# Regulatory Capital Rules: Regulatory Capital and Standardized Approach for Risk-Weighted Assets > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2026-05960 ## Record - **Collection:** Federal Register - **Document type:** Proposed Rule - **Published:** March 27, 2026 - **Citation:** 91 FR 15332 ## Text DEPARTMENT OF THE TREASURY Office of the Comptroller of the Currency 12 CFR Part 3 [Docket ID OCC-2026-0034] RIN 1557-AF49 FEDERAL RESERVE SYSTEM 12 CFR Parts 217, 238, 252 [Docket No. R-1888] RIN 7100-AH21 FEDERAL DEPOSIT INSURANCE CORPORATION 12 CFR Part 324 RIN 3064-AG23 Regulatory Capital Rules: Regulatory Capital and Standardized Approach for Risk-Weighted Assets AGENCY: Office of the Comptroller of the Currency (OCC), Treasury; the Board of Governors of the Federal Reserve System (Board); and the Federal Deposit Insurance Corporation (FDIC). ACTION: Notice of proposed rulemaking. SUMMARY: The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation are proposing to modify certain aspects of the regulatory capital rule (the proposal). The proposal would revise the risk-based capital treatment of certain exposure categories under the standardized approach, focusing on improving the calibration and risk sensitivity of risk weights that are particularly material to covered banking organizations' lending activities. The proposal would also modify the definition of regulatory capital by removing the threshold-based deduction for mortgage servicing assets for all banking organizations subject to the regulatory capital rule, including banking organizations subject to the community bank leverage ratio framework. In addition, the proposal would require Category III and IV banking organizations to recognize most elements of accumulated other comprehensive income in their regulatory capital. The agencies are concurrently publishing a separate proposal, which would require Category I and II banking organizations to use a new framework to calculate risk-weighted assets, called the expanded risk-based approach and would allow other banking organizations to elect to use the expanded risk-based approach. DATES: Comments must be received by June 18, 2026. ADDRESSES: Comments should be directed to: OCC: Commenters are encouraged to submit comments through the Federal eRulemaking Portal, if possible. Please use the title “Regulatory Capital Rules: Regulatory Capital and Standardized Approach for Risk-weighted Assets” to facilitate the organization and distribution of the comments and identify the number of the specific question(s) to which you are responding. You may submit comments by any of the following methods: • Federal eRulemaking Portal—Regulations.gov: Go to https://regulations.gov/. Enter Docket ID “OCC-2026-0034” in the Search Box and click “Search.” Public comments can be submitted via the “Comment” box below the displayed document information or by clicking on the document title and then clicking the “Comment” box on the top-left side of the screen. For help with submitting effective comments, please click on “Commenter's Checklist.” For assistance with the Regulations.gov site, please call 1-866-498-2945 (toll free) Monday-Friday, 9 a.m.-5 p.m. EST, or email regulationshelpdesk@gsa.gov. • Mail: Chief Counsel's Office, Attention: Comment Processing, Office of the Comptroller of the Currency, 400 7th Street SW, Suite 3E-218, Washington, DC 20219. • Hand Delivery/Courier: 400 7th Street SW, Suite 3E-218, Washington, DC 20219. Instructions: You must include “OCC” as the agency name and Docket ID “OCC-2026-0034” in your comment. In general, the OCC will enter all comments received into the docket and publish the comments on the Regulations.gov website without change, including any business or personal information provided such as name and address information, email addresses, or phone numbers. Comments received, including attachments and other supporting materials, are part of the public record and subject to public disclosure. Do not include any information in your comment or supporting materials that you consider confidential or inappropriate for public disclosure. You may review comments and other related materials that pertain to this action by the following method: Viewing Comments Electronically—Regulations.gov: Go to https://regulations.gov/. Enter Docket ID “OCC-2026-0034” in the Search Box and click “Search.” Click on the “Dockets” tab and then the document's title. After clicking the document's title, click the “Browse All Comments” tab. Comments can be viewed and filtered by clicking on the “Sort By” drop-down on the right side of the screen or the “Refine Comments Results” options on the left side of the screen. Supporting materials can be viewed by clicking on the “Browse Documents” tab. Click on the “Sort By” drop-down on the right side of the screen or the “Refine Results” options on the left side of the screen checking the “Supporting & Related Material” checkbox. For assistance with the Regulations.gov site, please call 1-866-498-2945 (toll free) Monday-Friday, 9 a.m.-5 p.m. EST, or email regulationshelpdesk@gsa.gov. The docket may be viewed after the close of the comment period in the same manner as during the comment period. Board: You may submit comments, identified by Docket No. R-1888, and RIN 7100-AH21 by any of the following methods: • Agency Website: https://www.federalreserve.gov/apps/proposals/. Follow the instructions for submitting comments, including attachments. Preferred Method. • Mail: Benjamin W. McDonough, Secretary, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue NW, Washington, DC 20551. • Hand Delivery/Courier: Same as mailing address. • Other Means: publiccomments@frb.gov. You must include the docket number in the subject line of the message. Comments received are subject to public disclosure. In general, comments received will be made available on the Board's website at https://www.federalreserve.gov/apps/proposals/ without change and will not be modified to remove personal or business information including confidential, contact, or other identifying information. Comments should not include any information such as confidential information that would not be appropriate for public disclosure. Comments should identify the number for the specific question(s) to which they respond. Public comments may also be viewed electronically or in person in Room M-4365A, 2001 C St. NW, Washington, DC 20551, between 9 a.m. and 5 p.m. during Federal business weekdays. FDIC: You may submit comments to the FDIC, identified by RIN 3064-AG23 and identify the number for the specific question(s) to which you are responding, by any of the following methods: Agency Website: https://www.fdic.gov/resources/regulations/federal-register-publications. Follow instructions for submitting comments on the FDIC's website. Email: comments@FDIC.gov. Include RIN 3064-AG23 in the subject line of the message. Mail: Jennifer M. Jones, Deputy Executive Secretary, Attention: Comments—RIN 3064-AG23, Federal Deposit Insurance Corporation, 550 17th Street NW, Washington, DC 20429. Hand Delivered/Courier: Comments may be hand-delivered to the guard station at the rear of the 550 17th Street NW building (located on F Street NW) on business days between 7 a.m. and 5 p.m. Public Inspection: Comments received, including any personal information provided, may be posted without change to https://www.fdic.gov/resources/regulations/federal-register-publications. Commenters should submit only information that the commenter wishes to make available publicly. The FDIC may review, redact, or refrain from posting all or any portion of any comment that it may deem to be inappropriate for publication, such as irrelevant or obscene material. The FDIC may post only a single representative example of identical or substantially identical comments, and in such cases will generally identify the number of identical or substantially identical comments represented by the posted example. All comments that have been redacted, as well as those that have not been posted, that contain comments on the merits of this document will be retained in the public comment file and will be considered as required under all applicable laws. All comments may be accessible under the Freedom of Information Act. FOR FURTHER INFORMATION CONTACT: OCC: Venus Fan, Risk Expert, Benjamin Pegg, Technical Expert, or Diana Wei, Risk Expert, Capital Policy, (202) 649-6370; Carl Kaminski, Assistant Director, Ron Shimabukuro, Senior Counsel, Kevin Korzeniewski, Counsel, Daniel Perez, Counsel, Chris Rafferty, Counsel, Chief Counsel's Office, (202) 649-5490, Office of the Comptroller of the Currency, 400 7th Street SW, Washington, DC 20219. If you are deaf, hard of hearing, or have a speech disability, please dial 7-1-1 to access telecommunications relay services. Board: Anna Lee Hewko, Associate Director, (202) 530-6260; Andrew Willis, Manager, (202) 430-1667; Missaka Nuwan Warusawitharana, Manager, (202) 452-3461; Marco Migueis, Principal Economist, (202) 452-6447; Ke Wang, Principal Economist, (202) 680-8527; Emily Davine, Senior Financial Institution Policy Analyst, (771) 216-7655; Division of Supervision and Regulation; or Jay Schwarz, Deputy Associate General Counsel, (202) 452-2970; Mark Buresh, Senior Special Counsel, (202) 452-5270; Gillian Burgess, Senior Counsel, (202) 736-5564; Jonah Kind, Senior Counsel, (202) 452-2045, Legal Division, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue NW, Washington, DC 20551. For users of TTY-TRS, please call 711 from any telephone, anywhere in the United States. FDIC: Benedetto Bosco, Chief Capital Policy Section; Bob Charurat, Corporate Expert; Irina Leonova, Corporate Expert; Andrew Carayiannis, Chief, Policy and Risk Analytics Section; Michael Maloney, Senior Policy Analyst; Iris Li, Senior Policy Analyst; Olga Lionakis, Senior Policy Analyst; Richard Smith, Capital Markets Policy Analyst; Ernest Barkett, Financial Analyst; Kyle McCormick, Senior Policy Analyst; Keith Bergstresser, Senior Policy Analyst; Lauren Brown, Senior Risk and Policy Analyst; Rachel Romm-Nisson, Risk Analytics Specialist; Jim Yu, Senior Policy Analyst, Peter Yen, Senior Policy Analyst; Huiyang Zhou, Senior Quantitative Risk Specialist; Soo Jeong Kim, Capital Markets Policy Analyst; Capital Markets and Accounting Policy Branch, Division of Risk Management Supervision; Catherine Wood, Counsel; Merritt Pardini, Counsel; Kevin Zhao, Senior Attorney; Nicholas Soyer, Attorney, Michael Overmyer, Special Counsel, Legal Division; regulatorycapital@fdic.gov, (202) 898-6888; Federal Deposit Insurance Corporation, 550 17th Street NW, Washington, DC 20429. SUPPLEMENTARY INFORMATION: Table of Contents I. Introduction and Overview II. Definition of Capital A. Removal of the Mortgage Servicing Asset Deduction B. Recognition of Accumulated Other Comprehensive Income for Category III and IV Banking Organizations III. Calculation of Risk-Weighted Assets Under the Standardized Approach A. General Risk Weight Treatment 1. Residential Mortgage Exposures a. Calculating the Loan-to-Value Ratio b. Risk Weights for Residential Mortgages 2. Corporate Exposures and Certain Other Assets B. Off-Balance Sheet Exposures 1. Definition of Commitment 2. Conversion Factors 3. Commitments With No Pre-Set Limit C. Derivative Contracts D. Credit Risk Mitigation 1. Guarantees and Credit Derivatives a. Substitution Approach b. Adjustment for Credit Derivatives Without Restructuring 2. Collateralized Transactions a. Simple Approach b. Collateral Haircut Approach i. Formula for Determining Exposure Amount ii. Market Price Volatility Haircuts 3. Prepaid Credit Protection 4. Maturity and Currency Mismatch Adjustment E. Securitization Framework 1. Definitions a. Synthetic Securitizations b. Technical Modifications 2. Operational Requirements a. Early Amortization Provisions b. Synthetic Excess Spread c. Minimum Payment Threshold d. Resecuritization Exposures e. Clean-Up Calls 3. Exposure Amount of a Securitization Exposure 4. Securitization Standardized Approach (SEC-SA) a. Definition of Attachment Point and Detachment Point b. Definition of W Parameter c. Delinquency-Adjusted (Ka) and Non-Adjusted (Kg) Weighted-Average Capital Requirement of the Underlying Exposures d. Supervisory Risk-Weight Floors 5. Exceptions to the SEC-SA Risk-Based Capital Treatment for Securitization Exposures a. Purchased Credit Derivatives b. Nth-to-Default Credit Derivatives c. Derivative Contracts That Do Not Provide Credit Enhancements d. Overlapping Exposures e. Look-Through Approach for Senior Securitizations Exposures f. Credit-Enhancing Interest Only Strips g. Non-Performing Loan Securitizations i. Attachment and Detachment Points for NPL Securitizations Subject to the SEC-SA 6. Credit Risk Mitigation for Securitization Exposures F. Indexing of Thresholds IV. Disclosure Requirements V. Estimated Impact on Capital Requirements A. Impact on Risk-Weighted Assets by Lending Category B. Trading-Related Impact on Risk-Weighted Assets C. Impact on Risk-Weighted Assets by Bank Size D. Impact of Changes to Risk-Weighted Assets on Required Capital E. Impact of AOCI Recognition F. Data and Estimation Methodology G. Data Appendix VI. Economic Analysis A. Reasonable Alternatives B. Effects on Lending C. Economic Efficiency D. Effects on Competitiveness E. Effects on Safety and Soundness F. Other Costs G. Interactions With CBLR Proposal H. Conclusion VII. Technical Amendments to the Capital Rule A. Accounting Standards Update 2025-08 B. Allowance for Loan and Lease Losses Definition C. Clarifications to Procedures, Effective Dates, and Severability VIII. Related Proposals and Proposed Amendments to Related Rules A. Related Proposals B. Board Amendments IX. Administrative Law Matters A. Paperwork Reduction Act B. Regulatory Flexibility Act C. Plain Language D. Riegle Community Development and Regulatory Improvement Act of 1994 E. OCC Unfunded Mandates Reform Act of 1995 F. Providing Accountability Through Transparency Act of 2023 G. Executive Orders 12866, 13563, and 14192 I. Introduction and Overview The Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (Board), and the Federal Deposit Insurance Corporation (FDIC) (collectively, the agencies) are proposing to modify aspects of the capital rule. Specifically, the proposal would revise certain elements of the calculation of the denominator of the risk-based capital ratios (risk-weighted assets) under the standardized approach and make certain adjustments to the definition of regulatory capital. 