Proposed Rule2026-05960
Regulatory Capital Rules: Regulatory Capital and Standardized Approach for Risk-Weighted Assets
Primary source
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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 modify certain aspects of the regulatory capital rule (the proposal). The proposal would revise the risk-based capital treatment of certain exposure categories under the standardized approach, focusing on improving the calibration and risk sensitivity of risk weights that are particularly material to covered banking organizations' lending activities. The proposal would also modify the definition of regulatory capital by removing the threshold- based deduction for mortgage servicing assets for all banking organizations subject to the regulatory capital rule, including banking organizations subject to the community bank leverage ratio framework. In addition, the proposal would require Category III and IV banking organizations to recognize most elements of accumulated other comprehensive income in their regulatory capital. The agencies are concurrently publishing a separate proposal, which would require Category I and II banking organizations to use a new framework to calculate risk-weighted assets, called the expanded risk-based approach and would allow other banking organizations to elect to use the expanded risk-based approach.
Full Text
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[Federal Register Volume 91, Number 59 (Friday, March 27, 2026)]
[Proposed Rules]
[Pages 15332-15452]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2026-05960]
[[Page 15331]]
Vol. 91
Friday,
No. 59
March 27, 2026
Part IV
Department of the Treasury
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Office of the Comptroller of the Currency
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12 CFR Part 3
Federal Reserve System
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12 CFR Parts 217, 238, 252
Federal Deposit Insurance Corporation
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12 CFR Part 324
Regulatory Capital Rules: Regulatory Capital and Standardized Approach
for Risk-Weighted Assets; Proposed Rule
Federal Register / Vol. 91 , No. 59 / Friday, March 27, 2026 /
Proposed Rules
[[Page 15332]]
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DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Part 3
[Docket ID OCC-2026-0034]
RIN 1557-AF49
FEDERAL RESERVE SYSTEM
12 CFR Parts 217, 238, 252
[Docket No. R-1888]
RIN 7100-AH21
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 324
RIN 3064-AG23
Regulatory Capital Rules: Regulatory Capital and Standardized
Approach for Risk-Weighted Assets
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 modify certain aspects of the
regulatory capital rule (the proposal). The proposal would revise the
risk-based capital treatment of certain exposure categories under the
standardized approach, focusing on improving the calibration and risk
sensitivity of risk weights that are particularly material to covered
banking organizations' lending activities. The proposal would also
modify the definition of regulatory capital by removing the threshold-
based deduction for mortgage servicing assets for all banking
organizations subject to the regulatory capital rule, including banking
organizations subject to the community bank leverage ratio framework.
In addition, the proposal would require Category III and IV banking
organizations to recognize most elements of accumulated other
comprehensive income in their regulatory capital. The agencies are
concurrently publishing a separate proposal, which would require
Category I and II banking organizations to use a new framework to
calculate risk-weighted assets, called the expanded risk-based approach
and would allow other banking organizations to elect to use the
expanded risk-based approach.
DATES: Comments must be received by June 18, 2026.
ADDRESSES: Comments should be directed to:
OCC: Commenters are encouraged to submit comments through the
Federal eRulemaking Portal, if possible. Please use the title
``Regulatory Capital Rules: Regulatory Capital and Standardized
Approach for Risk-weighted Assets'' 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:
<bullet> Federal eRulemaking Portal--<a href="http://Regulations.gov">Regulations.gov</a>:
Go to <a href="https://regulations.gov/">https://regulations.gov/</a>. Enter Docket ID ``OCC-2026-0034''
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#e89a8d8f9d84899c8187869b808d84988c8d9b83a88f9b89c68f879e"><span class="__cf_email__" data-cfemail="95e7f0f2e0f9f4e1fcfafbe6fdf0f9e5f1f0e6fed5f2e6f4bbf2fae3">[email protected]</span></a>.
<bullet> Mail: Chief Counsel's Office, Attention: Comment
Processing, Office of the Comptroller of the Currency, 400 7th Street
SW, Suite 3E-218, Washington, DC 20219.
<bullet> Hand Delivery/Courier: 400 7th Street SW, Suite 3E-218,
Washington, DC 20219.
Instructions: You must include ``OCC'' as the agency name and
Docket ID ``OCC-2026-0034'' 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-2026-0034''
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#03716664766f62776a6c6d706b666f7367667068436470622d646c75"><span class="__cf_email__" data-cfemail="05776062706964716c6a6b766d6069756160766e456276642b626a73">[email protected]</span></a>.
The docket may be viewed after the close of the comment period in
the same manner as during the comment period.
Board: You may submit comments, identified by Docket No. R-1888,
and RIN 7100-AH21 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#0c7c796e60656f6f6361616962787f4c6a7e6e226b637a"><span class="__cf_email__" data-cfemail="710104131d1812121e1c1c141f0502311703135f161e07">[email protected]</span></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 not be 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-
AG23 and identify the number for the specific question(s) to which you
are
[[Page 15333]]
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.
Email: <a href="/cdn-cgi/l/email-protection#c7a4a8aaaaa2a9b3b48781838e84e9a0a8b1"><span class="__cf_email__" data-cfemail="fe9d9193939b908a8dbeb8bab7bdd0999188">[email protected]</span></a>. Include RIN 3064-AG23 in the subject line
of the message.
Mail: Jennifer M. Jones, Deputy Executive Secretary, Attention:
Comments--RIN 3064-AG23, 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.
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, Chris Rafferty, 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; Marco Migueis, Principal Economist, (202) 452-
6447; Ke Wang, Principal Economist, (202) 680-8527; Emily Davine,
Senior Financial Institution Policy Analyst, (771) 216-7655; 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#02706765776e63766d707b6163726b76636e4264666b612c656d74"><span class="__cf_email__" data-cfemail="c8baadafbda4a9bca7bab1aba9b8a1bca9a488aeaca1abe6afa7be">[email protected]</span></a>, (202) 898-6888; Federal Deposit Insurance
Corporation, 550 17th Street NW, Washington, DC 20429.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction and Overview
II. Definition of Capital
A. Removal of the Mortgage Servicing Asset Deduction
B. Recognition of Accumulated Other Comprehensive Income for
Category III and IV Banking Organizations
III. Calculation of Risk-Weighted Assets Under the Standardized
Approach
A. General Risk Weight Treatment
1. Residential Mortgage Exposures
a. Calculating the Loan-to-Value Ratio
b. Risk Weights for Residential Mortgages
2. Corporate Exposures and Certain Other Assets
B. Off-Balance Sheet Exposures
1. Definition of Commitment
2. Conversion Factors
3. Commitments With No Pre-Set Limit
C. Derivative Contracts
D. Credit Risk Mitigation
1. Guarantees and Credit Derivatives
a. Substitution Approach
b. Adjustment for Credit Derivatives Without Restructuring
2. Collateralized Transactions
a. Simple Approach
b. Collateral Haircut Approach
i. Formula for Determining Exposure Amount
ii. Market Price Volatility Haircuts
3. Prepaid Credit Protection
4. Maturity and Currency Mismatch Adjustment
E. Securitization Framework
1. Definitions
a. Synthetic Securitizations
b. Technical Modifications
2. Operational Requirements
a. Early Amortization Provisions
b. Synthetic Excess Spread
c. Minimum Payment Threshold
d. Resecuritization Exposures
e. Clean-Up Calls
3. Exposure Amount of a Securitization Exposure
4. Securitization Standardized Approach (SEC-SA)
a. Definition of Attachment Point and Detachment Point
b. Definition of W Parameter
c. Delinquency-Adjusted (Ka) and Non-Adjusted (Kg) Weighted-
Average Capital Requirement of the Underlying Exposures
d. Supervisory Risk-Weight Floors
5. Exceptions to the SEC-SA Risk-Based Capital Treatment for
Securitization Exposures
a. Purchased Credit Derivatives
b. Nth-to-Default Credit Derivatives
c. Derivative Contracts That Do Not Provide Credit Enhancements
d. Overlapping Exposures
e. Look-Through Approach for Senior Securitizations Exposures
f. Credit-Enhancing Interest Only Strips
g. Non-Performing Loan Securitizations
i. Attachment and Detachment Points for NPL Securitizations
Subject to the SEC-SA
6. Credit Risk Mitigation for Securitization Exposures
F. Indexing of Thresholds
IV. Disclosure Requirements
V. Estimated Impact on Capital Requirements
A. Impact on Risk-Weighted Assets by Lending Category
B. Trading-Related Impact on Risk-Weighted Assets
C. Impact on Risk-Weighted Assets by Bank Size
D. Impact of Changes to Risk-Weighted Assets on Required Capital
E. Impact of AOCI Recognition
F. Data and Estimation Methodology
G. Data Appendix
VI. Economic Analysis
A. Reasonable Alternatives
B. Effects on Lending
C. Economic Efficiency
D. Effects on Competitiveness
E. Effects on Safety and Soundness
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F. Other Costs
G. Interactions With CBLR Proposal
H. Conclusion
VII. Technical Amendments to the Capital Rule
A. Accounting Standards Update 2025-08
B. Allowance for Loan and Lease Losses Definition
C. Clarifications to Procedures, Effective Dates, and
Severability
VIII. Related Proposals and Proposed Amendments to Related Rules
A. Related Proposals
B. Board Amendments
IX. 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
F. Providing Accountability Through Transparency Act of 2023
G. Executive Orders 12866, 13563, and 14192
I. Introduction and Overview
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 modify aspects of the capital rule. Specifically, the
proposal would revise certain elements of the calculation of the
denominator of the risk-based capital ratios (risk-weighted assets)
under the standardized approach and make certain adjustments to the
definition of regulatory capital.\1\ The proposed changes aim to
improve risk sensitivity while generally retaining the simplicity of
the current framework. Elements of the proposal would also address
comments received from the Economic Growth and Regulatory Paperwork
Reduction Act (EGRPRA) public notices.\2\ The banking organizations
that would be subject to the changes to risk-weighted assets under this
proposal are referred to as ``covered banking organizations'' herein.
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\1\ The standardized approach does not apply to banking
organizations that have elected to use the community bank leverage
ratio framework. Under the terms of a concurrent proposal, the
standardized approach would not apply to Category I or II banking
organizations or to banking organizations that elect to use the
expanded risk-based approach. 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 GSIBs
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
exposure 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 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).
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The prompt corrective action framework in section 38 of the Federal
Deposit Insurance Act (FDI Act) requires the agencies to set 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.\3\ 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.\4\ Further,
Congress has authorized the agencies to establish enhanced risk-based
capital requirements and standards for larger banking organizations
subject to the capital rule.\5\
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\3\ See 12 U.S.C. 1831o(c)(1)(A), (c)(1)(B)(i).
\4\ 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).
\5\ See., e.g., section 165 of the Dodd-Frank Wall Street Reform
and Consumer Protection Act (Dodd-Frank Act), as amended by section
401 of the Economic Growth, Regulatory Relief, and Consumer
Protection Act, which 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.
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In a concurrent notice of proposed rulemaking, the agencies are
seeking comment on changes to the risk-based capital framework that
would apply to Category I and II banking organizations as well as
banking organizations with significant trading activity (expanded risk-
based proposal).\6\ That proposal would introduce a new ``expanded
risk-based approach''--which would include requirements for credit
risk, equity risk, and operational risk--and a revised market risk
framework. Notably, the expanded risk-based proposal would allow
banking organizations of any size to elect to use the expanded risk-
based approach to determine requirements for credit risk, equity risk,
and operational risk in place of the standardized approach.\7\
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\6\ Banking organizations with significant trading activities
that are not Category I or II banking organizations would apply (1)
the market risk framework under the expanded risk-based proposal and
(2) the standardized approach in this proposal (unless they elect to
use expanded risk-based approach under the expanded risk-based
proposal) to determine their risk-weighted assets.
\7\ 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. Although the
expanded risk-based proposal poses more operational complexity
relative to this proposal, the expanded risk-based proposal would
allow other banking organizations to elect to use it. A banking
organization that elects to do so would be subject to the same
definition of capital as Category I and II banking organizations.
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Analysis undertaken by the agencies in connection with the expanded
risk-based proposal included evaluating the appropriateness of the risk
weights applicable to exposures at the business-line level. That
analysis informs the changes in this proposal, including revisions to
risk weights that are particularly material to lending activities.
Specifically, the analysis suggests revisions would be appropriate to
the risk weights applicable to residential mortgage exposures,
corporate exposures, and certain exposures in the current standardized
approach's ``other assets'' category. The proposal would reduce the
risk weight applicable to corporate exposures from 100 percent to 95
percent and the risk weight applicable to all assets not specifically
assigned a different risk weight under the rule from 100 percent to 90
percent. The proposal would also introduce a broader range of risk
weights for residential mortgage exposures, based on more granular risk
factors. In addition, the proposal would adopt the same definition of
commitment as the expanded risk-based proposal and would align the
credit conversion factors for certain off-
[[Page 15335]]
balance sheet exposures, including equity commitments, with that
proposal.
These changes focus on exposure categories that comprise a
substantial amount of total risk-weighted assets for covered banking
organizations and aim to balance a more risk-sensitive calibration of
the requirements with retaining the simplicity of the standardized
approach.\8\ \9\
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\8\ See Table V.G.1 in the Data Appendix (Section V.G.) for a
breakdown of the size of the exposure categories whose treatment
would be revised under this proposal.
\9\ The calculation of the risk-weighted assets under the
expanded risk-based approach is more complex than under the
standardized approach as it is more granular and includes several
additional risk factors. The expanded risk-based approach would also
include an operational risk capital requirement and the requirement
to use the standardized approach for counterparty credit risk to
determine the exposure amount for derivative contracts. Banking
organizations subject to the expanded risk-based approach would also
be subject to a more risk-sensitive but complex definition of
capital, including the requirement to include most elements of
accumulated other comprehensive income in regulatory capital.
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To improve risk sensitivity, this proposal would also make targeted
adjustments to the existing methodologies for determining exposure
amounts for counterparty credit risk and risk-weighted asset amounts
for securitizations, as well as for recognizing the benefits of credit
risk mitigants. These targeted adjustments would align with adjustments
included in the expanded risk-based proposal. 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.
In addition to changes to the calculation of risk-weighted assets,
the proposal would modify the definition of regulatory capital by
removing the threshold-based deduction of mortgage servicing assets
(MSAs). All MSAs 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 threshold. This proposed
revision would promote mortgage origination and servicing by banking
organizations in a risk-appropriate manner and would apply to all
banking organizations subject to the regulatory capital rule, including
banking organizations subject to the community bank leverage ratio
framework.\10\
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\10\ The expanded risk-based approach proposal contains a
corresponding change that would apply to Category I and II banking
organizations.
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The proposal would require Category III and IV banking
organizations to include most elements of accumulated other
comprehensive income (AOCI) in common equity tier 1 capital, consistent
with the current treatment applicable to Category I and II banking
organizations.\11\ This change would better reflect the capital
adequacy and loss-absorbing capacity of Category III and IV banking
organizations in their regulatory capital ratios. The proposal would
include a transition period five years from the effective date of any
final rule for Category III and IV banking organizations to phase-in
the effect of recognizing AOCI in regulatory capital; this transition
period would provide sufficient time to adapt to the changes while
minimizing any potential adverse impact.\12\
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\11\ AOCI generally includes accumulated unrealized gains and
losses on certain assets and liabilities that have not been included
in net income but are included in equity under U.S. generally
accepted accounting principles (for example, unrealized gains and
losses on securities designated as available-for-sale).
\12\ This transition period would mirror the transition period
under the expanded risk-based proposal provided to banking
organizations that elect to use the expanded risk-based approach and
that do not currently recognize AOCI in their regulatory capital.
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The proposal would also amend certain dollar-based regulatory
thresholds in the standardized approach to reflect inflation and ensure
that such thresholds preserve their intended application in real terms
over time. Finally, the proposal would not make any modifications to
the enhanced disclosure requirements under section _.63 of the capital
rule but seeks comment on whether certain modifications would be
appropriate.\13\
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\13\ The agencies anticipate proposing revisions to several
reporting forms of the agencies filed by covered banking
organizations that would align with the proposed revisions to the
capital rule.
