Report to Congressional Committees Regarding Differences in Capital and Accounting Standards Among the Federal Banking and Thrift Agencies

[Federal Register Volume 61, Number 70 (Wednesday, April 10, 1996)]
[Notices]
[Pages 15947-15954]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-8873]



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FEDERAL RESERVE SYSTEM

Report to Congressional Committees Regarding Differences in 
Capital and Accounting Standards Among the Federal Banking and Thrift 
Agencies

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Notice of report to the Committee on Banking, Housing, and 
Urban Affairs of the United States Senate and to the Committee on 
Banking, Finance and Urban Affairs of the United States House of 
Representatives.

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SUMMARY: This report has been prepared by the Federal Reserve Board 
pursuant to section 121 of the Federal Deposit Insurance Corporation 
Improvement Act of 1991. Section 121 requires each Federal banking and 
thrift agency to report annually to the above specified Congressional 
Committees regarding any differences between the accounting or capital 
standards used by such agency and the accounting or capital standards 
used by other banking and thrift agencies. The report must also contain 
an explanation of the reasons for any discrepancy in such accounting or 
capital standards. The report must be published in the Federal 
Register.

FOR FURTHER INFORMATION CONTACT: Rhoger H Pugh, Assistant Director 
(202/728-5883), Norah Barger, Manager (202/452-2402), Gerald A. 
Edwards, Jr., Assistant Director (202/452-2741), Robert E. Motyka, 
Supervisory Financial Analyst (202/452-3621), or Arthur W. Lindo, 
Supervisory Financial Analyst (202/452-2695), Division of Banking 
Supervision and Regulation, Board of Governors of the Federal Reserve 
System. For the hearing impaired only, Telecommunication Device for the 
Deaf (TDD), Dorothea Thompson (202/452-3544), Board of Governors of the 
Federal Reserve System, 20th & C Streets NW., Washington, DC 20551.

Introduction and Overview

    This is the sixth annual report 1 on the differences in 
capital standards and accounting practices that currently exist among 
the three banking agencies (the Board of Governors of the Federal 
Reserve System (FRB), the Office of the Comptroller of the Currency 
(OCC), and the Federal Deposit Insurance Corporation (FDIC)) and the 
Office of Thrift Supervision (OTS).2 Section One of the report 
focuses on differences in the agencies' capital standards; Section Two 
discusses differences in accounting standards. The remainder of this 
introduction provides an overview of the discussion contained in these 
sections.

    \1\ The first two reports prepared by the Federal Reserve Board 
were made pursuant to section 1215 of the Financial Institutions 
Reform, Recovery, and Enforcement Act of 1989 (FIRREA). The third, 
fourth, and fifth reports were made pursuant to section 121 of the 
Federal Deposit Insurance Corporation Improvement Act of 1991 
(FDICIA), which superseded section 1215 of FIRREA.
    \2\ At the federal level, the Federal Reserve System has primary 
supervisory responsibility for state-chartered banks that are 
members of the Federal Reserve System as well as all bank holding 
companies. The FDIC has primary responsibility for state nonmember 
banks and FDIC-supervised savings banks. National banks are 
supervised by the OCC. The OTS has primary responsibility for 
savings and loan associations.
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Capital Standards

    As stated in the previous reports to the Congress, the three bank 
regulatory agencies have, for a number of years, employed a common 
regulatory framework that establishes minimum capital adequacy ratios 
for commercial banking organizations. In 1989, all three banking 
agencies and the OTS adopted a risk-based capital framework that was 
based upon the international capital accord (Basle Accord) developed by 
the Basle Committee on Banking Regulations and Supervisory Practices 
(referred to as the Basle Supervisors' Committee) and endorsed by the 
central bank governors of the G-10 countries.

[[Page 15948]]

    The risk-based capital framework establishes minimum ratios of 
total and Tier 1 (core) capital to risk-weighted assets. The Basle 
Accord requires banking organizations to have total capital equal to at 
least 8 percent, and Tier 1 capital equal to at least 4 percent, of 
risk-weighted assets after a phase-in period that ended on December 31, 
1992. Tier 1 capital is principally comprised of common shareholders' 
equity and qualifying perpetual preferred stock, less disallowed 
intangibles, such as goodwill. The other component of total capital, 
Tier 2, may include certain supplementary capital items, such as 
general loan loss reserves and subordinated debt. The risk-based 
capital requirements are viewed by the three banking agencies and the 
OTS as minimum standards, and most institutions are expected to, and 
generally do, maintain capital levels well above the minimums.
    In addition to specifying identical ratios, the risk-based capital 
framework implemented by the three banking agencies includes a common 
definition of regulatory capital and a uniform system of risk weights 
and categories. While the minimum standards and risk weighting 
framework are common to all the banking agencies, there are some 
technical differences in language and interpretation among the 
agencies. The OTS employs a similar risk-based capital framework, 
although it differs in some respects from that adopted by the three 
banking agencies. These differences, as well as other technical 
differences in the agencies' capital standards, are discussed in 
Section One of this report.
    In addition to the risk-based capital requirements, the agencies 
also have established leverage standards setting forth minimum ratios 
of capital to total assets. As discussed in Section One, the three 
banking agencies employ uniform leverage standards, while the OTS has 
established, pursuant to FIRREA, somewhat different standards.
    The staffs of the agencies meet regularly to identify and address 
differences and inconsistencies in their capital standards. The 
agencies are committed to continuing this process in an effort to 
achieve full uniformity in their capital standards. In this regard, 
Section One contains discussions of the banking agencies' efforts 
during the past year to achieve uniformity with respect to final rules 
on the capital treatment of the sale of assets with recourse that were 
required by Sections 208 and 350 of the Riegle Community Development 
and Regulatory Improvement Act of 1994, implementation of proposed 
amendments made by the Basle Supervisors' Committee to the Basle Accord 
with regard to country transfer risk and, the recognition of the 
effects of netting on potential future exposure of derivative 
contracts, guidelines on interest rate risk, and the capital treatment 
of certain assets to address recent accounting changes issued by the 
Financial Accounting Standards Board (FASB), specifically FASB 
statements nos. 115 (``Accounting for Certain Investments in Debt and 
Equity Securities''), 109 (``Accounting for Income Taxes''), and 122 
(``Accounting for Mortgage Servicing Rights'').

