Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, Standardized Approach for Risk-weighted Assets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital Rule

Federal RegisterSep 10, 2013

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FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Parts 303, 308, 324, 327, 333, 337, 347, 349, 360, 362, 363, 364, 365, 390, and 391

RIN 3064-AD95

Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, Standardized Approach for Risk-weighted Assets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital Rule

AGENCY:

Federal Deposit Insurance Corporation.

ACTION:

Interim final rule with request for comments.

SUMMARY:

The Federal Deposit Insurance Corporation (FDIC) is adopting an interim final rule that revises its risk-based and leverage capital requirements for FDIC-supervised institutions. This interim final rule is substantially identical to a joint final rule issued by the Office of the Comptroller of the Currency (OCC) and the Board of Governors of the Federal Reserve System (Federal Reserve) (together, with the FDIC, the agencies). The interim final rule consolidates three separate notices of proposed rulemaking that the agencies jointly published in the

Federal Register

on August 30, 2012, with selected changes. The interim final rule implements a revised definition of regulatory capital, a new common equity tier 1 minimum capital requirement, a higher minimum tier 1 capital requirement, and, for FDIC-supervised institutions subject to the advanced approaches risk-based capital rules, a supplementary leverage ratio that incorporates a broader set of exposures in the denominator. The interim final rule incorporates these new requirements into the FDIC's prompt corrective action (PCA) framework. In addition, the interim final rule establishes limits on FDIC-supervised institutions' capital distributions and certain discretionary bonus payments if the FDIC-supervised institution does not hold a specified amount of common equity tier 1 capital in addition to the amount necessary to meet its minimum risk-based capital requirements. The interim final rule amends the methodologies for determining risk-weighted assets for all FDIC-supervised institutions. The interim final rule also adopts changes to the FDIC's regulatory capital requirements that meet the requirements of section 171 and section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The interim final rule also codifies the FDIC's regulatory capital rules, which have previously resided in various appendices to their respective regulations, into a harmonized integrated regulatory framework. In addition, the FDIC is amending the market risk capital rule (market risk rule) to apply to state savings associations.

The FDIC is issuing these revisions to its capital regulations as an interim final rule. The FDIC invites comments on the interaction of this rule with other proposed leverage ratio requirements applicable to large, systemically important banking organizations. This interim final rule otherwise contains regulatory text that is identical to the common rule text adopted as a final rule by the Federal Reserve and the OCC. This interim final rule enables the FDIC to proceed on a unified, expedited basis with the other federal banking agencies pending consideration of other issues. Specifically, the FDIC intends to evaluate this interim final rule in the context of the proposed well-capitalized and buffer levels of the supplementary leverage ratio applicable to large, systemically important banking organizations, as described in a separate Notice of Proposed Rulemaking (NPR) published in the

Federal Register

August 20, 2013.

The FDIC is seeking commenters' views on the interaction of this interim final rule with the proposed rule regarding the supplementary leverage ratio for large, systemically important banking organizations.

DATES:

Effective date:

January 1, 2014.

Mandatory compliance date:

January 1, 2014 for advanced approaches FDIC-supervised institutions; January 1, 2015 for all other FDIC-supervised institutions. Comments on the interim final rule must be received no later than November 12, 2013.

ADDRESSES:

You may submit comments, identified by RIN 3064-AD95, by any of the following methods:

•

Agency Web site: http://www.fdic.gov/regulations/laws/federal/propose.html

. Follow instructions for submitting comments on the Agency Web site.

•

Email: Comments@fdic.gov

. Include the RIN 3064-AD95 on the subject line of the message.

•

Mail:

Robert E. Feldman, Executive Secretary, Attention: Comments, Federal Deposit Insurance Corporation, 550 17th Street NW., Washington, DC 20429.

•

Hand Delivery:

Comments may be hand delivered to the guard station at the rear of the 550 17th Street Building (located on F Street) on business days between 7:00 a.m. and 5:00 p.m.

Public Inspection:

All comments received must include the agency name and RIN 3064-AD95 for this rulemaking. All comments received will be posted without change to

http://www.fdic.gov/regulations/laws/federal/propose.html

, including any personal information provided. Paper copies of public comments may be ordered from the FDIC Public Information Center, 3501 North Fairfax Drive, Room E-1002, Arlington, VA 22226 by telephone at (877) 275-3342 or (703) 562-2200.

FOR FURTHER INFORMATION CONTACT:

Bobby R. Bean, Associate Director,

bbean@fdic.gov

; Ryan Billingsley, Chief, Capital Policy Section,

rbillingsley@fdic.gov

; Karl Reitz, Chief, Capital Markets Strategies Section,

kreitz@fdic.gov

; David Riley, Senior Policy Analyst,

dariley@fdic.gov

; Benedetto Bosco, Capital Markets Policy Analyst,

bbosco@fdic.gov, regulatorycapital@fdic.gov

, Capital Markets Branch, Division of Risk Management Supervision, (202) 898-6888; or Mark Handzlik, Counsel,

mhandzlik@fdic.gov

; Michael Phillips, Counsel,

mphillips@fdic.gov

; Greg Feder, Counsel,

gfeder@fdic.gov

; Ryan Clougherty, Senior Attorney,

rclougherty@fdic.gov

; or Rachel Jones, Attorney,

racjones@fdic.gov

, Supervision Branch, Legal Division, Federal Deposit Insurance Corporation, 550 17th Street NW., Washington, DC 20429.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction

II. Summary of the Three Notices of Proposed Rulemaking

A. The Basel III Notice of Proposed Rulemaking

B. The Standardized Approach Notice of Proposed Rulemaking

C. The Advanced Approaches Notice of Proposed Rulemaking

III. Summary of General Comments on the Basel III Notice of Proposed Rulemaking and on the Standardized Approach Notice of Proposed Rulemaking; Overview of the Interim Final Rule

A. General Comments on the Basel III Notice of Proposed Rulemaking and on the Standardized Approach Notice of Proposed Rulemaking

1. Applicability and Scope

2. Aggregate Impact

3. Competitive Concerns

4. Costs

B. Comments on Particular Aspects of the Basel III Notice of Proposed Rulemaking and on the Standardized Approach Notice of Proposed Rulemaking

1. Accumulated Other Comprehensive Income

2. Residential Mortgages

3. Trust Preferred Securities for Smaller FDIC-Supervised Institutions

C. Overview of the Interim Final Rule

D. Timeframe for Implementation and Compliance

IV. Minimum Regulatory Capital Ratios, Additional Capital Requirements, and Overall Capital Adequacy

A. Minimum Risk-Based Capital Ratios and Other Regulatory Capital Provisions

B. Leverage Ratio

C. Supplementary Leverage Ratio for Advanced Approaches FDIC-Supervised Institutions

D. Capital Conservation Buffer

E. Countercyclical Capital Buffer

F. Prompt Corrective Action Requirements

G. Supervisory Assessment of Overall Capital Adequacy

H. Tangible Capital Requirement for State Savings Associations

V. Definition of Capital

A. Capital Components and Eligibility Criteria for Regulatory Capital Instruments

1. Common Equity Tier 1 Capital

2. Additional Tier 1 Capital

3. Tier 2 Capital

4. Capital Instruments of Mutual FDIC-Supervised Institutions

5. Grandfathering of Certain Capital Instruments

6. Agency Approval of Capital Elements

7. Addressing the Point of Non-Viability Requirements Under Basel III

8. Qualifying Capital Instruments Issued by Consolidated Subsidiaries of an FDIC-Supervised Institution

9. Real Estate Investment Trust Preferred Capital

B. Regulatory Adjustments and Deductions

1. Regulatory Deductions from Common Equity Tier 1 Capital

a. Goodwill and Other Intangibles (other than Mortgage Servicing Assets)

b. Gain-on-Sale Associated with a Securitization Exposure

c. Defined Benefit Pension Fund Net Assets

d. Expected Credit Loss That Exceeds Eligible Credit Reserves

e. Equity Investments in Financial Subsidiaries

f. Deduction for Subsidiaries of Savings Associations That Engage in Activities That Are Not Permissible for National Banks

g. Identified Losses for State Nonmember Banks

2. Regulatory Adjustments to Common Equity Tier 1 Capital

a. Accumulated Net Gains and Losses on Certain Cash-Flow Hedges

b. Changes in an FDIC-Supervised Institution's Own Credit Risk

c. Accumulated Other Comprehensive Income

d. Investments in Own Regulatory Capital Instruments

e. Definition of Financial Institution

f. The Corresponding Deduction Approach

g. Reciprocal Crossholdings in the Capital Instruments of Financial Institutions

h. Investments in the FDIC-Supervised Institution's Own Capital Instruments or in the Capital of Unconsolidated Financial Institutions

i. Indirect Exposure Calculations

j. Non-Significant Investments in the Capital of Unconsolidated Financial Institutions

k. Significant Investments in the Capital of Unconsolidated Financial Institutions That Are Not in the Form of Common Stock

l. Items Subject to the 10 and 15 Percent Common Equity Tier 1 Capital Threshold Deductions

m. Netting of Deferred Tax Liabilities Against Deferred Tax Assets and Other Deductible Assets

3. Investments in Hedge Funds and Private Equity Funds Pursuant to Section 13 of the Bank Holding Company Act

VI. Denominator Changes Related to the Regulatory Capital Changes

VII. Transition Provisions

A. Transitions Provisions for Minimum Regulatory Capital Ratios

B. Transition Provisions for Capital Conservation and Countercyclical Capital Buffers

C. Transition Provisions for Regulatory Capital Adjustments and Deductions

1. Deductions for Certain Items Under Section 22(a) of the Interim Final Rule

2. Deductions for Intangibles Other Than Goodwill and Mortgage Servicing Assets

3. Regulatory Adjustments Under Section 22(b)(1) of the Interim Final Rule

4. Phase-Out of Current Accumulated Other Comprehensive Income Regulatory Capital Adjustments

5. Phase-Out of Unrealized Gains on Available for Sale Equity Securities in Tier 2 Capital

6. Phase-In of Deductions Related to Investments in Capital Instruments and to the Items Subject to the 10 and 15 Percent Common Equity Tier 1 Capital Deduction Thresholds (Sections 22(c) and 22(d)) of the Interim Final Rule

D. Transition Provisions for Non-Qualifying Capital Instruments

VIII. Standardized Approach for Risk-Weighted Assets

A. Calculation of Standardized Total Risk-Weighted Assets

B. Risk-Weighted Assets for General Credit Risk

1. Exposures to Sovereigns

2. Exposures to Certain Supranational Entities and Multilateral Development Banks

3. Exposures to Government-Sponsored Enterprises

4. Exposures to Depository Institutions, Foreign Banks, and Credit Unions

5. Exposures to Public-Sector Entities

6. Corporate Exposures

7. Residential Mortgage Exposures

8. Pre-Sold Construction Loans and Statutory Multifamily Mortgages

9. High-Volatility Commercial Real Estate

10. Past-Due Exposures

11. Other Assets

C. Off-Balance Sheet Items

1. Credit Conversion Factors

2. Credit-Enhancing Representations and Warranties

D. Over-the-Counter Derivative Contracts

E. Cleared Transactions

1. Definition of Cleared Transaction

2. Exposure Amount Scalar for Calculating for Client Exposures

3. Risk Weighting for Cleared Transactions

4. Default Fund Contribution Exposures

F. Credit Risk Mitigation

1. Guarantees and Credit Derivatives

a. Eligibility Requirements

b. Substitution Approach

c. Maturity Mismatch Haircut

d. Adjustment for Credit Derivatives Without Restructuring as a Credit Event

e. Currency Mismatch Adjustment

f. Multiple Credit Risk Mitigants

2. Collateralized Transactions

a. Eligible Collateral

b. Risk-Management Guidance for Recognizing Collateral

c. Simple Approach

d. Collateral Haircut Approach

e. Standard Supervisory Haircuts

f. Own Estimates of Haircuts

g. Simple Value-at-Risk and Internal Models Methodology

G. Unsettled Transactions

H. Risk-Weighted Assets for Securitization Exposures

1. Overview of the Securitization Framework and Definitions

2. Operational Requirements

a. Due Diligence Requirements

b. Operational Requirements for Traditional Securitizations

c. Operational Requirements for Synthetic Securitizations

d. Clean-Up Calls

3. Risk-Weighted Asset Amounts for Securitization Exposures

a. Exposure Amount of a Securitization Exposure

b. Gains-on-Sale and Credit-Enhancing Interest-Only Strips

c. Exceptions Under the Securitization Framework

d. Overlapping Exposures

e. Servicer Cash Advances

f. Implicit Support

4. Simplified Supervisory Formula Approach

5. Gross-Up Approach

6. Alternative Treatments for Certain Types of Securitization Exposures

a. Eligible Asset-Backed Commercial Paper Liquidity Facilities

b. A Securitization Exposure in a Second-Loss Position or Better to an Asset-Backed Commercial Paper Program

7. Credit Risk Mitigation for Securitization Exposures

8. Nth-to-Default Credit Derivatives

IX. Equity Exposures

A. Definition of Equity Exposure and Exposure Measurement

B. Equity Exposure Risk Weights

C. Non-Significant Equity Exposures

D. Hedged Transactions

E. Measures of Hedge Effectiveness

F. Equity Exposures to Investment Funds

1. Full Look-through Approach

2. Simple Modified Look-through Approach

3. Alternative Modified Look-Through Approach

X. Market Discipline and Disclosure Requirements

A. Proposed Disclosure Requirements

B. Frequency of Disclosures

C. Location of Disclosures and Audit Requirements

D. Proprietary and Confidential Information

E. Specific Public Disclosure Requirements

XI. Risk-Weighted Assets—Modifications to the Advanced Approaches

A. Counterparty Credit Risk

1. Recognition of Financial Collateral

a. Financial Collateral

b. Revised Supervisory Haircuts

2. Holding Periods and the Margin Period of Risk

3. Internal Models Methodology

a. Recognition of Wrong-Way Risk

b. Increased Asset Value Correlation Factor

4. Credit Valuation Adjustments

a. Simple Credit Valuation Adjustment Approach

b. Advanced Credit Valuation Adjustment Approach

5. Cleared Transactions (Central Counterparties)

6. Stress Period for Own Estimates

B. Removal of Credit Ratings

1. Eligible Guarantor

2. Money Market Fund Approach

3. Modified Look-Through Approaches for Equity Exposures to Investment F

C. Revisions to the Treatment of Securitization Exposures

1. Definitions

2. Operational Criteria for Recognizing Risk Transference in Traditional Securitizations

3. The Hierarchy of Approaches

4. Guarantees and Credit Derivatives Referencing a Securitization Expo

5. Due Diligence Requirements for Securitization Exposures

6. Nth-to-Default Credit Derivatives

D. Treatment of Exposures Subject to Deduction

E. Technical Amendments to the Advanced Approaches Rule

1. Eligible Guarantees and Contingent U.S. Government Guarantees

2. Calculation of Foreign Exposures for Applicability of the Advanced Approaches—Changes to Federal Financial Institutions Examination Council 009

3. Applicability of the Interim Final Rule

4. Change to the Definition of Probability of Default Related to Seasoning

5. Cash Items in Process of Collection

6. Change to the Definition of Qualifying Revolving Exposure

7. Trade-Related Letters of Credit

8. Defaulted Exposures That Are Guaranteed by the U.S. Government

9. Stable Value Wraps

10. Treatment of Pre-Sold Construction Loans and Multi-Family Residential Loans

F. Pillar 3 Disclosures

1. Frequency and Timeliness of Disclosures

2. Enhanced Securitization Disclosure Requirements

3. Equity Holdings That Are Not Covered Positions

XII. Market Risk Rule

XIII. Abbreviations

XIV. Regulatory Flexibility Act

XV. Paperwork Reduction Act

XVI. Plain Language

XVII. Small Business Regulatory Enforcement Fairness Act of 1996

I. Introduction

On August 30, 2012, the agencies published in the

Federal Register

three joint notices of proposed rulemaking seeking public comment on revisions to their risk-based and leverage capital requirements and on methodologies for calculating risk-weighted assets under the standardized and advanced approaches (each, a proposal, and together, the NPRs, the proposed rules, or the proposals).