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Taken together, the proposed changes aim to improve the risk
sensitivity of the framework while retaining its simplicity. The
agencies expect the proposal to reduce the common equity tier 1 capital
requirements applicable to Category III and IV holding companies by 3.0
percent and the capital requirements applicable to smaller holding
companies \14\ by 7.8 percent. The reduction in requirements for
Category III and IV holding companies reflects a 6.1 percent reduction
due to the revised risk-weighted assets combined with an estimated 3.1
percent increase in capital requirements due to an estimated long-run
average impact of including AOCI in regulatory capital. Similarly, the
agencies expect the proposal to reduce the common equity tier 1 capital
requirements applicable to depository institution subsidiaries of
Category III and IV banking organizations by 4.7 percent, and those
applicable to smaller depository institutions by 8.0 percent. The
agencies performed economic analysis to assess the potential effects of
the proposal (see Section VI). The improvements in risk sensitivity of
capital requirements and associated benefits expected to result from
the proposal justify the proposal's expected costs.
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\14\ Refers to holding companies with total assets under $100
billion that are required to report risk-based capital information
on the FR Y9-C.
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The agencies seek comment on all aspects of the proposal.
II. Definition of Capital
The proposal would broadly maintain the definition of capital
applicable to covered banking organizations in the current capital rule
with two modifications. The proposal would (1) eliminate the
requirement to deduct MSAs above a threshold from common equity tier 1
capital for all covered banking organizations \15\ and (2) require
Category III and IV banking organizations to recognize certain elements
of AOCI in common equity tier 1 capital.
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\15\ In addition, the proposal would require a covered 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 III.E.5.f.
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A. Removal of the Mortgage Servicing Asset Deduction
Under the current capital rule, covered banking organizations must
deduct from common equity tier 1 capital amounts of MSAs that exceed 25
percent of the banking organization's common equity tier 1 capital.
Under the proposal, covered banking organizations would no longer be
required to deduct any amount of MSAs from common equity tier 1
capital. 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 threshold.\16\
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\16\ This revision would also be consistent with comments
received under EGRPRA as commenters requested removal of the MSA
threshold. The expanded risk-based approach proposal would make the
same modification to the definition of regulatory capital for
Category I and II banking organizations and banking organizations
that elect to use the expanded risk-based approach.
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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.
MSAs can be a useful tool for banking organizations to manage
interest rate risk. The value of MSAs generally
[[Page 15336]]
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.\17\
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\17\ In a rising rate environment, the expected life of a
mortgage will increase due to reduced prepayments. As a result, MSAs
will increase in value, as the banking organization will collect
servicing fees over a longer period of time. The increased value of
MSAs act as a natural hedge against existing mortgage-backed
securities which would be expected to trade at a discount in such an
environment.
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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 bank 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.
Question 1: 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)?
B. Recognition of Accumulated Other Comprehensive Income for Category
III and IV Banking Organizations
Under the current capital rule, Category I and II banking
organizations are required to include most elements of AOCI in
regulatory capital. All other banking organizations, including all
covered banking organizations, had the option to make a one-time
election to opt-out of recognizing most elements of AOCI and related
deferred tax assets and liabilities within regulatory capital.\18\
Under the proposal, Category III and IV banking organizations would be
required to include all AOCI components in common equity tier 1
capital, except gains and losses on cash-flow hedges where the hedged
item is not recognized on a covered banking organization's balance
sheet at fair value. This would require all net unrealized gains and
losses on holdings of available-for-sale debt securities from changes
in fair value to flow through to common equity tier 1 capital,
including those that result primarily from fluctuations in benchmark
interest rates.\19\ This treatment would align with the treatment of
AOCI for banking organizations subject to the expanded risk-based
proposal.
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\18\ See 12 CFR 3.22(b) (OCC); 12 CFR 217.22(b) (Board); 12 CFR
324.22(b) (FDIC). A banking organization that made an opt-out
election is currently required to adjust common equity tier 1
capital as follows: subtract any net unrealized holding gains and
add any net unrealized holding losses on available-for-sale
securities; subtract any accumulated net gains and add any
accumulated net losses on cash flow hedges; subtract any amounts
recorded in AOCI attributed to defined benefit postretirement plans
resulting from the initial and subsequent application of the
relevant GAAP standards that pertain to such plans (excluding, at
the banking organization's option, the portion relating to pension
assets deducted under Sec. __.22(a)(5) of the current capital
rule); and, subtract any net unrealized holding gains and add any
net unrealized holding losses on held-to-maturity securities that
are included in AOCI.
\19\ Available-for-sale securities refers to debt securities.
Accounting Standards Update 2016-01 eliminated the classification of
available-for-sale equity securities under Accounting Standards
Codification Subtopic 321-10 and generally requires investments in
equity securities to be measured at fair value with changes in fair
value recognized in net income. Changes in the fair value of (i.e.,
the unrealized gains and losses on) a banking organization's equity
securities are recognized through net income rather than other
comprehensive income.
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AOCI is an important indicator that regulators and market observers
use to evaluate the capital strength of a banking organization. The
requirement to recognize elements of AOCI in regulatory capital has
helped improve the transparency of regulatory capital ratios for
Category I and II banking organizations, as it better reflects a
banking organization's actual loss-absorbing capacity at a specific
point in time, notwithstanding the potential volatility that such
recognition may pose for its regulatory capital ratios. Category III
and IV banking organizations have the tools and access to capital
markets to manage the volatility of regulatory capital that recognition
of AOCI in capital may cause. In addition, as noted in the expanded
risk-based proposal, any banking organization that elects to apply the
expanded risk-based approach would be required to include AOCI in
regulatory capital. Given the more complex nature of the expanded risk-
based proposal, these electing banking organizations are expected to
have the ability to manage the volatility which may arise from the
recognition of AOCI in capital, even if they are smaller banking
organizations.
AOCI contributes to a banking organization's balance sheet equity
and may be used by market participants in evaluating a banking
organization's capital position.\20\ Adverse trends in a banking
organization's balance sheet equity can result in negative market
perception and have liquidity implications.\21\ Banking organizations
that do not include AOCI in regulatory capital are often reluctant to
sell available-for-sale securities that have unrealized losses, as the
losses would have to be recognized upon sale, thereby reducing
regulatory capital. However, banking organizations may need to take
such steps to meet liquidity needs. Recognizing elements of AOCI in
regulatory capital achieves a better alignment of regulatory capital
with a banking organization's point-in-time loss-absorbing capacity.
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\20\ See 84 FR 59230, 59249 (Nov. 1, 2019)
\21\ See Interagency Advisory on Interest Rate Risk Management
(OCC Bulletin 2010-1, SR 10-1, FIL 2-2012, Jan. 11, 2010).
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Question 2: What are the advantages and disadvantages of requiring
Category III and IV banking organizations to recognize AOCI in their
regulatory capital? What other scope of application for the proposed
AOCI treatment should the agencies consider and why? Please provide any
supporting data and analysis.
[[Page 15337]]
The proposal includes transition provisions that would provide
Category III and IV banking organizations that do not currently
recognize AOCI in their regulatory capital with a phase-in for
reflecting AOCI in their regulatory capital over a five-year period
from the effective date of any final rule.\22\ Such a banking
organization would determine its AOCI adjustment amount as the sum of:
(1) net unrealized gains or losses on available-for-sale securities,
plus (2) accumulated net gains or losses on cash flow hedges, plus (3)
any amounts recorded in AOCI attributed to defined benefit
postretirement plans resulting from the initial and subsequent
application of the relevant GAAP standards that pertain to such plans,
plus (4) net unrealized holding gains or losses on held-to-maturity
securities that are included in AOCI. This AOCI adjustment amount would
be transitioned as set forth in Table 1 below for Category III and IV
banking organizations that have previously made the AOCI opt-out
election.\23\ If the banking organization's AOCI adjustment amount is
positive, it would multiply this amount by the percentage of the
appropriate transition period provided in Table 1 below and subtract
the resulting amount from its common equity tier 1 capital. If the AOCI
adjustment amount is negative, the banking organization would perform
the same calculation and add back the resulting amount to its common
equity tier 1 capital.
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\22\ This transition period would mirror the transition period
under the expanded risk-based proposal provided to banking
organizations that elect to use the expanded risk-based approach and
that do not currently recognize AOCI in their regulatory capital.
\23\ For simplicity and illustrative purposes, the transition
table assumes an effective date of January 1, 2027.
[GRAPHIC] [TIFF OMITTED] TP27MR26.016
Question 3: What are the advantages and disadvantages of the
proposed transition provisions for AOCI adjustments? What alternatives
to the proposed transition provisions should the agencies consider, and
why? For example, what are the costs and benefits of different
transition-period durations or different recognition percentages in
each period of the transition?
Question 4: Under the proposal, Category III or IV banking
organizations would recognize AOCI in common equity tier 1 capital
through a transition period, with only a portion of AOCI recognized
during the transition. Category III and IV banking organizations with
positive AOCI (for example, from unrealized gains on available-for-sale
securities) would recognize less AOCI in its regulatory capital ratios
during the transition period than they would if the full AOCI amount
were recognized immediately. What are the costs and benefits of making
the transition period optional, allowing Category III and IV banking
organizations to elect to recognize the full AOCI amount on the
effective date of the rule? Please provide relevant data to support
your views, including information on the magnitude of AOCI at Category
III and IV banking organizations and how it has varied over time and in
different interest rate environments.
Question 5: The expanded risk-based proposal would provide covered
banking organizations under this proposal the choice to adopt the
expanded risk-based approach. The expanded risk-based proposal includes
the same AOCI transition period for banking organizations that do not
currently recognize AOCI in their regulatory capital and that elect to
use the expanded risk-based approach. What are the costs and benefits
of applying the same AOCI transition provisions to banking
organizations that elect to adopt the expanded risk-based approach as
would apply to Category III and IV banking organizations under the
standardized approach? Should banking organizations that elect to adopt
the expanded risk-based approach be subject to different AOCI
transition provisions? If so, what alternative transition provisions
would be appropriate, and why?
III. Calculation of Risk-Weighted Assets Under the Standardized
Approach
Under the proposal, a covered banking organization would continue
to follow the mechanics of the current capital rule for determining its
standardized total risk-weighted assets.\24\ Accordingly, such a
banking organization would calculate its risk-weighted asset amounts
for its on- and off-balance sheet exposures and, if applicable, risk-
weighted assets for market risk covered positions. Risk-weighted asset
amounts generally are determined by assigning on-balance sheet assets
to broad risk-weight categories according to the counterparty, or, if
relevant, the guarantor or collateral. Similarly, risk-weighted asset
amounts for off-balance sheet items are calculated using a two-step
process: (1) multiplying the amount of the off-balance sheet exposure
by a conversion factor to determine a credit equivalent amount or
adjusted carrying value, and (2) assigning the credit equivalent amount
or adjusted carrying value to a relevant risk-weight category.
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\24\ See generally, 12 CFR part 3, subpart D (OCC); 12 CFR part
217, subpart D (Board); 12 CFR part 324, subpart D (FDIC).
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A. General Risk Weight Treatment
To improve the risk sensitivity of the standardized approach, the
proposal would make targeted revisions to the general risk weight
treatment of certain exposure categories that are particularly material
to bank lending activities. As more specifically discussed below, the
[[Page 15338]]
proposal would (1) introduce a more risk-sensitive treatment for
residential mortgage exposures and (2) amend the risk weights
applicable to corporate exposures and to all assets not specifically
assigned a different risk weight under the current standardized
approach. The risk weights applicable to all other exposure categories
would remain unchanged under the proposal.
1. Residential Mortgage Exposures
Under the proposal, a residential mortgage exposure would continue
to be defined as an exposure that is primarily secured by a first or
subsequent lien on one-to-four family residential property or an
exposure with an original and outstanding amount of $1 million or less
that is primarily secured by a first or subsequent lien on a
residential property that is not one-to-four family.\25\ A residential
mortgage exposure would not include an ADC exposure, a pre-sold
construction loan, a statutory multifamily mortgage, or an HVCRE
exposure.
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\25\ See 12 CFR __.2.
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To improve risk sensitivity, the proposal would introduce a loan-
to-value (LTV)-based approach for assigning risk weights to certain
residential mortgage exposures as discussed in section III.A.1.b. of
this SUPPLEMENTARY INFORMATION. LTV ratios are a useful credit risk
indicator as higher levels of homeowner equity generally reduce the
likelihood of borrower default and provide lenders with a degree of
protection against credit losses.
The proposed LTV-based approach would further differentiate risk
weights based on whether a residential mortgage is dependent on cash
flows generated by the real estate securing the extension of credit.
Residential mortgage exposures in which the primary source of repayment
is dependent on cash flows generated by the real estate can expose a
banking organization to elevated credit risk relative to residential
mortgage exposures where the source of repayment does not face such
dependency, 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.\26\ Residential
mortgage exposures that are dependent on such cash flows to repay the
loan can also be more 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 could lower
rental prices and suppress cash flows needed to support repayment of
the loan.
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\26\ 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>.
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If the underwriting process at origination of the residential
mortgage exposure considers any cash flows generated by the real estate
securing the loan, such as from rental payments, 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 for full
repayment of the loan. Given their increased credit risk, the proposal
would assign higher risk weights to residential mortgage 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 from
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.\27\ 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 covered 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.\28\
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\27\ 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,'' 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. Pg. 6. https://www.richmondfed.org/~/media/richmondfedorg/
publications/research/working_papers/2010/pdf/wp10-11.pdf.
\28\ 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 covered 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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To be eligible to use the proposed LTV-based approach, a
residential mortgage exposure would be required to: (1) be secured by a
property that is either owner-occupied or rented; (2) be made in
accordance with prudent underwriting standards, including relating to
the loan amount as a percent of the value of the property; \29\ (3) not
be 90 days or more past due or carried in nonaccrual status; and (4)
not be restructured or modified.\30\ \31\ Additionally, the property
would need to be valued in accordance with the proposed requirements
included in the proposed LTV ratio calculation, as discussed below.
Consistent with the current capital rule, residential mortgage
exposures that do not meet the above criteria or are a junior lien
residential mortgage exposure would continue to receive a 100 percent
risk weight.
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\29\ The agencies expect these underwriting standards to align
with the agencies' safety and soundness and real estate lending
guidelines. 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).
\30\ Consistent with the current capital rule and under the
proposal, when a covered banking organization holds the first-lien
and junior-lien(s) residential mortgage exposures and no other party
holds an intervening lien, the covered banking organization would be
required to combine the exposures and treat them as a single first-
lien residential mortgage exposure.
\31\ These requirements generally align with the current capital
rule's requirements for first-lien residential mortgages that are
eligible for a 50 percent risk weight.
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Question 6: The agencies seek comment on the set of residential
mortgage exposures that are eligible to use the LTV-based approach.
What are the advantages and disadvantages of aligning the scope of
mortgages eligible to use the LTV-based approach with the current
capital rule's 50 percent risk-weight category for residential mortgage
exposures? What other alternatives should the agencies consider? Should
covered banking organizations have the option to adopt the LTV-based
approach or the option to retain the current treatment which applies
less risk-sensitive risk weights of 50 and 100 percent?
Question 7: The agencies seek comment on the appropriateness of
using an LTV-based approach to determine risk-weights for residential
mortgages as a standardized approach and the operational or
administrative
[[Page 15339]]
burden associated with its implementation. What are the advantages or
disadvantages of using an LTV-based approach for the standardized
approach? What alternative approaches should the agencies consider, and
why? Please provide examples of potential operational or administrative
challenges associated with implementing the LTV-based approach.
a. Calculating the Loan-to-Value Ratio
Under the proposal and in line with the expanded risk-based
approach proposal, covered banking organizations would use an LTV ratio
to assign a risk weight applicable to certain residential mortgage
exposures. The proposed calculation of the LTV ratio would generally
align with the real estate lending guidelines, except with respect to
the recognition of private mortgage insurance.
A covered banking organization would calculate the LTV ratio for
purposes of Table III.1 and Table III.2 below by dividing the extension
of credit by the value of the property. The extension of credit means
the total outstanding amount of the loan, including any undrawn
committed amount. The total outstanding amount reflects the current
amortized balance as the loan pays down, which would allow a covered
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 covered banking organization would reflect that increase
in the LTV ratio.