Accounting Standards

    Over the years, the three banking agencies, under the auspices of 
the Federal Financial Institutions Examination Council (FFIEC), have 
developed Uniform Reports of Condition and Income (Call Reports) for 
all commercial banks and FDIC-supervised savings banks. The reporting 
standards followed by the three banking agencies are substantially 
consistent, aside from a few limited exceptions, with generally 
accepted accounting principles (GAAP) as they are applied by commercial 
banks.3 The uniform bank Call Report serves as the basis for 
calculating risk-based capital and leverage ratios, as well as for 
other regulatory purposes. Thus, material differences in regulatory 
accounting and reporting standards among commercial banks and FDIC-
supervised savings banks do not exist.

    \3\ In those cases where bank Call Report standards are 
different from GAAP, the regulatory reporting requirements are 
intended to be more conservative than GAAP.
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    The OTS requires each thrift institution to file the Thrift 
Financial Report (TFR), which is generally consistent with GAAP. The 
TFR differs in some respects from the bank Call Report in that, as 
previously mentioned, there are a few areas in which the bank Call 
Report departs from GAAP. A summary of the differences between the bank 
Call Report and the TFR is presented in Section Two.
    As in the past, the agencies are continuing interagency efforts to 
reduce paperwork and regulatory burdens. The Federal Reserve has taken 
a leadership role in coordinating these efforts in developing 
supervisory guidance to further improve regulatory reporting 
requirements. For example, during 1995, senior Federal Reserve and FASB 
officials met a number of times to foster greater communication and 
closer coordination on major accounting issues affecting the banking 
industry. These efforts included discussion of a supervisory framework 
for derivatives reporting, a FASB special report that clarifies the 
reporting for debt and equity securities pursuant to FASB Statement No. 
115, and the remaining few differences between GAAP and regulatory 
reporting standards. Furthermore, in 1995 the agencies adopted for 
regulatory reporting purposes a new FASB accounting standard on 
mortgage servicing rights.
    On November 3, 1995, the FFIEC announced that the agencies would 
fully adopt GAAP as the reporting basis in the basic bank Call Report 
schedules, effective with the March 1997 report date. The adoption of 
GAAP will reduce regulatory burden by developing greater consistency in 
the information collected in bank Call Reports, bank holding company FR 
Y-9C reports, and general purpose financial statements. The adoption of 
GAAP for Call Report purposes should eliminate the differences in 
accounting standards among the agencies that are set forth later in 
this report.

Section One--Differences in Capital Standards Among Federal Banking 
Thrift Supervisory Agencies

Overview

Leverage Capital Ratios

    The three banking agencies employ a leverage standard based upon 
the common definition of Tier 1 capital contained in their risk-based 
capital guidelines. These standards, established in the second half of 
1990 and in early 1991, require the most highly-rated institutions to 
meet a minimum Tier 1 capital ratio of 3 percent. For all other 
institutions, these standards generally require an additional cushion 
of at least 100 to 200 basis points, i.e., a minimum leverage ratio of 
at least 4 to 5 percent, depending upon an organization's financial 
condition.
    As required by FIRREA, the OTS has established a 3 percent core 
capital ratio and a 1.5 percent tangible capital leverage requirement 
for thrift institutions. However, the OTS has not yet finalized a new 
leverage rule, which has been under consideration for some time. This 
leverage rule is intended to conform to the leverage rules of the three 
banking agencies. The differences that will exist after the OTS has 
adopted its new standard pertain to the definition of core capital. 
While this definition generally conforms to Tier 1 bank capital, 
certain adjustments discussed in this report apply to the core capital 
definition used by savings associations.

[[Page 15949]]


Risk-Based Capital Ratios

    The three banking agencies have adopted risk-based capital 
standards consistent with the Basle Accord. These standards, which were 
fully phased in at the end of 1992, require all commercial banking 
organizations to maintain a minimum ratio of total capital (Tier 1 plus 
Tier 2) to risk-weighted assets of 8 percent. Tier 1 capital includes 
common stock and surplus, retained earnings, qualifying perpetual 
preferred stock and surplus, and minority interests in consolidated 
subsidiaries, less goodwill. Tier 1 capital must comprise at least 50 
percent of the total risk-based capital requirement. Tier 2 capital 
includes such components as general loan loss reserves, subordinated 
term debt, and certain other preferred stock and convertible debt 
capital instruments, subject to appropriate limitations and conditions. 
Risk-weighted assets are calculated by assigning risk weights of 0, 20, 
50, and 100 percent to broad categories of assets and off-balance sheet 
items based upon their relative credit risks. The OTS has adopted a 
risk-based capital standard that in most respects is similar to the 
framework adopted by the banking agencies.
    All the banking agencies view the risk-based capital standard as a 
minimum supervisory benchmark. In part, this is because the risk-based 
capital standard focuses primarily on credit risk; it does not take 
full or explicit account of certain other banking risks, such as 
exposure to changes in interest rates. The full range of risks to which 
depository institutions are exposed are reviewed and evaluated 
carefully during on-site examinations. In view of these risks, most 
banking organizations are expected to operate with capital levels well 
above the minimum risk-based and leverage capital requirements.