The proposed rules, in part, reflected agreements reached by the Basel Committee on Banking Supervision (BCBS) in “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems” (Basel III), including subsequent changes to the BCBS's capital standards and recent BCBS consultative papers.

Basel III is intended to improve both the quality and quantity of banking organizations' capital, as well as to strengthen various aspects of the international capital standards for calculating regulatory capital. The proposed rules also reflect aspects of the Basel II Standardized Approach and other Basel Committee standards.

77 FR 52792 (August 30, 2012); 77 FR 52888 (August 30, 2012); 77 FR 52978 (August 30, 2012).

Basel III was published in December 2010 and revised in June 2011. The text is available at

http://www.bis.org/publ/bcbs189.htm

. The BCBS is a committee of banking supervisory authorities, which was established by the central bank governors of the G-10 countries in 1975. More information regarding the BCBS and its membership is available at

http://www.bis.org/bcbs/about.htm

. Documents issued by the BCBS are available through the Bank for International Settlements Web site at

http://www.bis.org

The proposals also included changes consistent with the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act);

would apply the risk-based and leverage capital rules to top-tier savings and loan holding companies (SLHCs) domiciled in the United States; and would apply the market risk capital rule (the market risk rule)

to Federal and state savings associations (as appropriate based on trading activity).

Public Law 111-203, 124 Stat. 1376, 1435-38 (2010).

The FDIC's market risk rule is at 12 CFR part 325, appendix C.

The NPR titled “Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Minimum Regulatory Capital Ratios, Capital Adequacy, Transition Provisions, and Prompt Corrective Action”

(the Basel III NPR), provided for the implementation of the Basel III revisions to international capital standards related to minimum capital requirements, regulatory capital, and additional capital “buffer” standards to enhance the resilience of FDIC-supervised institutions to withstand periods of financial stress. FDIC-supervised institutions include state nonmember banks and state savings associations. The term banking organizations includes national banks, state member banks, state nonmember banks, state and Federal savings associations, and top-tier bank holding companies domiciled in the United States not subject to the Federal Reserve's Small Bank Holding Company Policy Statement (12 CFR part 225, appendix C), as well as top-tier savings and loan holding companies domiciled in the United States, except certain savings and loan holding companies that are substantially engaged in insurance underwriting or commercial activities. The proposal included transition periods for many of the requirements, consistent with Basel III and the Dodd-Frank Act. The NPR titled “Regulatory Capital Rules: Standardized Approach for Risk-weighted Assets; Market Discipline and Disclosure Requirements”

(the Standardized Approach NPR), would revise the methodologies for calculating risk-weighted assets in the agencies' general risk-based capital rules

(the general risk-based capital rules), incorporating aspects of the Basel II standardized approach,

and establish alternative standards of creditworthiness in place of credit ratings, consistent with section 939A of the Dodd-Frank Act.

The proposed minimum capital requirements in section 10(a) of the Basel III NPR, as determined using the standardized capital ratio calculations in section 10(b), would establish minimum capital requirements that would be the “generally applicable” capital requirements for purpose of section 171 of the Dodd-Frank Act (Pub. L. 111-203, 124 Stat. 1376, 1435-38 (2010).

77 FR 52792 (August 30, 2012).

77 FR 52888 (August 30, 2012).

The FDIC's general risk-based capital rules is at 12 CFR part 325, appendix A, and 12 CFR part 390, subpart Z . The general risk-based capital rule is supplemented by the FDIC's market risk rule in 12 CFR part 325, appendix C.

See

BCBS, “International Convergence of Capital Measurement and Capital Standards: A Revised Framework,” (June 2006), available at

http://www.bis.org/publ/bcbs128.htm

(Basel II).

See

section 939A of the Dodd-Frank Act (15 U.S.C. 78o-7 note).

See 77 FR 52856 (August 30, 2012).

The NPR titled “Regulatory Capital Rules: Advanced Approaches Risk-Based Capital Rule; Market Risk Capital

Rule”

(the Advanced Approaches NPR) included proposed changes to the agencies' current advanced approaches risk-based capital rules (the advanced approaches rule)

to incorporate applicable provisions of Basel III and the “Enhancements to the Basel II framework” (2009 Enhancements) published in July 2009

and subsequent consultative papers, to remove references to credit ratings, to apply the market risk rule to savings associations and SLHCs, and to apply the advanced approaches rule to SLHCs meeting the scope of application of those rules. Taken together, the three proposals also would have restructured the agencies' regulatory capital rules (the general risk-based capital rules, leverage rules,

market risk rule, and advanced approaches rule) into a harmonized, codified regulatory capital framework.

77 FR 52978 (August 30, 2012).

The FDIC's advanced approaches rules is at 12 CFR part 325, appendix D, and 12 CFR part 390, subpart Z, appendix A. The advanced approaches rule is supplemented by the market risk rule.

See

“Enhancements to the Basel II framework” (July 2009), available at

http://www.bis.org/publ/bcbs157.htm.

The FDIC's tier 1 leverage rules are at 12 CFR 325.3 (state nonmember banks) and 390.467 (state savings associations).

The FDIC is finalizing the Basel III NPR, Standardized Approach NPR, and Advanced Approaches NPR in this interim final rule, with certain changes to the proposals, as described further below. The OCC and Federal Reserve are jointly finalizing the Basel III NPR, Standardized Approach NPR, and Advanced Approaches NPR as a final rule, with identical changes to the proposals as the FDIC. This interim final rule applies to FDIC-supervised institutions.

Certain aspects of this interim final rule apply only to FDIC-supervised institutions subject to the advanced approaches rule (advanced approaches FDIC-supervised institutions) or to FDIC-supervised institutions with significant trading activities, as further described below.

Likewise, the enhanced disclosure requirements in the interim final rule apply only to FDIC-supervised institutions with $50 billion or more in total consolidated assets.

As under the proposal, the minimum capital requirements in section 10(a) of the interim final rule, as determined using the standardized capital ratio calculations in section 10(b), which apply to all FDIC-supervised institutions, establish the “generally applicable” capital requirements under section 171 of the Dodd-Frank Act.

See

note 14,

supra.

Risk-weighted assets calculated under the market risk framework in subpart F of the interim final rule are included in calculations of risk-weighted assets both under the standardized approach and the advanced approaches.

Under the interim final rule, as under the proposal, in order to determine its minimum risk-based capital requirements, an advanced approaches FDIC-supervised institution that has completed the parallel run process and that has received notification from its primary Federal supervisor pursuant to section 324.121(d) of subpart E must determine its minimum risk-based capital requirements by calculating the three risk-based capital ratios using total risk-weighted assets under the standardized approach and, separately, total risk-weighted assets under the advanced approaches.

The lower ratio for each risk-based capital requirement is the ratio the FDIC-supervised institution must use to determine its compliance with the minimum capital requirement.

These enhanced prudential standards help ensure that advanced approaches FDIC-supervised institutions, which are among the largest and most complex FDIC-supervised institutions, have capital adequate to address their more complex operations and risks.

An advanced approaches FDIC-supervised institution must also use its advanced-approaches-adjusted total to determine its total risk-based capital ratio.

See

section 10(c) of the interim final rule.

II. Summary of the Three Notices of Proposed Rulemaking

A. The Basel III Notice of Proposed Rulemaking

As discussed in the proposals, the recent financial crisis demonstrated that the amount of high-quality capital held by banking organizations was insufficient to absorb the losses generated over that period. In addition, some non-common stock capital instruments included in tier 1 capital did not absorb losses to the extent previously expected. A lack of clear and easily understood disclosures regarding the characteristics of regulatory capital instruments, as well as inconsistencies in the definition of capital across jurisdictions, contributed to difficulties in evaluating a banking organization's capital strength. Accordingly, the BCBS assessed the international capital framework and, in 2010, published Basel III, a comprehensive reform package designed to improve the quality and quantity of regulatory capital and build additional capacity into the banking system to absorb losses in times of market and economic stress. On August 30, 2012, the agencies published the NPRs in the

Federal Register

to revise regulatory capital requirements, as discussed above. As proposed, the Basel III NPR generally would have applied to all U.S. banking organizations.

Consistent with Basel III, the Basel III NPR would have required banking organizations to comply with the following minimum capital ratios: (i) A new requirement for a ratio of common equity tier 1 capital to risk-weighted assets (common equity tier 1 capital ratio) of 4.5 percent; (ii) a ratio of tier 1 capital to risk-weighted assets (tier 1 capital ratio) of 6 percent, increased from 4 percent; (iii) a ratio of total capital to risk-weighted assets (total capital ratio) of 8 percent; (iv) a ratio of tier 1 capital to average total consolidated assets (leverage ratio) of 4 percent; and (v) for advanced approaches banking organizations only, an additional requirement that the ratio of tier 1 capital to total leverage exposure (supplementary leverage ratio) be at least 3 percent.

The Basel III NPR also proposed implementation of a capital conservation buffer equal to 2.5 percent of risk-weighted assets above the minimum risk-based capital ratio requirements, which could be expanded by a countercyclical capital buffer for advanced approaches banking organizations under certain circumstances. If a banking organization failed to hold capital above the minimum capital ratios and proposed capital conservation buffer (as potentially expanded by the countercyclical capital buffer), it would be subject to certain restrictions on capital distributions and discretionary bonus payments. The proposed countercyclical capital buffer was designed to take into account the macro-financial environment in which large, internationally active banking organizations function. The countercyclical capital buffer could be implemented if the agencies determined that credit growth in the economy became excessive. As proposed, the countercyclical capital buffer would initially be set at zero, and could expand to as much as 2.5 percent of risk-weighted assets.

The Basel III NPR proposed to apply a 4 percent minimum leverage ratio requirement to all banking organizations (computed using the new definition of capital), and to eliminate the exceptions for banking organizations with strong supervisory ratings or subject to the market risk rule. The Basel III NPR also

proposed to require advanced approaches banking organizations to satisfy a minimum supplementary leverage ratio requirement of 3 percent, measured in a manner consistent with the international leverage ratio set forth in Basel III. Unlike the FDIC's current leverage ratio requirement, the proposed supplementary leverage ratio incorporates certain off-balance sheet exposures in the denominator.

To strengthen the quality of capital, the Basel III NPR proposed more conservative eligibility criteria for regulatory capital instruments. For example, the Basel III NPR proposed that trust preferred securities (TruPS) and cumulative perpetual preferred securities, which were tier-1-eligible instruments (subject to limits) at the BHC level, would no longer be includable in tier 1 capital under the proposal and would be gradually phased out from tier 1 capital. The proposal also eliminated the existing limitations on the amount of tier 2 capital that could be recognized in total capital, as well as the limitations on the amount of certain capital instruments (for example, term subordinated debt) that could be included in tier 2 capital.

In addition, the proposal would have required banking organizations to include in common equity tier 1 capital accumulated other comprehensive income (AOCI) (with the exception of gains and losses on cash-flow hedges related to items that are not fair-valued on the balance sheet), and also would have established new limits on the amount of minority interest a banking organization could include in regulatory capital. The proposal also would have established more stringent requirements for several deductions from and adjustments to regulatory capital, including with respect to deferred tax assets (DTAs), investments in a banking organization's own capital instruments and the capital instruments of other financial institutions, and mortgage servicing assets (MSAs). The proposed revisions would have been incorporated into the regulatory capital ratios in the prompt corrective action (PCA) framework for depository institutions.

B. The Standardized Approach Notice of Proposed Rulemaking

The Standardized Approach NPR proposed changes to the agencies' general risk-based capital rules for determining risk-weighted assets (that is, the calculation of the denominator of a banking organization's risk-based capital ratios). The proposed changes were intended to revise and harmonize the agencies' rules for calculating risk-weighted assets, enhance risk sensitivity, and address weaknesses in the regulatory capital framework identified over recent years, including by strengthening the risk sensitivity of the regulatory capital treatment for, among other items, credit derivatives, central counterparties (CCPs), high-volatility commercial real estate, and collateral and guarantees.

In the Standardized Approach NPR, the agencies also proposed alternatives to credit ratings for calculating risk-weighted assets for certain assets, consistent with section 939A of the Dodd-Frank Act. These alternatives included methodologies for determining risk-weighted assets for exposures to sovereigns, foreign banks, and public sector entities, securitization exposures, and counterparty credit risk. The Standardized Approach NPR also proposed to include a framework for risk weighting residential mortgages based on underwriting and product features, as well as loan-to-value (LTV) ratios, and disclosure requirements for top-tier banking organizations domiciled in the United States with $50 billion or more in total assets, including disclosures related to regulatory capital instruments.

C. The Advanced Approaches Notice of Proposed Rulemaking

The Advanced Approaches NPR proposed revisions to the advanced approaches rule to incorporate certain aspects of Basel III, the 2009 Enhancements, and subsequent consultative papers. The proposal also would have implemented relevant provisions of the Dodd-Frank Act, including section 939A (regarding the use of credit ratings in agency regulations),

and incorporated certain technical amendments to the existing requirements. In addition, the Advanced Approaches NPR proposed to codify the market risk rule in a manner similar to the codification of the other regulatory capital rules under the proposals.

See

section 939A of Dodd-Frank Act (15 U.S.C. 78o-7 note).

Consistent with Basel III and the 2009 Enhancements, under the Advanced Approaches NPR, the agencies proposed further steps to strengthen capital requirements for internationally active banking organizations. This NPR would have required advanced approaches banking organizations to hold more appropriate levels of capital for counterparty credit risk, credit valuation adjustments (CVA), and wrong-way risk; would have strengthened the risk-based capital requirements for certain securitization exposures by requiring advanced approaches banking organizations to conduct more rigorous credit analysis of securitization exposures; and would have enhanced the disclosure requirements related to those exposures.

The agencies proposed to apply the market risk rule to SLHCs and to state and Federal savings associations.

III. Summary of General Comments on the Basel III Notice of Proposed Rulemaking and on the Standardized Approach Notice of Proposed Rulemaking; Overview of the Interim Final Rule

A. General Comments on the Basel III Notice of Proposed Rulemaking and on the Standardized Approach Notice of Proposed Rulemaking

Each agency received over 2,500 public comments on the proposals from banking organizations, trade associations, supervisory authorities, consumer advocacy groups, public officials (including members of the U.S. Congress), private individuals, and other interested parties. Overall, while most commenters supported more robust capital standards and the agencies' efforts to improve the resilience of the banking system, many commenters expressed concerns about the potential costs and burdens of various aspects of the proposals, particularly for smaller banking organizations. A substantial number of commenters also requested withdrawal of, or significant revisions to, the proposals. A few commenters argued that new capital rules were not necessary at this time. Some commenters requested that the agencies perform additional studies of the economic impact of part or all of the proposed rules. Many commenters asked for additional time to transition to the new requirements. A more detailed discussion of the comments provided on particular aspects of the proposals is provided in the remainder of this preamble.