1 The proposed changes aim to improve risk sensitivity while generally retaining the simplicity of the current framework. Elements of the proposal would also address comments received from the Economic Growth and Regulatory Paperwork Reduction Act (EGRPRA) public notices. 2 The banking organizations that would be subject to the changes to risk-weighted assets under this proposal are referred to as “covered banking organizations” herein. 1 The standardized approach does not apply to banking organizations that have elected to use the community bank leverage ratio framework. Under the terms of a concurrent proposal, the standardized approach would not apply to Category I or II banking organizations or to banking organizations that elect to use the expanded risk-based approach. In 2019, the agencies adopted rules establishing four categories of capital standards for U.S. banking organizations with $100 billion or more in total consolidated assets and foreign banking organizations with $100 billion or more in combined U.S. assets. Under this framework, Category I standards apply to U.S.-domiciled bank holding companies identified as GSIBs and their depository institution subsidiaries. Category II standards apply to banking organizations with at least $700 billion in total consolidated assets or at least $75 billion in cross-jurisdictional activity and their depository institution subsidiaries. Category III standards apply to banking organizations with total consolidated assets of at least $250 billion or at least $75 billion in weighted short-term wholesale funding, nonbank assets, or off-balance sheet exposure and their depository institution subsidiaries. Category IV standards apply to banking organizations with total consolidated assets of at least $100 billion that do not meet the thresholds for a higher category and their depository institution subsidiaries. See 12 CFR 3.2 (OCC); 12 CFR 217.400, 238.10, 252.5, (Board); 12 CFR 324.2 (FDIC); “Prudential Standards for Large Bank Holding Companies, Savings and Loan Holding Companies, and Foreign Banking Organizations,” 84 FR 59032 (Nov. 1, 2019); “Changes to Applicability Thresholds for Regulatory Capital and Liquidity Requirements,” 84 FR 59230 (Nov. 1, 2019). 2 The agencies, together with the Federal Financial Institutions Examination Council, commenced a review under the Economic Growth and Regulatory Paperwork Reduction Act of 1996 in 2024 to identify outdated or otherwise unnecessary regulatory requirements. The agencies will continue reviewing and considering these comments as part of any final rulemaking. Public Law 104-208, Div. A, Title II, section 2222, 110 Stat. 3009-414, (1996) (codified at 12 U.S.C. 3311). See also Regulatory Publication and Review Under the Economic Growth and Regulatory Paperwork Reduction Act of 1996, 90 FR. 35241 (Jul. 25, 2025). The prompt corrective action framework in section 38 of the Federal Deposit Insurance Act (FDI Act) requires the agencies to set capital standards for insured depository institutions that include a risk-based capital requirement and provides that the agencies may establish any additional relevant capital measures to carry out the purpose of that section. 3 Various other statutory authorities provide the agencies with broad discretionary authority to set capital requirements and standards for banking organizations supervised by the agencies, including national banking associations, state-chartered banks, savings associations, and depository institution holding companies. 4 Further, Congress has authorized the agencies to establish enhanced risk-based capital requirements and standards for larger banking organizations subject to the capital rule. 5 3 See 12 U.S.C. 1831o(c)(1)(A), (c)(1)(B)(i). 4 See 12 U.S.C. 93a (national banking associations); 12 U.S.C. 248(i), 324, 327, 329 (state member banks); 12 U.S.C. 1463 (savings associations); 12 U.S.C. 1467a(g)(1) (savings and loan holding companies); 12 U.S.C. 1844(b) (bank holding companies); 12 U.S.C. 3106 (certain U.S. operations of foreign banking organizations); 12 U.S.C. 3902(1)-(2), 3907(a), 3909(a), (c)(1)-(2) (depository institutions; affiliates of depository institutions, including holding companies; and certain U.S. operations of foreign banking organizations); 12 U.S.C. 5371 (insured depository institutions, depository institution holding companies, and nonbank financial companies supervised by the Board). 5 See., e.g., section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), as amended by section 401 of the Economic Growth, Regulatory Relief, and Consumer Protection Act, which requires the Board to establish enhanced prudential standards that include risk-based capital requirements for bank holding companies with $250 billion or more in total consolidated assets. In a concurrent notice of proposed rulemaking, the agencies are seeking comment on changes to the risk-based capital framework that would apply to Category I and II banking organizations as well as banking organizations with significant trading activity (expanded risk-based proposal). 6 That proposal would introduce a new “expanded risk-based approach”—which would include requirements for credit risk, equity risk, and operational risk—and a revised market risk framework. Notably, the expanded risk-based proposal would allow banking organizations of any size to elect to use the expanded risk-based approach to determine requirements for credit risk, equity risk, and operational risk in place of the standardized approach. 7 6 Banking organizations with significant trading activities that are not Category I or II banking organizations would apply (1) the market risk framework under the expanded risk-based proposal and (2) the standardized approach in this proposal (unless they elect to use expanded risk-based approach under the expanded risk-based proposal) to determine their risk-weighted assets. 7 The agencies consider the proposed requirements under the expanded risk-based approach to be appropriate for Category I and II banking organizations given their risk profiles, complexity, risk management resources, and international activities. Although the expanded risk-based proposal poses more operational complexity relative to this proposal, the expanded risk-based proposal would allow other banking organizations to elect to use it. A banking organization that elects to do so would be subject to the same definition of capital as Category I and II banking organizations. Analysis undertaken by the agencies in connection with the expanded risk-based proposal included evaluating the appropriateness of the risk weights applicable to exposures at the business-line level. That analysis informs the changes in this proposal, including revisions to risk weights that are particularly material to lending activities. Specifically, the analysis suggests revisions would be appropriate to the risk weights applicable to residential mortgage exposures, corporate exposures, and certain exposures in the current standardized approach's “other assets” category. The proposal would reduce the risk weight applicable to corporate exposures from 100 percent to 95 percent and the risk weight applicable to all assets not specifically assigned a different risk weight under the rule from 100 percent to 90 percent. The proposal would also introduce a broader range of risk weights for residential mortgage exposures, based on more granular risk factors. In addition, the proposal would adopt the same definition of commitment as the expanded risk-based proposal and would align the credit conversion factors for certain off- balance sheet exposures, including equity commitments, with that proposal. These changes focus on exposure categories that comprise a substantial amount of total risk-weighted assets for covered banking organizations and aim to balance a more risk-sensitive calibration of the requirements with retaining the simplicity of the standardized approach. 8 9 8 See Table V.G.1 in the Data Appendix (Section V.G.) for a breakdown of the size of the exposure categories whose treatment would be revised under this proposal. 9 The calculation of the risk-weighted assets under the expanded risk-based approach is more complex than under the standardized approach as it is more granular and includes several additional risk factors. The expanded risk-based approach would also include an operational risk capital requirement and the requirement to use the standardized approach for counterparty credit risk to determine the exposure amount for derivative contracts. Banking organizations subject to the expanded risk-based approach would also be subject to a more risk-sensitive but complex definition of capital, including the requirement to include most elements of accumulated other comprehensive income in regulatory capital. To improve risk sensitivity, this proposal would also make targeted adjustments to the existing methodologies for determining exposure amounts for counterparty credit risk and risk-weighted asset amounts for securitizations, as well as for recognizing the benefits of credit risk mitigants. These targeted adjustments would align with adjustments included in the expanded risk-based proposal. Improving the risk sensitivity of the regulatory capital framework would mean that a banking organization's capital requirements more readily increase or decrease due to changes in the risk of its business activities. In addition to changes to the calculation of risk-weighted assets, the proposal would modify the definition of regulatory capital by removing the threshold-based deduction of mortgage servicing assets (MSAs). All MSAs would receive a 250 percent risk weight under the proposal, consistent with the risk weight in the current capital rule for MSAs that do not exceed the deduction threshold. This proposed revision would promote mortgage origination and servicing by banking organizations in a risk-appropriate manner and would apply to all banking organizations subject to the regulatory capital rule, including banking organizations subject to the community bank leverage ratio framework. 10 10 The expanded risk-based approach proposal contains a corresponding change that would apply to Category I and II banking organizations. The proposal would require Category III and IV banking organizations to include most elements of accumulated other comprehensive income (AOCI) in common equity tier 1 capital, consistent with the current treatment applicable to Category I and II banking organizations. 11 This change would better reflect the capital adequacy and loss-absorbing capacity of Category III and IV banking organizations in their regulatory capital ratios. The proposal would include a transition period five years from the effective date of any final rule for Category III and IV banking organizations to phase-in the effect of recognizing AOCI in regulatory capital; this transition period would provide sufficient time to adapt to the changes while minimizing any potential adverse impact. 12 11 AOCI generally includes accumulated unrealized gains and losses on certain assets and liabilities that have not been included in net income but are included in equity under U.S. generally accepted accounting principles (for example, unrealized gains and losses on securities designated as available-for-sale). 12 This transition period would mirror the transition period under the expanded risk-based proposal provided to banking organizations that elect to use the expanded risk-based approach and that do not currently recognize AOCI in their regulatory capital. The proposal would also amend certain dollar-based regulatory thresholds in the standardized approach to reflect inflation and ensure that such thresholds preserve their intended application in real terms over time. Finally, the proposal would not make any modifications to the enhanced disclosure requirements under section _.63 of the capital rule but seeks comment on whether certain modifications would be appropriate. 