For the LTV ratio calculation, a covered 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 predominately engaged in the business of
providing credit protection (such as a monoline bond insurer or re-
insurer).\32\ During the 2007-2009 housing market stress, the
performance of private mortgage insurance deteriorated at the same time
as the underlying exposures.\33\ Under the proposal and consistent with
the current capital rule, private mortgage insurance is considered when
a covered banking organization identifies which of its residential
mortgage exposures are made in accordance with prudent underwriting
standards and eligible to use the proposed risk weights discussed in
section III.A.1.b. of this SUPPLEMENTARY INFORMATION.\34\
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\32\ 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). See definition of
eligible guarantor in Sec. __.2 of the capital rule. 12 CFR 3.2
(OCC); 12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC).
\33\ 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>.
\34\ See 12 CFR __.32(g)(1)(ii).
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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),\35\ 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
covered banking organization's origination and underwriting process.
Most residential mortgage exposures held by insured depository
institutions are subject to the agencies' appraisal rule, which also
provides for evaluations in some cases, and provides for certain
exceptions, such as where a lien on real estate is taken as an
abundance of caution. To help ensure that the value of the real estate
is determined in a prudently conservative manner, the proposal would
also provide that, for exposures not subject to the appraisal rule, the
valuations of the real estate properties would need to exclude
expectations of price increases and be adjusted downward to take into
account the potential for the current market prices to be significantly
above the values that would be sustainable over the life of the loan.
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\35\ 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).
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In addition, when the residential mortgage exposure finances the
purchase of a property, the value would be the lower of (1) the actual
acquisition cost of the property and (2) the market value obtained from
either (i) the valuation requirements under the appraisal rule (if
applicable) or (ii) as described above, an independent valuation using
prudently conservative valuation criteria that is separate from the
covered 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 covered banking organizations to use the value of the
property at the time of origination, except under the following
circumstances: (1) the covered banking organization's primary Federal
supervisor requires the covered banking organization to revise the
property value downward; (2) an extraordinary event occurs resulting in
a permanent reduction of the property value (for example, a natural
disaster); or (3) modifications are made to the property that increase
its market value and are supported by an appraisal or independent
evaluation using prudently conservative criteria. These proposed
exceptions are intended to constrain the use of values other than the
value of the property at loan origination only to exceptional
circumstances that are sufficiently material to warrant use of a
revised valuation.
For purposes of determining the value of the property, the proposal
would use the definition of readily marketable collateral and other
acceptable collateral consistent with the real estate lending
guidelines. Therefore, readily marketable collateral would mean insured
deposits, financial instruments, and bullion in which the covered
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, in an auction or
on similarly available daily bid and ask price market. Other acceptable
collateral would mean any collateral in which the covered banking
organization has a perfected security interest that has a quantifiable
value and is accepted by the covered banking organization in accordance
with safe and sound lending practices. Under the proposal, other
acceptable collateral would include,
[[Page 15340]]
among other items, unconditional irrevocable standby letters of credit
for the benefit of the covered banking organization. Readily marketable
collateral and other acceptable collateral must be appropriately
discounted by the covered banking organization consistent with the
banking organization's usual practices for making loans secured by such
collateral. The reasonableness of a covered 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 8: The agencies have considered various alternatives
relating to how private mortgage insurance should be recognized for
residential mortgages exposures beyond the proposed treatment of
considering private mortgage insurance when identifying which
residential mortgage exposures meet the requirements to be considered
prudently underwritten and eligible to use the proposed LTV-based
approach. What would be the pros and cons of providing explicit
recognition of private mortgage insurance in the calculation of LTV
ratios for purposes of determining the risk weights for residential
exposures? What, if any, increases in procyclicality and incentives for
increased risk-taking by covered 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.
b. Risk Weights for Residential Mortgage Exposures
Under the proposal, a covered banking organization would assign a
risk weight to an eligible residential mortgage exposure based on the
exposure's LTV ratio without private mortgage insurance and based on
whether repayment is dependent on the cash flows generated by the real
estate, in accordance with Tables III.1 and III.2 below.\36\ LTV ratios
and source of repayment would factor into the risk-weight treatment for
residential mortgage exposures because they are key determinants of
risk for real estate exposures.
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\36\ 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. See Appendix C to Part 208, Title 12.
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The proposed risk weights would recognize the reduction in risk due
to amortization, as the borrower pays down principal and builds
equity.\37\ Given the increased risk sensitivity of the LTV-based
approach relative to the current standardized approach, the risk
weights for eligible residential mortgage exposures would decrease
throughout the life of the loan as the obligor makes payments. Lower
LTVs are strongly associated with lower realized loss given
default.\38\
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\37\ For purposes of the LTV ratio calculation, the proposal
would require covered 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>.
\38\ Ken[ccedil], Turalay. ``Macroprudential regulation:
history, theory and policy.'' BIS Paper 86c (2016).
[GRAPHIC] [TIFF OMITTED] TP27MR26.017
[GRAPHIC] [TIFF OMITTED] TP27MR26.018
The proposed risk weights in Tables III.1 and III.2 would
appropriately balance the benefits of risk sensitivity, transparency,
and consistency in requirements across covered banking organizations.
Relative to the current standardized approach, the proposed risk
weights in Tables III.1 and III.2 would also align more closely with
the treatment of regulatory residential real estate exposures under the
expanded risk-based proposal. Consistent with the general risk weights
in the current
[[Page 15341]]
standardized approach and in contrast with the proposed expanded risk-
based approach, there is not a separate operational risk-based capital
requirement. Therefore, the proposed risk weights for residential
mortgage exposures under this proposal would not account exclusively
for credit risk. The difference in risk weights between the two
proposals is, therefore, explained by the differing approaches for how
risk categories, such as specific credit and operational risk-based
requirements, factor into each proposal's methodology for assigning
risk weights.\39\
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\39\ The calibration of the operational risk add-on followed a
similar logic to the one used for corporate exposures and other
assets (discussed below). Given that operational risk represents
approximately 12 percent of risk-weighted assets for traditional
lending under the expanded risk-based approach and assuming an
average 35 percent risk weight for eligible residential real estate
exposures, an operational risk add-on of approximately 5 percentage
points to residential real estate risk weights would be appropriate.
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Question 9: The agencies seek comment on the proposed risk-weights
for residential mortgage exposures in Tables III.1 and III.2. What
alternative approaches, if any, should the agencies consider to account
for risks other than credit risk posed by covered banking
organizations' residential mortgage lending activities? What
alternative risk weights, if any, should the agencies consider, and
why? Please provide any supporting data.
Question 10: What are the advantages and disadvantages of the
proposed LTV-based approach for residential mortgage exposures that are
dependent on the cash flows of the property? What, if any,
implementation challenges would the requirement to determine whether an
exposure is dependent on the cash flows of the property present? What
would be the advantages and disadvantages of an alternative LTV-based
approach that differentiates risk weights on whether the property
securing the residential mortgage exposure is owner occupied? If the
agencies were to implement such an approach for purposes of the final
rule, what would be the appropriate risk-weight calibration? The
agencies encourage commenters to provide data and supporting analysis.
2. Corporate Exposures and Certain Other Assets
The proposal would update the risk weights applicable to (1)
corporate exposures and (2) all assets not specifically assigned a
different risk weight under the capital rule and that are not deducted
from regulatory capital (other assets).
Under the proposal, the risk weight applicable to corporate
exposures would be reduced from 100 percent to 95 percent and the risk
weight applicable to other assets would be reduced from 100 percent to
90 percent.\40\ These changes aim to balance a more risk-sensitive
calibration with maintaining the simplicity of the standardized
approach. The proposal would maintain the existing definition of
corporate exposure and other assets.
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\40\ The other assets category is composed of exposures to
individuals, other real estate owned, and other exposures not
specifically assigned a different risk weight.
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When analyzing the risk-based capital requirements for specific
business lines under the expanded risk-based proposal, the agencies
determined that the current risk weights for certain exposure
categories may not appropriately reflect risks. The expanded risk-based
proposal includes reduced risk weights relative to the current
standardized approach for corporate exposures that are deemed
investment grade and retail exposures that exhibit reduced credit risk.
These changes in the expanded risk-based proposal are intended to
increase sensitivity to risk of the capital requirements for the
banking organizations covered by that proposal. However, the increased
complexity and operational burden for achieving these enhancements in
risk sensitivity would not be appropriate for a standardized approach
that applies to smaller and less complex banking organizations. To
better calibrate the standardized approach's general risk weights for
similar exposures while retaining their simplicity, the agencies
conducted additional data analysis.
The risk weights assigned to corporate exposures and other assets
under this proposal are informed by the risk weights for credit risk
and operational risk that would apply to domestic Category III and IV
banking organizations under the expanded risk-based approach.
Specifically, the exposure categories that would be risk-weighted as
corporate exposures and other assets were approximated using exposures
reported in the special data collection, risk-weighted as under the
expanded risk-based proposal.\41\ This analysis resulted in a weighted-
average credit risk weight of 85 percent for corporate exposures and 77
percent for other assets.
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\41\ In late 2023, the Board collected data on risk-weighted
assets from 32 large bank holding companies based on the specific
requirements contained in a July 27, 2023, capital proposal. See
<a href="https://www.federalreserve.gov/newsevents/pressreleases/bcreg20231020b.htm">https://www.federalreserve.gov/newsevents/pressreleases/bcreg20231020b.htm</a>. Corporate exposures were proxied using data
reported in line items containing corporate exposures (item 8),
certain real estate exposures (items 6.d, 6.g, 6.h, and 6.i), and
certain off-balance sheet items (items 13 to 25 and 27), where those
items were assigned one of the possible risk-weights corresponding
to corporate exposure under the expanded risk-based approach
proposal. Other asset exposures were proxied using data reported in
line items containing retail exposures (item 7), other assets (item
9), and certain off-balance sheet items (items 13) where such
exposures were assigned a risk weight corresponding to either retail
exposures or a risk weight of 100 percent.
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In addition to credit risk, the expanded risk-based proposal would
assign risk-weighted asset requirements for the operational risk of
these exposures. Consistent with the simple risk weighting of the
standardized approach, this proposal would reflect a nominal add-on to
account for operational risk. Analysis in the expanded risk-based
proposal suggests that risk-weighted assets for operational risk would
represent approximately 12 percent of credit risk-weighted assets for
traditional lending activities.\42\ Assuming approximately an 80
percent credit risk weight for these activities, this would result in
approximately a 10 percentage points risk-weight add-on for operational
risk. Moreover, the methodology used to determine the weighted-average
risk weight for other assets under the expanded risk-based approach is
likely slightly underestimated because the portfolios of non-Category
III or IV banking organizations subject to the standardized approach
likely include fewer transactor retail exposures (with relatively low
risk weights) as smaller banking organizations have more limited credit
card portfolios. Therefore, this proposal would assign risk weights of
95 percent for corporate exposures and 90 percent for other assets.
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\42\ See Table VII.6 in the expanded risk-based proposal. This
calculation is based on the risk-weighted assets estimated to apply
to the traditional lending activities of Category I and II bank
holding companies.
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Question 11: The agencies seek comment on the proposed risk weight
for corporate exposures. What alternative risk-weight should the
agencies consider, and why? Please provide any supporting data.
Question 12: The agencies seek comment on the proposed risk weight
for exposures to assets not otherwise assigned to a specific risk
weight under the current standardized approach and that are not
deducted from tier 1 or tier 2 capital pursuant to Sec. __.22. What
are the advantages and disadvantages of the proposed risk weight of 90
percent for this set of exposures? What alternative risk-weight should
the agencies
[[Page 15342]]
consider, and why? Please provide any supporting data.
Question 13: The agencies seek comment on whether to create a
separate category, or separate categories, for retail exposures in the
proposed standardized approach. What would be the advantages and
disadvantages of creating a separate category for retail exposures?
What are the appropriate criteria for defining retail exposures (for
example, the criteria used to define retail exposures under the
expanded risk-based proposal)? What risk weight would be appropriate
for retail exposures for covered banking organizations? In a revised
treatment where retail exposures are segregated into their own risk-
weight category, would it be appropriate to set a 100 percent risk
weight for other assets (not including retail exposures) and why?
Please provide relevant data to support your views, including
information on the historical loss rates and risk characteristics of
retail exposures.
B. Off-Balance Sheet Exposures
The proposal would better capture the risk of certain off-balance
sheet exposures relative to the current standardized approach by
revising the definition of commitment to clarify the off-balance sheet
exposures that would be subject to risk-based capital requirements and
modifying the conversion factors applicable to certain credit and
equity commitments.
1. Definition of Commitment
The current capital rule defines a commitment as any legally
binding arrangement that obligates a banking organization to extend
credit or to purchase assets.\43\ Such an arrangement is treated as a
commitment even when the banking organization has the unilateral right
to cancel the arrangement at any time. The agencies have received
questions from banking organizations regarding whether certain types of
arrangements, such as advised credit lines and uncommitted lines, would
be commitments even if they are unconditionally cancelable. In
addition, the agencies have observed an inconsistent application of the
current definition of commitment.
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\43\ See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2
(FDIC).
---------------------------------------------------------------------------
Consistent with the expanded risk-based proposal, the proposal
would revise the definition of commitment to clarify that any
contractual arrangement under which a banking organization and an
obligor agree to the terms applicable to one or more future extensions
of credit, purchases of assets, or issuances of credit substitutes by
the banking organization is a commitment, whether or not the
arrangement is unconditionally cancelable. Consistent with the current
capital rule, an unconditionally cancelable commitment would include a
commitment that permits a banking organization to, at any time, with or
without cause, refuse to extend credit, purchase assets, or issue
credit substitutes under the arrangement (to the extent permitted under
applicable law). Similarly, the proposal clarifies that a contractual
arrangement to extend credit, purchase assets, or issue credit
substitutes, but which does not obligate the banking organization to do
so, is also considered a commitment that is unconditionally
cancelable.\44\ This approach would promote comparable treatment across
banking organizations subject to the capital rule.
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\44\ The proposal would remove the definition of
``unconditionally cancelable'' and revise the definition of
``commitment'' to indicate which commitments are considered
unconditionally cancelable.
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Commitments represent an arrangement where the banking organization
could expect to purchase assets or to extend credit to an obligor, in
which case the credit becomes an on-balance sheet asset. The scope of
the definition is, therefore, not intended to be limited to those
situations in which the banking organization is obligated to provide
some amount of credit to an obligor. The agencies do not, however,
intend for the definition of commitment to include arrangements where a
banking organization has merely offered potential terms to a potential
obligor or that continue to be subject to negotiation between the
parties. For the purpose of the regulatory capital rule, a commitment
does not and would not include pre-approval letters for residential
mortgage loans, credit card offers, or other offers that have not yet
been agreed upon by both parties to the transaction.
Examples of arrangements that would generally be considered
commitments under the proposal include fronting commitments, where a
banking organization agrees to fund the obligations of other members of
a syndicate of lenders, and commitment letters, where a banking
organization agrees to provide financing in connection with an
acquisition or other transaction to be entered into by the obligor. The
proposal would also include other off-balance sheet activities such as
advised lines or ``uncommitted'' facilities as commitments (even if
they are unconditionally cancelable or provide that the banking
organization is not obligated to perform). For example, an arrangement
under which a banking organization retains full discretion as to
whether to extend credit to a potential borrower, but under which the
banking organization and the potential borrower have agreed to the
material terms on which such lending would take place if the banking
organization chose to extend credit, is an unconditionally cancelable
commitment under the proposal. An unconditionally cancelable commitment
also includes an arrangement where a banking organization provides an
initial line of credit with an additional amount that the banking
organization may extend in the future subject to prior approval by the
banking organization, with the agreed upon terms of the future
unconditionally cancelable line.
Exposures without pre-set limits on the amount of credit that can
be extended also can be unconditionally cancelable commitments. With
some retail products, such as with charge cards, the banking
organization does not disclose a pre-set credit limit to its obligors.
For charge cards, or similar types of off-balance sheet exposures, each
attempt to borrow by an obligor is individually underwritten and
requires the approval of the banking organization. Nevertheless,
because the banking organization and the borrower have agreed to the
material terms on which such lending would take place, such
arrangements meet the definition of commitment and, therefore, should
be treated as unconditionally cancelable commitments for regulatory
capital purposes.\45\
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\45\ See section V.F. for the proposed methodology to determine
the exposure amount for retail exposures with no pre-set limit.