1. Applicability and Scope

The agencies received a significant number of comments regarding the proposed scope and applicability of the Basel III NPR and the Standardized Approach NPR. The majority of comments submitted by or on behalf of community banking organizations requested an exemption from the proposals. These commenters suggested basing such an exemption on a banking organization's asset size—for example, total assets of less than $500 million, $1 billion, $10 billion, $15 billion, or $50 billion—or on its risk profile or business model. Under the latter approach, the

commenters suggested providing an exemption for banking organizations with balance sheets that rely less on leverage, short-term funding, or complex derivative transactions.

In support of an exemption from the proposed rule for community banking organizations, a number of commenters argued that the proposed revisions to the definition of capital would be overly conservative and would prohibit some of the instruments relied on by community banking organizations from satisfying regulatory capital requirements. Many of these commenters stated that, in general, community banking organizations have less access to the capital markets relative to larger banking organizations and could increase capital only by accumulating retained earnings. Owing to slow economic growth and relatively low earnings among community banking organizations, the commenters asserted that implementation of the proposal would be detrimental to their ability to serve local communities while providing reasonable returns to shareholders. Other commenters requested exemptions from particular sections of the proposed rules, such as maintaining capital against transactions with particular counterparties, or based on transaction types that they considered lower-risk, such as derivative transactions hedging interest rate risk.

The commenters also argued that application of the Basel III NPR and Standardized Approach NPR to community banking organizations would be unnecessary and inappropriate for the business model and risk profile of such organizations. These commenters asserted that Basel III was designed for large, internationally-active banking organizations in response to a financial crisis attributable primarily to those institutions. Accordingly, the commenters were of the view that community banking organizations require a different capital framework with less stringent capital requirements, or should be allowed to continue to use the general risk-based capital rules. In addition, many commenters, in particular minority depository institutions (MDIs), mutual banking organizations, and community development financial institutions (CDFIs), expressed concern regarding their ability to raise capital to meet the increased minimum requirements in the current environment and upon implementation of the proposed definition of capital. One commenter asked for an exemption from all or part of the proposed rules for CDFIs, indicating that the proposal would significantly reduce the availability of capital for low- and moderate-income communities. Another commenter stated that the U.S. Congress has a policy of encouraging the creation of MDIs and expressed concern that the proposed rules contradicted this purpose.

In contrast, however, a few commenters supported the proposed application of the Basel III NPR to all banking organizations. For example, one commenter stated that increasing the quality and quantity of capital at all banking organizations would create a more resilient financial system and discourage inappropriate risk-taking by forcing banking organizations to put more of their own “skin in the game.” This commenter also asserted that the proposed scope of the Basel III NPR would reduce the probability and impact of future financial crises and support the objectives of sustained growth and high employment. Another commenter favored application of the Basel III NPR to all banking organizations to ensure a level playing field among banking organizations within the same competitive market.

2. Aggregate Impact

A majority of the commenters expressed concern regarding the potential aggregate impact of the proposals, together with other provisions of the Dodd-Frank Act. Some of these commenters urged the agencies to withdraw the proposals and to conduct a quantitative impact study (QIS) to assess the potential aggregate impact of the proposals on banking organizations and the overall U.S. economy. Many commenters argued that the proposals would have significant negative consequences for the financial services industry. According to the commenters, by requiring banking organizations to hold more capital and increase risk weighting on some of their assets, as well as to meet higher risk-based and leverage capital measures for certain PCA categories, the proposals would negatively affect the banking sector. Commenters cited, among other potential consequences of the proposals: restricted job growth; reduced lending or higher-cost lending, including to small businesses and low-income or minority communities; limited availability of certain types of financial products; reduced investor demand for banking organizations' equity; higher compliance costs; increased mergers and consolidation activity, specifically in rural markets, because banking organizations would need to spread compliance costs among a larger customer base; and diminished access to the capital markets resulting from reduced profit and from dividend restrictions associated with the capital buffers. The commenters also asserted that the recovery of the U.S. economy would be impaired by the proposals as a result of reduced lending by banking organizations that the commenters believed would be attributable to the higher costs of regulatory compliance. In particular, the commenters expressed concern that a contraction in small-business lending would adversely affect job growth and employment.

3. Competitive Concerns

Many commenters raised concerns that implementation of the proposals would create an unlevel playing field between banking organizations and other financial services providers. For example, a number of commenters expressed concern that credit unions would be able to gain market share from banking organizations by offering similar products at substantially lower costs because of differences in taxation combined with potential costs from the proposals. The commenters also argued that other financial service providers, such as foreign banks with significant U.S. operations, members of the Federal Farm Credit System, and entities in the shadow banking industry, would not be subject to the proposed rule and, therefore, would have a competitive advantage over banking organizations. These commenters also asserted that the proposals could cause more consumers to choose lower-cost financial products from the unregulated, nonbank financial sector.

4. Costs

Commenters representing all types of banking organizations expressed concern that the complexity and implementation cost of the proposals would exceed their expected benefits. According to these commenters, implementation of the proposals would require software upgrades for new internal reporting systems, increased employee training, and the hiring of additional employees for compliance purposes. Some commenters urged the agencies to recognize that compliance costs have increased significantly over recent years due to other regulatory changes and to take these costs into consideration. As an alternative, some commenters encouraged the agencies to consider a simple increase in the minimum regulatory capital requirements, suggesting that such an approach would provide increased protection to the Deposit Insurance Fund and increase safety and soundness

without adding complexity to the regulatory capital framework.

B. Comments on Particular Aspects of the Basel III Notice of Proposed Rulemaking and on the Standardized Approach Notice of Proposed Rulemaking

In addition to the general comments described above, the agencies received a significant number of comments on four particular elements of the proposals: the requirement to include most elements of AOCI in regulatory capital; the new framework for risk weighting residential mortgages; and the requirement to phase out TruPS from tier 1 capital for all banking organizations.

1. Accumulated Other Comprehensive Income

AOCI generally includes accumulated unrealized gains and losses on certain assets and liabilities that have not been included in net income, yet are included in equity under U.S. generally accepted accounting principles (GAAP) (for example, unrealized gains and losses on securities designated as available-for-sale (AFS)). Under the agencies' general risk-based capital rules, most components of AOCI are not reflected in a banking organization's regulatory capital. In the proposed rule, consistent with Basel III, the agencies proposed to require banking organizations to include the majority of AOCI components in common equity tier 1 capital.

The agencies received a significant number of comments on the proposal to require banking organizations to recognize AOCI in common equity tier 1 capital. Generally, the commenters asserted that the proposal would introduce significant volatility in banking organizations' capital ratios due in large part to fluctuations in benchmark interest rates, and would result in many banking organizations moving AFS securities into a held-to-maturity (HTM) portfolio or holding additional regulatory capital solely to mitigate the volatility resulting from temporary unrealized gains and losses in the AFS securities portfolio. The commenters also asserted that the proposed rules would likely impair lending and negatively affect banking organizations' ability to manage liquidity and interest rate risk and to maintain compliance with legal lending limits. Commenters representing community banking organizations in particular asserted that they lack the sophistication of larger banking organizations to use certain risk-management techniques for hedging interest rate risk, such as the use of derivative instruments.

2. Residential Mortgages

The Standardized Approach NPR would have required banking organizations to place residential mortgage exposures into one of two categories to determine the applicable risk weight. Category 1 residential mortgage exposures were defined to include mortgage products with underwriting and product features that have demonstrated a lower risk of default, such as consideration and documentation of a borrower's ability to repay, and generally excluded mortgage products that included terms or other characteristics that the agencies have found to be indicative of higher credit risk, such as deferral of repayment of principal. Residential mortgage exposures with higher risk characteristics were defined as category 2 residential mortgage exposures. The agencies proposed to apply relatively lower risk weights to category 1 residential mortgage exposures, and higher risk weights to category 2 residential mortgage exposures. The proposal provided that the risk weight assigned to a residential mortgage exposure also depended on its LTV ratio.

The agencies received a significant number of comments objecting to the proposed treatment for one-to-four family residential mortgages and requesting retention of the mortgage treatment in the agencies' general risk-based capital rules. Commenters generally expressed concern that the proposed treatment would inhibit lending to creditworthy borrowers and could jeopardize the recovery of a still-fragile housing market. Commenters also criticized the distinction between category 1 and category 2 mortgages, asserting that the characteristics proposed for each category did not appropriately distinguish between lower- and higher-risk products and would adversely impact certain loan products that performed relatively well even during the recent crisis. Commenters also highlighted concerns regarding regulatory burden and the uncertainty of other regulatory initiatives involving residential mortgages. In particular, these commenters expressed considerable concern regarding the potential cumulative impact of the proposed new mortgage requirements combined with the Dodd-Frank Act's requirements relating to the definitions of qualified mortgage and qualified residential mortgage

and asserted that when considered together with the proposed mortgage treatment, the combined effect could have an adverse impact on the mortgage industry.

See, e.g.,

the definition of “qualified mortgage” in section 1412 of the Dodd-Frank Act (15 U.S.C. 129C) and “qualified residential mortgage” in section 941(e)(4) of the Dodd-Frank Act (15 U.S.C. 78o-11(e)(4)).

3. Trust Preferred Securities for Smaller FDIC-Supervised Institutions

The proposed rules would have required all banking organizations to phase-out TruPS from tier 1 capital under either a 3- or 10-year transition period based on the organization's total consolidated assets. The proposal would have required banking organizations with more than $15 billion in total consolidated assets (as of December 31, 2009) to phase-out of tier 1 capital any non-qualifying capital instruments (such as TruPS and cumulative preferred shares) issued before May 19, 2010. The exclusion of non-qualifying capital instruments would have taken place incrementally over a three-year period beginning on January 1, 2013. Section 171 provides an exception that permits banking organizations with total consolidated assets of less than $15 billion as of December 31, 2009, and banking organizations that were mutual holding companies as of May 19, 2010 (2010 MHCs), to include in tier 1 capital all TruPS (and other instruments that could no longer be included in tier 1 capital pursuant to the requirements of section 171) that were issued prior to May 19, 2010.

However, consistent with Basel III and the general policy purpose of the proposed revisions to regulatory capital, the agencies proposed to require banking organizations with total consolidated assets less than $15 billion as of December 31, 2009 and 2010 MHCs to phase out their non-qualifying capital instruments from regulatory capital over ten years.

Specifically, section 171 provides that deductions of instruments “that would be required” under the section are not required for depository institution holding companies with total consolidated assets of less than $15 billion as of December 31, 2009 and 2010 MHCs.

See

12 U.S.C. 5371(b)(4)(C).

See

12 U.S.C. 5371(b)(5)(A). While section 171 of the Dodd-Frank Act requires the agencies to establish minimum risk-based and leverage capital requirements subject to certain limitations, the agencies retain their general authority to establish capital requirements under other laws and regulations, including under the National Bank Act, 12 U.S.C. 1,

et seq.,

Federal Reserve Act, Federal Deposit Insurance Act, Bank Holding Company Act, International Lending Supervision Act, 12 U.S.C. 3901,

et seq.,

and Home Owners Loan Act, 12 U.S.C. 1461,

et seq.

Many commenters representing community banking organizations criticized the proposal's phase-out schedule for TruPS and encouraged the agencies to grandfather TruPS in tier 1 capital to the extent permitted by section 171 of the Dodd-Frank Act. Commenters asserted that this was the intent of the U.S. Congress, including this provision in the statute. These commenters also asserted that this aspect of the proposal would unduly burden community banking organizations that have limited ability to raise capital, potentially impairing the lending capacity of these banking organizations.

C. Overview of the Interim Final Rule

The interim final rule will replace the FDIC's general risk-based capital rules, advanced approaches rule, market risk rule, and leverage rules in accordance with the transition provisions described below. After considering the comments received, the FDIC has made substantial modifications in the interim final rule to address specific concerns raised by commenters regarding the cost, complexity, and burden of the proposals.

During the recent financial crisis, lack of confidence in the banking sector increased banking organizations' cost of funding, impaired banking organizations' access to short-term funding, depressed values of banking organizations' equities, and required many banking organizations to seek government assistance. Concerns about banking organizations arose not only because market participants expected steep losses on banking organizations' assets, but also because of substantial uncertainty surrounding estimated loss rates, and thus future earnings. Further, heightened systemic risks, falling asset values, and reduced credit availability had an adverse impact on business and consumer confidence, significantly affecting the overall economy. The interim final rule addresses these weaknesses by helping to ensure a banking and financial system that will be better able to absorb losses and continue to lend in future periods of economic stress. This important benefit in the form of a safer, more resilient, and more stable banking system is expected to substantially outweigh any short-term costs that might result from the interim final rule.

In this context, the FDIC is adopting most aspects of the proposals, including the minimum risk-based capital requirements, the capital conservation and countercyclical capital buffers, and many of the proposed risk weights. The FDIC has also decided to apply most aspects of the Basel III NPR and Standardized Approach NPR to all banking organizations, with some significant changes. Implementing the interim final rule in a consistent fashion across the banking system will improve the quality and increase the level of regulatory capital, leading to a more stable and resilient system for banking organizations of all sizes and risk profiles. The improved resilience will enhance their ability to continue functioning as financial intermediaries, including during periods of financial stress and reduce risk to the deposit insurance fund and to the financial system. The FDIC believes that, together, the revisions to the proposals meaningfully address the commenters' concerns regarding the potential implementation burden of the proposals.

The FDIC has considered the concerns raised by commenters and believe that it is important to take into account and address regulatory costs (and their potential effect on FDIC-supervised institutions' role as financial intermediaries in the economy) when the FDIC establishes or revises regulatory requirements. In developing regulatory capital requirements, these concerns are considered in the context of the FDIC's broad goals—to enhance the safety and soundness of FDIC-supervised institutions and promote financial stability through robust capital standards for the entire banking system.

The agencies participated in the development of a number of studies to assess the potential impact of the revised capital requirements, including participating in the BCBS's Macroeconomic Assessment Group as well as its QIS, the results of which were made publicly available by the BCBS upon their completion.

The BCBS analysis suggested that stronger capital requirements help reduce the likelihood of banking crises while yielding positive net economic benefits.

To evaluate the potential reduction in economic output resulting from the new framework, the analysis assumed that banking organizations replaced debt with higher-cost equity to the extent needed to comply with the new requirements, that there was no reduction in the cost of equity despite the reduction in the riskiness of banking organizations' funding mix, and that the increase in funding cost was entirely passed on to borrowers. Given these assumptions, the analysis concluded there would be a slight increase in the cost of borrowing and a slight decrease in the growth of gross domestic product. The analysis concluded that this cost would be more than offset by the benefit to gross domestic product resulting from a reduced likelihood of prolonged economic downturns associated with a banking system whose lending capacity is highly vulnerable to economic shocks.