13 13 The agencies anticipate proposing revisions to several reporting forms of the agencies filed by covered banking organizations that would align with the proposed revisions to the capital rule. Taken together, the proposed changes aim to improve the risk sensitivity of the framework while retaining its simplicity. The agencies expect the proposal to reduce the common equity tier 1 capital requirements applicable to Category III and IV holding companies by 3.0 percent and the capital requirements applicable to smaller holding companies 14 by 7.8 percent. The reduction in requirements for Category III and IV holding companies reflects a 6.1 percent reduction due to the revised risk-weighted assets combined with an estimated 3.1 percent increase in capital requirements due to an estimated long-run average impact of including AOCI in regulatory capital. Similarly, the agencies expect the proposal to reduce the common equity tier 1 capital requirements applicable to depository institution subsidiaries of Category III and IV banking organizations by 4.7 percent, and those applicable to smaller depository institutions by 8.0 percent. The agencies performed economic analysis to assess the potential effects of the proposal (see Section VI). The improvements in risk sensitivity of capital requirements and associated benefits expected to result from the proposal justify the proposal's expected costs. 14 Refers to holding companies with total assets under $100 billion that are required to report risk-based capital information on the FR Y9-C. The agencies seek comment on all aspects of the proposal. II. Definition of Capital The proposal would broadly maintain the definition of capital applicable to covered banking organizations in the current capital rule with two modifications. The proposal would (1) eliminate the requirement to deduct MSAs above a threshold from common equity tier 1 capital for all covered banking organizations 15 and (2) require Category III and IV banking organizations to recognize certain elements of AOCI in common equity tier 1 capital. 15 In addition, the proposal would require a covered banking organization to deduct from common equity tier 1 capital any portion of a credit-enhancing interest only strip that does not constitute an after-tax-gain-on sale, as discussed in section III.E.5.f. A. Removal of the Mortgage Servicing Asset Deduction Under the current capital rule, covered banking organizations must deduct from common equity tier 1 capital amounts of MSAs that exceed 25 percent of the banking organization's common equity tier 1 capital. Under the proposal, covered banking organizations would no longer be required to deduct any amount of MSAs from common equity tier 1 capital. Instead, MSAs would be subject to a 250 percent risk weight, consistent with the treatment in the current capital rule for MSAs that do not exceed the deduction threshold. 16 16 This revision would also be consistent with comments received under EGRPRA as commenters requested removal of the MSA threshold. The expanded risk-based approach proposal would make the same modification to the definition of regulatory capital for Category I and II banking organizations and banking organizations that elect to use the expanded risk-based approach. An MSA arises when a banking organization sells a loan to a third party but retains the obligation to service the loan in exchange for a fee. Banking organizations may also purchase, sell, or transfer MSAs separately from the underlying mortgage loans. MSAs can be a useful tool for banking organizations to manage interest rate risk. The value of MSAs generally increases when interest rates rise, which extends the expected duration of related servicing fees. As a result, they may provide a hedge against losses on other assets that decline in value in the same interest rate environment. 17 17 In a rising rate environment, the expected life of a mortgage will increase due to reduced prepayments. As a result, MSAs will increase in value, as the banking organization will collect servicing fees over a longer period of time. The increased value of MSAs act as a natural hedge against existing mortgage-backed securities which would be expected to trade at a discount in such an environment. Moreover, MSAs are important for banking organizations to maintain their relationship with borrowers by retaining customer-facing relationships even after transferring the underlying loans, allowing cross-selling of products. Banking organizations can also improve efficiency by increasing scale. A deduction approach for MSAs can discourage banking organizations from creating economies of scale, which can hinder their ability to compete in mortgage underwriting or servicing businesses and to manage risks. At the same time, MSAs have long been subject to elevated capital requirements because of the high level of uncertainty regarding the ability of banking organizations to realize value from these assets, especially under adverse financial conditions. MSAs may face significant valuation risk, which mainly stems from prepayment risk, default risk, and liquidity risk. For example, increased refinancing of mortgage loans due to lower interest rates can quickly erode the value of MSA portfolios, as can increased incidents of mortgage defaults. MSAs can also be difficult to value, as bank portfolios of MSAs can be heterogeneous and MSA valuations rely on assessments of future economic variables. Maintaining the 250 percent risk weight for MSAs would promote regulatory capital requirements that are commensurate with the risk of these assets. Question 1: What are the advantages and disadvantages of the proposed treatment of MSAs? What are the implications of the proposed treatment of MSAs for banking organizations' mortgage origination business? To what extent does the 250 percent risk weight appropriately reflect the risk of these assets throughout the economic cycle? Given the potential volatility of MSAs under certain circumstances, what are the advantages and disadvantages of the agencies imposing a higher limit on MSA as a percentage of common equity tier 1 capital (for example, 100 percent) and why? What are the advantages and disadvantages of differentiating the treatment of MSAs based on the size of the banking organization (for example, banking organizations with assets under $10 billion or over $100 billion) or applicable capital framework (for example, banking organizations that elect the community bank leverage ratio framework)? B. Recognition of Accumulated Other Comprehensive Income for Category III and IV Banking Organizations Under the current capital rule, Category I and II banking organizations are required to include most elements of AOCI in regulatory capital. All other banking organizations, including all covered banking organizations, had the option to make a one-time election to opt-out of recognizing most elements of AOCI and related deferred tax assets and liabilities within regulatory capital. 18 Under the proposal, Category III and IV banking organizations would be required to include all AOCI components in common equity tier 1 capital, except gains and losses on cash-flow hedges where the hedged item is not recognized on a covered banking organization's balance sheet at fair value. This would require all net unrealized gains and losses on holdings of available-for-sale debt securities from changes in fair value to flow through to common equity tier 1 capital, including those that result primarily from fluctuations in benchmark interest rates. 19 This treatment would align with the treatment of AOCI for banking organizations subject to the expanded risk-based proposal. 18 See 12 CFR 3.22(b) (OCC); 12 CFR 217.22(b) (Board); 12 CFR 324.22(b) (FDIC). A banking organization that made an opt-out election is currently required to adjust common equity tier 1 capital as follows: subtract any net unrealized holding gains and add any net unrealized holding losses on available-for-sale securities; subtract any accumulated net gains and add any accumulated net losses on cash flow hedges; subtract any amounts recorded in AOCI attributed to defined benefit postretirement plans resulting from the initial and subsequent application of the relevant GAAP standards that pertain to such plans (excluding, at the banking organization's option, the portion relating to pension assets deducted under § __.22(a)(5) of the current capital rule); and, subtract any net unrealized holding gains and add any net unrealized holding losses on held-to-maturity securities that are included in AOCI. 19 Available-for-sale securities refers to debt securities. Accounting Standards Update 2016-01 eliminated the classification of available-for-sale equity securities under Accounting Standards Codification Subtopic 321-10 and generally requires investments in equity securities to be measured at fair value with changes in fair value recognized in net income. Changes in the fair value of ( i.e., the unrealized gains and losses on) a banking organization's equity securities are recognized through net income rather than other comprehensive income. AOCI is an important indicator that regulators and market observers use to evaluate the capital strength of a banking organization. The requirement to recognize elements of AOCI in regulatory capital has helped improve the transparency of regulatory capital ratios for Category I and II banking organizations, as it better reflects a banking organization's actual loss-absorbing capacity at a specific point in time, notwithstanding the potential volatility that such recognition may pose for its regulatory capital ratios. Category III and IV banking organizations have the tools and access to capital markets to manage the volatility of regulatory capital that recognition of AOCI in capital may cause. In addition, as noted in the expanded risk-based proposal, any banking organization that elects to apply the expanded risk-based approach would be required to include AOCI in regulatory capital. Given the more complex nature of the expanded risk-based proposal, these electing banking organizations are expected to have the ability to manage the volatility which may arise from the recognition of AOCI in capital, even if they are smaller banking organizations. AOCI contributes to a banking organization's balance sheet equity and may be used by market participants in evaluating a banking organization's capital position. 20 Adverse trends in a banking organization's balance sheet equity can result in negative market perception and have liquidity implications. 21 Banking organizations that do not include AOCI in regulatory capital are often reluctant to sell available-for-sale securities that have unrealized losses, as the losses would have to be recognized upon sale, thereby reducing regulatory capital. However, banking organizations may need to take such steps to meet liquidity needs. Recognizing elements of AOCI in regulatory capital achieves a better alignment of regulatory capital with a banking organization's point-in-time loss-absorbing capacity. 20 See 84 FR 59230, 59249 (Nov. 1, 2019) 21 See Interagency Advisory on Interest Rate Risk Management (OCC Bulletin 2010-1, SR 10-1, FIL 2-2012, Jan. 11, 2010). Question 2: What are the advantages and disadvantages of requiring Category III and IV banking organizations to recognize AOCI in their regulatory capital? What other scope of application for the proposed AOCI treatment should the agencies consider and why? Please provide any supporting data and analysis. The proposal includes transition provisions that would provide Category III and IV banking organizations that do not currently recognize AOCI in their regulatory capital with a phase-in for reflecting AOCI in their regulatory capital over a five-year period from the effective date of any final rule. 22 Such a banking organization would determine its AOCI adjustment amount as the sum of: (1) net unrealized gains or losses on available-for-sale securities, plus (2) accumulated net gains or losses on cash flow hedges, plus (3) any amounts recorded in AOCI attributed to defined benefit postretirement plans resulting from the initial and subsequent application of the relevant GAAP standards that pertain to such plans, plus (4) net unrealized holding gains or losses on held-to-maturity securities that are included in AOCI. This AOCI adjustment amount would be transitioned as set forth in Table 1 below for Category III and IV banking organizations that have previously made the AOCI opt-out election. 23 If the banking organization's AOCI adjustment amount is positive, it would multiply this amount by the percentage of the appropriate transition period provided in Table 1 below and subtract the resulting amount from its common equity tier 1 capital. If the AOCI adjustment amount is negative, the banking organization would perform the same calculation and add back the resulting amount to its common equity tier 1 capital. 22 This transition period would mirror the transition period under the expanded risk-based proposal provided to banking organizations that elect to use the expanded risk-based approach and that do not currently recognize AOCI in their regulatory capital. 