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Question 14: The agencies seek comment on the clarification to the
definition of commitment. Does the proposal appropriately capture as
off-balance sheet exposures arrangements where the covered banking
organization is not legally obligated to extend credit, purchase
assets, or issue credit substitutes but which nonetheless arise out of
a contractual arrangement to extend credit or purchase assets? To what
extent would the proposed definition affect a covered banking
organization's business practices regarding commitments and similar
arrangements, including how covered banking organizations treat such
arrangements for regulatory capital and reporting purposes? Please
provide any rationale or data that may be helpful for the agencies to
consider.
[[Page 15343]]
2. Conversion Factors
Consistent with the current rule, under the proposed rule a covered
banking organization would calculate the exposure amount of an off-
balance sheet exposure by multiplying the off-balance sheet component,
which is usually the contractual amount or adjusted carrying value, by
the applicable conversion factor. The resulting exposure amount would
then be assigned to the relevant risk-weight category for the exposure.
The proposal would retain the same conversion factors from the current
capital rule, except with respect to commitments.\46\
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\46\ Note issuance facilities and revolving underwriting
facilities are forms of revolving credit. Notes issued under note
issuance facilities and revolving underwriting facilities are short-
term instruments issued under a legally binding medium-term
contractual arrangement. Under a revolving underwriting facility,
the underwriting banking organization agrees to provide loans should
the issue fail, but under a note issuance facility the banking
organization could either lend to the issuer or purchase the
outstanding notes. Consistent with the current rule and with the
Basel standards, the proposal would require banking organizations to
apply a 50 percent credit conversion factor to the off-balance sheet
amount of note issuance facilities and revolving underwriting
facilities, regardless of whether a lower credit conversion factor
would otherwise apply.
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Under the current standardized approach, commitments that are not
unconditionally cancelable with an original maturity of one year or
less receive a 20 percent credit conversion factor and those with an
original maturity of more than one year receive a 50 percent credit
conversion factor.\47\ The proposal would simplify the conversion
factors applicable to the unused portion of a credit or equity
commitment that is not unconditionally cancelable. For these
commitments, the proposal would no longer differentiate conversion
factors by original maturity of one year or less and greater than one
year.
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\47\ 12 CFR 3.33(b)(2) (OCC); 12 CFR 217.33(b)(2) (Board); 12
CFR 324.33(b)(2) (FDIC).
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Under the proposal, a credit commitment that is not unconditionally
cancelable would be subject to a credit conversion factor of 40 percent
regardless of the maturity of the facility.\48\ Removing the one-year
mark as a dividing line between substantially different treatments
would remove any regulatory incentive to structure transactions around
that line. The 40 percent credit conversion factor would align with the
expanded risk-based proposal and reflect that most outstanding
commitments that are not unconditionally cancelable have a maturity
greater than one year.\49\
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\48\ Under the proposal, a 40 percent conversion factor would
also apply to commitments that are not unconditionally cancelable
commitments for purposes of calculating the total leverage exposure
for the supplementary leverage ratio framework and for the
calculation of the Size Category of the FR Y-15 Systemic Risk Report
form.
\49\ In Q2 2025, prior to application of conversion factors,
commitments with maturity less than one year accounted for under 20
percent of aggregate risk-weighted assets associated with
commitments of Category III and smaller bank holding companies (See
FR Y-9C Schedule HC-R Part II, items 18.a and b).
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The proposal would also simplify the treatment of conditional
commitments to acquire an equity exposure by removing the
differentiation of conversion factors by maturity. Under the proposal a
covered banking organization would be required to multiply the
effective notional principal amount of a conditional commitment by a 40
percent conversion factor to calculate its adjusted carrying value.\50\
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\50\ Aside from this change, the equity framework would retain
the current capital rule's methods for calculating the adjusted
carrying value for equity exposures. Under the proposal, the risk-
weighted asset amount calculation for equity exposures would also be
consistent with the current rule.
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Question 15: What additional factors, if any, should the agencies
consider for determining the applicable credit conversion factors for
commitments?
Question 16: What are the advantages and disadvantages relative to
the proposal of using the current treatment for commitments, that are
not unconditionally cancelable which differentiates credit conversion
factors based on maturity, and would apply a 20 percent credit
conversion factor to those commitments with an original maturity of one
year or less, and a 50 percent credit conversion factor to those with
an original maturity of more than one year?
Question 17: What are the advantages and disadvantages of applying
the proposed 40 percent credit conversion factor for commitments
regardless of maturity that are not unconditionally cancelable to the
supplementary leverage ratio framework and to the Size Category of the
FR Y-15?
3. Commitments With No Pre-Set Limit
Most off-balance sheet exposures, such as credit card lines, allow
obligors to borrow up to a specified amount. However, some off-balance
sheet exposures such as charge cards do not have an explicit
contractual pre-set credit limit. For commitments that do not have an
express contractual maximum amount or pre-set limit, the proposal would
include an approach to calculate a proxy for the committed but undrawn
amount of the commitment (undrawn exposure amount). This approach would
generally align with that under the expanded risk-based proposal,
except for a broader scope of application under this proposal given the
objective to retain a simpler and less granular framework.
The proxy for the undrawn exposure amount is particularly important
for covered banking organizations subject to the supplementary leverage
ratio framework. Consistent with the current rule, under the proposal,
covered banking organizations would apply a zero percent credit
conversion factor to the unused portion of a commitment that is
unconditionally cancelable for risk-based capital purposes. However,
for purposes of the supplementary leverage ratio the minimum credit
conversion factor that may be assigned to an off-balance sheet exposure
is 10 percent.\51\
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\51\ See 12 CFR 3.10(c)(2)(viii) (OCC); 12 CFR
217.10(c)(2)(viii) (Board); 12 CFR 324.10(c)(2)(viii) (FDIC).
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The undrawn exposure amount would be calculated by using the
exposure's highest drawn amount over the previous 24 months as an
indicator of the amount of credit a covered banking organization is
likely to extend to an obligor in the future. Specifically, under the
proposal, a covered banking organization would first identify the
largest drawn amount by an obligor over the prior 24 months or, if the
covered banking organization has offered the product to the obligor for
fewer than 24 months, the largest drawn amount since the commitment was
first issued. The off-balance sheet exposure amount would be calculated
by first subtracting the current drawn amount from the largest drawn
amount and then multiplying this difference by the applicable credit
conversion factor. The risk-weighted asset amount would be the off-
balance sheet exposure amount multiplied by the applicable risk weight
for the obligor.
A substantial share of uncapped commitments is in the form of
charge cards to individuals, and these exposures have characteristics
that suggest the highest drawn balance method described above is a
reasonable proxy to estimate the undrawn exposure amount. A charge card
does not have a pre-set credit limit, its balance is generally required
to be paid in full at the end of each statement period, and charge card
transactions are generally underwritten separately and reviewed by the
issuing banking organization for approval or denial. Therefore, a
charge card obligor's spending pattern, which reflects a covered
banking organization's approval of the charge card obligor's usage, is
indicative of the off-balance sheet exposure amount for a charge card.
[[Page 15344]]
As an example of the proposed treatment, assume an obligor's charge
card had a maximum drawn amount of $4,000 during the period of the
prior 24 months and a current drawn amount of $3,000.\52\ To determine
the off-balance sheet exposure amount of the charge card, the covered
banking organization would (1) identify the maximum drawn amount over
the prior 24 months ($4,000), (2) subtract the applicable drawn amount
of $3,000 from $4,000 ($1,000), and (3) multiply $1,000 by the
applicable credit conversion factor.\53\
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\52\ The maximum balance would reflect the highest daily drawn
amount for the account with no pre-set limit over the period.
\53\ The applicable credit conversion factor for these types of
exposures, assuming they are unconditionally cancelable commitments,
would continue to be zero percent under the standardized approach
and 10 percent under the supplementary leverage ratio.
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Question 18: What are the advantages and disadvantages of the
proposed treatment for commitments with no express contractual maximum
amount or pre-set limit? What other time period or approach should the
agencies consider for calculating the highest drawn amount (for
example, using month-end balance or statement balances), and why?
Question 19: What would be the advantages and disadvantages of
applying a multiplier to the highest drawn amount to calculate the off-
balance sheet exposure amount (for example, multiplying the highest
drawn balance by a figure between 1.5 and 3) to calculate the off-
balance sheet exposure amount? <SUP>54</SUP> If applied, how should
such multiplier be calibrated? What data should the agencies use to
calibrate such a multiplier?
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\54\ If a multiplier of two were applied to the maximum drawn
amount over the prior 24 months, under the example presented above,
the off-balance sheet exposure amount would equal $5,000, which
corresponds to $4,000 times two minus $3,000. The other steps of the
process would remain unchanged and would result in a risk-weighted
asset amount of $225 for the off-balance sheet exposure.
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Question 20: The agencies seek feedback on commitments that contain
no express contractual maximum amount but also contain features such as
a ``pay over time'' limit, which allows a borrower to carry a balance
with interest on certain charges. What would be the advantages and
disadvantages of incorporating the ``pay over time'' limit as a floor
when calculating the highest drawn amount under the proposal? For
example, assume the maximum drawn amount over the prior 24 months is
$4,000 and the ``pay over time'' limit is $5,000. Under this
alternative, the applicable drawn amount would be subtracted from
$5,000 instead of $4,000.
Question 21: The agencies seek comment on whether the specific
treatment described above is appropriate for all commitments with no
contractual maximum or pre-set limit. What are the advantages and
disadvantages of instead limiting the proposed treatment for such
commitments to a narrower set of exposure categories (such as the scope
under the expanded risk-based proposal) and why? What alternative
treatments, if any, should the agencies consider for determining the
exposure amount when no contractual maximum or pre-set limit exists?
Describe in detail the types of alternative treatments that the
agencies should consider, and provide supporting rationale or data that
may be helpful for the agencies.
C. Derivative Contracts
Under the proposal and consistent with the current capital rule, a
covered banking organization would use the current exposure methodology
to calculate the exposure amount for derivative contracts unless it
elects to use the standardized approach for counterparty credit risk
(SA-CCR).<SUP>55 56</SUP> To promote consistency, a covered banking
organization that elects to use SA-CCR would apply the same revised SA-
CCR framework that is proposed in the expanded risk-based proposal
regardless of whether the banking organization is subject to the
standardized approach or the expanded risk-based approach.\57\ The
revised SA-CCR framework would better reflect the risk-reducing effects
of netting arrangements and collateral.
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\55\ See 12 CFR 3.34 (OCC); 12 CFR 217.34 (Board); 12 CFR 324.34
(FDIC).
\56\ 85 FR 4362 (Jan. 24, 2020).
\57\ See expanded risk-based proposal section IV.A.4.
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Specifically, the revised SA-CCR framework would recognize
qualifying cross-product master netting agreements for non-cleared
transactions and incorporate certain non-cleared repo-style
transactions, including client-facing transactions. The revised
framework would also permit the netting of collateralized-to-market and
settled-to-market client-facing derivative transactions. In addition,
the proposal would make technical revisions to promote consistent
implementation of SA-CCR and better reflect counterparty credit risk.
The accompanying expanded risk-based approach proposal provides further
details on the changes to the SA-CCR framework.
D. Credit Risk Mitigation
The current capital rule permits covered banking organizations to
recognize certain types of credit risk mitigants, such as guarantees,
credit derivatives, and collateral, for risk-based capital purposes
provided the credit risk mitigants satisfy the qualification standards
under the rule.\58\ Credit derivatives and guarantees can reduce the
credit risk of an exposure by placing a legal obligation on a third-
party protection provider to compensate the banking organization for
losses associated with a credit event of the original obligor.\59\
Similarly, the use of collateral often can reduce the credit risk of an
exposure by creating the right of a banking organization to take
ownership of and liquidate the collateral in the event of a default by
the counterparty. Prudent use of such mitigants can help a banking
organization reduce the credit risk of an exposure and in some
circumstances reduce the risk-based capital requirement associated with
that exposure.
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\58\ Consistent with the current capital rule, the proposal
would not require covered banking organizations to recognize a
credit risk mitigant that it has obtained. Credit derivatives that a
covered banking organization cannot or chooses not to recognize as a
credit risk mitigant would be subject to a separate counterparty
credit risk capital requirement.
\59\ Credit events are defined in the documents governing the
credit risk mitigant and often include events such as failure to pay
principal and interest and entry into insolvency or similar
proceedings.
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Credit risk mitigants recognized for risk-based capital purposes
must be of sufficiently high quality to effectively reduce credit risk.
For guarantees and credit derivatives, the current capital rule
primarily looks to the creditworthiness of the guarantor and the
features of the underlying contract to determine whether these forms of
credit risk mitigation may be recognized for risk-based capital
purposes (eligible guarantee or eligible credit derivative). With
respect to collateralized transactions, the current capital rule
primarily looks to the liquidity profile and quality of the collateral
received (such as the creditworthiness of the issuer of the collateral)
and the nature of the banking organization's security interest to
determine whether the collateral qualifies as financial collateral that
may be recognized for purposes of risk-based capital.\60\
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\60\ See definition of financial collateral in Sec. __.2 of the
capital rule. 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2
(FDIC).
---------------------------------------------------------------------------
The proposal would largely incorporate the treatments for
collateralized transactions, guarantees, and credit derivatives from
the current capital rule with enhancements to increase risk
sensitivity. For eligible guarantees and eligible credit
[[Page 15345]]
derivatives, the proposal would generally retain the substitution
approach from the current capital rule with two modifications.
Specifically, the proposal would modify the treatment for eligible
credit derivatives that do not include restructuring as a credit event
and no longer permit the recognition of credit protection from nth-to-
default credit derivatives.\61\
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\61\ See section III.E.5.b. of this SUPPLEMENTARY INFORMATION.
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For collateralized transactions where financial collateral secures
exposures that are not derivative contracts or netting sets of
derivative contracts, the proposal would generally retain the simple
approach from the current capital rule with the following two
modifications.\62\ First, the proposal would replace the requirement
that financial collateral be subject to a collateral agreement with
conditions including the requirement that the covered banking
organization have the right to liquidate or take legal possession of
the collateral upon an event of default. Second, the proposal would
permit covered banking organizations to recognize, under the simple
approach, the credit risk mitigation benefits of financial collateral
with a maturity or currency mismatch, after applying certain
adjustments. The proposal would also update the collateral haircut
approach to partially recognize the netting and diversification
benefits that may be present in repo-style transactions, eligible
margin loans, collateralized derivative contracts and single product
netting sets of such transactions.\63\
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\62\ The collateral haircut approach also would be available to
covered banking organizations to recognize the benefits of
collateral for eligible margin loans and repo-style transactions.
\63\ Consistent with the expanded risk-based approach, the
proposal would increase simplicity, consistency and comparability of
capital requirements eliminating the option for banking
organizations to use of their own estimates of haircuts for purposes
of the collateral haircut approach.
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The proposal would also introduce eligible prepaid credit
protection arrangements as a credit risk mitigant available to all
exposure types, including securitizations, and permit covered banking
organizations to recognize the credit risk mitigation benefits of the
protection amount of the prepaid credit protection arrangement,
discounted to reflect any applicable maturity and currency mismatch
adjustments.
1. Guarantees and Credit Derivatives
a. Substitution Approach
Consistent with the current capital rule, the proposal would permit
a covered banking organization to recognize the credit risk-mitigation
benefits of eligible guarantees and eligible credit derivatives by
substituting the risk weight applicable to the eligible guarantor or
counterparty to the eligible credit derivative (protection provider)
for the risk weight applicable to the hedged exposure. To recognize the
risk mitigating benefits of a guarantee or credit derivative for risk-
based capital purposes, the proposal would continue to require the
issuer of or counterparty to the eligible guarantee or eligible credit
derivative, respectively, to be an eligible guarantor.\64\ The proposal
would rely on the definition of eligible guarantor in Sec. __.2 of the
capital rule, which, among other criteria, requires an entity to have
issued and outstanding an unsecured debt security without credit
enhancement that is investment grade at the time the guarantee is
issued or anytime thereafter.