See

“Assessing the macroeconomic impact of the transition to stronger capital and liquidity requirements” (MAG Analysis), Attachment E, also available at:

http://www.bis.orpublIothp12.pdf

See also

“Results of the comprehensive quantitative impact study,” Attachment F, also available at:

http://www.bis.org/publ/bcbs186.pdf

See

“An assessment of the long-term economic impact of stronger capital and liquidity requirements,” Executive Summary, pg. 1, Attachment G.

The agencies' analysis also indicates that the overwhelming majority of banking organizations already have sufficient capital to comply with the new capital rules. In particular, the agencies estimate that over 95 percent of all insured depository institutions would be in compliance with the minimums and buffers established under the interim final rule if it were fully effective immediately. The interim final rule will help to ensure that these FDIC-supervised institutions maintain their capacity to absorb losses in the future. Some FDIC-supervised institutions may need to take advantage of the transition period in the interim final rule to accumulate retained earnings, raise additional external regulatory capital, or both. As noted above, however, the overwhelming majority of banking organizations have sufficient capital to comply with the revised capital rules, and the FDIC believes that the resulting improvements to the stability and resilience of the banking system outweigh any costs associated with its implementation.

The interim final rule includes some significant revisions from the proposals in response to commenters' concerns, particularly with respect to the treatment of AOCI; residential mortgages; tier 1 non-qualifying capital instruments; and the implementation timeframes. The timeframes for compliance are described in the next section and more detailed discussions of modifications to the proposals are provided in the remainder of the preamble.

Consistent with the proposed rules, the interim final rule requires all FDIC-supervised institutions to recognize in regulatory capital all components of AOCI, excluding accumulated net gains and losses on cash-flow hedges that relate to the hedging of items that are not recognized at fair value on the balance sheet. However, while the FDIC believes that the proposed AOCI treatment results in a regulatory capital

measure that better reflects FDIC-supervised institutions' actual loss absorption capacity at a specific point in time, the FDIC recognizes that for many FDIC-supervised institutions, the volatility in regulatory capital that could result from the proposals could lead to significant difficulties in capital planning and asset-liability management. The FDIC also recognizes that the tools used by larger, more complex FDIC-supervised institutions for managing interest rate risk are not necessarily readily available for all FDIC-supervised institutions.

Accordingly, under the interim final rule, and as discussed in more detail in section V.B of this preamble, an FDIC-supervised institution that is not subject to the advanced approaches rule may make a one-time election not to include most elements of AOCI in regulatory capital under the interim final rule and instead effectively use the existing treatment under the general risk-based capital rules that excludes most AOCI elements from regulatory capital (AOCI opt-out election). Such an FDIC-supervised institution must make its AOCI opt-out election in its Consolidated Reports of Condition and Income (Call Report) filed for the first reporting period after it becomes subject to the interim final rule. Consistent with regulatory capital calculations under the FDIC's general risk-based capital rules, an FDIC-supervised institution that makes an AOCI opt-out election under the interim final rule must adjust common equity tier 1 capital by: (1) Subtracting any net unrealized gains and adding any net unrealized losses on AFS securities; (2) subtracting any unrealized losses on AFS preferred stock classified as an equity security under GAAP and AFS equity exposures; (3) subtracting any accumulated net gains and adding any accumulated net losses on cash-flow hedges; (4) subtracting 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 FDIC-supervised institution's option, the portion relating to pension assets deducted under section 22(a)(5) of the interim final rule); and (5) subtracting any net unrealized gains and adding any net unrealized losses on held-to-maturity securities that are included in AOCI. Consistent with the general risk-based capital rules, common equity tier 1 capital includes any net unrealized losses on AFS equity securities and any foreign currency translation adjustment. An FDIC-supervised institution that makes an AOCI opt-out election may incorporate up to 45 percent of any net unrealized gains on AFS preferred stock classified as an equity security under GAAP and AFS equity exposures into its tier 2 capital.

An FDIC-supervised institution that does not make an AOCI opt-out election on the Call Report filed for the first reporting period after the FDIC-supervised institution becomes subject to the interim final rule will be required to recognize AOCI (excluding accumulated net gains and losses on cash-flow hedges that relate to the hedging of items that are not recognized at fair value on the balance sheet) in regulatory capital as of the first quarter in which it calculates its regulatory capital requirements under the interim final rule and continuing thereafter.

The FDIC has decided not to adopt the proposed treatment of residential mortgages. The FDIC has considered the commenters' observations about the burden of calculating the risk weights for FDIC-supervised institutions' existing mortgage portfolios, and has taken into account the commenters' concerns that the proposal did not properly assess the use of different mortgage products across different types of markets in establishing the proposed risk weights. The FDIC is also particularly mindful of comments regarding the potential effect of the proposal and other mortgage-related rulemakings on credit availability. In light of these considerations, as well as others raised by commenters, the FDIC has decided to retain in the interim final rule the current treatment for residential mortgage exposures under the general risk-based capital rules.

Consistent with the general risk-based capital rules, the interim final rule assigns a 50 or 100 percent risk weight to exposures secured by one-to-four family residential properties. Generally, residential mortgage exposures secured by a first lien on a one-to-four family residential property that are prudently underwritten and that are performing according to their original terms receive a 50 percent risk weight. All other one- to four-family residential mortgage loans, including exposures secured by a junior lien on residential property, are assigned a 100 percent risk weight. If an FDIC-supervised institution holds the first and junior lien(s) on a residential property and no other party holds an intervening lien, the FDIC-supervised institution must treat the combined exposure as a single loan secured by a first lien for purposes of assigning a risk weight.

The agencies also considered comments on the proposal to require certain depository institution holding companies to phase out their non-qualifying tier 1 capital instruments from regulatory capital over ten years. Although the agencies continue to believe that non-qualifying instruments do not absorb losses sufficiently to be included in tier 1 capital as a general matter, the agencies are also sensitive to the difficulties community banking organizations often face when issuing new capital instruments and are aware of the importance their capacity to lend can play in local economies. Therefore, the final rule adopted by the Federal Reserve allows certain depository institution holding companies to include in regulatory capital debt or equity instruments issued prior to September 12, 2010 that do not meet the criteria for additional tier 1 or tier 2 capital instruments but that were included in tier 1 or tier 2 capital respectively as of September 12, 2010 up to the percentage of the outstanding principal amount of such non-qualifying capital instruments.

D. Timeframe for Implementation and Compliance

In order to give non-internationally active FDIC-supervised institutions more time to comply with the interim final rule and simplify their transition to the new regime, the interim final rule will require compliance from different types of organizations at different times. Generally, and as described in further detail below, FDIC-supervised institutions that are not subject to the advanced approaches rule must begin complying with the interim final rule on January 1, 2015, whereas advanced approaches FDIC-supervised institutions must begin complying with the interim final rule on January 1, 2014. The FDIC believes that advanced approaches FDIC-supervised institutions have the sophistication, infrastructure, and capital markets access to implement the interim final rule earlier than either FDIC-supervised institutions that do not meet the asset size or foreign exposure threshold for application of those rules.

A number of commenters requested that the agencies clarify the point at which a banking organization that meets the asset size or foreign exposure threshold for application of the advanced approaches rule becomes subject to subpart E of the proposed rule, and thus all of the provisions that apply to an advanced approaches banking organization. In particular, commenters requested that the agencies clarify whether subpart E of the proposed rule only applies to those banking organizations that have

completed the parallel run process and that have received notification from their primary Federal supervisor pursuant to section 324.121(d) of subpart E, or whether subpart E would apply to all banking organizations that meet the relevant thresholds without reference to completion of the parallel run process.

The interim final rule provides that an advanced approaches FDIC-supervised institution is one that meets the asset size or foreign exposure thresholds for or has opted to apply the advanced approaches rule, without reference to whether that FDIC-supervised institution has completed the parallel run process and has received notification from its primary Federal supervisor pursuant to section 324.121(d) of subpart E of the interim final rule. The FDIC has also clarified in the interim final rule when completion of the parallel run process and receipt of notification from the primary Federal supervisor pursuant to section 324.121(d) of subpart E is necessary for an advanced approaches FDIC-supervised institution to comply with a particular aspect of the rules. For example, only an advanced approaches FDIC-supervised institution that has completed parallel run and received notification from its primary Federal supervisor under Section 324.121(d) of subpart E must make the disclosures set forth under subpart E of the interim final rule. However, an advanced approaches FDIC-supervised institution must recognize most components of AOCI in common equity tier 1 capital and must meet the supplementary leverage ratio when applicable without reference to whether the FDIC-supervised institution has completed its parallel run process.

Beginning on January 1, 2015, FDIC-supervised institutions that are not subject to the advanced approaches rule become subject to the revised definitions of regulatory capital, the new minimum regulatory capital ratios, and the regulatory capital adjustments and deductions according to the transition provisions.

All FDIC-supervised institutions must begin calculating standardized total risk-weighted assets in accordance with subpart D of the interim final rule, and if applicable, the revised market risk rule under subpart F, on January 1, 2015.

Prior to January 1, 2015, such FDIC-supervised institutions must continue to use the FDIC's general risk-based capital rules and tier 1 leverage rules.

The revised PCA thresholds, discussed further in section IV.E. of this preamble, become effective for all insured depository institutions on January 1, 2015.

Beginning on January 1, 2014, advanced approaches FDIC-supervised institutions must begin the transition period for the revised minimum regulatory capital ratios, definitions of regulatory capital, and regulatory capital adjustments and deductions established under the interim final rule. The revisions to the advanced approaches risk-weighted asset calculations will become effective on January 1, 2014.

From January 1, 2014 to December 31, 2014, an advanced approaches FDIC-supervised institution that is on parallel run must calculate risk-weighted assets using the general risk-based capital rules and substitute such risk-weighted assets for its standardized total risk-weighted assets for purposes of determining its risk-based capital ratios. An advanced approaches FDIC-supervised institution on parallel run must also calculate advanced approaches total risk-weighted assets using the advanced approaches rule in subpart E of the interim final rule for purposes of confidential reporting to its primary Federal supervisor on the Federal Financial Institutions Examination Council's (FFIEC) 101 report. An advanced approaches FDIC-supervised institution that has completed the parallel run process and that has received notification from its primary Federal supervisor pursuant to section 121(d) of subpart E will calculate its risk-weighted assets using the general risk-based capital rules and substitute such risk-weighted assets for its standardized total risk-weighted assets and also calculate advanced approaches total risk-weighted assets using the advanced approaches rule in subpart E of the interim final rule for purposes of determining its risk-based capital ratios from January 1, 2014 to December 31, 2014. Regardless of an advanced approaches FDIC-supervised institution's parallel run status, on January 1, 2015, the FDIC-supervised institution must begin to apply subpart D, and if applicable, subpart F, of the interim final rule to determine its standardized total risk-weighted assets.

The transition period for the capital conservation and countercyclical capital buffers for all FDIC-supervised institutions will begin on January 1, 2016.

An FDIC-supervised institution that is required to comply with the market risk rule must comply with the revised market risk rule (subpart F) as of the same date that it must comply with other aspects of the rule for determining its total risk-weighted assets.

Date

FDIC-Supervised institutions not subject to the advanced approaches rule*

January 1, 2015

Begin compliance with the revised minimum regulatory capital ratios and begin the transition period for the revised definitions of regulatory capital and the revised regulatory capital adjustments and deductions.

Begin compliance with the standardized approach for determining risk-weighted assets.

January 1, 2016

Begin the transition period for the capital conservation and countercyclical capital buffers.

Date

Advanced approaches FDIC-supervised institutions*

January 1, 2014

Begin the transition period for the revised minimum regulatory capital ratios, definitions of regulatory capital, and regulatory capital adjustments and deductions.

Begin compliance with the revised advanced approaches rule for determining risk-weighted assets.

January 1, 2015

Begin compliance with the standardized approach for determining risk-weighted assets.

January 1, 2016

Begin the transition period for the capital conservation and countercyclical capital buffers.

*If applicable, FDIC-supervised institutions must use the calculations in subpart F of the interim final rule (market risk) concurrently with the calculation of risk-weighted assets according either to subpart D (standardized approach) or subpart E (advanced approaches) of the interim final rule.

IV. Minimum Regulatory Capital Ratios, Additional Capital Requirements, and Overall Capital Adequacy

A. Minimum Risk-based Capital Ratios and Other Regulatory Capital Provisions

Consistent with Basel III, the proposed rule would have required banking organizations to comply with the following minimum capital ratios: a common equity tier 1 capital to risk-weighted assets ratio of 4.5 percent; a tier 1 capital to risk-weighted assets ratio of 6 percent; a total capital to risk-weighted assets ratio of 8 percent; a leverage ratio of 4 percent; and for advanced approaches banking organizations only, a supplementary leverage ratio of 3 percent. The common equity tier 1 capital ratio is a new minimum requirement designed to ensure that banking organizations hold sufficient high-quality regulatory capital that is available to absorb losses on a going-concern basis. The proposed capital ratios would apply to a banking organization on a consolidated basis.

The agencies received a substantial number of comments on the proposed minimum risk-based capital requirements. Several commenters supported the proposal to increase the minimum tier 1 risk-based capital requirement. Other commenters commended the agencies for proposing to implement a minimum capital requirement that focuses primarily on common equity. These commenters argued that common equity is the strongest form of capital and that the proposed minimum common equity tier 1 capital ratio of 4.5 percent would promote the safety and soundness of the banking industry.

Other commenters provided general support for the proposed increases in minimum risk-based capital requirements, but expressed concern that the proposals could present unique challenges to mutual institutions because they can only raise common equity through retained earnings. A number of commenters asserted that the objectives of the proposal could be achieved through regulatory mechanisms other than the proposed risk-based capital requirements, including enhanced safety and soundness examinations, more stringent underwriting standards, and alternative measures of capital.

Other commenters objected to the proposed increase in the minimum tier 1 capital ratio and the implementation of a common equity tier 1 capital ratio. One commenter indicated that increases in regulatory capital ratios would severely limit growth at many community banking organizations and could encourage consolidation through mergers and acquisitions. Other commenters stated that for banks under $750 million in total assets, increased compliance costs would not allow them to provide a reasonable return to shareholders, and thus would force them to consolidate. Several commenters urged the agencies to recognize community banking organizations' limited access to the capital markets and related difficulties raising capital to comply with the proposal.

One banking organization indicated that implementation of the common equity tier 1 capital ratio would significantly reduce its capacity to grow and recommended that the proposal recognize differences in the risk and complexity of banking organizations and provide favorable, less stringent requirements for smaller and non-complex institutions. Another commenter suggested that the proposed implementation of an additional risk-based capital ratio would confuse market observers and recommended that the agencies implement a regulatory capital framework that allows investors and the market to ascertain regulatory capital from measures of equity derived from a banking organization's balance sheet.

Other commenters expressed concern that the proposed common equity tier 1 capital ratio would disadvantage MDIs relative to other banking organizations. According to the commenters, in order to retain their minority-owned status, MDIs historically maintain a relatively high percentage of non-voting preferred stockholders that provide long-term, stable sources of capital. Any public offering to increase common equity tier 1 capital levels would dilute the minority investors owning the common equity of the MDI and could potentially compromise the minority-owned status of such institutions. One commenter asserted that, for this reason, the implementation of the Basel III NPR would be contrary to the statutory mandate of section 308 of the Financial Institutions, Reform, Recovery and Enforcement Act (FIRREA).