23 For simplicity and illustrative purposes, the transition table assumes an effective date of January 1, 2027. EP27MR26.016 Question 3: What are the advantages and disadvantages of the proposed transition provisions for AOCI adjustments? What alternatives to the proposed transition provisions should the agencies consider, and why? For example, what are the costs and benefits of different transition-period durations or different recognition percentages in each period of the transition? Question 4: Under the proposal, Category III or IV banking organizations would recognize AOCI in common equity tier 1 capital through a transition period, with only a portion of AOCI recognized during the transition. Category III and IV banking organizations with positive AOCI (for example, from unrealized gains on available-for-sale securities) would recognize less AOCI in its regulatory capital ratios during the transition period than they would if the full AOCI amount were recognized immediately. What are the costs and benefits of making the transition period optional, allowing Category III and IV banking organizations to elect to recognize the full AOCI amount on the effective date of the rule? Please provide relevant data to support your views, including information on the magnitude of AOCI at Category III and IV banking organizations and how it has varied over time and in different interest rate environments. Question 5: The expanded risk-based proposal would provide covered banking organizations under this proposal the choice to adopt the expanded risk-based approach. The expanded risk-based proposal includes the same AOCI transition period for banking organizations that do not currently recognize AOCI in their regulatory capital and that elect to use the expanded risk-based approach. What are the costs and benefits of applying the same AOCI transition provisions to banking organizations that elect to adopt the expanded risk-based approach as would apply to Category III and IV banking organizations under the standardized approach? Should banking organizations that elect to adopt the expanded risk-based approach be subject to different AOCI transition provisions? If so, what alternative transition provisions would be appropriate, and why? III. Calculation of Risk-Weighted Assets Under the Standardized Approach Under the proposal, a covered banking organization would continue to follow the mechanics of the current capital rule for determining its standardized total risk-weighted assets. 24 Accordingly, such a banking organization would calculate its risk-weighted asset amounts for its on- and off-balance sheet exposures and, if applicable, risk-weighted assets for market risk covered positions. Risk-weighted asset amounts generally are determined by assigning on-balance sheet assets to broad risk-weight categories according to the counterparty, or, if relevant, the guarantor or collateral. Similarly, risk-weighted asset amounts for off-balance sheet items are calculated using a two-step process: (1) multiplying the amount of the off-balance sheet exposure by a conversion factor to determine a credit equivalent amount or adjusted carrying value, and (2) assigning the credit equivalent amount or adjusted carrying value to a relevant risk-weight category. 24 See generally, 12 CFR part 3, subpart D (OCC); 12 CFR part 217, subpart D (Board); 12 CFR part 324, subpart D (FDIC). A. General Risk Weight Treatment To improve the risk sensitivity of the standardized approach, the proposal would make targeted revisions to the general risk weight treatment of certain exposure categories that are particularly material to bank lending activities. As more specifically discussed below, the proposal would (1) introduce a more risk-sensitive treatment for residential mortgage exposures and (2) amend the risk weights applicable to corporate exposures and to all assets not specifically assigned a different risk weight under the current standardized approach. The risk weights applicable to all other exposure categories would remain unchanged under the proposal. 1. Residential Mortgage Exposures Under the proposal, a residential mortgage exposure would continue to be defined as an exposure that is primarily secured by a first or subsequent lien on one-to-four family residential property or an exposure with an original and outstanding amount of $1 million or less that is primarily secured by a first or subsequent lien on a residential property that is not one-to-four family. 25 A residential mortgage exposure would not include an ADC exposure, a pre-sold construction loan, a statutory multifamily mortgage, or an HVCRE exposure. 25 See 12 CFR __.2. To improve risk sensitivity, the proposal would introduce a loan-to-value (LTV)-based approach for assigning risk weights to certain residential mortgage exposures as discussed in section III.A.1.b. of this SUPPLEMENTARY INFORMATION . LTV ratios are a useful credit risk indicator as higher levels of homeowner equity generally reduce the likelihood of borrower default and provide lenders with a degree of protection against credit losses. The proposed LTV-based approach would further differentiate risk weights based on whether a residential mortgage is dependent on cash flows generated by the real estate securing the extension of credit. Residential mortgage exposures in which the primary source of repayment is dependent on cash flows generated by the real estate can expose a banking organization to elevated credit risk relative to residential mortgage exposures where the source of repayment does not face such dependency, as the obligor may be unable to meet its financial commitments when cash flows from the property decrease, such as when tenants default or properties are unexpectedly vacant. 26 Residential mortgage exposures that are dependent on such cash flows to repay the loan can also be more affected by local market conditions and, thus, present elevated credit risk relative to exposures that are serviceable by the income, cash, or other assets of the obligor. For example, an increase in the supply of competitive rental property could lower rental prices and suppress cash flows needed to support repayment of the loan. 26 See Board of Governors of the Federal Reserve System, Financial Stability Report (November 2020), https://www.federalreserve.gov/publications/files/financial-stability-report-20201109.pdf. If the underwriting process at origination of the residential mortgage exposure considers any cash flows generated by the real estate securing the loan, such as from rental payments, then the exposure would meet the proposal's definition of dependent on the cash flows generated by the real estate. Evaluating the dependence on cash flows generated from the real estate is a conservative and straightforward measure of credit risk. Reliance on cash flows from the property for repayment of a loan indicates increased risk of nonpayment relative to when the borrower has sufficient funds from other sources for full repayment of the loan. Given their increased credit risk, the proposal would assign higher risk weights to residential mortgage exposures that are dependent on proceeds or cash flows generated from the real estate itself to service the loan. Under the proposal, additional loan characteristics can affect whether an exposure would be considered dependent on cash flows from the real estate. The proposal's definition of dependent on the cash flows generated by the real estate would exclude any residential mortgage exposure that is secured by the obligor's principal residence, as such mortgage exposures present reduced credit risk relative to real estate exposures that are secured by the obligor's non-principal residence. 27 For residential properties that are not the obligor's principal residence, including vacation homes and other second homes, such properties would be considered dependent on the cash flows generated by the real estate unless the covered banking organization has relied solely on the obligor's personal income and resources, rather than rental income (or resale or refinance of the property), to ascertain the obligor's capacity to repay the loan. 28 27 See Breck Robinson, Federal Reserve Bank of Richmond, and Richard M. Todd, Federal Reserve Bank of Minneapolis, “The Role of Non-Owner-Occupied Homes in the Current Housing and Foreclosure Cycle,” which cites multiple studies that loans on non-owner occupied properties have higher loss rates on mortgages to non-occupant owners than on mortgages to owner-occupants, at least after controlling for credit scores and other standard underwriting criteria. Pg. 6. https://www.richmondfed.org/~/media/richmondfedorg/publications/research/working_papers/2010/pdf/wp10-11.pdf. 28 For example, if (1) a borrower purchases a two-unit property with the intention of making one unit their principal residence, (2) the borrower intends to rent out the second unit to a third party, and (3) the covered banking organization considered the cash flows from the rental unit as a source of repayment, the exposure would not meet the proposal's definition of dependent on the cash flows generated by the real estate because the property securing the exposure is the borrower's principal residence. To be eligible to use the proposed LTV-based approach, a residential mortgage exposure would be required to: (1) be secured by a property that is either owner-occupied or rented; (2) be made in accordance with prudent underwriting standards, including relating to the loan amount as a percent of the value of the property; 29 (3) not be 90 days or more past due or carried in nonaccrual status; and (4) not be restructured or modified. 30 31 Additionally, the property would need to be valued in accordance with the proposed requirements included in the proposed LTV ratio calculation, as discussed below. Consistent with the current capital rule, residential mortgage exposures that do not meet the above criteria or are a junior lien residential mortgage exposure would continue to receive a 100 percent risk weight. 29 The agencies expect these underwriting standards to align with the agencies' safety and soundness and real estate lending guidelines. See 12 CFR part 30, appendix C and 12 CFR part 34, appendix A to subpart D (OCC); 12 CFR part 208, appendix C (Board); 12 CFR parts 364 and 365 (FDIC). 30 Consistent with the current capital rule and under the proposal, when a covered banking organization holds the first-lien and junior-lien(s) residential mortgage exposures and no other party holds an intervening lien, the covered banking organization would be required to combine the exposures and treat them as a single first-lien residential mortgage exposure. 31 These requirements generally align with the current capital rule's requirements for first-lien residential mortgages that are eligible for a 50 percent risk weight. Question 6: The agencies seek comment on the set of residential mortgage exposures that are eligible to use the LTV-based approach. What are the advantages and disadvantages of aligning the scope of mortgages eligible to use the LTV-based approach with the current capital rule's 50 percent risk-weight category for residential mortgage exposures? What other alternatives should the agencies consider? Should covered banking organizations have the option to adopt the LTV-based approach or the option to retain the current treatment which applies less risk-sensitive risk weights of 50 and 100 percent? Question 7: The agencies seek comment on the appropriateness of using an LTV-based approach to determine risk-weights for residential mortgages as a standardized approach and the operational or administrative burden associated with its implementation. What are the advantages or disadvantages of using an LTV-based approach for the standardized approach? What alternative approaches should the agencies consider, and why? Please provide examples of potential operational or administrative challenges associated with implementing the LTV-based approach. a. Calculating the Loan-to-Value Ratio Under the proposal and in line with the expanded risk-based approach proposal, covered banking organizations would use an LTV ratio to assign a risk weight applicable to certain residential mortgage exposures. The proposed calculation of the LTV ratio would generally align with the real estate lending guidelines, except with respect to the recognition of private mortgage insurance. A covered banking organization would calculate the LTV ratio for purposes of Table III.1 and Table III.2 below by dividing the extension of credit by the value of the property. The extension of credit means the total outstanding amount of the loan, including any undrawn committed amount. The total outstanding amount reflects the current amortized balance as the loan pays down, which would allow a covered banking organization to assign a lower risk weight to a loan over time as the principal is repaid. Similarly, if an extension of credit increases, a covered banking organization would reflect that increase in the LTV ratio. For the LTV ratio calculation, a covered banking organization would calculate the loan amount without making any adjustments for credit loss provisions or private mortgage insurance. Not recognizing private mortgage insurance for these purposes would be consistent with the current capital rule's definition of eligible guarantor, which does not recognize an insurance company predominately engaged in the business of providing credit protection (such as a monoline bond insurer or re-insurer). 