Efforts to Incorporate Non-Credit Risks

    The Federal Reserve has for some time been working with the other 
U.S. banking agencies and with regulatory authorities abroad to develop 
methods of measuring certain market and price risks and determining 
appropriate capital standards for these risks. These efforts have 
related to interest rate risk arising from all activities of a bank and 
to market risk associated (principally) with an institution's trading 
activities. Significant progress has been made in both areas.
    Regarding domestic efforts, the banking agencies have for several 
years been working to develop capital standards pertaining to interest 
rate risk. This effort was undertaken both in response to a specific 
statutory directive contained in section 305 of the FDICIA and to 
improve the agencies' overall supervision of banking organizations. 
Most recently, the agencies in August 1995 amended their capital 
standards to emphasize the importance of reviewing the effect of 
interest rate movements on the economic value of a bank's equity 
capital. At the same time, the agencies also issued for public comment 
a proposed measure of risk that supervisors would consider when 
evaluating capital adequacy. The comments on that quantitative measure 
and related reporting requirements remain under review by the agencies.
    In the international forum, the Basle Supervisors Committee issued 
a second proposal in April 1995 dealing with capital standards for 
market risk arising from foreign exchange and commodity positions of 
banks and from their traded debt and equity instruments. This proposal 
was developed in order to foster a more equitable level of competition 
among internationally active banking organizations and to provide these 
institutions with greater incentives to manage this risk prudently. The 
Committee's proposal was adopted on December 11, 1995 and permits 
institutions to use either a standardized measure of risk developed by 
supervisors or, alternatively, their own internal value-at-risk models 
in measuring market risk and calculating their capital requirements. 
This amendment to the 1988 Basle Capital Accord will go into effect no 
later than the end of 1997, pending relevant rulemaking procedures in 
member countries. The Federal Reserve, in cooperation with the other 
U.S. banking agencies, expects to incorporate this amendment into its 
own capital standards in early 1996.

Recent Interagency Efforts

    In addition to coordinating efforts to incorporate noncredit risks, 
the agencies worked together during 1995 to issue proposals for public 
comment that would amend the agencies' respective risk-based capital 
standards with respect to: 1) the sale of assets with recourse; 2) 
higher capital charges for long-dated and noninterest and nonexchange 
rate derivative contracts and reduced capital charges for the potential 
future exposure of contracts that are affected by netting arrangements; 
and 3) the definition of the OECD-based group of countries for the 
purpose of specifying country transfer risk. The agencies also 
coordinated efforts to make modifications in their capital guidelines 
in light of recent changes in accounting standards.

Recourse

    The agencies issued a joint proposal on May 24, 1994, that would 
amend their respective risk-based capital guidelines with regard to 
assets sold with recourse and direct credit substitutes. This 
publication included a notice and an advanced notice of proposed 
rulemakings. The intent of the notice of proposed rulemaking was to 
allow banking organizations to maintain lower amounts of capital 
against low-level recourse transactions. The advanced notice of 
proposed rulemaking represented a preliminary proposal to use credit 
ratings to match the risk-based capital assessment more closely to an 
institution's relative risk of loss in certain asset securitizations.
    Following issuance of this notice, Section 350 of the Riegle 
Community Development and Regulatory Improvement Act of 1994 (Riegle 
Act) was enacted. This Section required the agencies to amend their 
respective risk-based capital standards to take account of low-level 
recourse, which would also implement the proposed rulemaking on low-
level recourse transactions issued in May, 1994. The Board approved a 
final rule on February 7, 1995, that was effective on March 22, 1995, 
thus satisfying the requirements of Section 350 of the Riegle Act. The 
FDIC and OCC also issued final rules in 1995 to implement Section 350. 
The OTS already had a capital rule in place that satisfied the 
requirements of Section 350.
    In addition, Section 208 of the Riegle Act directed the Federal 
banking agencies to revise the current regulatory capital treatment 
applied to banks that sell small business obligations with recourse. 
The Federal Reserve approved a final rule implementing Section 208 
before the statutory deadline of March 22, 1995. However, because of 
renewed interagency discussions, the Board issued a revised final rule 
implementing Section 208 that was published in the Federal Register on 
August 31, 1995. The other agencies also published interim rules 
implementing Section 208 and expect to issue final rules in 1996. The 
effect of the final rules is to lower the capital charge for certain 
sales of small business loans with recourse.
    With regard to the advance notice of proposed rulemaking, the 
agencies met throughout 1995 to discuss various alternative approaches 
that were suggested by commenters.

[[Page 15950]]


Derivative Contracts and Recognizing the Effects of Netting on 
Potential Future Exposure

    The agencies worked together on proposing amendments to their 
respective risk-based capital guidelines that were based on proposed 
revisions to the Basle Accord that the Basle Supervisors Committee 
initiated in July 1994. The Board issued for public comment, on August 
22, 1994, a proposed rulemaking that would: (1) increase the capital 
charge for the potential future counterparty exposure of interest and 
exchange rate contracts that are over five years in remaining maturity, 
as well as of equity, precious metals, and other commodity-related 
contracts; and (2) recognize the effects of bilateral netting 
arrangements in calculating the potential future exposure for contracts 
subject to qualifying netting arrangements. Effective at year-end 1995, 
the G-10 Governors have approved a revision to the Basle Accord to 
permit institutions to recognize the effects of bilateral netting 
arrangements when calculating potential future exposure for contracts 
subject to qualifying bilateral netting arrangements. The Board issued 
a final rulemaking on September 5, 1995, the effective date of which 
was October 1, 1995. The other banking agencies also issued rules 
implementing these Basle revisions in 1995.