Accordingly, the commenters encouraged the agencies to exempt MDIs from the proposed common equity tier 1 capital ratio requirement.

12 U.S.C. 1463 note.

The FDIC believes that all FDIC-supervised institutions must have an adequate amount of loss-absorbing capital to continue to lend to their communities during times of economic stress, and therefore have decided to implement the regulatory capital requirements, including the minimum common equity tier 1 capital requirement, as proposed. For the reasons described in the NPR, including the experience during the crisis with lower quality capital instruments, the FDIC does not believe it is appropriate to maintain the general risk-based capital rules or to rely on the supervisory process or underwriting standards alone. Accordingly, the interim final rule maintains the minimum common equity tier 1 capital to total risk-weighted assets ratio of 4.5 percent. The FDIC has decided not to pursue the alternative regulatory mechanisms suggested by commenters, as such alternatives would be difficult to implement consistently across FDIC-supervised institutions and would not necessarily fulfill the objective of increasing the amount and quality of regulatory capital for all FDIC-supervised institutions.

In view of the concerns expressed by commenters with respect to MDIs, the FDIC evaluated the risk-based and leverage capital levels of MDIs to determine whether the interim final rule would disproportionately impact such institutions. This analysis found that of the 178 MDIs in existence as of March 31, 2013, 12 currently are not well capitalized for PCA purposes, whereas (according to the FDIC's estimates) 14 would not be considered well capitalized for PCA purposes under the interim final rule if it were fully implemented without transition today. Accordingly, the FDIC does not believe that the interim final rule would disproportionately impact MDIs and are not adopting any exemptions or special provisions for these institutions. While the FDIC recognizes MDIs may face impediments in meeting the common equity tier 1 capital ratio, the FDIC believes that the improvements to the safety and soundness of these institutions through higher capital standards are warranted and consistent with their obligations under section 308 of FIRREA. As a prudential matter, the FDIC has a long-established regulatory policy that FDIC-supervised institutions should hold capital commensurate with the level and nature of the risks to which they are exposed, which may entail holding capital significantly above the minimum requirements, depending on the nature of the FDIC-supervised institution's activities and risk profile. Section IV.G of this preamble describes the requirement for overall capital adequacy of FDIC-supervised institutions and the

supervisory assessment of capital adequacy.

Furthermore, consistent with the FDIC's authority under the general risk-based capital rules and the proposals, section 1(d) of the interim final rule includes a reservation of authority that allows FDIC to require the FDIC-supervised institution to hold a greater amount of regulatory capital than otherwise is required under the interim final rule, if the FDIC determines that the regulatory capital held by the FDIC-supervised institution is not commensurate with its credit, market, operational, or other risks. In exercising reservation of authority under the rule, the FDIC expects to consider the size, complexity, risk profile, and scope of operations of the FDIC-supervised institution; and whether any public benefits would be outweighed by risk to an insured depository institution or to the financial system.

B. Leverage Ratio

The proposals would require a banking organization to satisfy a leverage ratio of 4 percent, calculated using the proposed definition of tier 1 capital and the banking organization's average total consolidated assets, minus amounts deducted from tier 1 capital. The agencies also proposed to eliminate the exception in the agencies' leverage rules that provides for a minimum leverage ratio of 3 percent for banking organizations with strong supervisory ratings.

The agencies received a number of comments on the proposed leverage ratio applicable to all banking organizations. Several of these commenters supported the proposed leverage ratio, stating that it serves as a simple regulatory standard that constrains the ability of a banking organization to leverage its equity capital base. Some of the commenters encouraged the agencies to consider an alternative leverage ratio measure of tangible common equity to tangible assets, which would exclude non-common stock elements from the numerator and intangible assets from the denominator of the ratio and thus, according to these commenters, provide a more reliable measure of a banking organization's viability in a crisis.

A number of commenters criticized the proposed removal of the 3 percent exception to the minimum leverage ratio requirement for certain banking organizations. One of these commenters argued that removal of this exception is unwarranted in view of the cumulative impact of the proposals and that raising the minimum leverage ratio requirement for the strongest banking organizations may lead to a deleveraging by the institutions most able to extend credit in a safe and sound manner. In addition, the commenters cautioned the agencies that a restrictive leverage measure, together with more stringent risk-based capital requirements, could magnify the potential impact of an economic downturn.

Several commenters suggested modifications to the minimum leverage ratio requirement. One commenter suggested increasing the minimum leverage ratio requirement for all banking organizations to 6 percent, whereas another commenter recommended a leverage ratio requirement as high as 20 percent. Another commenter suggested a tiered approach, with minimum leverage ratio requirements of 6.25 percent and 8.5 percent for community banking organizations and large banking organizations, respectively. According to this commenter, such an approach could be based on the risk characteristics of a banking organization, including liquidity, asset quality, and local deposit levels, as well as its supervisory rating. Another commenter suggested a fluid leverage ratio requirement that would adjust based on certain macroeconomic variables. Under such an approach, the agencies could require banking organizations to meet a minimum leverage ratio of 10 percent under favorable economic conditions and a 6 percent leverage ratio during an economic contraction.

The FDIC continues to believe that a minimum leverage ratio requirement of 4 percent for all FDIC-supervised institutions is appropriate in light of its role as a complement to the risk-based capital ratios. The proposed leverage ratio is more conservative than the current leverage ratio because it incorporates a more stringent definition of tier 1 capital. In addition, the FDIC believes that it is appropriate for all FDIC-supervised institutions, regardless of their supervisory rating or trading activities, to meet the same minimum leverage ratio requirements. As a practical matter, the FDIC generally has found a leverage ratio of less than 4 percent to be inconsistent with a supervisory composite rating of “1.” Modifying the scope of the leverage ratio measure or implementing a fluid or tiered approach for the minimum leverage ratio requirement would create additional operational complexity and variability in a minimum ratio requirement that is intended to place a constraint on the maximum degree to which an FDIC-supervised institution can leverage its equity base. Accordingly, the interim final rule retains the existing minimum leverage ratio requirement of 4 percent and removes the 3 percent leverage ratio exception as of January 1, 2014 for advanced approaches FDIC-supervised institutions and as of January 1, 2015 for all other FDIC-supervised institutions.

C. Supplementary Leverage Ratio for Advanced Approaches FDIC-Supervised Institutions

As part of Basel III, the BCBS introduced a minimum leverage ratio requirement of 3 percent (the Basel III leverage ratio) as a backstop measure to the risk-based capital requirements, designed to improve the resilience of the banking system worldwide by limiting the amount of leverage that a banking organization may incur. The Basel III leverage ratio is defined as the ratio of tier 1 capital to a combination of on- and off-balance sheet exposures.

As discussed in the Basel III NPR, the agencies proposed the supplementary leverage ratio only for advanced approaches banking organizations because these banking organizations tend to have more significant amounts of off-balance sheet exposures that are not captured by the current leverage ratio. Under the proposal, consistent with Basel III, advanced approaches banking organizations would be required to maintain a minimum supplementary leverage ratio of 3 percent of tier 1 capital to on- and off-balance sheet exposures (total leverage exposure).

The agencies received a number of comments on the proposed supplementary leverage ratio. Several commenters stated that the proposed supplementary leverage ratio is unnecessary in light of the minimum leverage ratio requirement applicable to all banking organizations. These commenters stated that the implementation of the supplementary leverage ratio requirement would create market confusion as to the inter-relationships among the ratios and as to which ratio serves as the binding constraint for an individual banking organization. One commenter noted that an advanced approaches banking organization would be required to calculate eight distinct regulatory capital ratios (common equity tier 1, tier 1, and total capital to risk-weighted assets under the advanced approaches and the standardized approach, as well as two leverage ratios) and encouraged the agencies to streamline the application of regulatory capital ratios. In addition, commenters suggested that the agencies postpone the implementation of the supplementary

leverage ratio until January 1, 2018, after the international supervisory monitoring process is complete, and to collect supplementary leverage ratio information on a confidential basis until then.

At least one commenter encouraged the agencies to consider extending the application of the proposed supplementary leverage ratio on a case-by-case basis to banking organizations with total assets of between $50 billion and $250 billion, stating that such institutions may have significant off-balance sheet exposures and engage in a substantial amount of repo-style transactions. Other commenters suggested increasing the proposed supplementary leverage ratio requirement to at least 8 percent for BHCs, under the Federal Reserve's authority in section 165 of the Dodd-Frank Act to implement enhanced capital requirements for systemically important financial institutions.

See

section 165 of the Dodd-Frank Act, 12 U.S.C. 5365.

With respect to specific aspects of the supplementary leverage ratio, some commenters criticized the methodology for the total leverage exposure. Specifically, one commenter expressed concern that using GAAP as the basis for determining a banking organization's total leverage exposure would exclude a wide range of off-balance sheet exposures, including derivatives and securities lending transactions, as well as permit extensive netting. To address these issues, the commenter suggested requiring advanced approaches banking organizations to determine their total leverage exposure using International Financial Reporting Standards (IFRS), asserting that it restricts netting and, relative to GAAP, requires the recognition of more off-balance sheet securities lending transactions.

Several commenters criticized the proposed incorporation of off-balance sheet exposures into the total leverage exposure. One commenter argued that including unfunded commitments in the total leverage exposure runs counter to the purpose of the supplementary leverage ratio as an on-balance sheet measure of capital that complements the risk-based capital ratios. This commenter was concerned that the proposed inclusion of unfunded commitments would result in a duplicative assessment against banking organizations when the forthcoming liquidity ratio requirements are implemented in the United States. The commenter noted that the proposed 100 percent credit conversion factor for all unfunded commitments is not appropriately calibrated to the vastly different types of commitments that exist across the industry. If the supplementary leverage ratio is retained in the interim final rule, the commenter requested that the agencies align the credit conversion factors for unfunded commitments under the supplementary leverage ratio and any forthcoming liquidity ratio requirements.

Another commenter encouraged the agencies to allow advanced approaches banking organizations to exclude from total leverage exposure the notional amount of any unconditionally cancellable commitment. According to this commenter, unconditionally cancellable commitments are not credit exposures because they can be extinguished at any time at the sole discretion of the issuing entity. Therefore, the commenter argued, the inclusion of these commitments could potentially distort a banking organization's measure of total leverage exposure.

A few commenters requested that the agencies exclude off-balance sheet trade finance instruments from the total leverage exposure, asserting that such instruments are based on underlying client transactions (for example, a shipment of goods) and are generally short-term. The commenters argued that trade finance instruments do not create excessive systemic leverage and that they are liquidated by fulfillment of the underlying transaction and payment at maturity. Another commenter requested that the agencies apply the same credit conversion factors to trade finance instruments as under the general risk-based capital rules—that is, 20 percent of the notional value for trade-related contingent items that arise from the movement of goods, and 50 percent of the notional value for transaction-related contingent items, including performance bonds, bid bonds, warranties, and performance standby letters of credit. According to this commenter, such an approach would appropriately consider the low-risk characteristics of these instruments and ensure price stability in trade finance.

Several commenters supported the proposed treatment for repo-style transactions (including repurchase agreements, securities lending and borrowing transactions, and reverse repos). These commenters stated that securities lending transactions are fully collateralized and marked to market daily and, therefore, the on-balance sheet amounts generated by these transactions appropriately capture the exposure for purposes of the supplementary leverage ratio. These commenters also supported the proposed treatment for indemnified securities lending transactions and encouraged the agencies to retain this treatment in the interim final rule. Other commenters stated that the proposed measurement of repo-style transactions is not sufficiently conservative and recommended that the agencies implement a methodology that includes in total leverage exposure the notional amounts of these transactions.

A few commenters raised concerns about the proposed methodology for determining the exposure amount of derivative contracts. Some commenters criticized the agencies for not allowing advanced approaches banking organizations to use the internal models methodology to calculate the exposure amount for derivative contracts. According to these commenters, the agencies should align the methods for calculating exposure for derivative contracts for purposes of the supplementary leverage ratio and the advanced approaches risk-based capital ratios to more appropriately reflect the risk-management activities of advanced approaches banking organizations and to measure these exposures consistently across the regulatory capital ratios. At least one commenter requested clarification of the proposed treatment of collateral received in connection with derivative contracts. This commenter also encouraged the agencies to permit recognition of eligible collateral for purposes of reducing total leverage exposure, consistent with proposed legislation in other BCBS member jurisdictions.

The introduction of an international leverage ratio requirement in the Basel III capital framework is an important development that would provide a consistent leverage ratio measure across internationally-active institutions. Furthermore, the supplementary leverage ratio is reflective of the on- and off-balance sheet activities of large, internationally active banking organizations. Accordingly, consistent with Basel III, the interim final rule implements for reporting purposes the proposed supplementary leverage ratio for advanced approaches FDIC-supervised institutions starting on January 1, 2015 and requires advanced approaches FDIC-supervised institutions to comply with the minimum supplementary leverage ratio requirement starting on January 1, 2018. Public reporting of the supplementary leverage ratio during the international supervisory monitoring period is consistent with the international implementation timeline and enables transparency and comparability of

reporting the leverage ratio requirement across jurisdictions.

The FDIC is not applying the supplementary leverage ratio requirement to FDIC-supervised institutions that are not subject to the advanced approaches rule in the interim final rule. Applying the supplementary leverage ratio routinely could create operational complexity for smaller FDIC-supervised institutions that are not internationally active, and that generally do not have off-balance sheet activities that are as extensive as FDIC-supervised institutions that are subject to the advanced approaches rule. The FDIC notes that the interim final rule imposes risk-based capital requirements on all repo-style transactions and otherwise imposes constraints on all FDIC-supervised institutions' off-balance sheet exposures.

With regard to the commenters' views to require the use of IFRS for purposes of the supplementary leverage ratio, the FDIC notes that the use of GAAP in the interim final rule as a starting point to measure exposure of certain derivatives and repo-style transactions, has the advantage of maintaining consistency between regulatory capital calculations and regulatory reporting, the latter of which must be consistent with GAAP or, if another accounting principle is used, no less stringent than GAAP.

See

12 U.S.C. 1831n(a)(2).

In response to the commenters' views regarding the scope of the total leverage exposure, the FDIC notes that the supplementary leverage ratio is intended to capture on- and off-balance sheet exposures of an FDIC-supervised institution. Commitments represent an agreement to extend credit and thus including commitments (both funded and unfunded) in the supplementary leverage ratio is consistent with its purpose to measure the on- and off-balance sheet leverage of an FDIC-supervised institution, as well as with safety and soundness principles. Accordingly, the FDIC believes that total leverage exposure should include FDIC-supervised institutions' off-balance sheet exposures, including all loan commitments that are not unconditionally cancellable, financial standby letters of credit, performance standby letters of credit, and commercial and other similar letters of credit.

The proposal to include unconditionally cancellable commitments in the total leverage exposure recognizes that a banking organization may extend credit under the commitment before it is cancelled. If the banking organization exercises its option to cancel the commitment, its total leverage exposure amount with respect to the commitment will be limited to any extension of credit prior to cancellation. The proposal considered banking organizations' ability to cancel such commitments and, therefore, limited the amount of unconditionally cancellable commitments included in total leverage exposure to 10 percent of the notional amount of such commitments.

