.1016/j.jbankfin.2017.01.013">https://dx.doi.org/10.1016/j.jbankfin.2017.01.013</a>; and Barbora Stepankova, and Petr Teply,
``Consistency of Banks' Internal Probability of Default Estimates:
Empirical Evidence from the COVID-19 crisis,'' Journal of Banking
and Finance 154, 106969 (2023), <a href="https://doi.org/10.1016/j.jbankfin.2023.106969">https://doi.org/10.1016/j.jbankfin.2023.106969</a>.
---------------------------------------------------------------------------

Financial risk models designed to capture severe loss events can
suffer from substantial uncertainty.\28\ Such uncertainty can result in
substantial and unwarranted differences in capital requirements across
similar exposures that are unrelated to differences in risk.
---------------------------------------------------------------------------

\28\ See Jon Danielsson, ``Blame the Models,'' Journal of
Financial Stability, 321-28 (2008), <a href="https://doi.org/10.1016/j.jfs.2008.09.003">https://doi.org/10.1016/j.jfs.2008.09.003</a>.
---------------------------------------------------------------------------

The advanced approaches require banking organizations to estimate
loss given default conditional on an economic downturn. Ensuring that
banking organizations' loss given default estimates are consistent with
the risk of their exposures has proven challenging for several reasons,
including (1) limited data on loss given default and its drivers under
downturn conditions; (2) inconsistencies in constructing the loss given
default variables, arising from factors such as methodological
differences and difficulties in capturing all cash inflows and outflows
after default;\29\ and (3) difficulty in verifying certain modeling
assumptions, such as the time window used to calculate loss given
default in an economic downturn. To a lesser degree, verifying the
appropriateness of banking organizations' probability of default models
is challenging in some cases due to limited data for certain low
default portfolios and varying practices in identifying defaults across
banking organizations.30 31
---------------------------------------------------------------------------

\29\ For example, horizontal supervisory reviews have found
material deviations in loss rates at different banking organizations
with respect to the same defaulted exposure.
\30\ For example, banking organizations have followed different
practices regarding whether to count technical defaults (which are
situations where the borrower failed to uphold an aspect of the loan
agreement but has not failed to make regularly scheduled payments)
as defaults for purposes of modeling probability of default.
\31\ Various analyses conducted by the Basel Committee, to which
the agencies contributed, demonstrated significant divergence across
banking organizations in credit risk-weighted assets calculated
under the internal models-based approaches that could not be
explained by differences in the riskiness of banking organizations'
portfolios. 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>.
---------------------------------------------------------------------------

For operational risk, banking organizations subject to the advanced
approaches are required to estimate the 99.9th percentile of the
distribution of the aggregated annual operational losses under the
advanced measurement approaches (AMA). This requirement has presented
substantial challenges for banking organizations and supervisors as a
considerable amount of relevant data would be needed to empirically
verify model performance. Given the severe outcome that the requirement
is designed to estimate, model and parameter uncertainty can result in
substantial divergence in model outcomes and, consequently, substantial
divergence in capital requirements.\32\ In addition, infrequent large
operational loss events tend to have substantial influence on model
outcomes and can result in substantial volatility.\33\ Together, these
factors result in substantial uncertainty in internally modeled
operational risk capital requirements and likely inconsistent
requirements across banking organizations with similar operational risk
profiles.
---------------------------------------------------------------------------

\32\ See G. Mignola, and R. Ugoccioni, ``Sources of Uncertainty
in Modeling Operational Risk Losses,'' Journal of Operational Risk
1(2): 33-50 (2006); J. Ne[scaron]lehov[aacute], P. Embrechts, and V.
Chavez-Demoulin, ``Infinite Mean Models and the LDA for Operational
Risk,'' Journal of Operational Risk 1(1): 3-25 (2006); and E. Cope,
G. Mignola, G. Antonini, and R. Ugoccioni, ``Challenges and Pitfalls
in Measuring Operational Risk from Loss Data,'' Journal of
Operational Risk 4(4): 3-27 (2009).
\33\ See E. Cope, G. Mignola, G. Antonini, and R. Ugoccioni,
``Challenges and Pitfalls in Measuring Operational Risk from Loss
Data'' Journal of Operational Risk 4(4): 3-27 (2009); and J. Opdyke,
and A. Cavallo, ``Estimating Operational Risk Capital: The
Challenges of Truncation, the Hazards of Maximum Likelihood
Estimation, and the Promise of Robust Statistics,'' Journal of
Operational Risk 7(3): 3-90 (2012).
---------------------------------------------------------------------------

Taken together, the severe outcomes that the advanced approaches
rule expects banking organizations to model, the limitations of
available data, and the subjectivity of modeling assumptions

[[Page 14959]]

contribute to concerns about the reliability of internal model outputs
and unwarranted divergences in risk-based capital requirements for
credit and operational risk across banking organizations.
The application of the stress capital buffer requirement to
Category I and II bank holding companies also reduces the usefulness of
retaining the advanced approaches for these banking organizations.
Under the proposal, the stress capital buffer requirement would apply
to the single set of risk-based capital ratios to which these bank
holding companies would be subject, providing risk-sensitive capital
requirements that reflect a granular, forward-looking assessment of
risks. In this context, removing the advanced approaches simplifies the
framework without reducing the resilience of Category I and II bank
holding companies.
Under the current capital rule, banking organizations are required
to maintain capital commensurate with the level and nature of all risks
to which they are exposed \34\ and to have a process for assessing
their overall capital adequacy in relation to their risk profile and a
comprehensive strategy for maintaining an appropriate level of
capital.\35\ In addition, certain large banking organizations are
required to develop and maintain a capital plan \36\ and conduct
internal stress tests.\37\ The proposal would not change these
requirements. As discussed above, the advanced approaches have
limitations as a means to set consistent minimum risk-based capital
requirements. However, internal models can provide valuable information
to a banking organization's internal risk management, stress testing,
and planning functions and can be used to complement minimum capital
requirements in assessing a banking organization's capital adequacy.
Category I and II banking organizations, as well as other banking
organizations, should continue to employ internal modeling capabilities
for sound risk management as appropriate for the complexity of their
activities.
---------------------------------------------------------------------------

\34\ See 12 CFR 3.10(e)(1) (OCC); 12 CFR 217.10(e)(1) (Board);
12 CFR 324.10(e)(1) (FDIC).
\35\ See 12 CFR 3.10(e)(2) (OCC); 12 CFR 217.10(e)(2) (Board);
12 CFR 324.10(e)(2) (FDIC).
\36\ See 12 CFR 225.8; 12 CFR 238.170.
\37\ See 12 CFR part 46 (OCC); 12 CFR part 238, subparts P and
R, and 12 CFR part 252, subparts B and F (Board); 12 CFR part 325
(FDIC).
---------------------------------------------------------------------------

The proposal would continue to allow the use of internal models to
calculate market risk capital requirements, but only for trading desks
where modeling can be demonstrated to be appropriate. Market risk is
more easily and effectively modeled than credit and operational risk
because data on trading positions are observed at a much higher
frequency and depth, in particular for commonly traded instruments.
Trading creates price observations, which in turn provide daily
feedback on model calibration and performance to support empirical
verification through techniques such as back-testing. For these
reasons, the benefits of retaining models are larger for market risk
than for other exposure types.
Question 5: What are the advantages and disadvantages of removing
internal models for credit risk and operational risk? Are there
alternatives that the agencies should consider and if so, why?
Question 6: The Basel standards include a floor to risk-weighted
assets, the ``output floor,'' which corresponds to 72.5 percent of
risk-weighted assets calculated only using standardized approaches. The
proposal would not include this output floor because proposed
requirements would be almost completely standardized and, therefore,
the output floor would be unlikely to bind in most situations. What
would be the advantages and disadvantages of including a floor to risk-
weighted assets corresponding to 72.5 percent of the risk-weighted
assets calculated using only the standardized approaches in the
proposal.

D. Overlaps With the Stress Capital Buffer Requirement

In proposing these revised risk-based capital requirements for
Category I and II banking organizations, the Board is mindful of the
overlaps between the capital and stress testing frameworks. Together,
this proposal and a recent proposal to enhance the transparency and
public accountability of the Board's stress test,\38\ which requested
public comment on certain revisions to the Board's stress test models,
aim to improve risk sensitivity of requirements in a way that considers
the cumulative effect of the entire capital framework.
---------------------------------------------------------------------------

\38\ See Enhanced Transparency and Public Accountability of the
Supervisory Stress Test Models and Scenarios; Modifications to the
Capital Planning and Stress Capital Buffer Requirement Rule,
Enhanced Prudential Standards Rule, and Regulation LL, 90 FR 51856
(Nov. 18, 2025).
---------------------------------------------------------------------------

The stress capital buffer requirement represents an explicitly
forward-looking element in the risk-based capital requirements of large
bank holding companies. Informed by the Board's stress testing
framework, the stress capital buffer requirement aims to capture
exposures comprehensively and granularly under conditions of severe
stress.
Under the current rule, a bank holding company's stress capital
buffer requirement is applied to its risk-based capital ratios
calculated under the standardized approach, which do not include a
specific requirement for operational risk, and is not applied to the
bank holding company's requirements under the advanced approaches. This
historical choice was motivated, in part, by the goal of limiting
redundancy between the stress capital buffer requirement, based on the
Board's forward-looking assessment of stress risks, and the bank
holding company's modeling of tail risks under the advanced
approaches.\39\
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\39\ ``In addition, both the supervisory stress test and the
advanced approaches are calibrated to reflect tail risks; thus it
could be duplicative to require a firm to meet the requirements of
the advanced approaches on a post-stress basis.'' 83 FR 18160 (Apr.
25, 2018).
---------------------------------------------------------------------------

Consistent with international standards, the proposed expanded
risk-based approach would include a specific measure of operational
risk in risk-weighted assets. Also, the proposed changes to the market
risk framework would improve the measurement of tail risks in ways that
are expected to raise minimum market risk capital requirements for the
most complex banking organizations.
The outstanding Board stress testing proposal would introduce
meaningful revisions to stress test models and scenarios, including the
models for operational risk and trading positions. Operational risk
modeling would be enhanced by focusing on the more robust historical
simulation model. Similarly, the stress test proposal would improve the
modeling of trading positions under the global market shock component
of the severely adverse scenario by better measuring their liquidity
horizons. Both proposed revisions, on their own and independent of
other factors, are projected to somewhat reduce aggregate projected
stress capital buffer requirements.\40\
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\40\ As the Board noted in October 2025, in aggregate, the
proposed stress test model and scenario changes inform the Board's
determination of a firm's stress capital buffer requirement and are
not expected materially change capital requirements for firms
subject to the supervisory stress test, across various stress test
scenarios and jump-off conditions at the start of the test. That
proposal included illustrative analysis that considered the
potential effects of the proposed stress test model changes,
independent of other factors and components that inform the Board's
stress capital buffer determinations for specific firms, within the
2024 and 2025 supervisory stress tests. In that analysis,
implementing the proposed model changes and proposed revisions to
the global market shock component of the severely adverse scenario
in the 2024 and 2025 stress tests would have, independent of other
factors, increased the aggregate projected common equity tier 1
(CET1) stress ratio, on average, by 29 basis points, which would
have corresponded to a reduction in stress capital buffer
requirements of approximately 23 basis points or approximately 2.2
percent of current required capital. See 90 Federal Register 51856,
51874-51877 (Nov. 18, 2025). The analysis estimates that the
proposed model changes would reduce stress capital buffer
requirements by approximately 13 basis points and that the proposed
revisions to the global market shock scenario component would reduce
stress capital buffer requirements by approximately 10 basis points.
For U.S. GSIBs, the analysis estimates a decline of 25 basis points
in stress capital buffer requirements. See also Federal Reserve
Board--Federal Reserve Board requests comment on proposals to
enhance the transparency and public accountability of its annual
stress test; Dodd-Frank Act Stress Tests 2026 (Dec. 1, 2025).