Country Transfer Risk

    In July 1994, the G-10 Governors announced their intention to 
modify the Basle Accord in 1995 with regard to country transfer risk. 
Specifically, it was agreed to revise the definition of the OECD-based 
group of countries 4 that are accorded a preferential risk weight. 
The revision, which was adopted by the Basle Supervisors Committee and 
endorsed by the G-10 Governors in 1995, retains the OECD-based group of 
countries as the principle criterion for preferential risk weight 
status, but exclude for five years any country that reschedules its 
external sovereign debt. The Board and the OCC issued a joint notice of 
proposed rulemaking on October 14, 1994, that sought public comment on 
an amendment to their respective risk-based capital guidelines. The 
Board and the OCC worked with the FDIC to issue a final rule that is 
expected to be issued in early 1996.

    \4\ The OECD-based group of countries currently includes members 
of the Organization of Economic Cooperation and Development and 
countries that have concluded special lending arrangements with the 
International Monetary Fund (IMF) associated with the Fund's General 
Arrangements to Borrow. Saudi Arabia is the only non-OECD country 
that has concluded such arrangements.
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Capital Impact of Recent Changes to Accounting Standards

    Recently, FASB issued pronouncements concerning new and modified 
financial accounting standards. The adoption of some of these standards 
for regulatory reporting purposes had the potential of affecting the 
definition and calculation of regulatory capital. Accordingly, the 
staffs of the agencies worked together to propose uniform regulatory 
capital responses to such accounting changes. Over this past year, the 
agencies dealt with the capital effects of these accounting issues in 
the manner described below.
FAS 115, ``Accounting for Certain Investments in Debt and Equity 
Securities.''
    As discussed in last year's report, the agencies issued in 1993 and 
early 1994 proposed amendments to their respective risk-based capital 
standards that would include in Tier 1 capital the net unrealized 
changes in value of securities available for sale for purposes of 
calculating the risk-based and leverage capital ratios of banking 
organizations. On November 10, 1994, the FFIEC recommended to the 
agencies that they not adopt FAS 115 for capital purposes. Acting on 
this recommendation, the Board, on November 30, 1994, adopted a final 
rule effective December 31, 1994. Under the final rule, institutions 
are generally directed not to include in Tier 1 capital the component 
of common stockholders' equity, net unrealized holding gains and losses 
on securities available for sale, which was created by FAS 115. The 
other agencies approved similar rules in 1995.
FAS 109, ``Accounting for Income Taxes.''
    The agencies issued in 1993 proposals to limit the amount of 
deferred tax assets includable in calculating Tier 1 capital. Under the 
proposals, certain deferred tax assets are limited to the lesser of 10 
percent of Tier 1 capital or the amount of such assets the institution 
expects to realize in the subsequent year. On November 18, 1994, the 
FFIEC recommended that the agencies finalize these proposals. In 1995, 
the Board, along with the other banking agencies, issued a final rule 
that was similar to the proposal.
FAS 122, ``Accounting for Mortgage Servicing Rights.''
    The Board, along with the OCC, FDIC, and OTS, issued an interim 
final rule, which became effective on August 1, 1995, that amends the 
agencies' capital adequacy guidelines to treat originated mortgage 
servicing rights (OMSRs) the same as purchased mortgage servicing 
rights (PMSRs) for regulatory capital purposes. These rules were 
developed in response to the issuance of FAS 122, which eliminates the 
distinction between OMSRs and PMSRs by requiring OMSRs to be 
capitalized as balance sheet assets, a treatment previously required 
only for PMSRs. Under the interim rule, both OMSRs and PMSRs are 
included in (not deducted from) regulatory capital when determining 
Tier 1 (core) capital for purposes of the agencies' risk-based and 
leverage capital standards and in the calculation of tangible equity 
for purposes of prompt corrective action. OMSRS are subject to the 
regulatory capital limitations that previously applied only to PMSRs. 
Staffs of the agencies have reviewed the comments and interagency 
discussions are expected to begin shortly in anticipation of a final 
rule sometime in 1996.

Specific Capital Differences

    Differences among the risk-based capital standards of the OTS and 
the three banking agencies are discussed below.

Certain Collateralized Transactions

    On December 23, 1992, the Federal Reserve Board issued an amendment 
to its risk-based and leverage capital guidelines that lowers from 20 
to 0 percent the risk category for collateralized transactions meeting 
certain criteria. This preferential treatment is only available for 
claims fully collateralized by cash on deposit in the bank or by 
securities issued or guaranteed by OECD central governments or U.S. 
government agencies. In addition, a positive margin of collateral must 
be maintained on a daily basis fully taking into account any change in 
the banking organization's exposure to the obligor or counterparty 
under a claim in relation to the market value of the collateral held in 
support of that claim.
    As reported in the previous two reports, the OCC, on August 18, 
1993, issued a proposal for public comment that would also lower the 
risk weight for certain collateralized transactions. On December 28, 
1994, the OCC issued a final rule that is somewhat similar to the 
Board's final rule, but permits any

[[Page 15951]]
portion of a claim collateralized by cash or OECD government securities 
to receive a zero percent risk weight, provided that the collateral is 
marked to market daily and a positive margin is maintained. The FDIC 
and OTS have rules in place that permit portions of claims 
collateralized by cash or OECD government securities to receive a 20 
percent risk weight. Staffs of the four agencies have been meeting in 
an attempt to resolve these differences.