The FDIC notes that the credit conversion factors used in the supplementary leverage ratio and in any forthcoming liquidity ratio requirements have been developed to serve the purposes of the respective frameworks and may not be identical. Similarly, the commenters' proposed modifications to credit conversion factors for trade finance transactions would be inconsistent with the purpose of the supplementary leverage ratio—to capture all off-balance sheet exposures of banking organizations in a primarily non-risk-based manner.

For purposes of incorporating derivative contracts in the total leverage exposure, the proposal would require all advanced approaches banking organizations to use the same methodology to measure such exposures. The proposed approach provides a uniform measure of exposure for derivative contracts across banking organizations, without regard to their models. Accordingly, the FDIC does not believe an FDIC-supervised institution should be permitted to use internal models to measure the exposure amount of derivative contracts for purposes of the supplementary leverage ratio.

With regard to commenters requesting a modification of the proposed treatment for repo-style transactions, the FDIC does not believe that the proposed modifications are warranted at this time because international discussions and quantitative analysis of the exposure measure for repo-style transactions are still ongoing.

The FDIC is continuing to work with the BCBS to assess the Basel III leverage ratio, including its calibration and design, as well as the impact of any differences in national accounting frameworks material to the denominator of the Basel III leverage ratio. The FDIC will consider any changes to the supplementary leverage ratio as the BCBS revises the Basel III leverage ratio.

Therefore, the FDIC has adopted the proposed supplementary leverage ratio in the interim final rule without modification. An advanced approaches FDIC-supervised institution must calculate the supplementary leverage ratio as the simple arithmetic mean of the ratio of the FDIC-supervised institution's tier 1 capital to total leverage exposure as of the last day of each month in the reporting quarter. The FDIC also notes that collateral may not be applied to reduce the potential future exposure (PFE) amount for derivative contracts.

Under the interim final rule, total leverage exposure equals the sum of the following:

(1) The balance sheet carrying value of all of the FDIC-supervised institution's on-balance sheet assets

less

amounts deducted from tier 1 capital under section 22(a), (c), and (d) of the interim final rule;

(2) The PFE amount for each derivative contract to which the FDIC-supervised institution is a counterparty (or each single-product netting set of such transactions) determined in accordance with section 34 of the interim final rule, but without regard to section 34(b);

(3) 10 percent of the notional amount of unconditionally cancellable commitments made by the FDIC-supervised institution; and

(4) The notional amount of all other off-balance sheet exposures of the FDIC-supervised institution (excluding securities lending, securities borrowing, reverse repurchase transactions, derivatives and unconditionally cancellable commitments).

Advanced approaches FDIC-supervised institutions must maintain a minimum supplementary leverage ratio of 3 percent beginning on January 1, 2018, consistent with Basel III. However, as noted above, beginning on January 1, 2015, advanced approaches FDIC-supervised institutions must calculate and report their supplementary leverage ratio.

D. Capital Conservation Buffer

During the recent financial crisis, some banking organizations continued to pay dividends and substantial discretionary bonuses even as their financial condition weakened. Such capital distributions had a significant negative impact on the overall strength of the banking sector. To encourage better capital conservation by banking organizations and to enhance the resilience of the banking system, the proposed rule would have limited capital distributions and discretionary bonus payments for banking organizations that do not hold a

specified amount of common equity tier 1 capital in addition to the amount of regulatory capital necessary to meet the minimum risk-based capital requirements (capital conservation buffer), consistent with Basel III. In this way, the capital conservation buffer is intended to provide incentives for banking organizations to hold sufficient capital to reduce the risk that their capital levels would fall below their minimum requirements during a period of financial stress.

The proposed rules incorporated a capital conservation buffer composed of common equity tier 1 capital in addition to the minimum risk-based capital requirements. Under the proposal, a banking organization would need to hold a capital conservation buffer in an amount greater than 2.5 percent of total risk-weighted assets (plus, for an advanced approaches banking organization, 100 percent of any applicable countercyclical capital buffer amount) to avoid limitations on capital distributions and discretionary bonus payments to executive officers, as defined in the proposal. The proposal provided that the maximum dollar amount that a banking organization could pay out in the form of capital distributions or discretionary bonus payments during the current calendar quarter (the maximum payout amount) would be equal to a maximum payout ratio, multiplied by the banking organization's eligible retained income, as discussed below. The proposal provided that a banking organization with a buffer of more than 2.5 percent of total risk-weighted assets (plus, for an advanced approaches banking organization, 100 percent of any applicable countercyclical capital buffer), would not be subject to a maximum payout amount. The proposal clarified that the agencies reserved the ability to restrict capital distributions under other authorities and that restrictions on capital distributions and discretionary bonus payments associated with the capital conservation buffer would not be part of the PCA framework. The calibration of the buffer is supported by an evaluation of the loss experience of U.S. banking organizations as part of an analysis conducted by the BCBS, as well as by evaluation of historical levels of capital at U.S. banking organizations.

“Calibrating regulatory capital requirements and buffers: A top-down approach.” Basel Committee on Banking Supervision, October, 2010, available at

www.bis.org

The agencies received a significant number of comments on the proposed capital conservation buffer. In general, the commenters characterized the capital conservation buffer as overly conservative, and stated that the aggregate amount of capital that would be required for a banking organization to avoid restrictions on dividends and discretionary bonus payments under the proposed rule exceeded the amount required for a safe and prudent banking system. Commenters expressed concern that the capital conservation buffer could disrupt the priority of payments in a banking organization's capital structure, as any restrictions on dividends would apply to both common and preferred stock. Commenters also questioned the appropriateness of restricting a banking organization that fails to comply with the capital conservation buffer from paying dividends or bonus payments if it has established and maintained cash reserves to cover future uncertainty. One commenter supported the establishment of a formal mechanism for banking organizations to request agency approval to make capital distributions even if doing so would otherwise be restricted under the capital conservation buffer.

Other commenters recommended an exemption from the proposed capital conservation buffer for certain types of banking organizations, such as community banking organizations, banking organizations organized in mutual form, and rural BHCs that rely heavily on bank stock loans for growth and expansion purposes. Commenters also recommended a wide range of institutions that should be excluded from the buffer based on a potential size threshold, such as banking organizations with total consolidated assets of less than $250 billion. Commenters also recommended that S-corporations be exempt from the proposed capital conservation buffer because under the U.S. Internal Revenue Code, S-corporations are not subject to a corporate-level tax; instead, S-corporation shareholders must report income and pay income taxes based on their share of the corporation's profit or loss. An S-corporation generally declares a dividend to help shareholders pay their tax liabilities that arise from reporting their share of the corporation's profits. According to some commenters, the proposal disadvantaged S-corporations because shareholders of S-corporations would be liable for tax on the S-corporation's net income, and the S-corporation may be prohibited from making a dividend to these shareholders to fund the tax payment.

One commenter criticized the proposed composition of the capital conservation buffer (which must consist solely of common equity tier 1 capital) and encouraged the agencies to allow banking organizations to include noncumulative perpetual preferred stock and other tier 1 capital instruments. Several commenters questioned the empirical basis for a capital conservation buffer of 2.5 percent, and encouraged the agencies to provide a quantitative analysis for the proposal. One commenter suggested application of the capital conservation buffer only during economic downturn scenarios, consistent with the agencies' objective to restrict dividends and discretionary bonus payments during these periods. According to this commenter, a banking organization that fails to maintain a sufficient capital conservation buffer during periods of economic stress also could be required to submit a plan to increase its capital.

After considering these comments, the FDIC has decided to maintain common equity tier 1 capital as the basis of the capital conservation buffer and to apply the capital conservation buffer to all types of FDIC-supervised institutions at all times. Application of the buffer to all types of FDIC-supervised institutions and maintenance of a capital buffer during periods of market and economic stability is appropriate to encourage sound capital management and help ensure that FDIC-supervised institutions will maintain adequate amounts of loss-absorbing capital going forward, strengthening the ability of the banking system to continue serving as a source of credit to the economy in times of stress. A buffer framework that restricts dividends and discretionary bonus payments only for certain types of FDIC-supervised institutions or only during an economic contraction would not achieve these objectives. Similarly, basing the capital conservation buffer on the most loss-absorbent form of capital is most consistent with the purpose of the capital conservation buffer as it helps to ensure that the buffer can be used effectively by FDIC-supervised institutions at a time when they are experiencing losses.

The FDIC recognizes that S-corporation FDIC-supervised institutions structure their tax payments differently from C corporations. However, the FDIC notes that this distinction results from S-corporations' pass-through taxation, in which profits are not subject to taxation at the corporate level, but rather at the shareholder level. The FDIC is charged with evaluating the capital levels and safety and soundness of the FDIC-supervised institution. At the point where a decrease in the organization's capital triggers dividend restrictions, the

FDIC believes that capital should stay within the FDIC-supervised institution. S-corporation shareholders may receive a benefit from pass-through taxation, but with that benefit comes the risk that the corporation has no obligation to make dividend distributions to help shareholders pay their tax liabilities. Therefore, the interim final rule does not exempt S-corporations from the capital conservation buffer.

Accordingly, under the interim final rule an FDIC-supervised institution must maintain a capital conservation buffer of common equity tier 1 capital in an amount greater than 2.5 percent of total risk-weighted assets (plus, for an advanced approaches FDIC-supervised institution, 100 percent of any applicable countercyclical capital buffer amount) to avoid being subject to limitations on capital distributions and discretionary bonus payments to executive officers.

The proposal defined eligible retained income as a banking organization's net income (as reported in the banking organization's quarterly regulatory reports) for the four calendar quarters preceding the current calendar quarter, net of any capital distributions and associated tax effects not already reflected in net income. The agencies received a number of comments regarding the proposed definition of eligible retained income, which is used to calculate the maximum payout amount. Some commenters suggested that the agencies limit capital distributions based on retained earnings instead of eligible retained income, citing the Federal Reserve's Regulation H as an example of this regulatory practice.

Several commenters representing banking organizations organized as S-corporations recommended revisions to the definition of eligible retained income so that it would be net of pass-through tax distributions to shareholders that have made a pass-through election for tax purposes, allowing S-corporation shareholders to pay their tax liability notwithstanding any dividend restrictions resulting from failure to comply with the capital conservation buffer. Some commenters suggested that the definition of eligible retained income be adjusted for items such as goodwill impairment that are captured in the definition of “net income” for regulatory reporting purposes but which do not affect regulatory capital.

See

12 CFR part 208.

The interim final rule adopts the proposed definition of eligible retained income without change. The FDIC believes the commenters' suggested modifications to the definition of eligible retained income would add complexity to the interim final rule and in some cases may be counter-productive by weakening the incentives of the capital conservation buffer. The FDIC notes that the definition of eligible retained income appropriately accounts for impairment charges, which reduce eligible retained income but also reduces the balance sheet amount of goodwill that is deducted from regulatory capital. Further, the proposed definition of eligible retained income, which is based on net income as reported in the banking organization's quarterly regulatory reports, reflects a simple measure of a banking organization's recent performance upon which to base restrictions on capital distributions and discretionary payments to executive officers. For the same reasons as described above regarding the application of the capital conservation buffer to S-corporations generally, the FDIC has determined that the definition of eligible retained income should not be modified to address the tax-related concerns raised by commenters writing on behalf of S-corporations.

The proposed rule generally defined a capital distribution as a reduction of tier 1 or tier 2 capital through the repurchase or redemption of a capital instrument or by other means; a dividend declaration or payment on any tier 1 or tier 2 capital instrument if the banking organization has full discretion to permanently or temporarily suspend such payments without triggering an event of default; or any similar transaction that the primary Federal supervisor determines to be in substance a distribution of capital.

Commenters provided suggestions on the definition of “capital distribution.” One commenter requested that a “capital distribution” be defined to exclude any repurchase or redemption to the extent the capital repurchased or redeemed was replaced in a contemporaneous transaction by the issuance of capital of an equal or higher quality tier. The commenter maintained that the proposal would unnecessarily penalize banking organizations that redeem capital but contemporaneously replace such capital with an equal or greater amount of capital of an equivalent or higher quality. In response to comments, and recognizing that redeeming capital instruments that are replaced with instruments of the same or similar quality does not weaken a banking organization's overall capital position, the interim final rule provides that a redemption or repurchase of a capital instrument is not a distribution provided that the banking organization fully replaces that capital instrument by issuing another capital instrument of the same or better quality (that is, more subordinate) based on the interim final rule's eligibility criteria for capital instruments, and provided that such issuance is completed within the same calendar quarter the banking organization announces the repurchase or redemption. For purposes of this definition, a capital instrument is issued at the time that it is fully paid in. For purposes of the interim final rule, the FDIC changed the defined term from “capital distribution” to “distribution” to avoid confusion with the term “capital distribution” used in the Federal Reserve's capital plan rule.

See

12 CFR 225.8.

The proposed rule defined discretionary bonus payment as a payment made to an executive officer of a banking organization (as defined below) that meets the following conditions: The banking organization retains discretion as to the fact of the payment and as to the amount of the payment until the payment is awarded to the executive officer; the amount paid is determined by the banking organization without prior promise to, or agreement with, the executive officer; and the executive officer has no contractual right, express or implied, to the bonus payment.

The agencies received a number of comments on the proposed definition of discretionary bonus payments to executive officers. One commenter expressed concern that the proposed definition of discretionary bonus payment may not be effective unless the agencies provided clarification as to the type of payments covered, as well as the timing of such payments. This commenter asked whether the proposed rule would prohibit the establishment of a pre-funded bonus pool with mandatory distributions and sought clarification as to whether non-cash compensation payments, such as stock options, would be considered a discretionary bonus payment.

The interim final rule's definition of discretionary bonus payment is unchanged from the proposal. The FDIC notes that if an FDIC-supervised institution prefunds a pool for bonuses payable under a contract, the bonus pool is not discretionary and, therefore, is not subject to the capital conservation buffer limitations. In addition, the definition of discretionary bonus payment does not include non-cash compensation payments that do not affect capital or earnings such as, in some cases, stock options.

Commenters representing community banking organizations maintained that the proposed restrictions on discretionary bonus payments would disproportionately impact such institutions' ability to attract and retain qualified employees. One commenter suggested revising the proposed rule so that a banking organization that fails to satisfy the capital conservation buffer would be restricted from making a discretionary bonus payment only to the extent it exceeds 15 percent of the employee's salary, asserting that this would prevent excessive bonus payments while allowing community banking organizations flexibility to compensate key employees. The interim final rule does not incorporate this suggestion. The FDIC notes that the potential limitations and restrictions under the capital conservation buffer framework do not automatically translate into a prohibition on discretionary bonus payments. Instead, the overall dollar amount of dividends and bonuses to executive officers is capped based on how close the banking organization's regulatory capital ratios are to its minimum capital ratios and on the earnings of the banking organization that are available for distribution. This approach provides appropriate incentives for capital conservation while preserving flexibility for institutions to decide how to allocate income available for distribution between discretionary bonus payments and other distributions.

The proposal defined executive officer as a person who holds the title or, without regard to title, salary, or compensation, performs the function of one or more of the following positions: President, chief executive officer, executive chairman, chief operating officer, chief financial officer, chief investment officer, chief legal officer, chief lending officer, chief risk officer, or head of a major business line, and other staff that the board of directors of the banking organization deems to have equivalent responsibility.