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[[Page 14960]]

In summary, this proposal is projected to increase the minimum
requirements for operational risk and market risk, while the stress
test proposal's analysis of the proposed model changes estimated a
decrease in related requirements for these risks, as they inform the
stress capital buffer requirement. The Board expects both sets of
revisions to improve risk sensitivity and coherence of the capital
framework, while the revisions in this proposal would contribute to
international consistency. The capital impact of these revisions would
largely offset each other, and the Board considers that the combined
calibration of these risks would be appropriate (see section VII for
additional analysis of the cumulative calibration of requirements by
risk type).
Question 7: The current Board stress testing methodology reflects a
constant balance sheet assumption and assumes that a banking
organization's risk-weighted assets generally remain unchanged over the
nine-quarter projection horizon. What would be the advantages and
disadvantages of adjusting the stress testing methodology to project
changes in risk-weighted assets for banking organizations subject to
the expanded risk-based approach and banking organizations subject to
the market risk framework? For example, what would be the advantages
and disadvantages of projecting changes in the risk-weighted assets
applicable to credit exposures to better reflect deteriorations in
obligors' credit quality during a stress period (such as migrating
corporate exposures in the investment grade 65 percent risk weight
category into the general corporate category or from the general
corporate category into the past due category)? What would be the
advantages and disadvantages of adjusting risk-weighted assets for
operational risk by projecting lower income amounts during a stress
period? What, if any, changes should the Board consider to better
project risk-weighted assets for trading positions and derivatives
during a stress period in light of the proposed market risk framework,
including the proposed credit valuation adjustment risk requirement
(these may include revisions to reflect changes in modelability of risk
factors and volatility)?

E. Indexing of Thresholds

The proposal uses certain thresholds to differentiate requirements
based on a banking organization's size, risk profile, and complexity as
well as on the characteristics of the exposures. However, static
dollar-based thresholds can lead to unintended consequences if
threshold levels are not periodically updated or indexed to inflation.
For example, banking organizations can become subject to additional
requirements and burden over time for reasons unrelated to changes in
their risk profile. Under the proposal, certain dollar-based thresholds
would be adjusted in the future to reflect inflation, pursuant to a
pre-determined indexing methodology.\41\ Indexing dollar-based
thresholds would preserve threshold levels in real terms, which would
efficiently and transparently preserve the thresholds' intended
application and align with intended policy objectives over time.
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\41\ This revision would also be consistent with comments
received under EGRPRA as commenters requested indexing of thresholds
going forward to reflect inflation.
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The proposed indexing methodology would adjust thresholds based on
the consumer price index for urban wage earners and clerical workers
(CPI-W) published by the U.S. Bureau of Labor Statistics. The use of
CPI-W to index thresholds is consistent with other bank regulations,
such as those relating to the Community Reinvestment Act and the
Board's Regulation CC.\42\ Further, the indexing methodology included
under the proposal would generally align with the methodology used to
adjust certain thresholds within FDIC regulations.\43\ Specifically,
certain dollar thresholds would be adjusted at the end of every
consecutive two-year period based on the cumulative percent change of
the non-seasonally adjusted CPI-W since the effective date of any final
rule. This two-year period is intended to provide an appropriate
cadence for capturing meaningful changes in inflation on a timely basis
while minimizing the burden of adjustment. To address the possibility
of periods of unusual inflation, the indexing methodology would also
allow for discretionary adjustment to thresholds by the agencies during
an off year. The proposal would also not lower thresholds in the event
of deflation.\44\ Additionally, thresholds adjusted under the proposed
indexing methodology would be rounded based on the size of the
threshold (e.g., billions, millions, thousands), generally, to the
nearest two significant digits, as appropriate.\45\
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\42\ The agencies' regulations that implement the Community
Reinvestment Act define small and intermediate-small banks by
reference to asset-size criteria expressed in dollar amounts, which
are adjusted annually based on the year-to-year change in inflation
through a Federal Register notice. Specifically, this adjustment
corresponds to the average of the Consumer Price Index for Urban
Wage Earners and Clerical Workers, not seasonally adjusted, for each
12-month period ending in November, with rounding to the nearest
million. See, e.g., Community Reinvestment Act Regulations Asset-
Size Thresholds, 89 FR 106480, 106481 (Dec. 30, 2024). See also 12
CFR 229.11.
\43\ See Adjusting and Indexing Certain Regulatory Thresholds,
90 FR 55789 (Dec. 1, 2025).
\44\ Any periods of deflation would be reflected in future
threshold increases, as threshold adjustments in the future would be
based on the positive net cumulative change in CPI-W.
\45\ For example, a threshold that would otherwise be calculated
as $5.964 million would be rounded to $6.0 million, or the nearest
$0.1 million.
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The proposal would index the following thresholds: (1) the $1
million threshold for a retail exposure to qualify as regulatory
retail; (2) the $50 million annual revenue threshold for a borrower to
qualify as a small or medium-sized entity; (3) the $10 million
threshold used to determine whether a company in which a covered
banking organization owns equity instruments meets the definition of
financial institution; (4) the $1 billion and the $30 billion business
indicator thresholds that determine the marginal coefficients
applicable for the calculation of the business indicator component in
the operational risk capital requirement; (5) the $20,000 threshold for
mandatory collection of operational loss events; (6) the $5 billion
trading activity threshold for application of the market risk
framework; (7) the $1 trillion derivatives exposure threshold for
application of the credit valuation adjustment risk requirement; (8)
the $20 million threshold above which net short positions must be
included in the market risk framework; and (9) the $2 billion threshold
for an equity issuer to be classified as having large market
capitalization in the market risk standardized approach.
To effectuate threshold changes under the proposal, the agencies
would announce threshold adjustments pursuant to the indexing
methodology by publishing the updated thresholds.

[[Page 14961]]

Threshold adjustments would be calculated based on cumulative CPI-W
data through August of the year in which the adjustment is made,
relative to the same initial baseline.\46\
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\46\ The U.S. Bureau of Labor Statistics publishes the CPI-W on
a monthly basis.
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Question 8: What are the advantages and disadvantages of the
proposed approach for indexing thresholds? What alternatives should the
agencies consider and why? What are the advantages and disadvantages of
using a different index for adjusting thresholds, such as nominal GDP
or the GDP deflator, instead of CPI-W?
Question 9: Are there specific thresholds within the proposal that
can result in an increase in operational burden when indexed? If so,
which are they and why?
Question 10: What are the advantages and disadvantages of
discretionary off-year adjustments for periods of unusual inflation?
Should the agencies consider a framework for adjustment in off years,
such as based on inflation or other threshold and, if so, why?

F. The Role of International Standards in Developing U.S. Capital
Requirements

The agencies participate in international fora, including the Basel
Committee, that support broadly aligned prudential financial regulation
across major economies, consistent with the agencies' mandates and
various statutory authorizations.\47\ Standards issued by these
international fora are not binding under U.S. law. The agencies
routinely consider the potential benefits of such standards as part of
a reasoned decision-making process when developing domestic rulemakings
to implement prudential requirements.
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\47\ See, e.g., 12 U.S.C. 1828 note, 3901, 3907, 3911, and 5373;
see also 22 U.S.C. 9522 note; Federal Deposit Insurance Corporation
Improvement Act of 1991 Sec. 305(b)(2), Public Law 102-242, 105
Stat. 2236, 2355.
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Where appropriate and consistent with the agencies' statutory
authorities and policy objectives, maintaining consistency between
domestic financial regulatory policy and international standards can
generate significant benefits, particularly regarding large,
internationally active banking organizations. Large, internationally
active banks and the U.S. financial system more broadly are highly
interconnected with the global financial system. Promoting the
application of suitable and robust prudential standards across
jurisdictions can enhance the resilience of the U.S. financial system
by reducing the likelihood of distress or other problems that arise in
a foreign jurisdiction having negative effects in the United
States.\48\
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\48\ The Basel Committee was originally formed after the failure
of Herstatt Bank in Germany in 1974, which contributed to serious
disruptions to foreign currency and banking markets within and
beyond Germany, demonstrating the need for better coordination among
bank regulators in different jurisdictions. See <a href="https://www.bis.org/bcbs/history.htm">https://www.bis.org/bcbs/history.htm</a>.
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Comparability of standards across jurisdictions can also reduce
complexity and compliance costs for banking organizations with
significant cross-border operations or activities.\49\ In particular,
similar prudential standards enable the agencies and foreign
supervisors to look to home country capital regimes when such
requirements are generally consistent with international standards.\50\
For example, similar prudential standards help to facilitate the
Board's assessment of the capital adequacy of foreign banking
organizations in connection with applications to establish operations
within the United States.\51\ In addition, consistent standards help
ensure that foreign banking organizations with U.S. operations are
subject to standards at the consolidated level that promote safety and
soundness and competitive equity with U.S. banking organizations. The
adoption of similar prudential standards across many jurisdictions
means that, consistent with section 165 of the Dodd-Frank Wall Street
Reform and Consumer Protection Act (Dodd-Frank Act),\52\ the Board's
enhanced prudential standards for large foreign banking organizations
may rely on the home country capital and stress testing regimes
applicable to a foreign banking organization, avoiding unnecessary
duplication of requirements.\53\ Additionally, comparability of
standards across jurisdictions helps home country and host country
supervisors, along with banking organization management and public
markets, understand and monitor positions and risks across
jurisdictions by providing all parties with a set of shared principles,
concepts, and measuring tools.\54\
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\49\ See GAO Report ``Bank Capital Requirements--Potential
Effects of New Changes on Foreign Holding Companies and U.S. Banks
Abroad'' (Jan. 2012), <a href="https://www.gao.gov/assets/gao-12-235.pdf">https://www.gao.gov/assets/gao-12-235.pdf</a>; see
also GAO Report ``International Banking--International Coordination
of Bank Supervision: The Record to Date'' (Feb. 1986), <a href="https://www.gao.gov/assets/nsiad-86-40.pdf">https://www.gao.gov/assets/nsiad-86-40.pdf</a>.
\50\ See, e.g., Board of Governors of the Federal Reserve System
and U.S. Department of the Treasury, ``Capital Equivalency Report''
(June 1992), <a href="https://fraser.stlouisfed.org/title/capital-equivalency-report-9009">https://fraser.stlouisfed.org/title/capital-equivalency-report-9009</a>; 12 U.S.C. 3105(j).
\51\ See, e.g., 12 CFR 211.24, 225.2(r)(3).
\52\ Public Law 111-203, 124 Stat. 1376 (2010). In applying
section 165 to a foreign-based bank holding company, the Dodd-Frank
Act directs the Board to give due regard to the principle of
national treatment and equality of competitive opportunity, and to
take into account the extent to which the foreign banking
organization is subject, on a consolidated basis, to home country
standards that are comparable to those applied to financial
companies in the United States. See 12 U.S.C. 5365(b)(2).
\53\ See, e.g., 12 CFR 252.143(a). Absent home-country standards
consistent with the Basel Capital Framework, a foreign banking
organization would be required to demonstrate to the Board's
satisfaction that it would meet Basel Capital Framework standards at
the consolidated level were those standards to apply. See 79 FR
17240 (Mar. 27, 2014).
\54\ See GAO Report ``International Banking--International
Coordination of Bank Supervision: The Record to Date'' (Feb. 1986),
<a href="https://www.gao.gov/assets/nsiad-86-40.pdf">https://www.gao.gov/assets/nsiad-86-40.pdf</a>.
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Notwithstanding these benefits, the agencies have, at various
times, concluded that departures from international standards are
appropriate and desirable in light of domestic requirements or
considerations, or where U.S. regulators simply believe different
standards are more appropriate. Consistent with previous rulemakings
that implemented aspects of the Basel standards in the United
States,\55\ the proposal may differ from the Basel standards in certain
areas to reflect factors such as specific characteristics of U.S.
markets, requirements under GAAP,\56\ practices of U.S. banking
organizations, and U.S. legal requirements and policy objectives.\57\
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\55\ For example, the GSIB surcharge framework adopted by the
Board includes a second method for calculating GSIB surcharges that
is different from the Basel GSIB surcharge methodology. See 80 FR
49082 (Aug. 14, 2015). Additionally, alignment with the Basel
standards can be achieved without using all methods specified in
them and, in the past, the agencies have chosen not to adopt some
methods included within the Basel standards. See, e.g., 61 FR 47358
(Sept. 6, 1996), 72 FR 69288 (Dec. 7, 2007), and 78 FR 62018 (Oct.
11, 2013).
\56\ See 12 U.S.C. 1831n.
\57\ See, e.g., 12 U.S.C. 1831bb and 5371; 15 U.S.C. 78o-7 note.
---------------------------------------------------------------------------