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\64\ Under the advanced approaches framework in the current
capital rule, an eligible guarantee need not be issued by an
eligible guarantor unless the exposure is a securitization exposure.
Under the proposal, an eligible guarantee would need to be issued by
an eligible guarantor.
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Question 22: The agencies seek comment on the requirement that the
entity has issued and outstanding an unsecured debt security without
credit enhancement that is investment grade to meet the definition of
an eligible guarantor. What, if any, alternatives to this requirement
should the agencies consider to help ensure that eligible guarantors
can be expected to perform on guarantees, and what would the pros and
cons of those alternatives be?
b. Adjustment for Credit Derivatives Without Restructuring
Credit derivative contracts in certain jurisdictions include debt
restructuring as a credit event that triggers a payment obligation by
the protection provider to the protection purchaser. Such
restructurings of the hedged exposure may involve forgiveness or
postponement of principal, interest, or fees that result in a loss to
investors. Consistent with the current capital rule, the proposal would
generally require a banking organization that seeks to recognize the
credit risk-mitigation benefits of an eligible credit derivative that
does not include a restructuring of the reference exposure as a credit
event to reduce the effective notional amount of the credit derivative
by 40 percent to account for any unmitigated losses that could occur as
a result of a restructuring of the hedged exposure.
Under the proposal, however, the 40 percent adjustment would not
apply to eligible credit derivatives without restructuring as a credit
event if both of the following requirements are satisfied: (1) the
terms of the hedged exposure (and the reference exposure, if different
from the hedged exposure) allow the maturity, principal, coupon,
currency, or seniority status to be amended outside of receivership,
insolvency, liquidation, or similar proceeding only by unanimous
consent of all parties; and (2) the covered banking organization has
conducted sufficient legal review to conclude with a well-founded basis
(and maintains sufficient written documentation of that legal review)
that the hedged exposure is subject to the U.S. Bankruptcy Code or a
domestic or foreign insolvency regime with similar features that allows
for a company to reorganize or restructure and provides for an orderly
settlement of creditor claims.
The unanimous consent requirement would mean that, for
restructurings occurring outside of an insolvency proceeding, all
holders of the hedged exposure (and the reference exposure, if
different from the hedged exposure) must agree to any restructuring for
the restructuring to occur, and no holder can vote against the
restructuring or abstain. This unanimous consent requirement would
reduce the risk that a covered banking organization would suffer a
credit loss on the hedged exposure that would not be offset by a
payment under the eligible credit derivative. Banking organizations
generally would only be incentivized to vote for a restructuring if the
terms of the restructuring provide a more beneficial outcome to the
banking organization relative to insolvency proceedings that would
trigger payment under the eligible credit derivative. Additionally, the
unanimous consent requirement for the reference exposure, if different
from the hedged exposure, would provide an additional layer of security
by significantly reducing the probability of reaching a restructuring
agreement that results in a loss of principal or interest for creditors
without triggering payment under the eligible credit derivative. The
unanimous consent requirement would need to be satisfied through the
terms of the hedged exposure (and the reference exposure, if different
from the hedged exposure), which could be accomplished through a
contractual provision of the exposure or the operation of the
applicable law.
The requirement that the hedged exposure be subject to the U.S.
Bankruptcy Code or a similar domestic or foreign insolvency regime
would help to ensure that any restructuring is done
[[Page 15346]]
in an orderly, predictable, and regulated process. In the event that
the obligor of the hedged exposure defaults and the default is not
cured, the obligor would either be required to enter insolvency
proceedings, which would trigger payment under the credit derivative,
or the obligor would be required to pursue restructuring outside of
insolvency, which could not occur without the banking organization's
consent. Together, the proposed conditions are intended to ensure that
credit derivatives that do not include restructuring as a credit event
but provide similarly effective protection as those that do contain
such provisions would be afforded similar recognition under the capital
framework.
Question 23: The agencies seek comment on allowing covered banking
organizations to recognize in full the effective notional amount of
credit derivatives that do not include restructuring as a credit event,
if certain conditions are met. What are the cost and benefits of this
approach? What, if any, less restrictive conditions for receiving full
recognition should the agencies consider that would more appropriately
capture credit derivatives that provide similar protection as those
that include restructuring as a credit event receive and why? For
example, what would be the advantages and disadvantages of requiring
the consent of all parties directly and adversely affected by a
restructuring, rather than the unanimous consent of all parties? What
would be the advantages and disadvantages of requiring the consent of
all parties affected by any change in lien position or priority in the
hedged or referenced exposure?
Question 24: To what extent is the proposed treatment of eligible
credit derivatives that do not include restructuring of the reference
exposure as a credit event relevant outside of the United States and
how should this be considered for purposes of the proposal?
Question 25: In order for a covered banking organization to
recognize the credit risk mitigation benefits of an eligible credit
derivative, the current capital rule requires that legally-enforceable
cross-default or cross-acceleration clauses be in place and that the
reference exposure and the hedged exposure be to the same legal entity.
What would be the advantages and disadvantages of allowing recognition
of credit derivatives where (1) the reference exposure is to a
different legal entity than the hedged exposure, (2) the reference
exposure's legal entity is guaranteed by its parent company, and (3)
the parent company is subject to a binding cross-default or cross-
acceleration provision related to the hedged exposure's debt?
2. Collateralized Transactions
a. Simple Approach
Consistent with the current capital rule, a covered banking
organization would be permitted to recognize the risk-mitigating
benefits of financial collateral using the simple approach by
substituting the risk weight applicable to an exposure with the risk
weight applicable to the financial collateral securing the exposure,
generally subject to a 20 percent floor.
Under the current capital rule, a requirement for recognizing the
credit risk mitigation benefit of financial collateral under the simple
approach is that the collateral must be subject to a collateral
agreement for at least the life of the exposure. The proposal would not
include this requirement under the simple approach because the
requirement is overly broad and not relevant for certain transaction
types. For example, while the right to close out a transaction would be
relevant with respect to a repurchase agreement, it may not be relevant
with respect to a loan. Instead, the proposal would require that the
legal mechanism by which the financial collateral is pledged or
transferred be enforceable and provide the covered banking organization
with an ability to exercise its applicable legal rights with respect to
the collateral in a timely manner upon an event of default. Depending
on the characteristics of the type of exposure and the financial
collateral in question, those rights may include the right to liquidate
or take legal possession of the financial collateral, to set off
amounts owed by the covered banking organization against amounts owed
by the obligor, and to close out the underlying transaction. However,
not all of these rights may be applicable with respect to all types of
exposures and financial collateral, and a covered banking organization
would only be required to have those rights that are applicable for the
type of exposure and financial collateral in question. This
requirement, in combination with the definition of financial
collateral--which, in part, requires a covered banking organization to
have a perfected, first-priority security interest (or the legal
equivalent thereof) in the collateral--and the other requirements of
Sec. __.37(b)(1) would provide a sufficient basis for recognizing the
collateral under the simple approach.
The requirement under the current capital rule that financial
collateral be subject to a collateral agreement often prevents a
covered banking organization from recognizing financial collateral as a
credit risk mitigant under the simple approach if the covered banking
organization's exercise of its rights may be stayed in a bankruptcy of
the obligor. This has generally meant that a covered banking
organization could not use the simple approach to recognize financial
collateral in respect of collateralized loans because the exercise of a
covered banking organization's collateral rights with respect to a loan
would often be subject to a stay in the bankruptcy or insolvency of a
borrower under the applicable law. Under the proposal, the fact that a
covered banking organization's rights may be subject to a stay in the
event of an obligor's bankruptcy would not preclude the banking
organization from recognizing the credit risk mitigation benefits of
financial collateral, provided the banking organization has a well-
founded basis for concluding that it will be able to exercise its
rights in a timely manner. The proposed change would permit covered
banking organizations to recognize the credit risk mitigation benefits
of financial collateral that protects exposures arising from many types
of loans and traditional credit products. Other elements of the simple
approach, such as the 20 percent risk-weight floor, help to address the
risk of declines in the value of collateral.
Typically, financial collateral in respect of a collateralized
transaction is pledged by the obligor of that exposure. In some cases,
collateral may be pledged or transferred by a party other than the
obligor. A third-party pledgor may be the parent or an affiliate of an
obligor or an unrelated party that is providing credit risk protection
to the banking organization. While collateral provided by a third party
may be an effective credit risk mitigant, it may also pose unique
risks. In particular, depending on the laws of the applicable
jurisdictions and the terms of the relevant legal agreements, the
bankruptcy or insolvency of a pledgor prior to an event of default of
the obligor may terminate or impair the banking organization's rights
to the collateral. In these circumstances, financial collateral does
not provide an effective credit risk mitigant. Consequently, the
proposal would require that the bankruptcy or insolvency of a third-
party pledgor not result in the termination or impairment of the
covered banking organization's rights in respect of the financial
collateral.
There may be situations where obligors have the ability to remove
collateral that they are contractually obligated to maintain when a
banking
[[Page 15347]]
organization is experiencing stress. This risk is most apparent when
financial collateral takes the form of cash on deposit at a banking
organization, where a banking organization's deposit systems may not
reflect the obligor's contractual obligation to maintain the deposit at
the banking organization. It may also arise, in respect of other types
of financial collateral, depending on the custody arrangement and
associated controls in respect of the collateral. Financial collateral
is not an effective credit risk mitigant if a banking organization
cannot appropriately safeguard its rights in respect of such financial
collateral. Consequently, the proposal would also require a covered
banking organization to be able to reasonably demonstrate the ability
to protect and enforce its rights in respect of any financial
collateral.
Other safeguards relating to the simple approach are intended to
sufficiently calibrate the benefits of the proposal's recognition of
financial collateral for a broader scope of products. For example, the
maturity mismatch adjustment, which is described in greater detail
below, reduces the benefit of financial collateral based on the
difference between the residual maturity of the legal mechanism by
which financial collateral is pledged and that of the secured exposure.
Additionally, for a situation with a maturity mismatch, the proposal
would only allow for recognition of the credit risk mitigant where the
original maturity of the legal mechanism is greater than or equal to
one year and the residual maturity of the legal mechanism is greater
than three months. These requirements, taken together with the other
requirements in section __.121 of the proposal, would incentivize
covered banking organizations to utilize credit risk mitigants that
provide effective credit risk transfer.
Question 26: Under the simple approach, the current capital rule
requires that collateral be revalued at least every six months. The
agencies recognize that, in practice, most collateral agreements for
liquid collateral provide for more frequent valuation. The proposal
would remove the requirement for collateral agreements. Given that
financial collateral is generally liquid, what would be the advantages
and disadvantages of requiring a more frequent minimum revaluation
interval--such as quarterly--under the simple approach? Please provide
rationale supporting or opposing a more frequent revaluation
requirement.
Question 27: The proposal would maintain the current capital rule's
definition of financial collateral and allow covered banking
organizations to recognize the risk-mitigating benefits of cash on
deposit, including cash held by a third-party custodian or trustee. The
agencies invite comment on whether the definition of financial
collateral is sufficiently clear with respect to cash collateral held
for a covered banking organization by a third-party custodian or
trustee. What would be the advantages or disadvantages of revising the
``cash on deposit'' prong of the definition of financial collateral to
explicitly recognize cash on deposit at any third-party depository
institution, regardless of whether it is a custodian or trustee? In
addition, what would be the appropriate risk weight for the
collateralized exposure where the financial collateral is, directly or
indirectly, in the form of a deposit claim on a third-party depository
institution and why? What would be the advantages and disadvantages of
subjecting the collateralized exposure to the 20 percent risk weight
floor? What, if any, other alternative approaches should the agencies
consider and why?
b. Collateral Haircut Approach
Under the proposal, as under the current capital rule, a covered
banking organization would be permitted to recognize the credit risk-
mitigation benefits of collateral supporting repo-style transactions,
eligible margin loans, collateralized derivative contracts, and single
product \65\ netting sets of such transactions by adjusting its
exposure amount to its counterparty to recognize financial collateral
received and any collateral posted to the counterparty. The collateral
haircut approach would continue to require a covered banking
organization to adjust the fair value of the collateral received and
posted to account for any potential market price volatility in the
value of the collateral during the margin period of risk, as well as to
address any currency mismatch. To increase the risk-sensitivity of the
collateral haircut approach, the proposal would modify certain of the
standard market price volatility haircuts. At the same time, to reduce
unwarranted divergence in risk-weighted assets, the proposal would no
longer allow a covered banking organization to use its own internal
estimates for calculating haircuts.
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\65\ SA-CCR is proposed for use under Subpart D Sec.
217.34(a)(3) and Sec. 217.37(f) for repo-style transactions that
are subject to a qualifying cross-product master netting agreement
with derivative contracts
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i. Formula for Determining Exposure Amount
The proposal would introduce a new formula for calculating the
exposure amount of eligible margin loans, repo-style transactions, or
netting sets thereof. The proposed exposure amount equation is revised
from the current formula to improve the recognition of the risk-
mitigating benefits of netting and portfolio diversification. The
proposed formula would revert to the current collateral haircut
approach formula in cases where there are no variables to populate the
second and the third components as described below. The modification
would increase the risk sensitivity of the capital requirement for such
transactions relative to the current collateral haircut approach. Under
the proposal, the exposure amount (E*) of a netting set of eligible
margin loans or repo-style transactions or an individual transaction
that is not part of a netting set would be determined according to the
following formula:
[GRAPHIC] [TIFF OMITTED] TP27MR26.019
[[Page 15348]]
Where:
<bullet> E* is the exposure amount of the eligible margin loan,
repo-style transaction, or netting set after credit risk mitigation.
<bullet> Ei is the current fair value of the instrument, cash, or
gold the banking organization has lent, sold subject to repurchase,
or posted as collateral to the counterparty.
<bullet> Ci is the current fair value of the instrument, cash, or
gold the banking organization has borrowed, purchased subject to
resale, or taken as collateral from the counterparty.
<bullet> netexposure = [verbar][Sigma]s Es Hs[verbar]
<bullet> grossexposure = [Sigma]s Es [verbar]Hs[verbar]
<bullet> Es is the absolute value of the net position in a given
instrument or in gold (where the net position in a given instrument
or gold equals the sum of the current fair values of the instrument
or gold the banking organization has lent, sold subject to
repurchase, or posted as collateral to the counterparty, minus the
sum of the current fair values of that same instrument or gold the
banking organization has borrowed, purchased subject to resale, or
taken as collateral from the counterparty).
<bullet> Hs is the haircut appropriate to Es as described in Table 1
to Sec. __.37, as applicable. Hs has a positive sign if the
instrument or gold is net lent, sold subject to repurchase, or
posted as collateral to the counterparty; Hs has a negative sign if
the instrument or gold is net borrowed, purchased subject to resale,
or taken as collateral from the counterparty.
<bullet> N is the number of instruments with a unique Committee on
Uniform Securities Identification Procedures (CUSIP) designation or
foreign equivalent, with certain exceptions. N includes any
instrument with a unique CUSIP that the banking organization lends,
sells subject to repurchase, or posts as collateral, as well as any
instrument with a unique CUSIP that the banking organization
borrows, purchases subject to resale, or takes as collateral.
However, N would not include collateral instruments that the banking
organization is not permitted to include within the credit risk
mitigation framework (such as nonfinancial collateral that is not
part of a repo-style transaction included in the banking
organization's market risk weighted assets) or elects not to include
within the credit risk mitigation framework. The number of
instruments for N would also not include any instrument (or gold)
for which the value Es is less than one-tenth of the value of the
largest Es in the netting set. Any amount of gold would be given a
value of one.
<bullet> Efx is the absolute value of the net position in each
currency fx different from the settlement currency.
<bullet> Hfx is the haircut appropriate for currency mismatch of
currency fx.