See

76 FR 21170 (April 14, 2011) for a comparable definition of “executive officer.”

Commenters generally supported a more restrictive definition of executive officer, arguing that the definition of executive officer should be no broader than the definition under the Federal Reserve's Regulation O,

which governs any extension of credit between a member bank and an executive officer, director, or principal shareholder. Some commenters, however, favored a more expansive definition of executive officer, with one commenter supporting the inclusion of directors of the banking organization or directors of any of the banking organization's affiliates, any other person in control of the banking organization or the banking organizations' affiliates, and any person in control of a major business line. In accordance with the FDIC's objective to include those individuals within an FDIC-supervised institution with the greatest responsibility for the organization's financial condition and risk exposure, the interim final rule maintains the definition of executive officer as proposed.

See

12 CFR part 215.

Under the proposal, advanced approaches banking organizations would have calculated their capital conservation buffer (and any applicable countercyclical capital buffer amount) using their advanced approaches total risk-weighted assets. Several commenters supported this aspect of the proposal, and one stated that the methodologies for calculating risk-weighted assets under the advanced approaches rule would more effectively capture the individual risk profiles of such banking organizations, asserting further that advanced approaches banking organizations would face a competitive disadvantage relative to foreign banking organizations if they were required to use standardized total risk-weighted assets to determine compliance with the capital conservation buffer. In contrast, another commenter suggested that advanced approaches banking organizations be allowed to use the advanced approaches methodologies as the basis for calculating the capital conservation buffer only when it would result in a more conservative outcome than under the standardized approach in order to maintain competitive equity domestically. Another commenter expressed concerns that the capital conservation buffer is based only on risk-weighted assets and recommended additional application of a capital conservation buffer to the leverage ratio to avoid regulatory arbitrage opportunities and to accomplish the agencies' stated objective of ensuring that banking organizations have sufficient capital to absorb losses.

The interim final rule requires that advanced approaches FDIC-supervised institutions that have completed the parallel run process and that have received notification from the FDIC supervisor pursuant to section 121(d) of subpart E use their risk-based capital ratios under section 10 of the interim final rule (that is, the lesser of the standardized and the advanced approaches ratios) as the basis for calculating their capital conservation buffer (and any applicable countercyclical capital buffer). The FDIC believes such an approach is appropriate because it is consistent with how advanced approaches FDIC-supervised institutions compute their minimum risk-based capital ratios.

Many commenters discussed the interplay between the proposed capital conservation buffer and the PCA framework. Some commenters encouraged the agencies to reset the buffer requirement to two percent of total risk-weighted assets in order to align it with the margin between the “adequately-capitalized” category and the “well-capitalized” category under the PCA framework. Similarly, some commenters characterized the proposal as confusing because a banking organization could be considered well capitalized for PCA purposes, but at the same time fail to maintain a sufficient capital conservation buffer and be subject to restrictions on capital distributions and discretionary bonus payments. These commenters encouraged the agencies to remove the capital conservation buffer for purposes of the interim final rule, and instead use their existing authority to impose restrictions on dividends and discretionary bonus payments on a case-by-case basis through formal enforcement actions. Several commenters stated that compliance with a capital conservation buffer that operates outside the traditional PCA framework adds complexity to the interim final rule, and suggested increasing minimum capital requirements if the agencies determine they are currently insufficient. Specifically, one commenter encouraged the agencies to increase the minimum total risk-based capital requirement to 10.5 percent and remove the capital conservation buffer from the rule.

The capital conservation buffer has been designed to give banking organizations the flexibility to use the buffer while still being well capitalized. Banking organizations that maintain their risk-based capital ratios at least 50 basis points above the well capitalized PCA levels will not be subject to any restrictions imposed by the capital conservation buffer, as applicable. As losses begin to accrue or a banking organization's risk-weighted assets begin to grow such that the capital ratios of a banking organization are below the capital conservation buffer but above the well capitalized thresholds, the incremental limitations on distributions are unlikely to affect planned capital distributions or discretionary bonus payments but may provide a check on rapid expansion or other activities that

would weaken the organization's capital position.

Under the interim final rule, the maximum payout ratio is the percentage of eligible retained income that an FDIC-supervised institution is allowed to pay out in the form of distributions and discretionary bonus payments, each as defined under the rule, during the current calendar quarter. The maximum payout ratio is determined by the FDIC-supervised institution's capital conservation buffer as calculated as of the last day of the previous calendar quarter.

An FDIC-supervised institution's capital conservation buffer is the lowest of the following ratios: (i) The FDIC-supervised institution's common equity tier 1 capital ratio minus its minimum common equity tier 1 capital ratio; (ii) the FDIC-supervised institution's tier 1 capital ratio minus its minimum tier 1 capital ratio; and (iii) the FDIC-supervised institution's total capital ratio minus its minimum total capital ratio. If the FDIC-supervised institution's common equity tier 1, tier 1 or total capital ratio is less than or equal to its minimum common equity tier 1, tier 1 or total capital ratio, respectively, the FDIC-supervised institution's capital conservation buffer is zero.

The mechanics of the capital conservation buffer under the interim final rule are unchanged from the proposal. An FDIC-supervised institution's maximum payout amount for the current calendar quarter is equal to the FDIC-supervised institution's eligible retained income, multiplied by the applicable maximum payout ratio, in accordance with Table 1. An FDIC-supervised institution with a capital conservation buffer that is greater than 2.5 percent (plus, for an advanced approaches FDIC-supervised institution, 100 percent of any applicable countercyclical capital buffer) is not subject to a maximum payout amount as a result of the application of this provision. However, an FDIC-supervised institution may otherwise be subject to limitations on capital distributions as a result of supervisory actions or other laws or regulations.

See, e.g.,

1831o(d)(1), 12 CFR 303.241, and 12 CFR part 324, Subpart H (state nonmember banks and state savings associations as of January 1, 2014 for advanced approaches banks and as of January 1, 2015 for all other organizations).

Table 1 illustrates the relationship between the capital conservation buffer and the maximum payout ratio. The maximum dollar amount that an FDIC-supervised institution is permitted to pay out in the form of distributions or discretionary bonus payments during the current calendar quarter is equal to the maximum payout ratio multiplied by the FDIC-supervised institution's eligible retained income. The calculation of the maximum payout amount is made as of the last day of the previous calendar quarter and any resulting restrictions apply during the current calendar quarter.

Table 1—Capital Conservation Buffer and Maximum Payout Ratio

Capital conservation buffer (as a percentage of standardized or advanced total risk-weighted assets, as applicable)

Maximum payout ratio (as a percentage of eligible retained income)

Greater than 2.5 percent

No payout ratio limitation applies.

Less than or equal to 2.5 percent, and greater than 1.875 percent

60 percent.

Less than or equal to 1.875 percent, and greater than 1.25 percent

40 percent.

Less than or equal to 1.25 percent, and greater than 0.625 percent

20 percent.

Less than or equal to 0.625 percent

0 percent.

Calculations in this table are based on the assumption that the countercyclical capital buffer amount is zero.

Table 1 illustrates that the capital conservation buffer requirements are divided into equal quartiles, each associated with increasingly stringent limitations on distributions and discretionary bonus payments to executive officers as the capital conservation buffer approaches zero. As described in the next section, each quartile expands proportionately for advanced approaches FDIC-supervised institutions when the countercyclical capital buffer amount is greater than zero. In a scenario where an FDIC-supervised institution's risk-based capital ratios fall below its minimum risk-based capital ratios plus 2.5 percent of total risk-weighted assets, the maximum payout ratio also would decline. An FDIC-supervised institution that becomes subject to a maximum payout ratio remains subject to restrictions on capital distributions and certain discretionary bonus payments until it is able to build up its capital conservation buffer through retained earnings, raising additional capital, or reducing its risk-weighted assets. In addition, as a general matter, an FDIC-supervised institution cannot make distributions or certain discretionary bonus payments during the current calendar quarter if the FDIC-supervised institution's eligible retained income is negative and its capital conservation buffer was less than 2.5 percent as of the end of the previous quarter.

Compliance with the capital conservation buffer is determined prior to any distribution or discretionary bonus payment. Therefore, an FDIC-supervised institution with a capital buffer of more than 2.5 percent is not subject to any restrictions on distributions or discretionary bonus payments even if such distribution or payment would result in a capital buffer of less than or equal to 2.5 percent in the current calendar quarter. However, to remain free of restrictions for purposes of any subsequent quarter, the FDIC-supervised institution must restore capital to increase the buffer to more than 2.5 percent prior to any distribution or discretionary bonus payment in any subsequent quarter.

In the proposal, the agencies solicited comment on the impact, if any, of prohibiting a banking organization that is subject to a maximum payout ratio of zero percent from making a penny dividend to common stockholders. One commenter stated that such banking organizations should be permitted to pay a penny dividend on their common stock notwithstanding the limitations imposed by the capital conservation buffer. This commenter maintained that the inability to pay any dividend on common stock could make it more difficult to attract equity investors such as pension funds that often are required to invest only in institutions that pay a quarterly dividend. While the FDIC did not incorporate a blanket exemption for penny dividends on common stock, under the interim final rule, as under the proposal, it may permit an FDIC-supervised institution to make a distribution or discretionary bonus payment if it determines that such distribution or payment would not be contrary to the purpose of the capital conservation buffer or the safety and soundness of the organization. In making such determinations, the FDIC would consider the nature of and circumstances giving rise to the request.

E. Countercyclical Capital Buffer

The proposed rule introduced a countercyclical capital buffer applicable to advanced approaches banking organizations to augment the capital conservation buffer during periods of excessive credit growth. Under the proposed rule, the countercyclical capital buffer would have required advanced approaches banking

organizations to hold additional common equity tier 1 capital during specific, agency-determined periods in order to avoid limitations on distributions and discretionary bonus payments. The agencies requested comment on the countercyclical capital buffer and, specifically, on any factors that should be considered for purposes of determining whether to activate it. One commenter encouraged the agencies to consider readily available indicators of economic growth, employment levels, and financial sector profits. This commenter stated generally that the agencies should activate the countercyclical capital buffer during periods of general economic growth or high financial sector profits, instead of reserving it only for periods of “excessive credit growth.”

Other commenters did not support using the countercyclical capital buffer as a macroeconomic tool. One commenter encouraged the agencies not to include the countercyclical capital buffer in the interim final rule and, instead, rely on the Federal Reserve's longstanding authority over monetary policy to mitigate excessive credit growth and potential asset bubbles. Another commenter questioned the buffer's effectiveness and encouraged the agencies to conduct a QIS prior to its implementation. One commenter recommended expanding the applicability of the proposed countercyclical capital buffer on a case-by-case basis to institutions with total consolidated assets between $50 and $250 billion. Another commenter, however, supported the application of the countercyclical capital buffer only to institutions with total consolidated assets above $250 billion.

The Dodd-Frank Act requires the agencies to consider the use of countercyclical aspects of capital regulation, and the countercyclical capital buffer is an explicitly countercyclical element of capital regulation.

The FDIC notes that implementation of the countercyclical capital buffer for advanced approaches FDIC-supervised institutions is an important part of the Basel III framework, which aims to enhance the resilience of the banking system and reduce systemic vulnerabilities. The FDIC believes that the countercyclical capital buffer is most appropriately applied only to advanced approaches FDIC-supervised institutions because, generally, such organizations are more interconnected with other financial institutions. Therefore, the marginal benefits to financial stability from a countercyclical capital buffer function should be greater with respect to such institutions. Application of the countercyclical capital buffer only to advanced approaches FDIC-supervised institutions also reflects the fact that making cyclical adjustments to capital requirements may produce smaller financial stability benefits and potentially higher marginal costs for smaller FDIC-supervised institutions. The countercyclical capital buffer is designed to take into account the macro-financial environment in which FDIC-supervised institutions function and to protect the banking system from the systemic vulnerabilities that may build-up during periods of excessive credit growth, which may potentially unwind in a disorderly way, causing disruptions to financial institutions and ultimately economic activity.

Section 616(a), (b), and (c) of the Dodd-Frank Act, codified at 12 U.S.C. 1844(b), 1464a(g)(1), and 3907(a)(1).

The countercyclical capital buffer aims to protect the banking system and reduce systemic vulnerabilities in two ways. First, the accumulation of a capital buffer during an expansionary phase could increase the resilience of the banking system to declines in asset prices and consequent losses that may occur when the credit conditions weaken. Specifically, when the credit cycle turns following a period of excessive credit growth, accumulated capital buffers act to absorb the above-normal losses that an FDIC-supervised institution likely would face. Consequently, even after these losses are realized, FDIC-supervised institutions would remain healthy and able to access funding, meet obligations, and continue to serve as credit intermediaries. Second, a countercyclical capital buffer also may reduce systemic vulnerabilities and protect the banking system by mitigating excessive credit growth and increases in asset prices that are not supported by fundamental factors. By increasing the amount of capital required for further credit extensions, a countercyclical capital buffer may limit excessive credit.

Thus, the FDIC believes that the countercyclical capital buffer is an appropriate macroeconomic tool and is including it in the interim final rule. One commenter expressed concern that the proposed rule would not require the agencies to activate the countercyclical capital buffer pursuant to a joint, interagency determination. This commenter encouraged the agencies to adopt an interagency process for activating the buffer for purposes of the interim final rule. As discussed in the Basel III NPR, the agencies anticipate making such determinations jointly. Because the countercyclical capital buffer amount would be linked to the condition of the overall U.S. financial system and not the characteristics of an individual banking organization, the agencies expect that the countercyclical capital buffer amount would be the same at the depository institution and holding company levels. The agencies solicited comment on the appropriateness of the proposed 12-month prior notification period for the countercyclical capital buffer amount. One commenter expressed concern regarding the potential for the agencies to activate the countercyclical capital buffer without providing banking organizations sufficient notice, and specifically requested the implementation of a prior notification requirement of not less than 12 months for purposes of the interim final rule.

The operation of the countercyclical capital buffer is also consistent with sections 616(a), (b), and (c) of the Dodd-Frank Act, codified at 12 U.S.C. 1844(b), 1464a(g)(1), and 3907(a)(1).

In general, to provide banking organizations with sufficient time to adjust to any changes to the countercyclical capital buffer under the interim final rule, the agencies expect to announce an increase in the U.S. countercyclical capital buffer amount with an effective date at least 12 months after their announcement. However, if the agencies determine that a more immediate implementation is necessary based on economic conditions, the agencies may require an earlier effective date. The agencies will follow the same procedures in adjusting the countercyclical capital buffer applicable for exposures located in foreign jurisdictions.

For purposes of the interim final rule, consistent with the proposal, a decrease in the countercyclical capital buffer amount will be effective on the day following announcement of the final determination or the earliest date permissible under applicable law or regulation, whichever is later. In addition, the countercyclical capital buffer amount will return to zero percent 12 months after its effective date, unless the agencies announce a decision to maintain the adjusted countercyclical capital buffer amount or adjust it again before the expiration of the 12-month period.

The countercyclical capital buffer augments the capital conservation buffer by up to 2.5 percent of an FDIC-supervised institution's total risk-weighted assets. Consistent with the proposal, the interim final rule requires an advanced approaches FDIC-

supervised institution to determine its countercyclical capital buffer amount by calculating the weighted average of the countercyclical capital buffer amounts established for the national jurisdictions where the FDIC-supervised institution has private sector credit exposures. The contributing weight assigned to a jurisdiction's countercyclical capital buffer amount is calculated by dividing the total risk-weighted assets for the FDIC-supervised institution's private sector credit exposures located in the jurisdiction by the total risk-weighted assets for all of the FDIC-supervised institution's private sector credit exposures.