G. Treatments Retained From the Current Standardized Approach

Taking the current standardized approach as a starting point, the
proposal would generally adopt treatments consistent with the Basel
standards when they would improve the risk sensitivity and consistency
of the requirements applicable to covered banking organizations, do not
conflict with existing U.S. law, and are appropriate for U.S. banking
organizations. Many elements of the expanded risk-based approach would
be consistent with the Basel standards and different in some respects
from the treatment under the current standardized approach. In some
cases, the current standardized approach is

[[Page 14962]]

appropriately risk sensitive for application to Category I and II
banking organizations and, therefore, the agencies are retaining those
treatments with minimal or no change.\58\
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\58\ For example, the expanded risk-based approach would treat
sovereign exposures, certain exposures to government-sponsored
entities, and exposures to public sector entities the same as the
current standardized approach.
---------------------------------------------------------------------------

III. Definition of Capital

Under the proposal, all banking organizations required to apply the
expanded risk-based approach, or that choose to adopt the expanded
risk-based approach, would be subject to the same definition of
capital. The proposal would broadly maintain the definition of capital
for Category I and II banking organizations in the current capital
rule, with one modification to eliminate the requirement to deduct MSAs
\59\ above a threshold from common equity tier 1 capital.\60\ Banking
organizations that choose to adopt the expanded risk-based approach
would, therefore, be required to include most components of accumulated
other comprehensive income in regulatory capital.
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\59\ An MSA arises when a banking organization sells a loan to a
third party but retains the obligation to service the loan in
exchange for a fee. Banking organizations may also purchase, sell,
or transfer MSAs separately from the underlying mortgage loans.
\60\ In addition, the proposal would require a banking
organization to deduct from common equity tier 1 capital any portion
of a credit-enhancing interest only strip that does not constitute
an after-tax-gain-on sale, as discussed in section IV.B.5.f. of this
SUPPLEMENTARY INFORMATION.
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Under the current capital rule, Category I and II banking
organizations 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 (collectively, threshold items) that
individually exceed 10 percent of the banking organization's common
equity tier 1 capital minus certain deductions and adjustments. In
addition, these banking organizations must deduct from common equity
tier 1 capital the aggregate amount of the threshold items that exceeds
15 percent of common equity tier 1 capital.
Under the proposal, Category I and II banking organizations would
no longer be required to deduct any amount of MSAs from common equity
tier 1 capital and would not consider MSAs when calculating the
aggregate deduction amount for temporary difference DTAs and
significant investments in the capital of unconsolidated financial
institutions in the form of common stock. Instead, MSAs would be
subject to a 250 percent risk weight, consistent with the treatment in
the current capital rule for MSAs that do not exceed the deduction
thresholds.\61\ MSAs can be a useful tool for banking organizations to
manage interest rate risk. The value of MSAs generally increases when
interest rates rise, which extends the expected duration of related
servicing fees. As a result, they may provide a hedge against losses on
other assets that decline in value in the same interest rate
environment.
---------------------------------------------------------------------------

\61\ The agencies' standardized approach proposal would make the
same modification to the definition of regulatory capital for all
other banking organizations.
---------------------------------------------------------------------------

Moreover, MSAs are important for banking organizations to maintain
their relationship with borrowers by retaining customer-facing
relationships even after transferring the underlying loans, allowing
cross-selling of products. Banking organizations can also improve
efficiency by increasing scale. A deduction approach for MSAs can
discourage banking organizations from creating economies of scale,
which can hinder their ability to compete in mortgage underwriting or
servicing businesses and to manage risks.
At the same time, MSAs have long been subject to elevated capital
requirements because of the high level of uncertainty regarding the
ability of banking organizations to realize value from these assets,
especially under adverse financial conditions. MSAs may face
significant valuation risk, which mainly stems from prepayment risk,
default risk, and liquidity risk. For example, increased refinancing of
mortgage loans due to lower interest rates can quickly erode the value
of MSA portfolios, as can increased incidents of mortgage defaults.
MSAs can also be difficult to value, as banking organization portfolios
of MSAs can be heterogeneous and MSA valuations rely on assessments of
future economic variables. Maintaining the 250 percent risk weight for
MSAs would promote regulatory capital requirements that are
commensurate with the risk of these assets.\62\
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\62\ In the 2013 capital rule (78 FR 62069, Oct 11, 2013), in
connection with section 475 of the Federal Deposit Insurance
Corporation Improvement Act of 1991 (12 U.S.C. 1828 note), the
agencies made a finding that the treatment under the capital rule of
readily marketable purchased MSAs would not have an adverse effect
on the Deposit Insurance Fund or the safety and soundness of insured
depository institutions. The proposal would continue to apply a 250
percent risk weight to all MSAs, while removing the threshold
deduction, and the agencies continue to consider the proposed
treatment to not have an adverse effect on the Deposit Insurance
Fund or the safety and soundness of insured depository institutions.
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Question 11: What are the advantages and disadvantages of the
proposed treatment of MSAs? What are the implications of the proposed
treatment of MSAs for banking organizations' mortgage origination
business? To what extent does the 250 percent risk weight appropriately
reflect the risk of these assets throughout the economic cycle? Given
the potential volatility of MSAs under certain circumstances, what are
the advantages and disadvantages of the agencies imposing a higher
limit on MSA as a percentage of common equity tier 1 capital (for
example, 100 percent) and why? What are the advantages and
disadvantages of differentiating the treatment of MSAs based on the
size of the banking organization (for example, banking organizations
with assets under $10 billion or over $100 billion) or applicable
capital framework (for example, banking organizations that elect the
community bank leverage ratio framework)?

IV. Calculation of Risk-Weighted Assets Under the Expanded Risk-Based
Approach

A. 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. Certain transactions give rise to
counterparty credit risk, which generally refers to the risk that a
counterparty to a transaction will default before the final settlement
of the transaction and will fail to make all the payments required by
the transaction. Transactions that give rise to counterparty credit
risk include repo-style transactions, eligible margin loans, and
derivatives transactions. Counterparty credit exposure is determined by
the market value of the transaction, which fluctuates with market
conditions. Thus, the current exposure to a counterparty's default
continuously changes and the future exposure is uncertain.
Under the proposal, a banking organization subject to the expanded

[[Page 14963]]