Equity Investments

    In general, commercial banks that are members of the Federal 
Reserve System are not permitted to invest in equity securities, nor 
are they generally permitted to engage in real estate investment or 
development activities. To the extent that commercial banks are 
permitted to hold equity securities (for example, in connection with 
debts previously contracted), the three banking agencies generally 
assign such investments to the 100 percent risk category for risk-based 
capital purposes.
    Under the three banking agencies' rules, the agencies may, on a 
case-by-case basis, deduct equity investments from the parent bank's 
capital or make other adjustments, if necessary, to assess an 
appropriate capital charge above the minimum requirement. The banking 
agencies' treatment of investments in subsidiaries is discussed below.
    The OTS risk-based capital standards require that thrift 
institutions deduct certain equity investments from capital over a 
phase-in period, which ended on July 1, 1994, as explained more fully 
below in the section on subsidiaries.

FSLIC/FDIC--Covered Assets (Assets Subject to Guarantee Arrangements by 
the FSLIC or FDIC)

    The three banking agencies generally place these assets in the 20 
percent risk category, the same category to which claims on depository 
institutions and government-sponsored agencies are assigned.
    The OTS places these assets in the zero percent risk category.

Limitation on Subordinated Debt and Limited-Life Preferred Stock

    Consistent with the Basle Accord, the three banking agencies limit 
the amount of subordinated debt and limited-life preferred stock that 
may be included in Tier 2 capital. This limit, in effect, states that 
these components together may not exceed 50 percent of Tier 1 capital. 
In addition, maturing capital instruments must be discounted by 20 
percent in each of the last five years prior to maturity.
    Neither subordinated debt nor limited-life preferred stock is a 
permanent source of funds, and subordinated debt cannot absorb losses 
while the bank continues to operate as a going-concern. On the other 
hand, both capital components can provide a cushion of protection to 
the FDIC insurance fund. Thus, the 50 percent limitation permits the 
inclusion of some subordinated debt in capital, while assuring that 
permanent stockholders' equity capital remains the predominant element 
in bank regulatory capital.
    The OTS has no limitation on the total amount of limited-life 
preferred stock or maturing capital instruments that may be included 
within Tier 2 capital. In addition, the OTS allows thrifts the option 
of: (1) discounting maturing capital instruments issued on or after 
November 7, 1989, by 20 percent a year over the last 5 years of their 
term--the approach required by the banking agencies; or (2) including 
the full amount of such instruments provided that the amount maturing 
in any of the next seven years does not exceed 20 percent of the 
thrift's total capital.

Subsidiaries

    Consistent with the Basle Accord and long-standing supervisory 
practices, the three banking agencies generally consolidate all 
significant majority-owned subsidiaries of the parent organization for 
capital purposes. This consolidation assures that the capital 
requirements are related to all of the risks to which the banking 
organization is exposed.
    As with most other bank subsidiaries, banking and finance 
subsidiaries generally are consolidated for regulatory capital 
purposes. However, in cases where banking and finance subsidiaries are 
not consolidated, the Federal Reserve, consistent with the Basle 
Accord, generally deducts investments in such subsidiaries in 
determining the adequacy of the parent bank's capital.
    The Federal Reserve's risk-based capital guidelines provide a 
degree of flexibility in the capital treatment of unconsolidated 
subsidiaries (other than banking and finance subsidiaries) and 
investments in joint ventures and associated companies. For example, 
the Federal Reserve may deduct investments in such subsidiaries from an 
organization's capital, may apply an appropriate risk-weighted capital 
charge against the proportionate share of the assets of the entity, may 
require a line-by-line consolidation of the entity, or otherwise may 
require that the parent organization maintain a level of capital above 
the minimum standard that is sufficient to compensate for any risks 
associated with the investment.
    The guidelines also permit the deduction of investments in 
subsidiaries that, while consolidated for accounting purposes, are not 
consolidated for certain specified supervisory or regulatory purposes. 
For example, the Federal Reserve deducts investments in, and unsecured 
advances to, Section 20 securities subsidiaries from the parent bank 
holding company's capital. The FDIC accords similar treatment to 
securities subsidiaries of state nonmember banks established pursuant 
to Section 337.4 of the FDIC regulations.
    Similarly, in accordance with Section 325.5(f) of the FDIC 
regulations, a state nonmember bank must deduct investments in, and 
extensions of credit to, certain mortgage banking subsidiaries in 
computing the parent bank's capital. (The Federal Reserve does not have 
a similar requirement with regard to mortgage banking subsidiaries. The 
OCC does not have requirements dealing specifically with the capital 
treatment of either mortgage banking or securities subsidiaries. The 
OCC, however, does reserve the right to require a national bank, on a 
case-by-case basis, to deduct from capital investments in, and 
extensions of credit to, any nonbanking subsidiary.)
    The deduction of investments in subsidiaries from the parent's 
capital is designed to ensure that the capital supporting the 
subsidiary is not also used as the basis of further leveraging and 
risk-taking by the parent banking organization. In deducting 
investments in, and advances to, certain subsidiaries from the parent's 
capital, the Federal Reserve expects the parent banking organization to 
meet or exceed minimum regulatory capital standards without reliance on 
the capital invested in the particular subsidiary. In assessing the 
overall capital adequacy of banking organizations, the Federal Reserve 
may also consider the organization's fully consolidated capital 
position.
    Under the OTS capital guidelines, a distinction, mandated by 
FIRREA, is drawn between subsidiaries that are engaged in activities 
that are permissible for national banks and subsidiaries that are 
engaged in ``impermissible'' activities for national banks. 
Subsidiaries of thrift institutions that engage only in permissible 
activities are consolidated on a line-by-line basis if majority-owned 
and on a pro rata basis if ownership is between 5 percent and 50 
percent. As a general rule, investments, including loans, in 
subsidiaries that engage in impermissible activities are deducted in 
determining the capital adequacy of the

[[Page 15952]]
parent. However, investments, including loans, outstanding as of April 
12, 1989, to subsidiaries that were engaged in impermissible activities 
prior to that date are grandfathered and were phased-out of capital 
over a transition period that expired on July 1, 1994. During this 
transition period, investments in subsidiaries engaged in impermissible 
activities that have not been phased-out of capital were consolidated 
on a pro rata basis.