32 During the 2007-2009 housing market stress, the performance of private mortgage insurance deteriorated at the same time as the underlying exposures. 33 Under the proposal and consistent with the current capital rule, private mortgage insurance is considered when a covered banking organization identifies which of its residential mortgage exposures are made in accordance with prudent underwriting standards and eligible to use the proposed risk weights discussed in section III.A.1.b. of this SUPPLEMENTARY INFORMATION . 34 32 A guarantor is not an eligible guarantor under the current capital rule if the guarantor's creditworthiness is positively correlated with the credit risk of the exposures for which it has provided guarantees. 78 FR 62141 (Oct. 11, 2013). See definition of eligible guarantor in § __.2 of the capital rule. 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC). 33 See Laurie Goodman and Karan Kuhl, “Sixty Years of Private Mortgage Insurance in the United States”, The Urban Institute Housing Finance Policy Center, August 2017.Pg. 7, https://www.urban.org/sites/default/files/publication/92676/2017_08_18_sixty_years_of_pmi_finalizedv3_3.pdf. 34 See 12 CFR __.32(g)(1)(ii). The value of the property would mean the value at the time of origination of all real estate properties securing the extension of credit, including the increased estimated value of the property if the property is being improved by an extension of credit. The value of the property would also include the fair value of any readily marketable collateral and other acceptable collateral, as defined in the real estate lending guidelines, that secures the extension of credit. For exposures subject to the Real Estate Lending, Appraisal Standards, and Minimum Requirements for Appraisal Management Companies or Appraisal Standards for Federally Related Transactions (collectively, the appraisal rule), 35 the market value of real estate would be a valuation that meets all requirements of that rule. For exposures not subject to the appraisal rule, the proposal would require that (1) the market value of real estate be obtained from an independent valuation of the property using prudently conservative valuation criteria and (2) the valuation be done independently from the covered banking organization's origination and underwriting process. Most residential mortgage exposures held by insured depository institutions are subject to the agencies' appraisal rule, which also provides for evaluations in some cases, and provides for certain exceptions, such as where a lien on real estate is taken as an abundance of caution. To help ensure that the value of the real estate is determined in a prudently conservative manner, the proposal would also provide that, for exposures not subject to the appraisal rule, the valuations of the real estate properties would need to exclude expectations of price increases and be adjusted downward to take into account the potential for the current market prices to be significantly above the values that would be sustainable over the life of the loan. 35 See 12 CFR part 34, subpart C or subpart G (OCC); 12 CFR part 208, subpart E or 12 CFR part 225, subpart G (Board); 12 CFR part 323 (FDIC). In addition, when the residential mortgage exposure finances the purchase of a property, the value would be the lower of (1) the actual acquisition cost of the property and (2) the market value obtained from either (i) the valuation requirements under the appraisal rule (if applicable) or (ii) as described above, an independent valuation using prudently conservative valuation criteria that is separate from the covered banking organization's origination and underwriting process. Using the value of a property at origination when calculating the LTV ratio protects against volatility risk or short-term market price inflation. For purposes of the LTV ratio calculation, the proposal would require covered banking organizations to use the value of the property at the time of origination, except under the following circumstances: (1) the covered banking organization's primary Federal supervisor requires the covered banking organization to revise the property value downward; (2) an extraordinary event occurs resulting in a permanent reduction of the property value (for example, a natural disaster); or (3) modifications are made to the property that increase its market value and are supported by an appraisal or independent evaluation using prudently conservative criteria. These proposed exceptions are intended to constrain the use of values other than the value of the property at loan origination only to exceptional circumstances that are sufficiently material to warrant use of a revised valuation. For purposes of determining the value of the property, the proposal would use the definition of readily marketable collateral and other acceptable collateral consistent with the real estate lending guidelines. Therefore, readily marketable collateral would mean insured deposits, financial instruments, and bullion in which the covered banking organization has a perfected security interest. Financial instruments and bullion would need to be salable under ordinary circumstances with reasonable promptness at a fair market value determined by quotations based on actual transactions, in an auction or on similarly available daily bid and ask price market. Other acceptable collateral would mean any collateral in which the covered banking organization has a perfected security interest that has a quantifiable value and is accepted by the covered banking organization in accordance with safe and sound lending practices. Under the proposal, other acceptable collateral would include, among other items, unconditional irrevocable standby letters of credit for the benefit of the covered banking organization. Readily marketable collateral and other acceptable collateral must be appropriately discounted by the covered banking organization consistent with the banking organization's usual practices for making loans secured by such collateral. The reasonableness of a covered banking organization's underwriting criteria would continue to be reviewed through the supervisory process to help ensure its real estate lending policies are consistent with safe and sound banking practices. Question 8: The agencies have considered various alternatives relating to how private mortgage insurance should be recognized for residential mortgages exposures beyond the proposed treatment of considering private mortgage insurance when identifying which residential mortgage exposures meet the requirements to be considered prudently underwritten and eligible to use the proposed LTV-based approach. What would be the pros and cons of providing explicit recognition of private mortgage insurance in the calculation of LTV ratios for purposes of determining the risk weights for residential exposures? What, if any, increases in procyclicality and incentives for increased risk-taking by covered banking organizations might such recognition create? What conditions could the agencies impose on such recognition to mitigate concerns about the wrong-way risk of monoline credit insurance? In recognition that private mortgage insurance may not provide protection under all relevant stress events, what are the advantages and disadvantages of recognizing a portion (such as 50 percent) of the value of the private mortgage insurance in determining the total outstanding amount of the loan in the calculation of the LTV ratio? Please provide any data and analysis supporting alternative approaches. b. Risk Weights for Residential Mortgage Exposures Under the proposal, a covered banking organization would assign a risk weight to an eligible residential mortgage exposure based on the exposure's LTV ratio without private mortgage insurance and based on whether repayment is dependent on the cash flows generated by the real estate, in accordance with Tables III.1 and III.2 below. 36 LTV ratios and source of repayment would factor into the risk-weight treatment for residential mortgage exposures because they are key determinants of risk for real estate exposures. 36 The risk weight assigned to loans does not impact the appropriate treatment of loans under the agencies' other regulations and guidance, such as the supervisory LTV limits under the real estate lending guidelines. See Appendix C to Part 208, Title 12. The proposed risk weights would recognize the reduction in risk due to amortization, as the borrower pays down principal and builds equity. 37 Given the increased risk sensitivity of the LTV-based approach relative to the current standardized approach, the risk weights for eligible residential mortgage exposures would decrease throughout the life of the loan as the obligor makes payments. Lower LTVs are strongly associated with lower realized loss given default. 38 37 For purposes of the LTV ratio calculation, the proposal would require covered banking organizations to use the value of the property at the time of origination, except under limited circumstances. See also Luis Otero González, Pablo Durán Santomil, Milagros Vivel Búa and Rubén Lado Sestayo, “The Impact of Loan-to-Value on The Default Rate of Residential MBS” Journal of Credit Risk (July 2016), https://www.risk.net/journal-of-credit-risk/2465626/the-impact-of-loan-to-value-on-the-default-rate-of-residential-mortgage-backed-securities. 38 Kenç, Turalay. “Macroprudential regulation: history, theory and policy.” BIS Paper 86c (2016). EP27MR26.017 EP27MR26.018 The proposed risk weights in Tables III.1 and III.2 would appropriately balance the benefits of risk sensitivity, transparency, and consistency in requirements across covered banking organizations. Relative to the current standardized approach, the proposed risk weights in Tables III.1 and III.2 would also align more closely with the treatment of regulatory residential real estate exposures under the expanded risk-based proposal. Consistent with the general risk weights in the current standardized approach and in contrast with the proposed expanded risk-based approach, there is not a separate operational risk-based capital requirement. Therefore, the proposed risk weights for residential mortgage exposures under this proposal would not account exclusively for credit risk. The difference in risk weights between the two proposals is, therefore, explained by the differing approaches for how risk categories, such as specific credit and operational risk-based requirements, factor into each proposal's methodology for assigning risk weights. 39 39 The calibration of the operational risk add-on followed a similar logic to the one used for corporate exposures and other assets (discussed below). Given that operational risk represents approximately 12 percent of risk-weighted assets for traditional lending under the expanded risk-based approach and assuming an average 35 percent risk weight for eligible residential real estate exposures, an operational risk add-on of approximately 5 percentage points to residential real estate risk weights would be appropriate. Question 9: The agencies seek comment on the proposed risk-weights for residential mortgage exposures in Tables III.1 and III.2. What alternative approaches, if any, should the agencies consider to account for risks other than credit risk posed by covered banking organizations' residential mortgage lending activities? What alternative risk weights, if any, should the agencies consider, and why? Please provide any supporting data. Question 10: What are the advantages and disadvantages of the proposed LTV-based approach for residential mortgage exposures that are dependent on the cash flows of the property? What, if any, implementation challenges would the requirement to determine whether an exposure is dependent on the cash flows of the property present? What would be the advantages and disadvantages of an alternative LTV-based approach that differentiates risk weights on whether the property securing the residential mortgage exposure is owner occupied? If the agencies were to implement such an approach for purposes of the final rule, what would be the appropriate risk-weight calibration? The agencies encourage commenters to provide data and supporting analysis. 2. Corporate Exposures and Certain Other Assets The proposal would update the risk weights applicable to (1) corporate exposures and (2) all assets not specifically assigned a different risk weight under the capital rule and that are not deducted from regulatory capital (other assets). Under the proposal, the risk weight applicable to corporate exposures would be reduced from 100 percent to 95 percent and the risk weight applicable to other assets would be reduced from 100 percent to 90 percent. 40 These changes aim to balance a more risk-sensitive calibration with maintaining the simplicity of the standardized approach. The proposal would maintain the existing definition of corporate exposure and other assets. 