risk-based approach would follow similar mechanics to those in the
current standardized approach to determine its risk-weighted assets for
credit risk. Such a banking organization would first determine the
exposure amount of each on-balance sheet exposure, derivative contract,
and off-balance sheet commitment, trade and transaction-related
contingency, guarantee, repo-style transaction, financial standby
letter of credit, forward agreement, or other similar transaction
(excluding certain transaction types or exposures as specified in the
proposed rule). In certain cases, exposure amount is measured at the
netting-set level. The banking organization would then multiply the
exposure amount by the risk weight appropriate to the exposure based on
the exposure type or counterparty. In addition, the proposal would
allow for the recognition of certain credit risk mitigants through
adjustments to the risk-weighted asset amount for protected exposures.
Section IV.A.1. of this SUPPLEMENTARY INFORMATION describes in
general terms the approaches for determining exposure amount under the
proposal; section IV.A.2. of this SUPPLEMENTARY INFORMATION describes
the risk-weight treatment for credit exposures under the proposal;
section IV.A.3. of this SUPPLEMENTARY INFORMATION describes the
proposed exposure measurement of off-balance sheet exposures; section
IV.A.4. of this SUPPLEMENTARY INFORMATION describes the proposed
exposure measurement for counterparty credit risk-related exposures;
and section IV.A.5. of this SUPPLEMENTARY INFORMATION describes the
available approaches for recognizing the benefits of credit risk
mitigants including certain guarantees, certain credit derivatives,
financial collateral, and prepaid credit protection arrangements.
1. Exposure Amounts
a. On-Balance Sheet Exposure Amount
Under the proposal, as under the current standardized approach, the
exposure amount of an on-balance sheet exposure would generally be the
banking organization's carrying value \63\ of the exposure, consistent
with the value of the asset on the balance sheet as determined in
accordance with GAAP. Continuing to use the carrying value of an asset
under GAAP to determine a banking organization's exposure amount would
minimize burden and provide a consistent framework that can be easily
applied across all banking organizations because, in most cases, GAAP
serves as the basis for the information presented in financial
statements and regulatory reports.\64\
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\63\ 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 IV.A.4, IVA.5.b.,
and IV.B. of this Supplementary Information. The standardized
approach proposal also includes a technical amendment that would
modify the term adjusted allowance for credit losses (AACL) and
carrying value to exclude allowance for credit losses (ACLs) on
purchased seasoned loans (PSLs) in addition to those on purchased
credit deteriorated (PCD) assets and available-for-sale (AFS) debt
securities. The standardized approach proposal also amends the
definition of AACL and carrying value to provide the same treatment
as PCD assets to other assets that may in the future become subject
to the gross approach following a change to GAAP by FASB.
\64\ See 12 U.S.C. 1831n.
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b. Off-Balance Sheet Exposure Amount
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
obligors or counterparties to provide credit or other support. Such
arrangements may not be recorded on-balance sheet under GAAP until the
arrangement is drawn upon. These off-balance sheet exposures often
include commitments, contingent items, guarantees, certain repo-style
transactions, financial standby letters of credit, and forward
agreements. Under the proposal, consistent with the current
standardized approach, in most cases a banking organization determines
the exposure amount for an off-balance sheet component of an exposure
by multiplying the notional amount of the off-balance sheet component
by the appropriate credit conversion factor specified in the rule. The
proposed credit conversion factors would range from 10 percent to 100
percent to reflect the likelihood that a given off-balance sheet item
would become an on-balance sheet credit exposure, taking into account
the contractual features of the off-balance sheet item. For example, a
100 percent credit conversion factor would apply to a guarantee
provided by a banking organization because the banking organization is
effectively assuming the risk of the guaranteed exposure and thus such
an off-balance sheet item should be converted at the full amount. In
contrast, with respect to commitments, often an obligor does not draw
down on the commitment or only draws down a portion of the available
credit, so such off-balance sheet items would be converted at less than
100 percent. Thus, the proposal would vary the credit conversion
factors according to the likelihood that different types of off-balance
sheet items may become on-balance sheet credit exposures.
c. Approaches for Determining Exposure Amount for Counterparty Credit
Risk-Related Transactions
The current capital rule includes several approaches that a banking
organization may use to calculate the exposure amount for repo-style
transactions, eligible margin loans, derivative transactions, and
netting sets of such transactions. These approaches take into account
the offsetting of positions and financial collateral that meets the
criteria in the rule within a netting set and incorporate both current
and potential future exposure. For purposes of the expanded risk-based
approach, the proposal would continue to include the collateral haircut
approach for eligible margin loans and repo-style transactions, and
netting sets of such transactions, and the standardized approach for
counterparty credit risk (SA-CCR) for derivative contracts, netting
sets of such transactions, and would expand SA-CCR to qualifying cross-
product netting sets of derivative transactions and certain repo-style
transactions, with modifications further described below in section
IV.A.4. of this SUPPLEMENTARY INFORMATION.
To determine the exposure amount for eligible margin loans, repo-
style transactions, or the netting sets of such transactions, the
proposed expanded risk-based approach would include the collateral
haircut approach with two proposed modifications to increase risk
sensitivity: (1) adjustments to the market price volatility haircuts;
and (2) a modified formula that reflects netting and diversification
benefits, each further described below in section IV.A.4.a. of this
SUPPLEMENTARY INFORMATION. A banking organization would have the option
of applying SA-CCR to certain repo-style transactions that are subject
to a qualifying cross-product master netting agreement that includes
derivative transactions.
To determine the exposure amount for derivative contracts, the
proposed expanded risk-based approach would require banking
organizations to apply SA-CCR, with certain modifications to better
reflect evolving market dynamics

[[Page 14964]]

and the potential for increased central clearing. The agencies are
proposing to revise SA-CCR to permit the netting of collateralized-to-
market and settled-to-market client-facing derivative transactions and
incorporate non-cleared repo-style transactions. Specifically, the
agencies are proposing to permit a banking organization to elect to
treat as a derivative contract any non-cleared repo-style transaction
subject to a qualifying cross-product master netting agreement that
also contains a derivative contract. These proposed amendments and
other proposed technical revisions to SA-CCR are described below in
section IV.A.4.b. of this SUPPLEMENTARY INFORMATION.
As stated earlier, the proposal would increase simplicity,
transparency, consistency, and comparability of capital requirements by
reducing banking organization's use of models. Therefore, the proposal
does not include the internal models methodology (IMM) or the simple
value-at-risk (VaR) methodology for measuring counterparty credit risk
or the use of a banking organization's own estimates of haircuts for
purposes of the collateral haircut approach.
2. Proposed Risk Weights for Credit Risk
The proposed expanded risk-based approach would introduce credit
risk weights that generally align with the Basel standards and use many
of the same definitions in Sec. __.2 of the current capital rule. Some
elements of the proposed expanded risk-based approach for credit risk
would apply the same risk weights provided in the current standardized
approach, including exposures to sovereigns, specified supranational
entities \65\ and multilateral development banks,\66\ 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,\67\ public sector
entities (PSEs), exposures that are 90 days or more past due or in
nonaccrual,\68\ and certain insurance assets. Consistent with statutory
mandates, the proposal would also maintain the same risk-weight
treatment provided in the current standardized approach to pre-sold
construction loans, statutory multifamily mortgages, and high-
volatility commercial real estate (HVCRE) exposures.
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\65\ Under the proposal, specified supranational entities would
include the Bank for International Settlements, the European Central
Bank, the European Commission, the International Monetary Fund, the
European Stability Mechanism, and the European Financial Stability
Facility. Consistent with the current capital rule, exposures to
such entities would continue to be subject to a zero percent risk
weight for the purposes of the expanded risk-based approach.
\66\ Under the proposal, multilateral development bank would
include International Bank for Reconstruction and Development, the
Multilateral Investment Guarantee Agency, the International Finance
Corporation, the Inter-American Development Bank, the Asian
Development Bank, the African Development Bank, the European Bank
for Reconstruction and Development, the European Investment Bank,
the European Investment Fund, the Nordic Investment Bank, the
Caribbean Development Bank, the Islamic Development Bank, the
Council of Europe Development Bank, and any other multilateral
lending institution or regional development bank in which the U.S.
government is a shareholder or contributing member or which the
primary Federal supervisor determines poses comparable credit risk.
Consistent with the current capital rule, exposures to these
entities would continue to be subject to a zero percent risk weight
for the purposes of the expanded risk-based approach
\67\ For treatment of other exposures to GSEs, see discussion
related to equity exposures in section IV.C. and subordinated
exposures in section IV.A.2.f. of this SUPPLEMENTARY INFORMATION.
\68\ Certain residential mortgage exposures that are 90 days
past due or in nonaccrual would receive a higher risk weight under
the proposal. See section IV.A.2.c.v of this SUPPLEMENTARY
INFORMATION.
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Relative to the advanced approaches under the current capital rule,
the proposed expanded risk-based approach would result in more
consistent and 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 divergence 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 expanded risk-based approach would introduce new
risk weights for exposures to depository institutions, foreign banks,
and credit unions; subordinated exposures, including those to GSEs; and
real estate, retail, and corporate exposures. The proposed risk weights
for each of these categories are described in the following sections of
this SUPPLEMENTARY INFORMATION.
Question 12: What are the pros and cons of continuing the risk-
weights in the current standardized approach for sovereigns, specified
supranational entities and multilateral development banks, GSEs in the
form of senior debt and guaranteed exposures, FHLB and Farmer Mac
equity exposures, PSEs, exposures that are 90 days or more past due or
in nonaccrual, insurance assets, and other exposures?
Question 13: To enhance the risk sensitivity of the rule, what
alternatives to ``exposures that are 90 days or more past due or in
nonaccrual'' should the agencies consider to identify exposures in or
near default? What are the advantages and disadvantages of using an
approach similar to the definition of defaulted exposures in the
advanced approaches, that would include exposures where (a) 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 (b) 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 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, or an interest rate reduction?
a. Exposures to Government-Sponsored Enterprises
The proposal would assign a 20 percent risk weight to most GSE \69\
exposures, consistent with the current standardized approach. GSE
exposures that are subordinated exposures or equity exposures, however,
would receive higher risk weights. As discussed later in sections IV.C.
and IV.A.2.f. of this SUPPLEMENTARY INFORMATION, equity exposures and
subordinated exposures would generally be subject to an increased risk
weight to reflect their heightened risk relative to senior credit
exposures. As an exception to this general rule, the proposal would
apply a 20 percent risk weight to all exposures to FHLB or Farmer Mac,
including equity exposures and exposures to subordinated debt
instruments, which is consistent with the treatment under the current
standardized approach.
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\69\ 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).
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b. Exposures to Depository Institutions, Foreign Banks, and Credit
Unions
The proposal would define the scope of exposures to depository
institutions,

[[Page 14965]]

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 a depository
institution, foreign bank, or credit union.70 71
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\70\ 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 (Oct. 11,
2013).
\71\ The proposal would require banking organizations to apply a
150 percent risk weight to bank exposures that are either
subordinated exposures, as described in section IV.A.2.f. of this
SUPPLEMENTARY INFORMATION, or covered debt instruments that are not
deducted.
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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 a bank exposure to a category would be based on the
indicators of creditworthiness of 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,\72\ or under similar rules of the National Credit Union
Administration.\73\ For a bank exposure to be considered investment
grade, a banking organization would have to determine that the obligor
has adequate capacity to meet financial commitments, consistent with
the current rule.\74\ 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, including if the obligor depository institution
were in the grace period under the CBLR framework.\75\ As a result,
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.
Additionally, as described further in the next paragraph, a Grade A
exposure to depository institutions that have opted into the CBLR
framework would receive a reduced risk weight relative to other Grade A
exposures.
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\72\ 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).
\73\ See 12 CFR part 702 (National Credit Union Administration).
\74\ 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.
\75\ See 12 CFR 3.12(a)(1) (OCC); 12 CFR 217.12(a)(1) (Board);
12 CFR 324.12(a)(1) (FDIC). See also 90 FR 55048 (Dec. 1, 2025).
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Certain Grade A exposures to depository institutions, foreign
banks, and credit unions would be subject to a 30 percent risk weight,
whereas the others would be assigned a 40 percent risk weight.
Specifically, a banking organization could assign a 30 percent risk
weight to Grade A exposures to: (1) Category I, II, or III depository
institutions with a common equity tier 1 capital ratio of 14 percent or
higher and a supplementary leverage ratio (SLR) of five percent or
higher; (2) depository institutions that have opted into the CBLR
framework; and (3) depository institutions not subject to the SLR or
CBLR framework with a common equity tier 1 capital ratio of 14 percent
or higher and a tier 1 leverage ratio of five percent or higher.\76\ To
qualify for the 30 percent risk weight, a foreign bank obligor would
have to meet the same requirements of having a 14 percent or higher
common equity tier 1 capital ratio and a five percent or higher
leverage ratio as determined by the applicable capital standards of the
foreign bank's home country jurisdiction.\77\ Under this proposed
criteria, 68.3 percent of U.S. depository institutions would meet the
criteria for a highly capitalized bank exposure and be assigned a 30
percent risk weight, based on Call Report data as of June 30, 2025.
Grade A exposures to credit unions would be subject to the 30 percent
risk weight if the obligor credit union has a net worth ratio of 9
percent or higher.\78\ These requirements would be broadly consistent
with those in the Basel standards and provide a preferential risk
weight for institutions presenting a materially lower credit risk than
other Grade A bank exposures. The 30 percent risk weight for exposures
to banks with materially higher capital levels would increase risk
sensitivity while maintaining competitive equity across various sizes
of obligor institutions.
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\76\ An exposure to a depository institution that has not opted
into the CBLR framework and is not required to calculate a common
equity tier 1 ratio and a SLR or tier 1 leverage ratio, as
applicable, under the agencies' capital rule would not qualify for
the 30 percent risk weight.
\77\ The Grade A foreign bank would have to meet the five
percent Basel leverage ratio level for the 30 percent risk weight,
as implemented by the foreign bank's home country. The Basel
leverage ratio is substantially similar to the supplementary
leverage ratio under the agencies' capital rule.
\78\ For comparison, a well-capitalized credit union must have a
net worth ratio (NWR) of 7 percent or greater. A NWR of 9 percent
was selected given that is the level used in their Complex Credit
Union Leverage Ratio (CCULR) framework. The average NWR of Risk-
Based Capital reporters was 9.83 percent as of 2025 Q2. See
Quarterly Credit Union Data Summary 2025 Q2 (Page 20) and Risk-Based
Capital Frequently Asked Questions [verbar] NCUA.
---------------------------------------------------------------------------