Nonresidential Construction and Land Loans

    The three banking agencies assign loans for real estate development 
and construction purposes to the 100 percent risk category. Reserves or 
charge-offs are required, in accordance with examiner judgment, when 
weaknesses or losses develop in such loans. The banking agencies have 
no requirement for an automatic charge-off when the amount of a loan 
exceeds the fair value of the property pledged as collateral for the 
loan.
    The OTS generally assigns these loans to the 100 percent risk 
category. However, if the amount of the loan exceeds 80 percent of the 
fair value of the property, that excess portion must be deducted from 
capital in accordance with a phase-in arrangement, which ended on July 
1, 1994.

Mortgage-Backed Securities (MBS)

    The three banking agencies, in general, place privately-issued MBSs 
in a risk category appropriate to the underlying assets but in no case 
to the zero percent risk category. In the case of privately-issued MBSs 
where the direct underlying assets are mortgages, this treatment 
generally results in a risk weight of 50 percent or 100 percent. 
Privately-issued MBSs that have government agency or government-
sponsored agency securities as their direct underlying assets are 
generally assigned to the 20 percent risk category.
    The OTS assigns privately-issued high quality mortgage-related 
securities to the 20 percent risk category. These are, generally, 
privately-issued MBSs with AA or better investment ratings.
    At the same time, both the banking and thrift agencies 
automatically assign to the 100 percent risk weight category certain 
MBSs, including interest-only strips, residuals, and similar 
instruments that can absorb more than their pro rata share of loss. The 
Federal Reserve, in conjunction with the other banking agencies and the 
OTS, issued, on January 10, 1992, more specific guidance as to the 
types of ``high risk'' MBSs that will qualify for a 100 percent risk 
weight.

Assets Sold with Recourse

    In general, recourse arrangements allow the purchaser of an asset 
to ``put'' the asset back to the originating institution under certain 
circumstances, for example, if the asset ceases to perform 
satisfactorily. This, in turn, can expose the originating institution 
to any loss associated with the asset. On May 25, 1994, the three 
banking agencies and the OTS, under the auspices of the FFIEC, sought 
public comment on various aspects of the capital treatment of recourse 
transactions by publishing a Notice of Proposed Rulemaking (NPR) and an 
Advance Notice of Proposed Rulemaking (ANPR), which is a more 
preliminary step in the formal rulemaking process.
    The NPR proposed to amend the banking agencies' risk-based capital 
guidelines by:
    (1) reducing the risk-based capital charge for ``low level'' 
recourse arrangements to an amount equal to the maximum contractual 
recourse obligation;
    (2) requiring equivalent capital treatment of recourse arrangements 
and direct credit substitutes that provide first dollar loss 
protection. This would increase the capital assessment for first loss 
standby letters of credit and purchased subordinated interests that 
only provide partial credit enhancement; and,
    (3) defining ``recourse'' and associated terms such as ``standard 
representations and warranties.''
    The ANPR proposed incorporating into the risk-based capital 
guidelines a framework based on formal credit ratings for assessing 
capital against exposures with different levels of risk in certain 
asset securitizations. Thus, if there is more risk in a particular 
position with a securitized transaction, a higher capital charge should 
be accorded.
    As described more fully above, Section 350 of the Riegle Act 
required the agencies to finalize a rule amending their respective 
risk-based capital standards to take account of low-level recourse, as 
was proposed by the NPR issued by the agencies. The low-level approach 
was implemented by the Federal Reserve by a final rule issued on 
February 7, 1995, and made effective on March 22, 1995, which satisfied 
the requirements of Section 350 of the Riegle Act. The FDIC and OCC 
also issued final rules in 1995 to implement Section 350. The OTS 
already had a capital rule in place that satisfied the requirements of 
Section 350.
    Section 208 of the Riegle Act directed the Federal banking agencies 
to revise the current regulatory capital treatment applied to banks 
that sell small business obligations with recourse. The Federal Reserve 
approved a final rule implementing Section 208 before the statutory 
deadline of March 22, 1995. However, because of renewed interagency 
discussions, the Board issued a revised final rule implementing Section 
208 that was published in the Federal Register on August 31, 1995. The 
other agencies also published final rules implementing Section 208 this 
year.
    With regard to the ANPR, the agencies have been meeting throughout 
the past year to consider approaches suggested by commenters.

Agricultural Loan Loss Amortization

    In the computation of regulatory capital, those banks accepted into 
the agricultural loan loss amortization program pursuant to Title VIII 
of the Competitive Equality Banking Act of 1987 are permitted to defer 
and amortize losses incurred on agricultural loans between January 1, 
1984 and December 31, 1991.
    The program also applies to losses incurred between January 1, 1983 
and December 31, 1991, as a result of reappraisals and sales of 
agricultural Other Real Estate Owned (OREO) and agricultural personal 
property. These loans must be fully amortized over a period not to 
exceed seven years and, in any case, must be fully amortized by year-
end 1998. Thrifts are not eligible to participate in the agricultural 
loan loss amortization program established by this statute.