The first component in the above formula ([Sigma]iEi-[Sigma]iCi)
would capture the baseline exposure of eligible margin loans, repo-
style transactions, or netting sets thereof, after accounting for the
value of any collateral received. The second (0.4 x
net<INF>exposure</INF>) and third (0.6 x (gross<INF>exposure</INF>/
<INF>[radic]N</INF>)) components in the above formula would allow for
the partial recognition of the netting and diversification benefit of
instruments exchanged between a covered banking organization and a
given counterparty within a netting set. The net exposure component
partially recognizes the offsetting of gross exposures between a given
instrument that is both lent and received as collateral within a
netting set. Additionally, because the contribution from the gross
exposure component to the exposure amount would decrease proportionally
with an increase in the number of unique instruments by CUSIP
designations or foreign equivalent, the gross exposure component would
capture the impact of diversification in the types of instruments lent
or received. The fourth component ([Sigma]fx (Efx x Hfx)) would capture
any adjustment to reflect currency mismatch, if applicable.
When determining the market price volatility and currency mismatch
haircuts, the covered banking organization would use the market price
volatility haircuts described in the following section and a standard 8
percent currency mismatch haircut, subject to certain adjustments.
Question 28: What are the pros and cons of basing N for purposes of
the collateral haircut approach on the number of unique CUSIPs in a
netting set? What alternatives should the agencies consider and how
would such alternatives align with the goal of identifying the number
of instruments for purposes of measuring diversification in the pool?
Question 29: The agencies seek comment on the appropriateness of
the proposed collateral haircut approach formula, in particular for
banking organizations that use the current exposure methodology for
derivatives. What are the advantages and disadvantages of revising the
collateral haircut approach to align with the formula in the expanded
risk-based approach proposal? What, if any, risks may not be
appropriately captured by the proposed change for banking organizations
that use the current exposure methodology for derivative transactions
and why?
ii. Market Price Volatility Haircuts
Under the proposal, a covered banking organization would apply the
market price volatility haircut appropriate for the type of collateral,
as provided in Table 1 to Sec. __.37 below, when calculating the
exposure amount for repo-style transactions, eligible margin loans,
collateralized derivative contracts, and single-product netting sets
thereof using the collateral haircut approach and in the calculation of
the net independent collateral amount and the variation margin amount
for collateralized derivative transactions using SA-CCR, if
applicable.\66\ Consistent with the current capital rule, the proposal
would require covered banking organizations to apply an 8 percent
supervisory haircut, subject to adjustments, to the absolute value of
the net position in each currency that is different from the settlement
currency.
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\66\ As described in section III.C. of this Supplementary
Information, under the proposal and consistent with the current
capital rule, a covered banking organization would use the current
exposure methodology to calculate the exposure amount for derivative
contracts unless it elects to use SA-CCR.
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Proposed Table 1 to Sec. __.37
[[Page 15349]]
[GRAPHIC] [TIFF OMITTED] TP27MR26.020
[[Page 15350]]
The proposed haircuts would strike a balance between simplicity and
risk sensitivity relative to the supervisory haircuts in the current
capital rule by introducing additional granularity with respect to
residual maturity, which is a meaningful driver for distinguishing
between the market price volatility of different instruments, and by
streamlining other aspects of the collateral haircut approach where the
exposure's risk weight figures less prominently in the instrument's
market price volatility, as described below.
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\67\ Includes a foreign PSE that receives a zero percent risk
weight.
\68\ Includes senior securitization exposures with the risk
weight greater than or equal to 100 percent and sovereign exposures
with a risk weight greater than 100 percent.
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The proposal would apply haircuts primarily based on residual
maturity, rather than a combination of residual maturity and underlying
risk weight as under the current capital rule, for non-sovereign
investment grade debt securities. These haircuts are derived from
observed stress volatilities during 10-business day periods during the
2008 financial crisis. Debt securities with longer maturities are
subject to higher price volatility from changes in both interest rates
and the creditworthiness of the issuer.
Because securitization exposures tend to be more volatile than
corporate debt, the proposal would provide a distinct category of
market price volatility haircuts for certain securitization exposures
consistent with the current capital rule. The proposal would
distinguish between non-senior and senior securitization exposures to
enhance risk sensitivity.\69\ Because senior securitization exposures
absorb losses only after more junior securitization exposures, these
exposures have an added layer of security and distinct market price
volatility. Therefore, the proposal would only specify term-based
haircuts for investment grade senior securitization exposures that
receive a risk weight of less than 100 percent under the securitization
framework. Other securitization exposures would receive the 30 percent
market price volatility haircut applicable to ``other'' exposure types.
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\69\ As described in section III.E.5.e. of this SUPPLEMENTARY
INFORMATION, the proposal would define a senior securitization
exposure as an exposure that has a first priority claim on the cash
flows from the underlying exposures.
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The proposal would require a banking organization to apply market
price volatility haircuts of 20 percent for main index equities
(including convertible bonds) and gold, 30 percent for other publicly
traded equities and convertible bonds, and 30 percent for other
exposure types. Equities in a main index typically are more liquid than
those that are not included in a main index, in part because investors
may seek to replicate the index by purchasing the referenced equities
or engaging in derivative transactions involving the index or equities
within the index. The lower haircuts for equities included in a main
index under the proposal would reflect the higher liquidity of those
securities compared to other publicly traded equities or exposure
types, which would generally help to reduce losses to banking
organizations when liquidating those securities during stress
conditions.
For collateral in the form of mutual fund shares, the proposal
would be consistent with the current collateral haircut approach in
which a covered banking organization would apply the highest haircut
applicable to any security in which the fund can invest. Under the
proposal, a covered banking organization could treat exchange traded
fund (ETF) shares in the same manner as mutual fund shares and apply
haircuts based on the underlying instruments in the fund. Given that
ETFs (like mutual funds) may benefit from diversification and tend to
have lower levels of price volatility compared to non-pooled investment
vehicles, a look-through approach is more risk sensitive than applying
the publicly traded equities haircut for ETF shares. The proposal also
would include an alternative method available to a covered banking
organization if the mutual fund or ETF qualifies for the full look-
through approach for purposes of the equity framework under the current
rule.\70\ This alternative method would provide a more risk-sensitive
calculation of the haircut on fund shares collateral by using the
weighted average of haircuts applicable to the instruments held by the
fund.\71\
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\70\ See 12 CFR 3.53(b) (OCC); 12 CFR 217.53(b) (Board); 12 CFR
324.53(b) (FDIC).
\71\ If the mutual fund qualifies for the full look-through
approach in Sec. __.53(b) of the capital rule but would be treated
as a market risk covered position if the covered banking
organization held the mutual fund directly, the proposal would allow
a covered banking organization that is subject to market risk
capital requirements to apply the alternative method to calculate
the haircut.
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In addition, consistent with the expanded risk-based approach
proposal, the proposal would require a covered banking organization to
apply a market price volatility haircut of 30 percent to address the
potential market price volatility for any instruments that the covered
banking organization has lent, sold subject to repurchase, or posted as
collateral that is not of a type otherwise specified in Table 1 to
Sec. __.37.
Question 30: The agencies seek comment on the appropriateness of
the calibration of the market price volatility haircuts. Commenters are
encouraged to submit data with their response.
3. Prepaid Credit Protection
The proposal would introduce eligible prepaid credit protection
arrangements as an additional type of credit risk mitigant. The
proposal would define a prepaid credit protection arrangement as a
contractual agreement in which a protection purchaser receives an
initial amount in cash from a protection provider that the protection
purchaser is required to repay, less any losses that the protection
purchaser incurs due to a credit event on the protected exposures, such
as borrower default on the protected exposures. In this type of
arrangement, the amount paid by the protection provider is not
collateral that secures a future obligation of the protection provider;
rather, it is consideration for a right to future payments, contingent
on the performance of the protected exposure(s), from the protection
purchaser. This form of credit risk mitigant effectively transfers
credit risk to the protection provider, as the banking organization's
liability created by the prepaid credit protection arrangement
generally would be reduced at the same time the banking organization
incurs a loss on the protected exposure(s). A common example of a
prepaid credit protection arrangement are fully funded credit-linked
notes issued by a banking organization that transfer the credit risk of
a reference exposure or portfolio of reference exposures to third party
investors.\72\
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\72\ See e.g., Frequently Asked Questions, 12 CFR part 217, Q2
and Q3, <a href="https://www.federalreserve.gov/supervisionreg/legalinterpretations/reg-q-frequently-asked-questions.htm">https://www.federalreserve.gov/supervisionreg/legalinterpretations/reg-q-frequently-asked-questions.htm</a>. This
revision would also be consistent with comments received under
EGRPRA as commenters requested recognition of the risk-mitigation
benefits of credit-linked notes.
---------------------------------------------------------------------------
Under the proposal, a prepaid credit protection arrangement would
be required to meet specific requirements to be recognized for risk-
based capital purposes as an eligible prepaid credit protection
arrangement. Specifically, the proposal would define an eligible
prepaid credit protection arrangement as a prepaid credit protection
arrangement that:
(1) Is written;
(2) Is unconditional;
(3) Covers all or a pro rata portion of all contractual payments
due to be paid
[[Page 15351]]
on the reference exposure or reference exposures;
(4) Provides that the amount and timing of payments due from the
protection purchaser to the protection provider are incorporated into
the arrangement and the arrangement only allows these terms to change
in the event of a breach of the arrangement by the protection
purchaser;
(5) Provides that entry of the protection provider into
receivership, insolvency, liquidation, conservatorship, or similar
proceeding does not change the amounts or timing of payments due by the
protection purchaser under the arrangement;
(6) Is legally valid and enforceable under applicable law of the
relevant jurisdictions;
(7) Upon a failure by the obligor on the one or more reference
exposures to make a contractually required payment, or the occurrence
of other credit events as described in the arrangement, allows the
protection purchaser promptly to reduce the outstanding balance of the
initial principal amount due to the protection provider by the loss of
the protection purchaser on the reference exposures without input from
the protection provider; and
(8) Does not increase the protection purchaser's cost of credit
protection in response to deterioration in the credit quality of any of
the reference exposures.
The protection amount of an eligible prepaid credit protection
arrangement would be the effective notional amount of the prepaid
credit protection, reduced to reflect any currency mismatch or maturity
mismatch. The effective notional amount for an eligible prepaid credit
protection arrangement would be the lesser of the contractual notional
amount of the credit risk mitigant and the exposure amount of the
reference exposure(s), multiplied by the percentage coverage of the
credit risk mitigant.
Under the proposal, if the protection amount of the eligible
prepaid credit protection arrangement is greater than or equal to the
exposure amount of the reference exposure, a covered banking
organization would be allowed to assign a zero percent risk weight to
the exposure.
If the protection amount of the eligible prepaid credit protection
arrangement is less than the exposure amount of the reference
exposure(s) and any losses are shared on a pro rata basis between the
covered banking organization and the protection provider,\73\ the
proposal would require the covered banking organization to treat the
reference exposure(s) as two separate exposures, protected and
unprotected, in order to recognize the credit risk mitigation benefit
of the eligible prepaid credit protection arrangement. In such cases, a
covered banking organization would apply a zero percent risk weight to
the protected exposure. The covered banking organization would
calculate its risk-weighted asset amount for the unprotected exposure
under the standardized approach using the risk weight assigned to the
exposure and an exposure amount equal to the exposure amount of the
original reference exposure minus the protection amount.
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\73\ Exposures on which there is a tranching of credit risk
(reflecting at least two different levels of seniority) generally
are securitization exposures, as described in section III.E. of this
SUPPLEMENTARY INFORMATION.
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Question 31: Under the definition of eligible prepaid credit
protection arrangement, the proposal would require that a protection
purchaser be able to reduce the outstanding balance due to the
protection provider promptly upon realizing or otherwise recognizing a
loss on the reference exposure, in the event that the obligor on one or
more reference exposures fails to make a contractually required
payment, or the occurrence of other credit events as described in the
arrangement. What, if any, are the exposure types in respect of which,
or circumstances when, a protection purchaser may be exposed to losses
before such losses are manifested in a way that would permit a
reduction in the protection purchaser's repayment obligation? For
example, what would be the instances where nonpayment or other loss on
the reference exposure may not always result in an accounting write-
down of the eligible prepaid credit protection arrangement at the same
time? What, if any, changes to the proposed definitions of prepaid
credit protection arrangement and eligible prepaid credit protection
arrangement should the agencies consider to further ensure that a
protection purchaser would be able to reduce its repayment obligation
on a prepaid credit protection arrangement as contemporaneously as
possible with the manifestation of losses in respect of a reference
exposure?
Question 32: The proposal would define the protection amount of an
eligible prepaid credit protection arrangement to mean the effective
notional amount of the prepaid credit protection. Certain credit-linked
notes that may qualify as eligible prepaid credit protection under the
proposal, are sometimes accounted for on a fair value basis. The fair
value of such credit-linked notes may be affected by factors other than
losses or credit events (for example, a change in interest rates) in
respect of the reference exposure. As a result, at the time that credit
losses in respect of the reference exposure are realized, the fair
value of the credit-linked note, and the amount by which the covered
banking organization may set off its losses in respect of the reference
exposure, may be less than the notional amount of the note. What, if
any, modifications to the proposal should the agencies consider to
address the risk that a covered banking organization may not be able to
set off losses on a reference exposure against the full notional amount
of a prepaid credit protection instrument? What would be the advantages
and disadvantages of defining the protection amount of an eligible
prepaid credit protection instrument to be the instrument's carrying
value (for example, the fair value if the covered banking organizations
elects this accounting treatment)?
Question 33: The definition of prepaid credit protection requires
that the protection purchaser is obligated to repay the initial
principal amount to the protection provider on or before the maturity
date of the transaction, less any losses that the protection purchaser
realizes or otherwise recognizes due to nonpayment of all contractual
payments due to be paid on the reference exposure by the obligors. The
agencies seek comment as to whether the definition is sufficiently
broad to capture the types of prepaid credit protection arrangements
that covered banking organizations may enter into to transfer credit
risk. For example, may prepaid credit protection arrangements be
structured to allow for a reduction in the initial principal amount of
the arrangement upon the recognition of losses on one or more reference
exposures due to credit quality deterioration of the exposures, even in
the absence of any nonpayment. If so, what if any changes to the
definition of prepaid credit protection should the agencies consider?
4. Maturity and Currency Mismatch Adjustment
The simple approach in the current capital rule does not permit a
covered banking organization to recognize credit risk mitigation
benefits where the transaction is subject to a collateral agreement
that has a shorter tenor than
[[Page 15352]]
that of the secured exposure.\74\ To improve the risk sensitivity of
the simple approach, the proposal would permit covered banking
organizations to recognize financial collateral and prepaid credit
protection with a maturity mismatch after adjusting the fair value of
the financial collateral or the effective notional amount of the
eligible prepaid credit protection arrangement to reflect any maturity
mismatch.\75\
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\74\ For determining maturity mismatch, the comparison is
between the remaining maturity of the protected exposure against the
remaining maturity of the legal mechanism by which financial
collateral is pledged. For example, if the legal mechanism by which
financial collateral is pledged to a 5-year loan has a 5-year term,
even if the remaining maturity of the collateral is 2 years, there
would be no maturity mismatch under the proposal as long as the
security interest transfers without any breaks to the proceeds of
the matured collateral or replacement collateral.
\75\ The proposal would define residual maturity as the longest
possible remaining time before the obligated party of the secured
exposure is scheduled to fulfill its obligation on the reference
exposure. If a contract has embedded options that may reduce its
term, the proposal would require the covered banking organization to
adjust the residual maturity of the contract. If a call is at the
discretion of the protection provider, the residual maturity of the
contract would be at the first call date. If the call is at the
discretion of the covered banking organization, but the terms of the
arrangement at origination of the contract contain a positive
incentive for the covered banking organization to cancel the
contract before contractual maturity, the remaining time to the
first call date would be the residual maturity of the contract.
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Under the proposal, the residual maturity of an eligible prepaid
credit protection arrangement would be determined in the same manner as
applies to eligible credit derivatives and eligible guarantees under
the current capital rule. For financial collateral that is not cash on
deposit at the covered banking organization, but including cash held
for the covered banking organization by a third-party custodian or
trustee, the residual maturity of any amount of such financial
collateral would be the earliest date on which the covered banking
organization's rights in respect of such amount of financial collateral
may be terminated without the pledgor being subject to a
contemporaneous requirement to pledge additional financial collateral.