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-

[[Page 14966]]

capitalized category \79\ under the agencies' prompt corrective action
framework, or under similar rules of the National Credit Union
Administration.
---------------------------------------------------------------------------

\79\ See 12 CFR 6.4(b)(2) (OCC); 12 CFR 208.43(b)(2) (Board); 12
CFR 324.403(b)(2) (FDIC).
---------------------------------------------------------------------------

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 broadly consistent with
international capital standards issued by the Basel Committee. This
requirement aims to maintain competitive equity and recognize
creditworthiness of institutions subject to capital standards that are
broadly consistent--the capital standards issued by the Basel Committee
are comparable to U.S. capital rules.
Under the proposal, an exposure to a foreign bank 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.
In addition, an exposure would not qualify as a Grade A or Grade B
bank exposure if: (1) the obligor depository institution, foreign bank,
or credit union does not have capital ratios that are publicly
disclosed within the last six months; or (2) 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.
A Grade C bank exposure would mean a bank exposure that does not
qualify as a Grade A or Grade B bank exposure.
The proposal would 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 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) for an
exposure to a branch of a foreign bank in a foreign jurisdiction that
is not the home country of the foreign bank, the exposure is in the
local currency of the jurisdiction in which the foreign branch
operates.\80\ The risk weight floor would not apply to short-term self-
liquidating, trade-related contingent items that arise from the
movement of goods.
---------------------------------------------------------------------------

\80\ See Table 1 in 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 20 percent to 150 percent. The
proposal provides more granular and higher risk weights for bank
exposures compared to the standardized approach to better reflect the
range of credit risks presented by these exposures. In addition, the
proposal better accounts for financial system interconnectedness
inherent in exposures to depository institutions, foreign banks, and
credit unions, which can pose systemic risk to the financial system.
[GRAPHIC] [TIFF OMITTED] TP27MR26.060

The proposed risk weights in Table 1 for exposures to depository
institutions, credit unions and foreign banks, especially those that
are Grade A, reflect that those institutions present reduced credit
risk relative to exposures to other types of financial institutions or
companies. U.S. depository institutions and credit unions are subject
to strong capital requirements, are subject to robust federal
supervision, and have limitations in the types of riskier financial
transactions in which they can engage. Foreign banks that qualify as
Grade A would have broadly consistent capital standards as U.S.
depository institutions and also would be subject to regulatory and
supervisory frameworks broadly equivalent with those in the Basel
standards. Additionally, the proposed risk weights for bank exposures
under the expanded risk-based approach would be more risk sensitive
than the current standardized

[[Page 14967]]

approach as the expanded risk-based approach incorporates more credit-
risk indicators and characteristics of the obligor depository
institution, foreign bank, or credit union.
Question 14: What would be the advantages and disadvantages of the
agencies treating an exposure to a nonbank financial institution such
as foreign holding companies or broker dealer subsidiary institutions
that are located in a foreign jurisdiction as a foreign bank exposure,
when that foreign jurisdiction has determined that the given type of
financial institution is regulated and supervised in that jurisdiction
in a manner equivalent to banks?
Question 15: What are the advantages and disadvantages of assigning
a 30 percent risk weight to Grade A bank exposures meeting the
additional criteria discussed above? To what extent would the lower 30
percent risk weight contribute to the pro-cyclicality of bank capital
requirements? To what extent might the risk weight contribute to credit
contraction during economic downturns and credit acceleration during
economic expansions?
Question 16: The agencies seek comment on the appropriateness of
the additional requirements that must be met to for Grade A bank
exposures to qualify for a 30 percent risk weight. What alternative
calibration of common equity tier 1 capital ratio and supplementary
leverage ratio levels would be appropriate for Category I, II, and III
Grade A depository institutions to receive a 30 percent risk weight?
What alternative calibration of common equity tier 1 capital ratio and
tier 1 leverage ratio levels would be appropriate for depository
institutions not subject to the CBLR framework or SLR to receive a 30
percent risk weight? Please provide analytical support.
Question 17: The agencies seek comment on whether the proposed
treatment for exposures to depository institutions, foreign banks, and
credit unions is appropriate for uninsured trust banks that do not have
capital ratios that were publicly disclosed within the last six months,
including such entities that issue payment stablecoins. What
alternative calibrations or approaches should the agencies consider to
differentiate the financial strength of uninsured trust banks that
would be appropriately risk-sensitive and consistent with the objective
of establishing simple, transparent, and consistent requirements?
Question 18: What would be the advantages and disadvantages of the
agencies requiring broadly consistent capital standards in the foreign
jurisdiction, as well as robust regulatory and supervisory frameworks
that are consistent with international capital standards issued by the
Basel Committee for certain foreign banks to qualify as Grade A and
Grade B? What are appropriate alternative indicators that could be used
to determine whether a foreign bank qualifies for a Grade A
classification? What are the advantages and disadvantages of looking to
the applicable capital requirements in foreign jurisdictions for
determining if a Grade A foreign bank meets the thresholds described
above to be eligible to apply a 30 percent risk weight? What
alternatives should the agencies consider to determine whether a
foreign bank has sufficient capital to warrant applying a 30 percent
risk weight to a Grade A foreign bank exposure?
c. 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) primarily secured by
collateral in the form of real estate,\81\ (3) a pre-sold construction
loan,\82\ (4) a statutory multifamily mortgage,\83\ (5) a high
volatility commercial real estate (HVCRE) exposure,\84\ 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
would be unchanged from the current standardized approach.
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\81\ For purposes of the proposal, ``primarily 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.
\82\ 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.
\83\ 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.
\84\ 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.
---------------------------------------------------------------------------

Risks related to exposures secured by real estate depend on what
type of real estate secures the exposure. Residential real estate loans
generally have lower historical charge off rates than commercial real
estate exposures.\85\ Residential real estate exposures are generally
amortizing, often have stricter underwriting standards for leverage
than commercial real estate, and often are easier to value. In
addition, residential and commercial real estate exposures that are
deemed prudently underwritten reflect reduced credit risk relative to
those real estate exposures that are not prudently underwritten.\86\
The proposal would therefore 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 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, and hotels); and (3) in the case of regulatory
residential or regulatory commercial real estate exposures, the loan-
to-value (LTV) ratio of the exposure.
---------------------------------------------------------------------------

\85\ See ``Charge Off Rates for Loans and Leases at Commercial
Banks,'' <a href="https://www.federalreserve.gov/releases/chargeoff/delallsa.htm">https://www.federalreserve.gov/releases/chargeoff/delallsa.htm</a>.
\86\ See sections IV.A.2.c.i. and ii of this SUPPLEMENTARY
INFORMATION for more information about the prudential criteria
differentiating regulatory residential and regulatory commercial
real estate exposures.
---------------------------------------------------------------------------

The 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. These
criteria include a requirement that loans are made in accordance with
prudent underwriting standards as described in

[[Page 14968]]

the existing Interagency Guidelines for Real Estate Lending Policies
(real estate lending guidelines).\87\ Loans that are prudently
underwritten are less likely to lead to credit losses. Thus, the risk
weights proposed for these exposures are lower than for other real
estate exposures.
---------------------------------------------------------------------------

\87\ 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).
---------------------------------------------------------------------------

Moreover, real estate loans for which repayment is dependent on the
cash flows generated by the real estate can expose a banking
organization to elevated credit risk relative to real estate exposures
where repayment is not dependent on cash flows generated by the
property,\88\ as the obligor 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.\89\ Exposures
that are dependent on the cash flows generated by real estate to repay
the loan can also be affected by local market conditions and, thus,
present elevated credit risk relative to exposures that are serviceable
by the income, cash, or other assets of the obligor. For example, an
increase in the supply of competitive rental property can lower demand
and suppress cash flows needed to support repayment of a loan.
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\88\ Loans secured by real estate where the repayment of the
loan does not depend on cash flows generated by the real estate
include owner-occupied properties, where repayment of the loan is
generally based on the income or revenue of the borrower. See
additional discussion of dependent on the cash flows generated by
the real estate in section IV.A.2.c.iii. of this SUPPLEMENTARY
INFORMATION.
\89\ 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>.
---------------------------------------------------------------------------

In addition, LTV ratios are a meaningful risk indicator for the
credit quality of a real estate exposure because the amount of an
obligor's equity in a real estate property is negatively correlated
with default risk and provides banking organizations with a degree of
protection against losses.\90\ LTV ratios are also one of several key
factors that market participants, including banking organizations,
consider for differentiating credit risk.\91\ Therefore, under the
proposal, exposures with lower LTV ratios generally would receive a
lower risk weight than comparable real estate exposures with higher LTV
ratios.
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\90\ Id., at 30. For evidence on the correlation between LTV and
loss rates in mortgage loans, see Laurie Goodman and Jun Zhu, ``Bank
Capital Notice of Proposed Rulemaking--A Look at the Provisions
Affecting Mortgage Loans in Bank Portfolios,'' Urban Institute
(2023), <a href="https://www.urban.org/sites/default/files/2023-09/BankCapitalNoticeofProposedRulemaking.pdf">https://www.urban.org/sites/default/files/2023-09/BankCapitalNoticeofProposedRulemaking.pdf</a>; and Sewin Chan, Andrew
Haughwout, Andrew Hayashi, and Wilbert van der Klaauw,
``Determinants of Mortgage Default and Consumer Credit Use: The
Effects of Foreclosure Laws and Foreclosure Delays,'' Federal
Reserve Bank of New York, Staff Report No. 732 (2015), <a href="https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr732.pdf">https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr732.pdf</a>.
\91\ See Avery et al, ``Credit Risk, Credit Scoring, and the
Performance of Home Mortgages,'' Federal Reserve Board of Governors,
Federal Reserve Bulletin (1996), <a href="https://www.federalreserve.gov/pubs/bulletin/1996/796lead.pdf">https://www.federalreserve.gov/pubs/bulletin/1996/796lead.pdf</a>. See also 12 CFR part 1240.
---------------------------------------------------------------------------