Treatment of Junior Liens on 1- to 4-Family Residential Properties

    In some cases, a banking organization may make two loans on a 
single residential property, one loan secured by a first lien, the 
other by a second lien. In such a situation, the Federal Reserve views 
these two transactions as a single loan, provided there are no 
intervening liens. This could result in assigning the total amount of 
these transactions to the 100 percent risk weight category, if, in the 
aggregate, the two loans exceeded a prudent loan-to-value ratio and, 
therefore, did not qualify for the 50 percent risk weight. This 
approach is intended to avoid possible circumvention of the capital 
requirements and capture the risks associated with the combined 
transactions.
    The FDIC, OCC, and the OTS generally assign the loan secured by the 
first lien to the 50 percent risk-weight category and the loan secured 
by the

[[Page 15953]]
second lien to the 100 percent risk-weight category.

Pledged Deposits and Nonwithdrawable Accounts

    The capital guidelines of the OTS permit thrift institutions to 
include in capital certain pledged deposits and nonwithdrawable 
accounts that meet the criteria of the OTS. Income Capital Certificates 
and Mutual Capital Certificates held by the OTS may also be included in 
capital by thrift institutions. These instruments are not relevant to 
commercial banks, and, therefore, they are not addressed in the three 
banking agencies' capital guidelines.

Mutual Funds

    The three banking agencies generally assign all of a bank's 
holdings in a mutual fund to the risk category appropriate to the 
highest risk asset that a particular mutual fund is permitted to hold 
under its operating rules. The purpose of this is to take into account 
the maximum degree of risk to which a bank may be exposed when 
investing in a mutual fund in view of the fact that the future 
composition and risk characteristics of the fund's holding cannot be 
known in advance.
    The OTS applies a capital charge appropriate to the riskiest asset 
that a mutual fund is actually holding at a particular time. In 
addition, both the OTS and the OCC guidelines also permit, on a case-
by-case basis, investments in mutual funds to be allocated on a pro 
rata basis in a manner consistent with the actual composition of the 
mutual fund.

Section Two--Differences in Accounting Standards Among Federal Banking 
and Thrift Supervisory Agencies

    Under the auspices of the FFIEC, the three banking agencies have 
developed uniform reporting standards for commercial banks which are 
used in the preparation of the Call Report. The FDIC has also applied 
these uniform Call Report standards to savings banks under its 
supervision. The income statement and balance sheet accounts presented 
in the Call Report are used by the bank supervisory agencies for 
determining the capital adequacy of banks and for other regulatory, 
supervisory, surveillance, analytical, and general statistical 
purposes.
    Section 121 of FDICIA requires accounting principles applicable to 
financial reports (including the Call Report) filed by federally 
insured depository institutions with a federal banking agency to be 
uniform and consistent with generally accepted accounting principles 
(GAAP). However, under Section 121, a federal banking agency may 
require institutions to use accounting principles ``no less stringent 
than GAAP'' when the agency determines that a specific accounting 
standard under GAAP does not meet these new accounting objectives. The 
banking agencies believe that GAAP generally satisfies the three 
accounting objectives included in FDICIA Section 121. The three 
accounting objectives in FDICIA Section 121 mandate that accounting 
principles should:
    1. Result in financial statements and reports of condition that 
accurately reflect the institution's capital;
    2. Facilitate effective supervision of depository institutions; and
    3. Facilitate prompt corrective action at least cost to the 
insurance funds.
    As indicated above, Section 121 of FDICIA requires the Federal 
Reserve and the other federal banking agencies to utilize accounting 
principles for regulatory reports that are consistent with GAAP or are 
no less stringent than GAAP. The reporting instructions for Call 
Reports that are required by the three banking agencies are 
substantially consistent, aside from a few limited exceptions, with 
GAAP as applied by commercial banks. In those cases where accounting 
principles applicable to bank Call Reports are different from GAAP, the 
regulatory accounting principles are intended to be more conservative 
than GAAP. Thus, the accounting principles that are followed for 
regulatory reporting purposes are consistent with the objectives and 
mandate of FDICIA Section 121.
    The OTS has developed and maintains a separate reporting system for 
the thrift institutions under its supervision. The TFR is based on GAAP 
as applied by thrifts.
    On November 3, 1995, the FFIEC announced that it is adopting GAAP 
as the reporting basis for the basic balance sheet, income statement, 
and related schedules in the bank Call Reports, effective with the 
March 1997 report date. This action will eliminate the existing 
differences between GAAP and regulatory accounting principles. The 
agencies believe that the FFIEC action is consistent with the 
objectives of FDICIA 121 and the objectives of Section 307(b) of the 
Riegle Community Development and Regulatory Improvement Act of 1994, 
which requires the agencies to work jointly to develop a single form 
for the filing of core information by banks, savings associations, and 
bank holding companies. The adoption of GAAP for Call Report purposes 
should eliminate the differences in accounting standards among the 
agencies that are set forth below.
    A summary of the primary differences in accounting principles by 
the federal banking and thrift agencies for regulatory reporting 
purposes are set forth below, based on a study developed on an 
interagency basis:

Futures and Forward Contracts

    The banking agencies, as a general rule, do not permit the deferral 
of gains and losses by banks on futures and forwards whether or not 
they are used for hedging purposes. All changes in market value of 
futures and forward contracts are reported in current period income. 
The banking agencies adopted this reporting standard as a supervisory 
policy prior to the adoption of FASB Statement No. 80, which allows 
hedge accounting, under certain circumstances. Contrary to this general 
rule, hedge accounting in accordance with FASB Statement No. 80 is 
permitted by the three banking agencies only for futures and forward 
contracts used in mortgage banking operations.
    The OTS practice is to follow FASB Statement No. 80 for futures 
contracts. In accordance with this statement, when hedging criteria are 
satisfied, the accounting for the futures contract is related to the 
accounting for the hedged item. Changes in the market value of the 
futures contract are recognized in income when the effects of related 
changes in the price or interest rate of the hedged item are 
recognized. Such reporting can result in deferred gains and losses 
which would be reflected as liabilities and assets on the thrift's 
balance sheet in accordance with GAAP.