Under the proposed rule, private sector credit exposure was defined as an exposure to a company or an individual that is included in credit risk-weighted assets, not including an exposure to a sovereign entity, the Bank for International Settlements, the European Central Bank, the European Commission, the International Monetary Fund, a multilateral development bank (MDB), a public sector entity (PSE), or a Government-sponsored Enterprise (GSE). While the proposed definition excluded covered positions with specific risk under the market risk rule, the agencies explicitly recognized that they should be included in the measure of risk-weighted assets for private-sector exposures and asked a question regarding how to incorporate these positions in the measure of risk-weighted assets, particularly for positions for which an FDIC-supervised institution uses models to measure specific risk. The agencies did not receive comments on this question.

The interim final rule includes covered positions under the market risk rule in the definition of private sector credit exposure. Thus, a private sector credit exposure is an exposure to a company or an individual, not including an exposure to a sovereign entity, the Bank for International Settlements, the European Central Bank, the European Commission, the International Monetary Fund, an MDB, a PSE, or a GSE. The interim final rule is also more specific than the proposal regarding how to calculate risk-weighted assets for private sector credit exposures, and harmonizes that calculation with the advanced approaches FDIC-supervised institution's determination of its capital conservation buffer generally. An advanced approaches FDIC-supervised institution is subject to the countercyclical capital buffer regardless of whether it has completed the parallel run process and received notification from the FDIC pursuant to section 121(d) of the rule. The methodology an advanced approaches FDIC-supervised institution must use for determining risk-weighted assets for private sector credit exposures must be the methodology that the FDIC-supervised institution uses to determine its risk-based capital ratios under section 10 of the interim final rule. Notwithstanding this provision, the risk-weighted asset amount for a private sector credit exposure that is a covered position is its specific risk add-on, as determined under the market risk rule's standardized measurement method for specific risk, multiplied by 12.5. The FDIC chose this methodology because it allows the specific risk of a position to be allocated to the position's geographic location in a consistent manner across FDIC-supervised institutions.

Consistent with the proposal, under the interim final rule the geographic location of a private sector credit exposure (that is not a securitization exposure) is the national jurisdiction where the borrower is located (that is, where the borrower is incorporated, chartered, or similarly established or, if it is an individual, where the borrower resides). If, however, the decision to issue the private sector credit exposure is based primarily on the creditworthiness of a protection provider, the location of the non-securitization exposure is the location of the protection provider. The location of a securitization exposure is the location of the underlying exposures, determined by reference to the location of the borrowers on those exposures. If the underlying exposures are located in more than one national jurisdiction, the location of a securitization exposure is the national jurisdiction where the underlying exposures with the largest aggregate unpaid principal balance are located.

Table 2 illustrates how an advanced approaches FDIC-supervised institution calculates its weighted average countercyclical capital buffer amount. In the following example, the countercyclical capital buffer established in the various jurisdictions in which the FDIC-supervised institution has private sector credit exposures is reported in column A. Column B contains the FDIC-supervised institution's risk-weighted asset amounts for the private sector credit exposures in each jurisdiction. Column C shows the contributing weight for each countercyclical capital buffer amount, which is calculated by dividing each of the rows in column B by the total for column B. Column D shows the contributing weight applied to each countercyclical capital buffer amount, calculated as the product of the corresponding contributing weight (column C) and the countercyclical capital buffer set by each jurisdiction's national supervisor (column A). The sum of the rows in column D shows the FDIC-supervised institution's weighted average countercyclical capital buffer, which is 1.4 percent of risk-weighted assets.

Table 2—Example of Weighted Average Buffer Calculation for an Advanced Approaches FDIC-Supervised Institution

(A) Countercyclical capital buffer amount set by national supervisor

(percent)

(B) FDIC-supervised institution's risk-weighted assets for private sector credit exposures

($b)

(column B/column B total)

(D) Contributing weight applied to each countercyclical capital buffer amount

(column A * column C)

Non-U.S. jurisdiction 1

2.0

250

0.29

0.6

Non-U.S. jurisdiction 2

1.5

100

0.12

0.2

U.S.

500

0.59

0.6

Total

850

1.00

1.4

The countercyclical capital buffer expands an FDIC-supervised institution's capital conservation buffer range for purposes of determining the FDIC-supervised institution's maximum payout ratio. For instance, if an advanced approaches FDIC-supervised institution's countercyclical capital buffer amount is equal to zero percent of total risk-weighted assets, the FDIC-supervised institution must maintain a buffer of greater than 2.5 percent of total risk-weighted assets to avoid restrictions on its distributions and discretionary bonus payments. However, if its countercyclical capital buffer amount is equal to 2.5 percent of total risk-weighted assets, the FDIC-supervised institution must maintain a buffer of greater than 5 percent of total risk-weighted assets to avoid restrictions on its distributions and discretionary bonus payments.

As another example, if the advanced approaches FDIC-supervised institution from the example in Table 2 above has a capital conservation buffer of 2.0 percent, and each of the jurisdictions in which it has private sector credit exposures sets its countercyclical capital buffer amount equal to zero, the FDIC-supervised institution would be subject to a maximum payout ratio of 60 percent. If, instead, each country sets its countercyclical capital buffer amount as shown in Table 2, resulting in a countercyclical capital buffer amount of 1.4 percent of total risk-weighted assets, the FDIC-supervised institution's capital conservation buffer ranges would be expanded as shown in Table 3 below. As a result, the FDIC-supervised institution would now be subject to a stricter 40 percent maximum payout ratio based on its capital conservation buffer of 2.0 percent.

Table 3—Capital Conservation Buffer and Maximum Payout Ratio

Capital conservation buffer as expanded by the countercyclical capital buffer amount from Table 2

Maximum payout ratio (as a percentage of eligible retained income)

Greater than 3.9 percent (2.5 percent + 100 percent of the countercyclical capital buffer of 1.4)

No payout ratio limitation applies.

Less than or equal to 3.9 percent, and greater than 2.925 percent (1.875 percent plus 75 percent of the countercyclical capital buffer of 1.4)

60 percent.

Less than or equal to 2.925 percent, and greater than 1.95 percent (1.25 percent plus 50 percent of the countercyclical capital buffer of 1.4)

40 percent.

Less than or equal to 1.95 percent, and greater than 0.975 percent (.625 percent plus 25 percent of the countercyclical capital buffer of 1.4)

20 percent.

Less than or equal to 0.975 percent

0 percent.

The countercyclical capital buffer amount under the interim final rule for U.S. credit exposures is initially set to zero, but it could increase if the agencies determine that there is excessive credit in the markets that could lead to subsequent wide-spread market failures. Generally, a zero percent countercyclical capital buffer amount will reflect an assessment that economic and financial conditions are consistent with a period of little or no excessive ease in credit markets associated with no material increase in system-wide credit risk. A 2.5 percent countercyclical capital buffer amount will reflect an assessment that financial markets are experiencing a period of excessive ease in credit markets associated with a material increase in system-wide credit risk.

Calculations in this table are based on the assumption that the countercyclical capital buffer amount is 1.4 percent of risk-weighted assets, per the example in Table 2.

F. Prompt Corrective Action Requirements

All insured depository institutions, regardless of total asset size or foreign exposure, currently are required to compute PCA capital levels using the agencies' general risk-based capital rules, as supplemented by the market risk rule. Section 38 of the Federal Deposit Insurance Act directs the federal banking agencies to resolve the problems of insured depository institutions at the least cost to the Deposit Insurance Fund.

To facilitate this purpose, the agencies have established five regulatory capital categories in the PCA regulations that include capital thresholds for the leverage ratio, tier 1 risk-based capital ratio, and the total risk-based capital ratio for insured depository institutions. These five PCA categories under section 38 of the Act and the PCA regulations are: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” Insured depository institutions that fail to meet these capital measures are subject to increasingly strict limits on their activities, including their ability to make capital distributions, pay management fees, grow their balance sheet, and take other actions.

Insured depository institutions are expected to be closed within 90 days of becoming “critically undercapitalized,” unless their primary Federal supervisor takes such other action as that primary Federal supervisor determines, with the concurrence of the FDIC, would better achieve the purpose of PCA.

12 U.S.C. 1831o.

12 U.S.C. 1831o(e)-(i).

See

12 CFR part 325, subpart B.

12 U.S.C. 1831o(g)(3).

The proposal maintained the structure of the PCA framework while increasing some of the thresholds for the PCA capital categories and adding the proposed common equity tier 1 capital ratio. For example, under the proposed rule, the thresholds for adequately capitalized FDIC-supervised institutions would be equal to the minimum capital requirements. The risk-based capital ratios for well capitalized FDIC-supervised institutions under PCA would continue to be two percentage points higher than the ratios for adequately-capitalized FDIC-supervised institutions, and the leverage ratio for well capitalized FDIC-supervised institutions under PCA would be one percentage point higher than for adequately-capitalized FDIC-supervised institutions. Advanced approaches FDIC-supervised institutions that are insured depository institutions also would be required to satisfy a supplementary leverage ratio of 3 percent in order to be considered adequately capitalized. While the proposed PCA levels do not incorporate the capital conservation buffer, the PCA and capital conservation buffer frameworks would complement each other to ensure that FDIC-supervised institutions hold an adequate amount of common equity tier 1 capital.

The agencies received a number of comments on the proposed PCA framework. Several commenters suggested modifications to the proposed PCA levels, particularly with respect to the leverage ratio. For example, a few commenters encouraged the agencies to

increase the adequately-capitalized and well capitalized categories for the leverage ratio to six percent or more and eight percent or more, respectively. According to one commenter, such thresholds would more closely align with the actual leverage ratios of many state-charted depository institutions.

Another commenter expressed concern regarding the operational complexity of the proposed PCA framework in view of the addition of the common equity tier 1 capital ratio and the interaction of the PCA framework and the capital conservation buffer. For example, under the proposed rule a banking organization could be well capitalized for PCA purposes and, at the same time, be subject to restrictions on dividends and bonus payments. Other banking organizations expressed concern that the proposed PCA levels would adversely affect their ability to lend and generate income. This, according to a commenter, also would reduce net income and return-on-equity.

The FDIC believes the capital conservation buffer complements the PCA framework—the former works to keep FDIC-supervised institutions above the minimum capital ratios, whereas the latter imposes increasingly stringent consequences on depository institutions, particularly as they fall below the minimum capital ratios. Because the capital conservation buffer is designed to absorb losses in stressful periods, the FDIC believes it is appropriate for a depository institution to be able to use some of its capital conservation buffer without being considered less than well capitalized for PCA purposes.

Consistent with the proposal, the interim final rule augments the PCA capital categories by introducing a common equity tier 1 capital measure for four of the five PCA categories (excluding the critically undercapitalized PCA category).

In addition, the interim final rule revises the three current risk-based capital measures for four of the five PCA categories to reflect the interim final rule's changes to the minimum risk-based capital ratios, as provided in revisions to the FDIC's PCA regulations. All FDIC-supervised institutions will remain subject to leverage measure thresholds using the current leverage ratio in the form of tier 1 capital to average total consolidated assets. In addition, the interim final rule amends the PCA leverage measure for advanced approaches depository institutions to include the supplementary leverage ratio that explicitly applies to the “adequately capitalized” and “undercapitalized” capital categories.

12 U.S.C. 1831o(c)(1)(B)(i).

All insured depository institutions must comply with the revised PCA thresholds beginning on January 1, 2015. Consistent with transition provisions in the proposed rules, the supplementary leverage measure for advanced approaches FDIC-supervised institutions that are insured depository institutions becomes effective on January 1, 2018. Changes to the definitions of the individual capital components that are used to calculate the relevant capital measures under PCA are governed by the transition arrangements discussed in section VIII.3 below. Thus, the changes to these definitions, including any deductions from or adjustments to regulatory capital, automatically flow through to the definitions in the PCA framework.

Table 4 sets forth the risk-based capital and leverage ratio thresholds under the interim final rule for each of the PCA capital categories for all insured depository institutions. For each PCA category except critically undercapitalized, an insured depository institution must satisfy a minimum common equity tier 1 capital ratio, in addition to a minimum tier 1 risk-based capital ratio, total risk-based capital ratio, and leverage ratio. In addition to the aforementioned requirements, advanced approaches FDIC-supervised institutions that are insured depository institutions are also subject to a supplementary leverage ratio.

Table 4—PCA Levels for All Insured Depository Institutions

PCA category

Total risk-based Capital (RBC) measure (total RBC ratio)

(percent)

Tier 1 RBC

measure (tier 1 RBC ratio)

(percent)

Common equity tier 1 RBC

measure

(common

equity tier 1 RBC ratio)

(percent)

Leverage measure

Leverage ratio

(percent)

Supplementary

leverage ratio

(percent)*

PCA requirements

Well capitalized

≥10

≥8

≥6.5

≥5

Not applicable

Unchanged from current rule.*

Adequately-capitalized

≥8

≥6

≥4.5

≥4

>3.0

(*).

Undercapitalized

<4.5

<3.00

(*).

Significantly undercapitalized

Not applicable

(*).

Critically undercapitalized

Tangible Equity (defined as tier 1 capital plus non-tier 1 perpetual preferred stock) to Total Assets ≤2

Not applicable

(*).

* The supplementary leverage ratio as a PCA requirement applies only to advanced approaches FDIC-supervised institutions that are insured depository institutions. The supplementary leverage ratio also applies to advanced approaches bank holding companies, although not in the form of a PCA requirement.

To be well capitalized for purposes of the interim final rule, an insured depository institution must maintain a total risk-based capital ratio of 10 percent or more; a tier 1 capital ratio of 8 percent or more; a common equity tier 1 capital ratio of 6.5 percent or more; and a leverage ratio of 5 percent or more. An adequately-capitalized depository institution must maintain a total risk-based capital ratio of 8 percent or more; a tier 1 capital ratio of 6 percent or more; a common equity tier 1 capital ratio of 4.5 percent or more; and a leverage ratio of 4 percent or more.

An insured depository institution is undercapitalized under the interim final rule if its total capital ratio is less than 8 percent, if its tier 1 capital ratio is less than 6 percent, its common equity tier

1 capital ratio is less than 4.5 percent, or its leverage ratio is less than 4 percent. If an institution's tier 1 capital ratio is less than 4 percent, or its common equity tier 1 capital ratio is less than 3 percent, it would be considered significantly undercapitalized. The other numerical capital ratio thresholds for being significantly undercapitalized remain unchanged from the current rules.

Under current PCA standards, in order to qualify as well-capitalized, an insured depository institution must not be subject to any written agreement, order, capital directive, or prompt corrective action directive issued by its primary Federal regulator pursuant to section 8 of the Federal Deposit Insurance Act, the International Lending Supervision Act of 1983, or section 38 of the Federal Deposit Insurance Act, or any regulation thereunder.

See

12 CFR 325.103(b)(1)(iv) (state nonmember banks) and 12 CFR 390.453(b)(1)(iv) (state savings associations). The interim final rule does not change this requirement.

The determination of whether an insured depository institution is critically undercapitalized for PCA purposes is based on its ratio of tangible eq

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