The proposed scope, risk drivers, and risk weights described below
are generally consistent with those in the Basel standards.
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 of the current capital rule) that is not an ADC
exposure, a pre-sold construction loan, a statutory multifamily
mortgage, or an HVCRE exposure, provided the exposure meets certain
prudential criteria.\92\ First, the loan would be required to be
secured by a residential 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 supervisory LTVs as described in the interagency real estate
lending guidelines.\93\ Third, during the underwriting process, the
banking organization would be required to apply underwriting policies
that account for the ability of the obligor to repay based on clear and
measurable underwriting standards that enable the banking organization
to evaluate these credit factors. The agencies expect these
underwriting standards to be consistent with the agencies' safety and
soundness and real estate lending guidelines.\94\ Fourth, the property
must be valued in accordance with the proposed requirements included in
the proposed LTV ratio calculation, as discussed below in section
IV.A.2.c.iv. of this SUPPLEMENTARY INFORMATION. Finally, the loan must
not have been modified or restructured.\95\
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\92\ 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.
\93\ For more information on determining the value of the
property, see section IV.A.2.c.iv. of this SUPPLEMENTARY
INFORMATION.
\94\ See 12 CFR part 30, appendix C and 12 CFR part 34, appendix
A to subpart D (OCC); 12 CFR part 208, appendix C (Board); 12 CFR
parts 364 and 365 (FDIC).
\95\ Consistent with the current standardized approach, a
residential real estate loan that is modified or restructured solely
pursuant to the U.S. Treasury's Home Affordable Mortgage Program is
not modified or restructured under this criterion for regulatory
residential real estate exposures.
---------------------------------------------------------------------------

As discussed, residential real estate exposures that meet these
criteria present relatively lower credit risk than other residential
real estate exposures. Loans on property that are owner-occupied or
rented have both a consistent expected flow of payments on the loan, as
well as an occupant of the property that is present. Evaluating the
ability of the obligor to repay using consistent and transparent
metrics allows banking organizations and supervisors to more easily
compare the obligor's ability to repay with other borrowers in the
banking organization's loan portfolio. Modified or restructured loans
reflect that there might be deterioration in the ability of the
borrower to repay and, though not necessarily indications of likely
default, merit higher applicable risk weights than those that have no
such indications of potential deterioration in credit quality.
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, 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 would
be required to be primarily secured by fully completed real estate.\96\
Second, the banking organization would be required to hold a first
priority security interest in the property that is legally enforceable
in all relevant jurisdictions.\97\ Third, the exposure would be
required to be made in accordance with prudent underwriting standards,
including standards relating to supervisory LTVs. Fourth, during the
underwriting process, the banking organization would be required to
apply underwriting policies that account for the ability of the obligor
to repay in a timely manner

[[Page 14969]]

based on clear and measurable underwriting standards that enable the
banking organization to evaluate these credit factors. The agencies
expect that these underwriting standards would be consistent with the
agencies' safety and soundness and real estate lending guidelines. The
property would be required to be valued in accordance with the
requirements included in the proposed LTV ratio calculation, as
discussed below. Finally, the loan must not have been modified or
restructured.
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\96\ Commercial properties where the construction is complete
and the property is ready for its intended use.
\97\ 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 the criteria for a
regulatory commercial real estate exposure.
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As previously discussed, commercial real estate exposures that meet
these criteria would present relatively lower credit risk than other
commercial real estate exposures. Loans on property that is still under
construction are reliant on the completion of the property for
repayment of the loan, which can be delayed or interrupted by many
factors such as changes in market condition or financial difficulty of
the obligor.\98\ A perfected, first priority security interest would
provide the banking organization with priority for repayment in the
case of bankruptcy of the obligor.\99\ Evaluating the ability of the
obligor to repay using consistent and transparent metrics allows
banking organizations and supervisors to more easily compare the
obligor's ability to repay with other borrowers in the banking
organization's loan portfolio. As with residential exposures, permanent
commercial real estate loans that have been modified or restructured
indicate there might be a deterioration in the ability of the borrower
to repay, meriting higher applicable risk weights than those that have
no such indications.
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\98\ See, e.g., <a href="https://www.occ.gov/publications-and-resources/publications/comptrollers-handbook/files/commercial-real-estate-lending/pub-ch-commercial-real-estate.pdf">https://www.occ.gov/publications-and-resources/publications/comptrollers-handbook/files/commercial-real-estate-lending/pub-ch-commercial-real-estate.pdf</a>.
\99\ See, e.g., <a href="https://www.occ.treas.gov/static/ots/exam-handbook/ots-exam-handbook-214aa.pdf">https://www.occ.treas.gov/static/ots/exam-handbook/ots-exam-handbook-214aa.pdf</a>.
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Question 19: What are the pros and cons of the proposed
requirements for real estate exposures to qualify as regulatory
commercial real estate exposures? How would the requirement for the
banking organization to hold a first-priority security interest in the
property that is legally enforceable in all relevant jurisdictions
impact loans to different types of commercial borrowers? For those
commercial real estate exposures where banking organizations do not
hold a first priority security interest in the underlying property,
what, if any, alternatives should the agencies consider that would
result in the same priority for repayment in the case of bankruptcy of
the obligor?
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 obligor's ability to service the loan is
dependent on cash flows generated by the real estate.
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 the dependence on cash flows generated from the
real estate is a conservative and straightforward measure of credit
risk. Reliance on cash flows from the property for repayment of a loan
indicates increased risk of nonpayment relative to when the borrower
has sufficient funds from other sources, such as income or business
profits, for full repayment of the loan. Given their increased credit
risk, the proposal would assign higher risk weights to exposures that
are dependent on proceeds or cash flows generated from the real estate
itself to service the loan.
Under the proposal, additional loan characteristics can affect
whether an exposure would be considered dependent on cash flows
generated by the real estate. The proposal's definition of dependent on
the cash flows generated by the real estate would exclude any
residential mortgage exposure that is secured by the obligor's
principal residence, as such mortgage exposures present reduced credit
risk relative to real estate exposures that are secured by the
obligor's non-principal residence.\100\ For residential properties that
are not the obligor'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 obligor's personal income and
resources, rather than rental income (or resale or refinance of the
property), to ascertain the obligor's capacity to repay the loan.\101\
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\100\ See Breck Robinson, Federal Reserve Bank of Richmond, and
Richard M. Todd, Federal Reserve Bank of Minneapolis, ``The Role of
Non-Owner-Occupied Homes in the Current Housing and Foreclosure
Cycle,'' Pg. 6, which cites multiple studies that loans on non-owner
occupied properties have higher loss rates on mortgages to non-
occupant owners than on mortgages to owner-occupants, at least after
controlling for credit scores and other standard underwriting
criteria. https://www.richmondfed.org/~/media/richmondfedorg/
publications/research/working_papers/2010/pdf/wp10-11.pdf.
\101\ 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.
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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 often dependent on
the cash flows generated by the real estate for repayment of the loan.
In the case of a loan to an obligor to purchase or refinance real
estate where the obligor will operate a business, such as a retail
store or factory, and rely solely on the revenues from the business or
resources of the obligor 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 obligor will rely solely on the
sale of products from the farm or other resources of the obligor other
than rental, resale, or other income from the real estate for
repayment.
Question 20: What are the pros and cons of the agencies
establishing a ``materially'' dependent on cash flows test that would
consider the source of repayment to be partly from the borrower's own
resources and partly from the cash flows/income generated by the real
estate? What, if any, quantitative threshold should the agencies
consider in determining whether a real estate exposure is dependent on
cash flows generated by the real estate (for example, the cash flows
generated from real estate reflect between 5 and 50 percent of amount
needed for repayment of the loan)? Further, if the agencies decide to
adopt a quantitative threshold, either for regulatory residential or
regulatory commercial real estate exposures, what should the agencies
consider when calibrating such a threshold for regulatory residential,
and separately for regulatory commercial real estate

[[Page 14970]]

exposures, and what would be the appropriate calibration levels for
each? Provide specific examples, including calculations and supporting
data. Relatedly, please provide views on how to define cash flows and
what expenses, if any, the agencies should consider.
iv. Calculating the Loan-to-Value Ratio
The proposal would require a banking organization to use LTV ratios
to assign a risk weight to a regulatory residential or regulatory
commercial real estate exposure. The proposed calculation of the 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.
Under the proposal, an LTV ratio would be calculated as the
extension of credit divided by the value of the property. The extension
of credit would mean the total outstanding amount of the loan including
the notional total of 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 would allow a banking
organization to assign a lower risk weight to a loan over time as the
principal is repaid. Similarly, if an extension of credit increases, a
banking organization would reflect that increase in the LTV ratio.
For purposes of the LTV ratios in Tables 2, 3, 4, 5 below, 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 for these purposes 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).\102\ During the 2007-2009 housing
market stress, the performance of private mortgage insurance
deteriorated at the same time as the underlying exposures.\103\ Under
the proposal and consistent with the current capital rule, private
mortgage insurance is considered when banking organizations identify if
a residential mortgage exposure is made in accordance with prudent
underwriting standards. As discussed earlier, under the proposal a
residential mortgage exposure must be made in accordance with prudent
underwriting standards and must meet other requirements to be
considered regulatory residential real estate exposures and therefore
eligible to be risk weighted according to the LTV table described
below.\104\
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\102\ A guarantor is not an eligible guarantor under the current
capital rule if the guarantor's creditworthiness is positively
correlated with the credit risk of the exposures for which it has
provided guarantees. 78 FR 62141 (Oct.11, 2013).
\103\ See Laurie Goodman and Karan Kuhl, ``Sixty Years of
Private Mortgage Insurance in the United States,'' The Urban
Institute Housing Finance Policy Center, August 2017. Pg. 7, <a href="https://www.urban.org/sites/default/files/publication/92676/2017_08_18_sixty_years_of_pmi_finalizedv3_3.pdf">https://www.urban.org/sites/default/files/publication/92676/2017_08_18_sixty_years_of_pmi_finalizedv3_3.pdf</a>.
\104\ As described in section IV.A.2.c.i. of this SUPPLEMENTARY
INFORMATION, regulatory residential mortgage exposures must be made
in accordance with prudent underwriting standards, including
standards relating to supervisory LTVs, which allow for the
consideration of private mortgage insurance for permanent mortgage
or home equity loans on owner-occupied, 1- to 4-family residential
properties.
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The value of the property would mean the value at the time of
origination of all real estate properties securing the extension of
credit, including the increased estimated value of the property if the
property is being improved by an extension of credit. The value of the
property would also include 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
(collectively, the appraisal rule),\105\ 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 out of 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.
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\105\ 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 of the
property using prudently conservative valuation criteria and that is
separate from the banking organization's origination and underwriting
process.
Using the value of a 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 a new 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 from 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, by an auction, or by a similarly available daily
bid and ask price market. 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.