40 The other assets category is composed of exposures to individuals, other real estate owned, and other exposures not specifically assigned a different risk weight. When analyzing the risk-based capital requirements for specific business lines under the expanded risk-based proposal, the agencies determined that the current risk weights for certain exposure categories may not appropriately reflect risks. The expanded risk-based proposal includes reduced risk weights relative to the current standardized approach for corporate exposures that are deemed investment grade and retail exposures that exhibit reduced credit risk. These changes in the expanded risk-based proposal are intended to increase sensitivity to risk of the capital requirements for the banking organizations covered by that proposal. However, the increased complexity and operational burden for achieving these enhancements in risk sensitivity would not be appropriate for a standardized approach that applies to smaller and less complex banking organizations. To better calibrate the standardized approach's general risk weights for similar exposures while retaining their simplicity, the agencies conducted additional data analysis. The risk weights assigned to corporate exposures and other assets under this proposal are informed by the risk weights for credit risk and operational risk that would apply to domestic Category III and IV banking organizations under the expanded risk-based approach. Specifically, the exposure categories that would be risk-weighted as corporate exposures and other assets were approximated using exposures reported in the special data collection, risk-weighted as under the expanded risk-based proposal. 41 This analysis resulted in a weighted-average credit risk weight of 85 percent for corporate exposures and 77 percent for other assets. 41 In late 2023, the Board collected data on risk-weighted assets from 32 large bank holding companies based on the specific requirements contained in a July 27, 2023, capital proposal. See https://www.federalreserve.gov/newsevents/pressreleases/bcreg20231020b.htm. Corporate exposures were proxied using data reported in line items containing corporate exposures (item 8), certain real estate exposures (items 6.d, 6.g, 6.h, and 6.i), and certain off-balance sheet items (items 13 to 25 and 27), where those items were assigned one of the possible risk-weights corresponding to corporate exposure under the expanded risk-based approach proposal. Other asset exposures were proxied using data reported in line items containing retail exposures (item 7), other assets (item 9), and certain off-balance sheet items (items 13) where such exposures were assigned a risk weight corresponding to either retail exposures or a risk weight of 100 percent. In addition to credit risk, the expanded risk-based proposal would assign risk-weighted asset requirements for the operational risk of these exposures. Consistent with the simple risk weighting of the standardized approach, this proposal would reflect a nominal add-on to account for operational risk. Analysis in the expanded risk-based proposal suggests that risk-weighted assets for operational risk would represent approximately 12 percent of credit risk-weighted assets for traditional lending activities. 42 Assuming approximately an 80 percent credit risk weight for these activities, this would result in approximately a 10 percentage points risk-weight add-on for operational risk. Moreover, the methodology used to determine the weighted-average risk weight for other assets under the expanded risk-based approach is likely slightly underestimated because the portfolios of non-Category III or IV banking organizations subject to the standardized approach likely include fewer transactor retail exposures (with relatively low risk weights) as smaller banking organizations have more limited credit card portfolios. Therefore, this proposal would assign risk weights of 95 percent for corporate exposures and 90 percent for other assets. 42 See Table VII.6 in the expanded risk-based proposal. This calculation is based on the risk-weighted assets estimated to apply to the traditional lending activities of Category I and II bank holding companies. Question 11: The agencies seek comment on the proposed risk weight for corporate exposures. What alternative risk-weight should the agencies consider, and why? Please provide any supporting data. Question 12: The agencies seek comment on the proposed risk weight for exposures to assets not otherwise assigned to a specific risk weight under the current standardized approach and that are not deducted from tier 1 or tier 2 capital pursuant to § __.22. What are the advantages and disadvantages of the proposed risk weight of 90 percent for this set of exposures? What alternative risk-weight should the agencies consider, and why? Please provide any supporting data. Question 13: The agencies seek comment on whether to create a separate category, or separate categories, for retail exposures in the proposed standardized approach. What would be the advantages and disadvantages of creating a separate category for retail exposures? What are the appropriate criteria for defining retail exposures (for example, the criteria used to define retail exposures under the expanded risk-based proposal)? What risk weight would be appropriate for retail exposures for covered banking organizations? In a revised treatment where retail exposures are segregated into their own risk-weight category, would it be appropriate to set a 100 percent risk weight for other assets (not including retail exposures) and why? Please provide relevant data to support your views, including information on the historical loss rates and risk characteristics of retail exposures. B. Off-Balance Sheet Exposures The proposal would better capture the risk of certain off-balance sheet exposures relative to the current standardized approach by revising the definition of commitment to clarify the off-balance sheet exposures that would be subject to risk-based capital requirements and modifying the conversion factors applicable to certain credit and equity commitments. 1. Definition of Commitment The current capital rule defines a commitment as any legally binding arrangement that obligates a banking organization to extend credit or to purchase assets. 43 Such an arrangement is treated as a commitment even when the banking organization has the unilateral right to cancel the arrangement at any time. The agencies have received questions from banking organizations regarding whether certain types of arrangements, such as advised credit lines and uncommitted lines, would be commitments even if they are unconditionally cancelable. In addition, the agencies have observed an inconsistent application of the current definition of commitment. 43 See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC). Consistent with the expanded risk-based proposal, the proposal would revise the definition of commitment to clarify that any contractual arrangement under which a banking organization and an obligor agree to the terms applicable to one or more future extensions of credit, purchases of assets, or issuances of credit substitutes by the banking organization is a commitment, whether or not the arrangement is unconditionally cancelable. Consistent with the current capital rule, an unconditionally cancelable commitment would include a commitment that permits a banking organization to, at any time, with or without cause, refuse to extend credit, purchase assets, or issue credit substitutes under the arrangement (to the extent permitted under applicable law). Similarly, the proposal clarifies that a contractual arrangement to extend credit, purchase assets, or issue credit substitutes, but which does not obligate the banking organization to do so, is also considered a commitment that is unconditionally cancelable. 44 This approach would promote comparable treatment across banking organizations subject to the capital rule. 44 The proposal would remove the definition of “unconditionally cancelable” and revise the definition of “commitment” to indicate which commitments are considered unconditionally cancelable. Commitments represent an arrangement where the banking organization could expect to purchase assets or to extend credit to an obligor, in which case the credit becomes an on-balance sheet asset. The scope of the definition is, therefore, not intended to be limited to those situations in which the banking organization is obligated to provide some amount of credit to an obligor. The agencies do not, however, intend for the definition of commitment to include arrangements where a banking organization has merely offered potential terms to a potential obligor or that continue to be subject to negotiation between the parties. For the purpose of the regulatory capital rule, a commitment does not and would not include pre-approval letters for residential mortgage loans, credit card offers, or other offers that have not yet been agreed upon by both parties to the transaction. Examples of arrangements that would generally be considered commitments under the proposal include fronting commitments, where a banking organization agrees to fund the obligations of other members of a syndicate of lenders, and commitment letters, where a banking organization agrees to provide financing in connection with an acquisition or other transaction to be entered into by the obligor. The proposal would also include other off-balance sheet activities such as advised lines or “uncommitted” facilities as commitments (even if they are unconditionally cancelable or provide that the banking organization is not obligated to perform). For example, an arrangement under which a banking organization retains full discretion as to whether to extend credit to a potential borrower, but under which the banking organization and the potential borrower have agreed to the material terms on which such lending would take place if the banking organization chose to extend credit, is an unconditionally cancelable commitment under the proposal. An unconditionally cancelable commitment also includes an arrangement where a banking organization provides an initial line of credit with an additional amount that the banking organization may extend in the future subject to prior approval by the banking organization, with the agreed upon terms of the future unconditionally cancelable line. Exposures without pre-set limits on the amount of credit that can be extended also can be unconditionally cancelable commitments. With some retail products, such as with charge cards, the banking organization does not disclose a pre-set credit limit to its obligors. For charge cards, or similar types of off-balance sheet exposures, each attempt to borrow by an obligor is individually underwritten and requires the approval of the banking organization. Nevertheless, because the banking organization and the borrower have agreed to the material terms on which such lending would take place, such arrangements meet the definition of commitment and, therefore, should be treated as unconditionally cancelable commitments for regulatory capital purposes. 45 45 See section V.F. for the proposed methodology to determine the exposure amount for retail exposures with no pre-set limit. Question 14: The agencies seek comment on the clarification to the definition of commitment. Does the proposal appropriately capture as off-balance sheet exposures arrangements where the covered banking organization is not legally obligated to extend credit, purchase assets, or issue credit substitutes but which nonetheless arise out of a contractual arrangement to extend credit or purchase assets? To what extent would the proposed definition affect a covered banking organization's business practices regarding commitments and similar arrangements, including how covered banking organizations treat such arrangements for regulatory capital and reporting purposes? Please provide any rationale or data that may be helpful for the agencies to consider. 2. Conversion Factors Consistent with the current rule, under the proposed rule a covered banking organization would calculate the exposure amount of an off-balance sheet exposure by multiplying the off-balance sheet component, which is usually the contractual amount or adjusted carrying value, by the applicable conversion factor. The resulting exposure amount would then be assigned to the relevant risk-weight category for the exposure. The proposal would retain the same conversion factors from the current capital rule, except with respect to commitments. 