For financial collateral that is cash on deposit at the covered banking
organization, the residual maturity of any amount of such collateral
would be the earliest date on which a depositor may withdraw such
amount, notwithstanding any notice requirements or early withdrawal
fees or penalties. For example, if an obligor is subject to a loan
covenant requiring the obligor to maintain a certain deposit balance at
the covered banking organization until the maturity of the loan, the
residual maturity of the cash on deposit would be the remaining
maturity of the loan. Any amount of a deposit balance that an obligor
is contractually permitted to withdraw, however, would have a residual
maturity of the earliest date on which the deposit may be withdrawn. If
an obligor may withdraw a deposit at any time, including where an
obligor may be subject to a notice period or an early withdrawal fee or
penalty, the residual maturity would be zero, notwithstanding any
stated maturity date of the deposit instrument.
Under the proposal, a covered banking organization would be
required to apply the same adjustment to reduce the fair value of the
financial collateral or the effective notional amount of the prepaid
credit protection arrangement as currently applies to eligible credit
derivatives and eligible guarantees under the substitution approach:
Pm = E x [(t-0.25)/(T-0.25)]
Where:
Pm = fair value of the financial collateral or effective notional
amount of the eligible prepaid credit protection arrangement,
adjusted for maturity mismatch;
E = fair value of the financial collateral or effective notional
amount of the eligible prepaid credit protection arrangement;
t = the lesser of T or the residual maturity of the credit risk
mitigant, expressed in years; and
T = the lesser of five or the residual maturity of the secured
exposure or reference exposure, as applicable, expressed in years.
Similarly, the proposal would eliminate the current capital rule's
requirement that financial collateral be denominated in the same
currency as the secured exposure for a covered banking organization to
use the simple approach. The proposal would permit covered banking
organizations to recognize the credit risk mitigation benefits of
financial collateral and eligible prepaid credit protection
arrangements when denominated in a different currency than the currency
of the secured exposure, after adjusting the fair value or the
effective notional amount, as applicable, to reflect any currency
mismatch. Under the proposal, a covered banking organization would use
the following formula to adjust the fair value of the financial
collateral or the effective notional amount of the eligible prepaid
credit protection arrangement:
P<INF>c</INF> = P<INF>r</INF> x (1-H<INF>FX</INF>)
Where:
P<INF>c</INF> = fair value of the financial collateral or effective
notional amount of the eligible prepaid credit protection
arrangement, adjusted for currency mismatch (and maturity mismatch,
if applicable).
P<INF>r</INF> = fair value of the financial collateral or effective
notional amount of the eligible prepaid credit protection
arrangement (adjusted for maturity mismatch, if applicable).
H<INF>FX</INF> = haircut appropriate for the currency mismatch
between the financial collateral and the secured exposure or the
eligible prepaid credit protection arrangement and the reference
exposure.
Consistent with substitution approach for guarantees and credit
derivatives in the current capital rule, the proposal would require
covered banking organizations to use a standard supervisory haircut of
8 percent for H<INF>FX</INF> (based on a ten business-day holding
period and daily marking-to-market and re-margining). If a covered
banking organization revalues the financial collateral or eligible
prepaid credit protection arrangement less frequently than once every
10 business days, the proposal would require the covered banking
organization to scale up the haircut using the following square root of
time formula:
[GRAPHIC] [TIFF OMITTED] TP27MR26.021
Where:
TM = the greater of 10 or the number of business days between
revaluations.
Question 34: The agencies seek comment on the effectiveness of the
credit risk mitigation of collateral and eligible prepaid credit
protection arrangement when there is a maturity mismatch between the
credit risk mitigant and the hedged reference portfolio, for example,
longer-dated assets that are protected by a shorter-dated prepaid
credit protection arrangement. The agencies seek comment on whether the
covered banking organization has effectively mitigated credit risk if
the losses on the assets are estimated to occur after the expiration of
the prepaid credit protection arrangement. Does the proposed maturity
mismatch adjustment sufficiently capitalize for the residual risks of
hedging longer-dated assets with shorter-term prepaid credit protection
arrangement? Please provide supporting data and analysis.
E. Securitization Framework
The securitization framework is designed to produce capital
requirements for exposures that involve tranching of the credit risk of
one or
[[Page 15353]]
more underlying financial exposures.\76\ The risk and complexity posed
by securitizations differ relative to direct exposures to the
underlying financial exposures because the credit risk of those
exposures is divided into different levels of risk using a wide range
of structural mechanisms.\77\ The performance of a securitization
exposure depends not only on the structure of the securitization, but
also on the performance of the underlying exposures \78\ and certain
parties to the securitization structure, including the asset servicer
and any liquidity facility provider. Such structural features and the
involvement of these parties make securitization exposures susceptible
to additional risks as compared to direct exposures to the underlying
financial exposures.
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\76\ To segment the credit risk of the underlying financial
exposures (``reference portfolio''), securitization exposures divide
the reference portfolio into different slices (known as
``tranches'') such that any cash flows or losses are allocated to
the various tranches based on a predetermined order of priority.
This payment structure is sometimes referred to as the cash flow
waterfall (or simply the ``waterfall'') and dictates the manner in
which interest or principal payments from the reference portfolio
must be allocated, creating different risk-return profiles for each
tranche.
\77\ For example, assume a covered banking organization extends
a loan to a bankruptcy remote special purpose entity which holds
financial exposures (including equity securities) and the fair value
of the underlying financial assets exceeds that of the loan. Under
this transaction, the underlying financial exposures are pledged as
collateral to the lender. As the excess collateral would initially
absorb any losses arising from non-payment on the loan (after which
the covered banking organization would be exposed to any subsequent
losses), the loan would generally be viewed as tranched and could
qualify as a securitization exposure under the proposal, if the
transaction satisfies all of the other applicable requirements.
Consistent with the current capital rule, to the extent the fair
value of the collateral declines such that it no longer exceeds the
outstanding principal balance of the, the covered banking
organization's exposure to the borrower, the transaction would no
longer involve tranching of credit or equity risk--and thus would
not qualify as a securitization exposure under the proposal. Rather,
the covered banking organization would be required to calculate
risk-based capital requirements for the exposure using the general
risk-weight framework as described in section III.A. of this
SUPPLEMENTARY INFORMATION.
\78\ Consistent with the current capital rule, the proposal
would define equity exposure to include exposures to equity
instruments that do not have mandatory contractual payments, among
other requirements. Accordingly, under the proposal, the performance
of underlying equity exposures would refer to both changes in the
fair value of the equity exposures and whether the issuer(s) of the
equity exposures is subject to a bankruptcy or insolvency
proceeding.
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The proposed securitization framework would incorporate the
securitization framework in the current standardized approach with the
following modifications: (1) a revised definition of and additional
operational requirements for synthetic securitizations; (2) a modified
treatment for resecuritizations that meet the operational requirements;
(3) a modified definition of an eligible clean-up call; (4) a new
securitization standardized approach (SEC-SA), as a replacement to the
standardized supervisory formula approach (SSFA), which includes,
relative to the SSFA, modified definitions of attachment point and
detachment point, a modified definition of the W parameter,
modifications to the definition of K<INF>G</INF>, a lower risk-weight
floor for securitization exposures that are not resecuritization
exposures, and a higher risk-weight floor for resecuritization
exposures; (5) a revised treatment for purchased and sold nth-to-
default credit derivatives that would prohibit covered banking
organizations from recognizing any risk-mitigating benefit for such
exposures; (6) a revised treatment for certain derivative contracts
that are not credit derivatives and a new treatment for derivative
contracts that do not provide credit enhancement; (7) new provisions to
expand the scope of securitization exposures for which a covered
banking organization may apply the overlapping exposure treatment; (8)
a new treatment and eligibility criteria for certain senior
securitization exposures (the ``look-through approach''); (9) a
modification to the treatment for credit-enhancing interest only
strips; (10) a new framework for non-performing loan securitizations;
and (11) elimination of the gross-up approach. The proposal would also
introduce certain minor technical edits to the definitions of
traditional securitization and synthetic securitization to clarify the
existing scope of exposures subject to the securitization framework
under the current capital rule.
Question 35: This proposal retains the current securitization
framework, except as noted above and below, to align with the proposed
expanded risk-based approach. As such, this proposal would not retain
the gross-up approach under the current capital rule, which generally
only is applicable to banking organizations not subject to the market
risk rule. What are the advantages and disadvantages of retaining the
gross-up approach for certain banking organizations, consistent with
the current capital rule?
1. Definitions
The proposal would generally retain the existing definitions of
traditional securitization and synthetic securitization under the
current capital rule, except for (1) revising the definition of
synthetic securitization to include prepaid credit protection
arrangements, and (2) introducing technical modifications to the
definitions of traditional securitization and synthetic securitization
that are intended to clarify the existing scope of exposures subject to
the securitization framework under the current capital rule.
a. Synthetic Securitization
As discussed in section III.D.3. of this SUPPLEMENTARY INFORMATION,
the proposal would permit covered banking organizations to recognize
risk mitigating benefits of eligible prepaid credit protection
arrangements. Consistent with these provisions, the proposal would
revise the definitional and operational criteria for synthetic
securitizations to include prepaid credit protection arrangements as
structures that can qualify as synthetic securitizations and to include
eligible prepaid credit protection arrangements as an eligible credit
risk mitigant within the securitization framework. Under the proposal,
a transaction would meet the definitional and operational criteria of
synthetic securitization if all or a portion of the credit risk of one
or more underlying exposures is transferred to one or more third
parties through prepaid credit protection arrangements, and the
transaction satisfies all other requirements of the securitization
framework under the proposal.
b. Technical Modifications
The proposal would modify paragraph (3) within the definitions of
traditional securitization and synthetic securitization to clarify that
the performance of the securitization exposure is expected to depend
solely upon the performance of the underlying exposures, aside from the
performance of common supporting transaction participants such as
servicers and trustees. For example, a transaction would not satisfy
this criterion if there is an expectation that any sources outside of
the underlying exposures would fund the interest or principal payments
due on the securitization exposures.
Consistent with the current capital rule, the proposed modification
would continue to permit certain transactions where a party provides a
specified amount of credit protection to qualify as a securitization
exposure. As an example, consider a multi-seller ABCP conduit that
funds itself entirely with a single class of commercial paper and
purchases assets such as wholesale loan exposures from multiple
sellers. As is typical in such multi-seller ABCP conduits, each seller
provides first-loss protection by over-collateralizing its
[[Page 15354]]
loans sold to the conduit. To ensure a high credit rating on the
commercial paper issued by the ABCP conduit, a banking organization
sponsor may provide either a pool-specific liquidity facility or a
program-wide credit enhancement such as a guarantee on a portion of the
losses not protected by the seller over-collateralization. Consistent
with the current capital rule, under the proposal, commercial paper
issued by the ABCP conduit with a pool-specific liquidity facility
generally would be a securitization exposure because the pool-specific
liquidity facility represents a tranche of the credit risk of the
underlying exposures (that is the repayment of the liquidity facility
depends upon the underlying exposures) and losses are allocated through
subordination. Conversely, if the sponsor provides a program-wide
credit enhancement that covers all credit losses across multiple asset
pools without reference to asset-level performance (not just those
above the seller-provided credit enhancement) or seller-specific
subordination, the commercial paper generally would not be a
securitization exposure, as the commercial paper holders are primarily
exposed to the default risk of the sponsor instead of the underlying
exposures and the commercial paper does not represent a tranched risk
position. The proposed modification is intended to clarify that a
securitization exposure to such program-wide guarantees, including
guarantees provided by an operating company to a special purpose entity
it establishes, generally would not satisfy the definition of
traditional or synthetic securitization.
Additionally, the proposal would modify paragraph (1) of the
definition of traditional securitization to clarify that a transaction
transferring equity risk could be subject to the securitization
framework if all of the other definitional criteria are satisfied. The
securitization framework generally applies to exposures to companies
with material liabilities that are not operating companies,\79\ and
whose underlying exposures are primarily financial exposures (including
when all or substantially all of the underlying assets are equity
exposures). For exposures to companies with material liabilities that
are not operating companies and whose underlying exposures are all or
substantially all financial exposures, the risk-based capital treatment
under the current capital rule reflects how the risk of exposures to
such entities depends primarily on the degree of leverage employed by
the company. Accordingly, the current capital rule generally requires
covered banking organizations to apply the securitization framework to
determine the risk-weighted asset amount for exposures to non-operating
companies with material liabilities, unless the primary Federal
supervisor determines that the exposure is not a traditional
securitization based on the transaction's leverage, risk profile or
economic substance. The proposal would modify paragraph (1) of
definition of traditional securitization to clarify that this treatment
would also apply to exposures to such companies with material
liabilities, where all or a portion of the credit or equity risk of one
or more underlying exposures is transferred to one or more third
parties (other than through the use of credit derivatives or guarantees
or prepaid credit protection arrangements).\80\ As a result, the
proposed definition of traditional securitization would continue to
include exposures to companies with material liabilities that are not
operating companies, where all or substantially all of the underlying
assets are financial exposures, and whose funding structure results in
the risk associated with the underlying exposures being separated into
at least two tranches with different levels of seniority.
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\79\ See 78 FR 62112 (Oct. 11, 2013).
\80\ Consistent with the current capital rule, under the
proposal, a covered banking organization would use the equity
framework to calculate risk-based capital requirements for equity
exposures to companies where all or substantially all of the
underlying assets are financial assets and that have no material
liabilities. See definition of investment fund in Sec. __.2 of the
current capital rule and the treatment of equity exposures to
investment funds in Sec. __.53 of the proposed rule.
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Question 36: What additional clarifications, if any, should the
agencies consider for the proposed modification to paragraph (3) of the
definition of traditional and synthetic securitization and why?
Question 37: What additional clarifications, if any, should the
agencies consider for the proposed modification to paragraph (1) of the
definition of traditional securitization and why? What would be the
advantages and disadvantages of making similar changes to paragraph (1)
of the definition of synthetic securitization?
Question 38: The agencies seek comment on the appropriateness of
requiring covered banking organizations to use the general risk-weight
framework for certain overcollateralized exposures if the fair value of
underlying equity exposures declines such that there is no longer
overcollateralization? What would be the advantages and disadvantages
of requiring covered banking organizations to use the general risk-
weight framework (rather than the securitization framework) to
determine the applicable risk weight for securitization exposures where
the underlying exposures are primarily equity exposures and the fair
value of the underlying equity exposures has significantly declined?
What criteria should the agencies consider to capture only those
securitization exposures for which such an approach would more
appropriately capture the risk and why?
2. Operational Requirements
The proposed operational requirements would be consistent with the
operational requirements in the current capital rule, with five
exceptions as described below and directly above in section III.E.1.a.
of this SUPPLEMENTARY INFORMATION. In addition, for resecuritization
exposures that meet the operational requirements, the proposal would
eliminate the option for covered banking organizations to treat the
exposures as if they had not been securitized.\81\
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\81\ In the case of non-performing loan securitizations, as
described in section III.E.5.g. of this SUPPLEMENTARY INFORMATION,
the proposal would allow a covered banking organization that meets
the operational requirements to choose to hold risk-based capital
against the transferred exposures as if they had not been
securitized and deduct from common equity tier 1 capital any after-
tax gain-on-sale resulting from the transaction.
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a. Early Amortization Provisions
Early amortization provisions cause investors in securitization
exposures to be repaid before the original stated maturity when certain
conditions are triggered. For example, many securitizations of
revolving credit facilities, most commonly credit-card receivable
securitizations, contain provisions that require the securitization to
be wound down and investors repaid on an accelerated basis if excess
spread falls below a certain threshold. This decrease in excess spread
would typically be caused by credit deterioration in the underlying
exposures. Such provisions can expose the originating banking
organization to increased credit and liquidity risk and potentially
increased capital requirements after the early amortization is
triggered as the banking organization could be obligated to fund the
borrowers' future draws on the revolving lines of credit.\82\ In such
an
[[Page 15355]]
instance, the originating banking organization may have to either find
a new funding source, whether internal or external, to cover the new
draws or reduce the borrowers' credit line availability.
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\82\ Under the capital rule, an originating banking
organization, with respect to a securitization, means a banking
organization that: (1) directly or indirectly originated or
securitized the underlying exposures included in the securitization;
or (2) serves as an ABCP program sponsor to the securitization. See
12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC).