[[Page 14971]]

Under the proposal, other acceptable collateral would include, among
other items, unconditional irrevocable standby letters of credit for
the benefit of the banking organization. Readily marketable collateral
and other acceptable collateral must be appropriately discounted by the
banking organization consistent with the banking organization's usual
practices for making loans secured by such collateral. The
reasonableness of a banking organization's underwriting criteria would
continue to be reviewed through the supervisory process to help ensure
its real estate lending policies are consistent with safe and sound
banking practices.
Question 21: What other approaches should the agencies consider to
recognize private mortgage insurance in the determination of the risk
weight of residential mortgage exposures? What would be the pros and
cons of providing explicit recognition of private mortgage insurance in
the calculation of LTV ratio for purposes of determining the risk
weights for regulatory real estate exposures? What, if any, increases
in procyclicality and incentives for increased risk-taking by banking
organizations might such recognition create? What conditions could the
agencies impose on such recognition to mitigate concerns about the
wrong-way risk of monoline credit insurance? In recognition that
private mortgage insurance may not provide protection under all
relevant stress events, what are the advantages and disadvantages of
recognizing a portion (such as 50 percent) of the value of the private
mortgage insurance in determining the total outstanding amount of the
loan in the calculation of the LTV ratio? Please provide any data and
analysis supporting alternative approaches.
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 without PMI and whether the exposure is dependent
on the cash flows generated by the real estate, in accordance with
Tables 2 and 3 below.\106\ 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 are meaningful determinants of credit risk for real estate
exposures. The proposed risk weights in each LTV ratio category are
intended to reflect differences in the credit risk of these
exposures.\107\
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\106\ Residential real estate exposures that are 90 days past
due or in nonaccrual would be assigned a 150 percent risk weight,
unless the exposure is a residential mortgage exposure that is not
dependent on the cash flows generated by the real estate, which
would be assigned a 100 percent risk weight.
\107\ 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.
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[GRAPHIC] [TIFF OMITTED] TP27MR26.062

The proposed risk weights in Tables 2 and 3 would appropriately
balance the benefits of risk sensitivity, transparency, and consistency
in the risk weight for real estate exposures across banking
organizations subject to the expanded risk-based approach. Applying
lower risk weights to loans with lower LTVs aligns the credit risk of
the loan with the applicable risk weight, and relying on cash flows
from the property for repayment has historically indicated increased
credit risk that merits higher risk weights.
The proposal would also recognize the reduction in credit risk of
regulatory residential real estate exposures due to amortization, as
the obligor pays down principal and builds equity.\108\ The risk
weights for such exposures could decrease throughout the life of the
respective loans as obligors make payments. For example, analysis by
the agencies indicates that residential mortgage loans issued in the 90
percent to 100 percent LTV ratio category would have a lifetime average
risk weight approximately five percentage points

[[Page 14972]]

lower than the applicable risk weight at origination.\109\
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\108\ 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 limited circumstances. See
also Luis Otero Gonz[aacute]lez, Pablo Dur[aacute]n Santomil,
Milagros Vivel B[uacute]a and Rub[eacute]n Lado Sestayo, ``The
Impact of Loan-to-Value on The Default Rate of Residential MBS''
Journal of Credit Risk (July 2016), <a href="https://www.risk.net/journal-of-credit-risk/2465626/the-impact-of-loan-to-value-on-the-default-rate-of-residential-mortgage-backed-securities">https://www.risk.net/journal-of-credit-risk/2465626/the-impact-of-loan-to-value-on-the-default-rate-of-residential-mortgage-backed-securities</a>.
\109\ See section VII of this SUPPLEMENTARY INFORMATION for more
information explaining the analysis of the estimated ``effective''
risk weights applicable to residential mortgage exposures under the
proposal.
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The agencies recognize that some home buyers, especially low- and
moderate-income home buyers or those in historically underserved
markets, are more likely to be obligors of loans with higher LTV ratios
and thus higher risk weights under the approach described above. As a
result, borrowing costs for some low- and moderate-income home buyers
could be higher relative to obligors with lower LTV ratios. However,
many low-to-moderate income borrowers obtain mortgages through loan
programs administered by the Federal Housing Administration (FHA) or
Department of Veterans Affairs (VA). Consistent with the current
capital rule, banking organizations generally would apply a 20 percent
risk weight to real estate exposures guaranteed by the U.S. government
through the FHA or VA under the proposal. In addition, the proposed
risk weights applicable to regulatory residential real estate exposures
that have high LTV ratios would be generally consistent with the
applicable risk weights under the current standardized approach for
residential real estate exposures. The agencies estimate that the
proposed risk-based capital requirements for regulatory residential
real estate exposures that are not dependent on the cash flows of the
real estate--reflecting both credit risk weights and estimated
operational risk requirements--would be lower than the applicable risk-
based capital requirements for residential real estate mortgages
exposures under the current standardized approach for exposures with
LTV ratios at or below 90 percent and very similar for such exposures
with LTV ratios between 90 and 99 percent.\110\
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\110\ According to agency analysis, effective risk weights,
which reflect both credit risk weights and estimated add-ons to
reflect operational risk, are relatively constant or falling for
almost all types of mortgage obligors relative to the applicable 50
percent risk weight for prudently underwritten residential mortgage
exposures in the current standardized framework. For instance, for
low-to-moderate income obligors, the total equivalent risk weight
under the proposal is estimated to be 46 percent (42 percent from
credit risk and 4 percent from operational risk). See the economic
analysis presented in section VIII.D.2 of this SUPPLEMENTARY
INFORMATION.
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Question 22: Given the proposed treatment of residential real
estate exposures, how, if at all, would the proposed risk weights
impact home affordability and home ownership opportunities,
particularly for low-to-moderate income obligors or customers in other
historically underserved markets? Please provide supporting data.
Question 23: What alternative approaches for determining applicable
risk weights to residential real estate exposures should the agencies
consider and why? Please provide data supporting alternative
approaches, including factors that were the basis for underwriting the
loans and the historical repayment performance of the loans.
vi. Risk Weights for Regulatory Commercial Real Estate Exposures
Similar to the proposed approach 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, in accordance with
Tables 4 and 5 below. Further, in the case of a regulatory commercial
real estate exposure that is not dependent on cash flows generated by
the real estate for repayment, a banking organization would be required
to assign the risk weight applicable to the obligor, as reflected in
Table 4. If the LTV ratio of such an exposure 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 obligor would be, the banking organization would be
required to assign a 100 percent risk weight to the exposure unless the
exposures is 90 days more past due or in nonaccrual.\111\
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\111\ Commercial real estate exposures that are 90 days past due
or in nonaccrual would be assigned a 150 percent risk weight.
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Regulatory commercial real estate exposures not dependent on cash
flows generated by the real estate often involve situations where the
borrowing entity occupies the property or the obligor has significant
other cash flows to repay the loan that the banking organization
considered when underwriting the loan. While these exposures generally
present lower credit risk relative to exposures to commercial real
estate dependent on cash flows

[[Page 14973]]

generated by the real estate, or other types of corporate exposures
where real estate collateral is not present, the risk profile of the
obligor impacts the applicable risk weight to appropriately reflect the
credit quality of the obligor in addition to the real estate
collateral. Therefore, the applicable risk weights in Table 4 for
regulatory commercial real estate exposures not dependent on cash flows
generated by the real estate reflect both the LTV ratio and the risk
profile of the obligor. In contrast, because the risks of commercial
real estate exposures dependent on cash flows generated by the real
estate are more dependent on the property, the risk weights in Table 5
reflect only the LTV ratio as a risk driver and generally are higher
relative to Table 4.
vii. 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.\112\ Real estate exposures that meet the definition of ADC
exposure but do not meet the definition of HVCRE exposure and are not
90 days past due or in nonaccrual 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 the
LTV ratio. 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 amortizing permanent loans for completed
residential or commercial real estate. ADC exposures have heightened
risk compared to permanent commercial real estate exposures, reflecting
uncertainty for unforeseen issues with construction or market
conditions, compared to the expected cash flow on a fully leased and
constructed commercial property. The proposal would be consistent with
the current standardized approach, as ADC exposures are generally
subject to a risk weight of 100 percent or more under the current
standardized approach.\113\
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\112\ 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.
\113\ OCC Commercial Real Estate Lending Handbook 2.0, <a href="https://www.occ.gov/publications-and-resources/publications/comptrollers-handbook/files/commercial-real-estate-lending/pub-ch-commercial-real-estate.pdf">https://www.occ.gov/publications-and-resources/publications/comptrollers-handbook/files/commercial-real-estate-lending/pub-ch-commercial-real-estate.pdf</a>.
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viii. Other Real Estate Exposures
The proposal would define other real estate exposures as real
estate exposures that are not 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
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 would
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.
The 100 percent risk weight would apply to other real estate
exposures that are a residential mortgage exposure that is not
dependent on the cash flows generated by the real estate, which could
include junior lien home equity lines of credit (where the banking
organization does not also hold the first lien) and other second
mortgages, as these exposures reflect heightened credit risk compared
to first-lien exposures because the banking organization would receive
repayment only after more senior creditors in the instance of the
obligor defaulting. In addition, if a banking organization does not
adequately evaluate the creditworthiness of an obligor for an owner-
occupied residential mortgage exposure, or if the obligor 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.
d. Retail Exposures
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 be defined as an exposure
that is not a real estate exposure, and is an exposure to a natural
person or persons or an exposure to a small or medium-sized entity
(SME) \114\ 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 recognizes that many small companies
have characteristics more similar to those of a natural person than of
a larger corporation with respect to financial resources and the time
horizon under which it operates. 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 the advanced approaches,
which includes a broader range of exposures, including residential 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 not include real estate exposures.
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\114\ Under the proposal, 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 standards 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.
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The proposal would differentiate the risk-weight treatment for
retail exposures based on whether the exposure (1) qualifies as a
regulatory