46 46 Note issuance facilities and revolving underwriting facilities are forms of revolving credit. Notes issued under note issuance facilities and revolving underwriting facilities are short-term instruments issued under a legally binding medium-term contractual arrangement. Under a revolving underwriting facility, the underwriting banking organization agrees to provide loans should the issue fail, but under a note issuance facility the banking organization could either lend to the issuer or purchase the outstanding notes. Consistent with the current rule and with the Basel standards, the proposal would require banking organizations to apply a 50 percent credit conversion factor to the off-balance sheet amount of note issuance facilities and revolving underwriting facilities, regardless of whether a lower credit conversion factor would otherwise apply. Under the current standardized approach, commitments that are not unconditionally cancelable with an original maturity of one year or less receive a 20 percent credit conversion factor and those with an original maturity of more than one year receive a 50 percent credit conversion factor. 47 The proposal would simplify the conversion factors applicable to the unused portion of a credit or equity commitment that is not unconditionally cancelable. For these commitments, the proposal would no longer differentiate conversion factors by original maturity of one year or less and greater than one year. 47 12 CFR 3.33(b)(2) (OCC); 12 CFR 217.33(b)(2) (Board); 12 CFR 324.33(b)(2) (FDIC). Under the proposal, a credit commitment that is not unconditionally cancelable would be subject to a credit conversion factor of 40 percent regardless of the maturity of the facility. 48 Removing the one-year mark as a dividing line between substantially different treatments would remove any regulatory incentive to structure transactions around that line. The 40 percent credit conversion factor would align with the expanded risk-based proposal and reflect that most outstanding commitments that are not unconditionally cancelable have a maturity greater than one year. 49 48 Under the proposal, a 40 percent conversion factor would also apply to commitments that are not unconditionally cancelable commitments for purposes of calculating the total leverage exposure for the supplementary leverage ratio framework and for the calculation of the Size Category of the FR Y-15 Systemic Risk Report form. 49 In Q2 2025, prior to application of conversion factors, commitments with maturity less than one year accounted for under 20 percent of aggregate risk-weighted assets associated with commitments of Category III and smaller bank holding companies ( See FR Y-9C Schedule HC-R Part II, items 18.a and b). The proposal would also simplify the treatment of conditional commitments to acquire an equity exposure by removing the differentiation of conversion factors by maturity. Under the proposal a covered banking organization would be required to multiply the effective notional principal amount of a conditional commitment by a 40 percent conversion factor to calculate its adjusted carrying value. 50 50 Aside from this change, the equity framework would retain the current capital rule's methods for calculating the adjusted carrying value for equity exposures. Under the proposal, the risk-weighted asset amount calculation for equity exposures would also be consistent with the current rule. Question 15: What additional factors, if any, should the agencies consider for determining the applicable credit conversion factors for commitments? Question 16: What are the advantages and disadvantages relative to the proposal of using the current treatment for commitments, that are not unconditionally cancelable which differentiates credit conversion factors based on maturity, and would apply a 20 percent credit conversion factor to those commitments with an original maturity of one year or less, and a 50 percent credit conversion factor to those with an original maturity of more than one year? Question 17: What are the advantages and disadvantages of applying the proposed 40 percent credit conversion factor for commitments regardless of maturity that are not unconditionally cancelable to the supplementary leverage ratio framework and to the Size Category of the FR Y-15? 3. Commitments With No Pre-Set Limit Most off-balance sheet exposures, such as credit card lines, allow obligors to borrow up to a specified amount. However, some off-balance sheet exposures such as charge cards do not have an explicit contractual pre-set credit limit. For commitments that do not have an express contractual maximum amount or pre-set limit, the proposal would include an approach to calculate a proxy for the committed but undrawn amount of the commitment (undrawn exposure amount). This approach would generally align with that under the expanded risk-based proposal, except for a broader scope of application under this proposal given the objective to retain a simpler and less granular framework. The proxy for the undrawn exposure amount is particularly important for covered banking organizations subject to the supplementary leverage ratio framework. Consistent with the current rule, under the proposal, covered banking organizations would apply a zero percent credit conversion factor to the unused portion of a commitment that is unconditionally cancelable for risk-based capital purposes. However, for purposes of the supplementary leverage ratio the minimum credit conversion factor that may be assigned to an off-balance sheet exposure is 10 percent. 51 51 See 12 CFR 3.10(c)(2)(viii) (OCC); 12 CFR 217.10(c)(2)(viii) (Board); 12 CFR 324.10(c)(2)(viii) (FDIC). The undrawn exposure amount would be calculated by using the exposure's highest drawn amount over the previous 24 months as an indicator of the amount of credit a covered banking organization is likely to extend to an obligor in the future. Specifically, under the proposal, a covered banking organization would first identify the largest drawn amount by an obligor over the prior 24 months or, if the covered banking organization has offered the product to the obligor for fewer than 24 months, the largest drawn amount since the commitment was first issued. The off-balance sheet exposure amount would be calculated by first subtracting the current drawn amount from the largest drawn amount and then multiplying this difference by the applicable credit conversion factor. The risk-weighted asset amount would be the off-balance sheet exposure amount multiplied by the applicable risk weight for the obligor. A substantial share of uncapped commitments is in the form of charge cards to individuals, and these exposures have characteristics that suggest the highest drawn balance method described above is a reasonable proxy to estimate the undrawn exposure amount. A charge card does not have a pre-set credit limit, its balance is generally required to be paid in full at the end of each statement period, and charge card transactions are generally underwritten separately and reviewed by the issuing banking organization for approval or denial. Therefore, a charge card obligor's spending pattern, which reflects a covered banking organization's approval of the charge card obligor's usage, is indicative of the off-balance sheet exposure amount for a charge card. As an example of the proposed treatment, assume an obligor's charge card had a maximum drawn amount of $4,000 during the period of the prior 24 months and a current drawn amount of $3,000. 52 To determine the off-balance sheet exposure amount of the charge card, the covered banking organization would (1) identify the maximum drawn amount over the prior 24 months ($4,000), (2) subtract the applicable drawn amount of $3,000 from $4,000 ($1,000), and (3) multiply $1,000 by the applicable credit conversion factor. 53 52 The maximum balance would reflect the highest daily drawn amount for the account with no pre-set limit over the period. 53 The applicable credit conversion factor for these types of exposures, assuming they are unconditionally cancelable commitments, would continue to be zero percent under the standardized approach and 10 percent under the supplementary leverage ratio. Question 18: What are the advantages and disadvantages of the proposed treatment for commitments with no express contractual maximum amount or pre-set limit? What other time period or approach should the agencies consider for calculating the highest drawn amount (for example, using month-end balance or statement balances), and why? Question 19: What would be the advantages and disadvantages of applying a multiplier to the highest drawn amount to calculate the off-balance sheet exposure amount (for example, multiplying the highest drawn balance by a figure between 1.5 and 3) to calculate the off-balance sheet exposure amount? 54 If applied, how should such multiplier be calibrated? What data should the agencies use to calibrate such a multiplier? 54 If a multiplier of two were applied to the maximum drawn amount over the prior 24 months, under the example presented above, the off-balance sheet exposure amount would equal $5,000, which corresponds to $4,000 times two minus $3,000. The other steps of the process would remain unchanged and would result in a risk-weighted asset amount of $225 for the off-balance sheet exposure. Question 20: The agencies seek feedback on commitments that contain no express contractual maximum amount but also contain features such as a “pay over time” limit, which allows a borrower to carry a balance with interest on certain charges. What would be the advantages and disadvantages of incorporating the “pay over time” limit as a floor when calculating the highest drawn amount under the proposal? For example, assume the maximum drawn amount over the prior 24 months is $4,000 and the “pay over time” limit is $5,000. Under this alternative, the applicable drawn amount would be subtracted from $5,000 instead of $4,000. Question 21: The agencies seek comment on whether the specific treatment described above is appropriate for all commitments with no contractual maximum or pre-set limit. What are the advantages and disadvantages of instead limiting the proposed treatment for such commitments to a narrower set of exposure categories (such as the scope under the expanded risk-based proposal) and why? What alternative treatments, if any, should the agencies consider for determining the exposure amount when no contractual maximum or pre-set limit exists? Describe in detail the types of alternative treatments that the agencies should consider, and provide supporting rationale or data that may be helpful for the agencies. C. Derivative Contracts Under the proposal and consistent with the current capital rule, a covered banking organization would use the current exposure methodology to calculate the exposure amount for derivative contracts unless it elects to use the standardized approach for counterparty credit risk (SA-CCR). 55 56 To promote consistency, a covered banking organization that elects to use SA-CCR would apply the same revised SA-CCR framework that is proposed in the expanded risk-based proposal regardless of whether the banking organization is subject to the standardized approach or the expanded risk-based approach. 57 The revised SA-CCR framework would better reflect the risk-reducing effects of netting arrangements and collateral. 55 See 12 CFR 3.34 (OCC); 12 CFR 217.34 (Board); 12 CFR 324.34 (FDIC). 56 85 FR 4362 (Jan. 24, 2020). 57 See expanded risk-based proposal section IV.A.4. Specifically, the revised SA-CCR framework would recognize qualifying cross-product master netting agreements for non-cleared transactions and incorporate certain non-cleared repo-style transactions, including client-facing transactions. The revised framework would also permit the netting of collateralized-to-market and settled-to-market client-facing derivative transactions. In addition, the proposal would make technical revisions to promote consistent implementation of SA-CCR and better reflect counterparty credit risk. The accompanying expanded risk-based approach proposal provides further details on the changes to the SA-CCR framework. D. Credit Risk Mitigation The current capital rule permits covered banking organizations to recognize certain types of credit risk mitigants, such as guarantees, credit derivatives, and collateral, for risk-based capital purposes provided the credit risk mitigants satisfy the qualification standards under the rule. 58 Credit derivatives and guarantees can reduce the credit risk of an exposure by placing a legal obligation on a third-party protection provider to compensate the banking organization for losses associated with a credit event of the original obligor. 59 Similarly, the use of collateral often can reduce the credit risk of an exposure by creating the right of a banking organization to take ownership of and liquidate the collateral in the event of a default by the counterparty. Prudent use of such mitigants can help a banking organization reduce the credit risk of an exposure and in some circumstances reduce the risk-based capital requirement associated with that exposure. 58 Consistent with the current capital rule, the proposal would not require covered banking organizations to recognize a credit risk mitigant that it has obtained. Credit derivatives that a covered banking organization cannot or chooses not to recognize as a credit risk mitigant would be subject to a separate counterparty credit risk capital requirement. 