Excess Servicing Fees

    As a general rule, the three banking agencies do not follow GAAP 
for excess servicing fees. Excess servicing results when loans are sold 
with servicing retained and the stated servicing fee rate is greater 
than the normal servicing fee rate. With the exception of sales of 
pools of first lien one-to-four family residential mortgages for which 
the banking agencies' approach is consistent with FASB Statement No. 
65, excess servicing fee income in banks must be reported as realized 
over the life of the transferred asset, not recognized up front as 
required by FASB Statement No. 65.
    The OTS allows the present value of the future excess servicing fee 
to be treated as an adjustment to the sales price for purposes of 
recognizing gain or loss on the sale. This approach is consistent with 
FASB Statement No. 65.

[[Page 15954]]


In-Substance Defeasance of Debt

    The banking agencies do not permit banks to report defeasance of 
their debt obligations in accordance with FASB Statement No. 76. 
Defeasance involves a debtor irrevocably placing risk-free monetary 
assets in a trust solely for satisfying the debt. Under FASB Statement 
No. 76, the assets in the trust and the defeased debt are removed from 
the balance sheet and a gain or loss for the current period can be 
recognized. However, for Call Report purposes, banks may not remove 
assets or defeased liabilities from their balance sheets or recognize 
resulting gains or losses. FASB has recently proposed to amend GAAP to 
adopt an approach similar to the Call Report treatment for these 
transactions.
    OTS practice is to follow FASB Statement No. 76.

Sales of Assets with Recourse

    In accordance with FASB Statement No. 77, a transfer of receivables 
with recourse is recognized as a sale if: (1) the transferor surrenders 
control of the future economic benefits; (2) the transferor's 
obligation under the recourse provisions can be reasonably estimated; 
and (3) the transferee cannot require repurchase of the receivables 
except pursuant to the recourse provisions.
    The practice of the three banking agencies is generally to permit 
commercial banks to report transfers of receivables with recourse as 
sales only when the transferring institution (1) retains no risk of 
loss from the assets transferred and (2) has no obligation for the 
payment of principal or interest on the assets transferred. As a 
result, virtually no transfers of assets with recourse can be reported 
as sales. However, this rule does not apply to the transfer of first 
lien 1- to 4-family residential or agricultural mortgage loans under 
certain government-sponsored programs (including the Federal National 
Mortgage Association and the Federal Home Loan Mortgage Corporation). 
Transfers of mortgages under these programs are generally treated as 
sales for Call Report purposes.
    Furthermore, private transfers of first lien 1- to 4-family 
residential mortgages are also reported as sales if the transferring 
institution retains only an insignificant risk of loss on the assets 
transferred. However, the seller's obligation under recourse provisions 
related to sales of mortgage loans under the government programs is 
viewed as an off-balance sheet exposure. Thus, for risk-based capital 
purposes, capital is generally expected to be held for recourse 
obligations associated with such transactions.
    The OTS policy is to follow FASB Statement No. 77. However, in the 
calculation of risk-based capital under the OTS guidelines, off-balance 
sheet recourse obligations generally are converted at 100 percent. This 
effectively negates the sale treatment recognized on a GAAP basis for 
risk-based capital purposes, but not for leverage capital purposes. 
Thus, by making this adjustment in the risk-based capital calculation, 
the differences between the OTS and the banking agencies for capital 
adequacy measurement purposes, are substantially reduced.

Push-Down Accounting

    When a depository institution is acquired in a purchase 
transaction, but retains its separate corporate existence, the 
institution is required to revalue all of the assets and liabilities at 
fair value at the time of acquisition. When push-down accounting is 
applied, the same revaluation made by the parent holding company is 
made at the depository institution level.
    The three banking agencies require push-down accounting when there 
is at least a 95 percent change in ownership. This approach is 
generally consistent with interpretations of the Securities and 
Exchange Commission.
    The OTS requires push-down accounting when there is at least a 90 
percent change in ownership.

Negative Goodwill

    The three banking agencies require that negative goodwill be 
reported as a liability, and not be netted against goodwill assets. 
Such a policy ensures that all goodwill assets are deducted in 
regulatory capital calculations, consistent with the Basle Accord.
    The OTS permits negative goodwill to offset goodwill assets 
reported in the financial statements.

Offsetting

    The three banking agencies generally prohibit netting of assets and 
liabilities in the Call Report. However, FASB Interpretation No. 39 
(FIN 39) netting requirements have been adopted for Call Report 
purposes solely for assets and liabilities that arise from off-balance-
sheet instruments. For example, under FIN 39, the assets and 
liabilities arising from these contracts may be netted when there is a 
legally enforceable bilateral master netting agreement.
    The OTS policy on netting for all assets and liabilities is 
consistent with GAAP, as set forth in FIN 39. FIN 39 allows 
institutions to offset assets and liabilities (e.g., loans and 
deposits) when four conditions are met. Moreover, the OTS permits 
netting for off-balance sheet conditional and exchange contracts to the 
same extent as the banking agencies.

    By order of the Board of Governors of the Federal Reserve 
System, April 4, 1996.
Jennifer J. Johnson,
Deputy Secretary of the Board.
[FR Doc. 96-8873 Filed 4-9-96; 8:45am]
BILLING CODE 6210-01-P