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The proposal would expand the applicability of the operational
requirements regarding early amortization provisions to synthetic
securitizations, similar to their application to traditional
securitizations under the current capital rule. The current capital
rule defines an early amortization provision as a provision in the
documentation governing a securitization that, when triggered, causes
investors in the securitization exposures to be repaid before the
original stated maturity of the securitization exposures, with certain
exceptions.\83\ Under the proposal, if a synthetic securitization
includes an early amortization provision and references one or more
underlying exposures in which the borrower is permitted to vary the
drawn amount within an agreed limit under a line of credit, the covered
banking organization would be required to hold risk-based capital
against the underlying exposures as if they had not been synthetically
securitized. Aligning this treatment for both traditional and synthetic
securitizations would provide greater consistency within the
securitization framework and reduce the likelihood that a covered
banking organization would provide implicit support for synthetic
securitization exposures.
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\83\ Under the capital rule, the exceptions to the definition of
early amortization provision are a provision that: (1) is triggered
solely by events not directly related to the performance of the
underlying exposures or the originating banking organization (such
as material changes in tax laws or regulations); or (2) leaves
investors fully exposed to future draws by borrowers on the
underlying exposures even after the provision is triggered. See
definition of early amortization provision in Sec. __.2 of the
capital rule. 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2
(FDIC).
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Question 39: What, if any, additional exceptions to the early
amortization provision definition should the agencies consider and why,
provided such exceptions would not incentivize a covered banking
organization to provide implicit support to a securitization exposure?
In particular, is the current rule's exception where early amortization
``is triggered solely by events not directly related to the performance
of the underlying exposures or the originating institution (such as
material changes in tax laws or regulations)'' sufficiently clear? What
types of early termination events should qualify as events not directly
related to either the performance of the underlying exposures or the
originating banking organization? Should events not directly related to
the performance of the underlying exposures or the originating banking
organization include customary provisions designed to protect against
non-performance of various contractual obligations by one of the
parties facilitating the securitization (including the originating
banking organization, if it has such a transaction facilitating role,
for example by acting as a servicer)? Commenters are also asked to
describe under what circumstances could a provision in a revolving loan
securitization that, when triggered, causes investors in the
securitization exposures to be repaid before the original stated
maturity of the securitization exposures, leaves investors ``fully
exposed to future draws by borrowers on the underlying exposures even
after the provision is triggered'', or otherwise should be deemed not
to be an early amortization provision. What are the advantages and
disadvantages of ``fully exposed'' encompassing only cash-funded
exposures versus also including exposures in the form of contractual
commitments to provide funding?
b. Synthetic Excess Spread
The proposal would prohibit a covered banking organization that is
an originating banking organization from recognizing the risk-
mitigating benefits of a synthetic securitization that includes
synthetic excess spread. Synthetic excess spread would be defined as
any contractual provision in a synthetic securitization that is
designed to absorb losses prior to any of the tranches of the
securitization structure. Synthetic excess spread is a form of credit
enhancement provided by the originating banking organization to the
investors in the synthetic securitization; therefore, the originating
banking organization should maintain capital against the credit
exposure represented by the synthetic excess spread. However, a risk-
based capital requirement for synthetic excess spread may not be
determinable with sufficient precision to promote comparability across
banking organizations because the amount of synthetic excess spread
made available to investors in the synthetic securitization would
depend upon the maturity of the underlying exposures, which itself
depends on whether any of the underlying exposures have defaulted or
prepaid. In particular, the total amount of synthetic excess spread
made available at inception to investors over the life of the
transaction may not be known ex ante, as the outstanding balance of the
securitization in future years is unknown. Therefore, if a synthetic
securitization structure includes synthetic excess spread, the proposal
would require the covered banking organization to maintain capital
against all the underlying exposures as if they had not been
synthetically securitized.
Question 40: What clarifications or modifications should the
agencies consider for the above proposed definition of synthetic excess
spread and why?
Question 41: What are the advantages and disadvantages of the
proposed treatment of synthetic securitizations with synthetic excess
spread? If the agencies were to permit a covered banking organization
that is an originating banking organization to recognize the credit
risk-mitigation benefits of securitizations with synthetic excess
spread, how should the exposure amount of the synthetic excess spread
be calculated, and what would be the appropriate capital requirement
for synthetic excess spread?
c. Minimum Payment Threshold
Under the proposal, the operational requirements for synthetic
securitizations would include a new requirement that any applicable
minimum payment threshold for the credit risk mitigant be consistent
with standard market practice.\84\ A contractual minimum payment
threshold refers to the delinquency condition that must exist before a
credit event is deemed to have occurred under the terms of the credit
protection. The proposed minimum payment threshold criterion is
intended to prohibit a covered banking organization that is an
originating banking organization from recognizing any risk mitigating
benefit for a synthetic securitization whose minimum payment threshold
is so large that it allows for material losses to occur without
triggering the credit protection acquired by the protection purchaser,
as such provisions would interfere with an effective transfer of credit
risk.
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\84\ For example, for derivative contracts written under ISDA
Master Agreement documentation, standard market practice for
contractual minimum payment thresholds would generally be $1 million
(or the equivalent in other currencies), such as established in ISDA
Credit Derivatives Definitions. See ISDA Credit Derivatives
Definitions Section 4.5 ``Failure to Pay'' and Section 4.9(d)
``Payment Requirement.''
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Question 42: What are the benefits and drawbacks of the proposed
minimum payment threshold criterion? What, if any, additional criteria
or clarifications should the agencies consider and why?
[[Page 15356]]
d. Resecuritization Exposures
For a resecuritization exposure arising from a traditional
securitization, if the operational requirements have been met, a
covered banking organization that is an originating banking
organization would be required to exclude the transferred exposures
from the calculation of its risk-weighted assets and maintain risk-
based capital against any credit risk it retains in connection with the
resecuritization. Unlike in the case of a securitization exposure that
is not a resecuritization exposure, the proposal would not provide the
option for a covered banking organization to elect to treat a
resecuritization exposure as if the underlying exposures had not been
resecuritized. While a securitization of non-securitized assets can be
used to diversify or transfer credit risk of those exposures, a
resecuritization might not offer similar risk reduction or
diversification benefits, particularly if the underlying exposures
reflect similar high-risk tranches of other securitizations. Therefore,
these resecuritization exposures warrant a higher regulatory capital
requirement than that applicable to the underlying exposures.
Similarly, for a resecuritization that is a synthetic
securitization, if the operational requirements have been met, a
covered banking organization that is an originating banking
organization would be required to recognize for risk-based capital
purposes the use of a credit risk mitigant to hedge the underlying
exposures and must hold capital against any credit risk of the
resecuritization exposures it retains in connection with the synthetic
securitization.
e. Clean-Up Calls
The proposal would use the definition of a clean-up call in the
current capital rule without change. The capital rule defines a clean-
up call as a contractual provision that permits an originating banking
organization or servicer to call securitization exposures before their
stated maturity date or call date. For an originating banking
organization to exclude the underlying exposures from its risk-based
capital calculation, any clean-up call associated with a securitization
must be an eligible clean-up call.
The proposal would expand the definition of an eligible clean-up
call. Under the current capital rule, an eligible clean-up call is
defined as a clean-up call that is exercisable solely at the discretion
of the originator or servicer, is not structured to avoid allocating
losses to securitization exposures held by investors or otherwise
structured to provide credit enhancement to the securitization, and is
only exercisable when 10 percent or less of the principal amount of the
initial pool of underlying or reference exposures is outstanding. The
proposal would expand the definition of an eligible clean-up call to
also include clean-up calls exercisable when certain regulatory and tax
events occur, in addition to the existing criteria under the current
capital rule. Specifically, the modification would permit the exercise
of a clean-up call upon the occurrence of (1) a regulatory event that
significantly changes the risk-weighted asset amount for the
securitization exposure under applicable risk-weighted asset standards
of the agencies, or (2) a tax event that significantly changes the tax
treatment of the securitization exposure under applicable tax laws. The
events must represent final actions, such as a final rule adopted by
the agencies or taxing authority, or a law enacted by Congress.
Proposed rules or legislative bills would not satisfy this requirement.
Question 43: What, if any, other modifications should the agencies
consider for the definition of an eligible clean-up call and why?
3. Exposure Amount of a Securitization Exposure
The proposal would maintain the exposure calculation methodology in
the current capital rule for both on-balance-sheet and off-balance-
sheet securitization exposures. The exposure amount for an on-balance-
sheet securitization exposure that is not a repo-style transaction, an
eligible margin loan, or a derivative contract (other than a credit
derivative) would equal the carrying value of the exposure.\85\ For
off-balance-sheet securitization exposures that are not a repo-style
transaction, eligible margin loan, or derivative contract (other than a
credit derivative), the exposure amount would equal the notional amount
of the exposure.\86\ For a securitization exposure that is a repo-style
transaction, eligible margin loan, or derivative contract (other than a
credit derivative), the exposure amount would be calculated based on
the proposed counterparty credit risk framework, described in sections
III.C. and III.D.2.b. of this SUPPLEMENTARY INFORMATION.
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\85\ Consistent with the current rule, under the proposal, the
exposure amount of an on-balance sheet securitization exposure that
is an available-for-sale or held-to-maturity security held by a
banking organization that has made an AOCI opt-out election would be
the banking organization's carrying value (including net accrued but
unpaid interest and fees), less any net unrealized gains on the
exposure and plus any net unrealized losses on the exposure.
\86\ The proposal would generally maintain the current capital
rule's treatment for off-balance sheet securitization exposures to
ABCP programs, with certain exceptions. The proposal would not
include the specific treatments provided for such exposures in
__.42(c)(3)(ii)-(iii) and __.44 in the current capital rule. The
other elements of the proposed securitization framework (for
example, the look through approach for senior securitization
exposures) are intended to better reflect the risk of such
exposures.
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Question 44: What, if any, clarifications should the agencies
consider regarding the determination of the exposure amount for
securitization exposures where one or more of the underlying exposures
are off-balance sheet exposures (such as unfunded commitments)?
Specifically, what are the advantages and disadvantages of a
modification that would clarify that covered banking organizations
could apply the same credit conversion factors described in section
III.B.2. of this SUPPLEMENTARY INFORMATION when calculating the
components of the SEC-SA (KG, W parameter, attachment point A and
detachment point D) for a securitization exposure where one or more of
the underlying exposures are off-balance sheet exposures? What would be
the effect of such a clarification on the volatility of the capital
requirements?
4. Securitization Standardized Approach (SEC-SA)
Under the proposal, a covered banking organization would determine
the capital requirements for most securitization exposures under the
SEC-SA. The SEC-SA would be substantively similar to the SSFA in the
current capital rule except for certain changes as discussed below.
Under the SEC-SA, a covered banking organization would determine the
risk weight for a securitization exposure based on the risk weight of
the underlying exposures that are adjusted to reflect (1) delinquencies
in such exposures, (2) the securitization exposure's subordination
level in the allocation of losses, and (3) the heightened correlation
and additional risks inherent in securitizations relative to direct
exposures to the underlying financial exposures.
To calculate the risk weight for a securitization exposure using
the SEC-SA, a covered banking organization would be required to have
accurate information on the parameters used in the SEC-SA calculation.
If the covered banking organization cannot, or chooses not to, apply
the SEC-SA, the covered
[[Page 15357]]
banking organization would be required to apply a 1,250 percent risk
weight to the securitization exposure. For synthetic securitizations,
the proposal would permit covered banking organizations to choose not
to recognize the credit risk mitigant and hold risk-based capital
against the underlying exposures as if they had not been synthetically
securitized.
Under the proposed SEC-SA, the risk weight assigned to a
securitization exposure, or portion of a securitization exposure, would
be determined according to the formula under Sec. __.44(a) of the
proposed rule, expressed as:
[GRAPHIC] [TIFF OMITTED] TP27MR26.022
Where:
<bullet> RWFLOOR is equal to 100 percent for resecuritization
exposures and 15 percent for all other securitization exposures.
<bullet> KA represents the delinquency-adjusted, weighted-average
capital requirement of the underlying exposures, as described in
section III.E.4.c. of this SUPPLEMENTARY INFORMATION.
<bullet> A represents the attachment point of the securitization
exposure, as described in section III.E.4.a. of this SUPPLEMENTARY
INFORMATION.
<bullet> D represents the detachment point of the securitization
exposure, as described in section III.E.4.a. of this SUPPLEMENTARY
INFORMATION.
[GRAPHIC] [TIFF OMITTED] TP27MR26.023
<bullet> u = D-KA
<bullet> l = max(A-KA, 0)
<bullet> e equals the base of the natural logarithm.
a. Definition of Attachment Point and Detachment Point
Under the current capital rule, the attachment point (parameter A)
of a securitization exposure equals the ratio of (1) the current dollar
amount of underlying exposures that are subordinated to the exposure of
the banking organization to (2) the current dollar amount of underlying
exposures. Any reserve account funded by the accumulated cash flows
from the underlying exposures that is subordinated to the covered
banking organization's securitization exposure may be included in the
calculation of parameter A to the extent that cash is present in the
account. The current capital rule generally requires a covered banking
organization to recognize cash or securities that are included in a
reserve account in the calculation of parameter A.\87\
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\87\ Consistent with the current capital rule, the proposal
would require covered banking organizations to treat any assets that
are included in a reserve account as underlying exposures of the
securitization exposure, which must be reflected in parameters A and
D as well as K<INF>G</INF> and the W parameter.
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The proposal would generally retain the existing definitions of
attachment point and detachment point under the current capital rule,
with one modification. Specifically, the proposal would not allow a
covered banking organization to include interest rate derivative
contracts and exchange rate derivative contracts, or the cash
collateral accounts related to these instruments, in the calculation of
parameters A and D. The agencies are proposing this treatment because
assets held in a funded reserve account, whether cash or securities,
can provide credit enhancement to a securitization exposure, whereas
interest rate and foreign exchange derivatives (and any cash collateral
held against these derivatives) do not.\88\
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\88\ For example, assume a securitization has assets denominated
in U.S. dollars and liabilities denominated in euros, and that the
securitization executes a USD-EUR foreign exchange swap with a
covered banking organization. The transaction would serve to hedge
the foreign exchange risk of the securitization's assets and
liabilities but would not provide credit enhancement to any of the
tranches of the securitization.
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b. Definition of W Parameter
Under the current capital rule, parameter W, which is expressed as
a decimal value between zero and one, reflects the proportion of
underlying exposures that are not performing or are delinquent,
according to criteria outlined in the rule.\89\ The proposal would
retain the current capital rule's definition of parameter W, with two
modifications. Specifically, the proposal would revise the definition
of parameter
[[Page 15358]]
W to (1) exclude any exposure that is directly and unconditionally
guaranteed by the U.S. government, its central bank, or a U.S.
government agency from the calculation of W, up to the amount of the
guarantee; and (2) clarify that for resecuritization exposures, any
underlying exposure that is a securitization exposure would only be
included in the denominator of the ratio and would be excluded from the
numerator of the ratio.
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\89\ Consistent with the current capital rule, the proposal
would define equity exposure to include exposures to equity
instruments that do not have mandatory contractual payments, among
other requirements. Accordingly, under the proposal, for purposes of
determining the W parameter for a securitization exposure, a covered
banking organization would not treat an underlying equity exposure
as being past due or in default on payments, but could treat an
underlying equity exposure as subject to a bankruptcy or insolvency
proceeding if the issuer of the equity exposure were subject to such
a proceeding. See definition of equity exposure in Sec. __.2 of the
capital rule. 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2
(FDIC).
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Under the proposal, a covered banking organization would exclude
from the calculation of parameter W any exposure that is directly and
unconditionally guaranteed by the U.S. government, its central bank, or
a U.S. government agency, up to the amount of the guarantee. By
allowing covered banking organizations to reflect the risk mitigation
effects of the U.S. government's guarantee, the proposed modification
is intended to more appropriately align the capital requirement with
the risk of such securitization exposures. For example, when a covered
banking organization invests in a securitization exposure where all of
the underlying exposures are unconditionally guaranteed by the U.S.
government, the covered banking organization may set parameter W equal
to zero.
For resecuritization exposures, parameter W would b
[…truncated; see source link]Indexed from Federal Register on March 27, 2026.
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