[[Page 14974]]

retail exposure, (2) further qualifies as a transactor exposure; or (3)
does not qualify for either of the previous categories and therefore is
treated as an other retail exposure. The proposed risk weights assigned
to retail exposures consider characteristics such as payment history
and exposure size the latter of which is individually generally small
in dollar-per-loan volume for exposures captured within the scope of
the proposal's retail exposure definition. 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 an 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).
In addition, under the proposal, the amount of retail exposures to a
single obligor and its affiliates that a banking organization could
treat as regulatory retail exposures would be limited. 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).\115\ Limiting the types of
products and the dollar amount of exposures to a single obligor that
would qualify as regulatory retail exposures under the proposal would
help ensure that the regulatory retail treatment applies only to a set
of small exposures to a diversified group of obligors. A banking
organization would include all outstanding and committed but unfunded
regulatory retail exposures in determining the aggregated total to a
single obligor and its affiliates.
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\115\ The $1 million threshold for a retail exposure to qualify
as regulatory retail would be indexed using CPI-W. See section II.E.
of this SUPPLEMENTARY INFORMATION. For an off-balance sheet
exposure, the full notional amount of the exposure would apply
towards the $1 million threshold. If a retail exposure to a single
obligor and its affiliates does exceed the $1 million threshold,
then none of the exposures to that obligor would qualify as
regulatory retail exposures.
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Under the proposal, if an exposure to an SME does not meet the
eligible product criterion and the aggregate limit criterion described
above, then none of the exposures to that SME would qualify as retail
exposures and all 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 it meets the definition of a transactor exposure. An
exposure would not be a transactor exposure if the credit facility has
a balance or the facility includes installment payments, even if the
obligor was not required to make a payment, including when the credit
facility had a promotional offer such as a zero percent interest.
Under the proposal, a banking organization would assign a risk
weight of 45 percent to a regulatory retail exposure that is a
transactor exposure and a 75 percent risk to a regulatory retail
exposure that is not a transactor exposure. All other retail exposures
would be assigned a 100 percent risk weight. The proposed relatively
low 45 percent risk weight for a transactor exposure is appropriate
because such obligors have a demonstrated history of full and timely
repayment. A regulatory retail exposure that is not a transactor
exposure warrants the proposed 75 percent risk weight, which would be
lower than the proposed 100 percent risk weight for all other retail
exposures, due to mitigating factors related to size or concentration
risk. Any retail exposure that would not qualify as a regulatory retail
or a transactor exposure warrants a risk weight of 100 percent. The
proposed retail categories, risk weights, and risk indicators are
largely consistent with the Basel standards.
Question 24: 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 25: What, if any, changes to the methodology for the
aggregate limit calculation should the agencies consider? What are the
pros and cons of treating the amount of retail exposures to a single
obligor, when aggregated, below $1 million as regulatory retail
exposures, while the amount of exposures above $1 million to the same
obligor in aggregate would be treated as other retail exposures? The
agencies seek comment on whether there is a differentiation of risk to
the same obligor for exposures above and below the aggregate limit.
e. 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
company 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 the general creditworthiness of the
obligor; each exposure's level of subordination and the expected source
of repayment.\116\ First, a banking organization would be permitted to
assign a 65 percent risk weight to a corporate exposure that is an
exposure to a company that is investment grade based on the banking
organization's internal ratings system, subject to the criteria
outlined further below. 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.\117\ Third, a banking organization would assign a 100
percent risk weight to a project finance exposure that is in the
operational phase; otherwise, such an exposure would receive a 130
percent risk weight.
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\116\ The proposal would require banking organizations to apply
a 150 percent risk weight to corporate exposures that are either
subordinated exposures, as described in section IV.A.2.f. of this
SUPPLEMENTARY INFORMATION, or covered debt instruments that are not
deducted. See the Federal Reserve Board's rule on ``Total Loss-
Absorbing Capacity, Long-Term Debt, and Clean Holding Company
Requirements for Systemically Important U.S. Bank Holding Companies
and Intermediate Holding Companies of Systemically Important Foreign
Banking Organizations'' 12 CFR part 252.
\117\ 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).
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Fourth, a banking organization would assign a 100 percent risk
weight to a corporate exposure that is for the purpose of acquiring or
financing equipment or physical commodities where repayment of the
exposure is dependent on the physical assets being financed or
acquired. This would include exposures that finance income-producing
assets or projects that engage in non-real estate activities where the

[[Page 14975]]

obligor entity itself has no independent capacity to repay the loan.
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 broadly reflects the relative
risk of such corporate exposures, as exposures not deemed investment
grade generally pose greater credit risk than that of investment grade
corporate exposures.
i. Investment Grade Companies
Under the proposal, a banking organization would be permitted to
assign a 65 percent risk weight to a corporate exposure that is not a
subordinated exposure and is an exposure to a company that the banking
organization, using one or more internal credit risk rating systems
that meet certain requirements, determines is investment grade, as that
term is defined in Sec. __.2 of the capital rule. The definition of
investment grade, which would remain unchanged under the proposal,
requires that the entity has adequate capacity to meet its financial
commitments for the projected life of the asset or exposure.\118\ The
rule further provides that an 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. Thus, the
investment grade classification is intended to apply to companies of
high credit quality.\119\
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\118\ See 12 CFR 3.2 (definition of investment grade) (OCC); 12
CFR 217.2 (definition of investment grade) (Board); 12 CFR 324.2
(definition of investment grade) (FDIC).
\119\ The use of the investment grade definition in the current
capital rule was expanded in 2013 as part of a set of alternatives
to external credit ratings for calculating risk-weighted assets for
certain exposures, to implement section 939A of the Dodd Frank Act.
These alternative creditworthiness standards were designed to be
consistent with safety and soundness while also exhibiting risk
sensitivity similar to external credit rating categories. See 15
U.S.C. 78o-7 note. Prior to the 2013 capital rule, investment grade
was used in several areas of the capital rule, including in the
market risk framework, the treatment of securitization and equity
exposures, and in the requirements for recognizing certain
guarantees and collateral in the calculation of risk-weighted
assets. See Risk-Based Capital Guidelines: Market Risk, 77 FR 53060
(Aug. 30, 2012) (when the concept was initially introduced). In the
now-superseded capital rule that contained such references, a long-
term credit rating of BBB- or better and a short-term credit rating
of A3 or better were provided as examples of credit ratings
considered to be investment grade. See Risk-Based Capital Standards:
Advanced Capital Adequacy Framework--Basel II, 72 FR 69288, (Dec. 7,
2007).
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Corporate exposures typically exhibit significant differences in
default probabilities, loss severities, and correlation with broader
economic conditions based on many factors including the financial
strength and stability of the obligor. An investment grade designation
would provide a mechanism to increase risk sensitivity in the capital
framework by subdividing corporate exposures by credit risk. Further,
assigning separate risk weights for corporate exposures to investment
grade companies and non-investment grade companies would align capital
requirements more closely with actual risk.
To help promote the consistency and reliability of a banking
organization's investment grade determinations for purposes of
assigning a 65 percent risk weight to a corporate exposure and to
promote comparability in such determinations across banking
organizations, the proposal would set forth requirements for any
internal credit risk rating system used by banking organizations for
such purposes. Additionally, a banking organization would have to meet
proposed requirements when validating such systems.
The proposal would require that the internal credit risk rating
system that a banking organization would rely upon to make investment
grade determinations also be used to inform material business or risk
management decisions, such as those related to accounting, regulatory
reporting, risk management and measurement, loan loss reserve
estimation, capital planning, loan pricing, or supporting board of
directors' decision making. Using existing systems would allow banking
organizations to leverage existing data on obligors that are used for
other purposes to support their investment grade determinations under
the proposal, thus reducing regulatory burden. In addition, given their
importance in fundamental business processes, such systems are subject
to internal controls, oversight, and validation processes that help
ensure their reliability.
The banking organization would be required to define which obligor
rating grades within its internal credit risk rating system(s) are
considered to be investment grade, as that term is defined in Sec.
__.2 of the capital rule. Because the rating assessment and the
corresponding determination of investment grade would occur at the
obligor level, such determinations would not include exposure level
loss given default factors, such as credit enhancements, transaction
structure, and collateral.\120\ The proposal would require the internal
credit risk rating system to assign a rating grade for each obligor in
an accurate and timely manner, no less frequently than annually and
whenever the banking organization receives new material information
regarding the creditworthiness of the obligor. The proposal would also
require the internal credit risk rating system to incorporate both
quantitative and qualitative factors relating to the historical and
projected patterns of payment behaviors, the financial situation and
performance of each obligor, and any relevant developments that affect
the investment grade determination. Examples of quantitative risk
factors fitting these characteristics include, but are not limited to,
metrics relating to cash flow available to cover debt obligations,
levels of equity relative to debt, and quantities of liquid assets
relative to liabilities. Qualitative risk factors could include the
business model and economic sector of the obligor, the obligor's
willingness to repay, and market conditions. A banking organization
would not be permitted to rely solely on third-party assessments of
credit risk in its rating of obligors for purposes of determining
investment grade status. The proposal would require a banking
organization, at least annually, to validate the robustness,
consistency, and reliability of its internal credit risk rating system,
using data from at least one full credit cycle and taking care to
ensure that benign and stressful periods are appropriately represented.
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\120\ Under the proposal, credit risk mitigation techniques
could not be used to support investment grade determinations. See
section IV.A.5. of this SUPPLEMENTARY INFORMATION for a description
of how credit risk mitigants, such as guarantees and collateral, can
reduce the risk-weighted asset amount for certain exposures.
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As part of the validation of the internal credit rating system, the
proposal would require a banking organization to evaluate whether the
performance of the obligors identified by the internal credit risk
rating system as investment grade is consistent with the definition of
investment grade in Sec. __.2 of the capital rule, including by
benchmarking the investment grade ratings resulting from the internal
credit risk rating system with external information relating to the
creditworthiness of obligors. Such benchmarking may include comparisons
to external credit ratings of obligors produced by third parties. Using
external information as part of validating the internal credit risk
rating system could identify areas for improvement in the system and
may enhance consistency in investment

[[Page 14976]]

grade determinations across banking organizations.
Also, as part of the validation, the proposal would require a
banking organization to assess the reliability, accuracy, completeness,
timeliness, and appropriateness of the data sources used as part of the
investment grade determinations. The proposal would require a banking
organization to incorporate available information that is reasonably
expected to support a robust evaluation of the internal credit rating
system, including information regarding the performance of companies
that have ceased operations or that have been sold to a third party to
address potential survivorship bias. Properly accounting for obligors
that are sold to a third party or that cease operations would reduce
the likelihood of rating grades being skewed.
The proposal also would require a banking organization to ensure
that the validation process is independent of the internal credit risk
system's development, implementation, and operation, or subject the
validation process to an independent review of its adequacy and
effectiveness. These requirements around independence would help ensure
the objectivity, reliability, and integrity of the validation process.
Consistent with requirements under the current advanced approaches,
the proposal would require the validation process to incorporate
default data covering a period of at least five years and include a
period of stress. If the banking organization has relevant data that
extends beyond the five-year period, it would be required to
incorporate that data into the validation process. The banking
organization also would not be permitted to place undue weight on data
from periods of favorable or benign economic conditions relative to
economic downturn conditions. Appropriately reflecting and balancing
all relevant data over at least five years would h

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