59 Credit events are defined in the documents governing the credit risk mitigant and often include events such as failure to pay principal and interest and entry into insolvency or similar proceedings. Credit risk mitigants recognized for risk-based capital purposes must be of sufficiently high quality to effectively reduce credit risk. For guarantees and credit derivatives, the current capital rule primarily looks to the creditworthiness of the guarantor and the features of the underlying contract to determine whether these forms of credit risk mitigation may be recognized for risk-based capital purposes (eligible guarantee or eligible credit derivative). With respect to collateralized transactions, the current capital rule primarily looks to the liquidity profile and quality of the collateral received (such as the creditworthiness of the issuer of the collateral) and the nature of the banking organization's security interest to determine whether the collateral qualifies as financial collateral that may be recognized for purposes of risk-based capital. 60 60 See definition of financial collateral in § __.2 of the capital rule. 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); 12 CFR 324.2 (FDIC). The proposal would largely incorporate the treatments for collateralized transactions, guarantees, and credit derivatives from the current capital rule with enhancements to increase risk sensitivity. For eligible guarantees and eligible credit derivatives, the proposal would generally retain the substitution approach from the current capital rule with two modifications. Specifically, the proposal would modify the treatment for eligible credit derivatives that do not include restructuring as a credit event and no longer permit the recognition of credit protection from nth-to-default credit derivatives. 61 61 See section III.E.5.b. of this SUPPLEMENTARY INFORMATION . For collateralized transactions where financial collateral secures exposures that are not derivative contracts or netting sets of derivative contracts, the proposal would generally retain the simple approach from the current capital rule with the following two modifications. 62 First, the proposal would replace the requirement that financial collateral be subject to a collateral agreement with conditions including the requirement that the covered banking organization have the right to liquidate or take legal possession of the collateral upon an event of default. Second, the proposal would permit covered banking organizations to recognize, under the simple approach, the credit risk mitigation benefits of financial collateral with a maturity or currency mismatch, after applying certain adjustments. The proposal would also update the collateral haircut approach to partially recognize the netting and diversification benefits that may be present in repo-style transactions, eligible margin loans, collateralized derivative contracts and single product netting sets of such transactions. 63 62 The collateral haircut approach also would be available to covered banking organizations to recognize the benefits of collateral for eligible margin loans and repo-style transactions. 63 Consistent with the expanded risk-based approach, the proposal would increase simplicity, consistency and comparability of capital requirements eliminating the option for banking organizations to use of their own estimates of haircuts for purposes of the collateral haircut approach. The proposal would also introduce eligible prepaid credit protection arrangements as a credit risk mitigant available to all exposure types, including securitizations, and permit covered banking organizations to recognize the credit risk mitigation benefits of the protection amount of the prepaid credit protection arrangement, discounted to reflect any applicable maturity and currency mismatch adjustments. 1. Guarantees and Credit Derivatives a. Substitution Approach Consistent with the current capital rule, the proposal would permit a covered banking organization to recognize the credit risk-mitigation benefits of eligible guarantees and eligible credit derivatives by substituting the risk weight applicable to the eligible guarantor or counterparty to the eligible credit derivative (protection provider) for the risk weight applicable to the hedged exposure. To recognize the risk mitigating benefits of a guarantee or credit derivative for risk-based capital purposes, the proposal would continue to require the issuer of or counterparty to the eligible guarantee or eligible credit derivative, respectively, to be an eligible guarantor. 64 The proposal would rely on the definition of eligible guarantor in § __.2 of the capital rule, which, among other criteria, requires an entity to have issued and outstanding an unsecured debt security without credit enhancement that is investment grade at the time the guarantee is issued or anytime thereafter. 64 Under the advanced approaches framework in the current capital rule, an eligible guarantee need not be issued by an eligible guarantor unless the exposure is a securitization exposure. Under the proposal, an eligible guarantee would need to be issued by an eligible guarantor. Question 22: The agencies seek comment on the requirement that the entity has issued and outstanding an unsecured debt security without credit enhancement that is investment grade to meet the definition of an eligible guarantor. What, if any, alternatives to this requirement should the agencies consider to help ensure that eligible guarantors can be expected to perform on guarantees, and what would the pros and cons of those alternatives be? b. Adjustment for Credit Derivatives Without Restructuring Credit derivative contracts in certain jurisdictions include debt restructuring as a credit event that triggers a payment obligation by the protection provider to the protection purchaser. Such restructurings of the hedged exposure may involve forgiveness or postponement of principal, interest, or fees that result in a loss to investors. Consistent with the current capital rule, the proposal would generally require a banking organization that seeks to recognize the credit risk-mitigation benefits of an eligible credit derivative that does not include a restructuring of the reference exposure as a credit event to reduce the effective notional amount of the credit derivative by 40 percent to account for any unmitigated losses that could occur as a result of a restructuring of the hedged exposure. Under the proposal, however, the 40 percent adjustment would not apply to eligible credit derivatives without restructuring as a credit event if both of the following requirements are satisfied: (1) the terms of the hedged exposure (and the reference exposure, if different from the hedged exposure) allow the maturity, principal, coupon, currency, or seniority status to be amended outside of receivership, insolvency, liquidation, or similar proceeding only by unanimous consent of all parties; and (2) the covered banking organization has conducted sufficient legal review to conclude with a well-founded basis (and maintains sufficient written documentation of that legal review) that the hedged exposure is subject to the U.S. Bankruptcy Code or a domestic or foreign insolvency regime with similar features that allows for a company to reorganize or restructure and provides for an orderly settlement of creditor claims. The unanimous consent requirement would mean that, for restructurings occurring outside of an insolvency proceeding, all holders of the hedged exposure (and the reference exposure, if different from the hedged exposure) must agree to any restructuring for the restructuring to occur, and no holder can vote against the restructuring or abstain. This unanimous consent requirement would reduce the risk that a covered banking organization would suffer a credit loss on the hedged exposure that would not be offset by a payment under the eligible credit derivative. Banking organizations generally would only be incentivized to vote for a restructuring if the terms of the restructuring provide a more beneficial outcome to the banking organization relative to insolvency proceedings that would trigger payment under the eligible credit derivative. Additionally, the unanimous consent requirement for the reference exposure, if different from the hedged exposure, would provide an additional layer of security by significantly reducing the probability of reaching a restructuring agreement that results in a loss of principal or interest for creditors without triggering payment under the eligible credit derivative. The unanimous consent requirement would need to be satisfied through the terms of the hedged exposure (and the reference exposure, if different from the hedged exposure), which could be accomplished through a contractual provision of the exposure or the operation of the applicable law. The requirement that the hedged exposure be subject to the U.S. Bankruptcy Code or a similar domestic or foreign insolvency regime would help to ensure that any restructuring is done in an orderly, predictable, and regulated process. In the event that the obligor of the hedged exposure defaults and the default is not cured, the obligor would either be required to enter insolvency proceedings, which would trigger payment under the credit derivative, or the obligor would be required to pursue restructuring outside of insolvency, which could not occur without the banking organization's consent. Together, the proposed conditions are intended to ensure that credit derivatives that do not include restructuring as a credit event but provide similarly effective protection as those that do contain such provisions would be afforded similar recognition under the capital framework. Question 23: The agencies seek comment on allowing covered banking organizations to recognize in full the effective notional amount of credit derivatives that do not include restructuring as a credit event, if certain conditions are met. What are the cost and benefits of this approach? What, if any, less restrictive conditions for receiving full recognition should the agencies consider that would more appropriately capture credit derivatives that provide similar protection as those that include restructuring as a credit event receive and why? For example, what would be the advantages and disadvantages of requiring the consent of all parties directly and adversely affected by a restructuring, rather than the unanimous consent of all parties? What would be the advantages and disadvantages of requiring the consent of all parties affected by any change in lien position or priority in the hedged or referenced exposure? Question 24: To what extent is the proposed treatment of eligible credit derivatives that do not include restructuring of the reference exposure as a credit event relevant outside of the United States and how should this be considered for purposes of the proposal? Question 25: In order for a covered banking organization to recognize the credit risk mitigation benefits of an eligible credit derivative, the current capital rule requires that legally-enforceable cross-default or cross-acceleration clauses be in place and that the reference exposure and the hedged exposure be to the same legal entity. What would be the advantages and disadvantages of allowing recognition of credit derivatives where (1) the reference exposure is to a different legal entity than the hedged exposure, (2) the reference exposure's legal entity is guaranteed by its parent company, and (3) the parent company is subject to a binding cross-default or cross-acceleration provision related to the hedged exposure's debt? 2. Collateralized Transactions a. Simple Approach Consistent with the current capital rule, a covered banking organization would be permitted to recognize the risk-mitigating benefits of financial collateral using the simple approach by substituting the risk weight applicable to an exposure with the risk weight applicable to the financial collateral securing the exposure, generally subject to a 20 percent floor. Under the current capital rule, a requirement for recognizing the credit risk mitigation benefit of financial collateral under the simple approach is that the collateral must be subject to a collateral agreement for at least the life of the exposure. The proposal would not include this requirement under the simple approach because the requirement is overly broad and not relevant for certain transaction types. For example, while the right to close out a transaction would be relevant with respect to a repurchase agreement, it may not be relevant with respect to a loan. Instead, the proposal would require that the legal mechanism by which the financial collateral is pledged or transferred be enforceable and provide the covered banking organization with an ability to exercise its applicable legal rights with respect to the collateral in a timely manner upon an event of default. Depending on the characteristics of the type of exposure and the financial collateral in question, those rights may include the right to liquidate or take legal possession of the financial collateral, to set off amounts owed by the covered banking organization against amounts owed by the obligor, and to close out the underlying transaction. However, not all of these rights may be applicable with respect to all types of exposures and financial collateral, and a covered banking organization would only be required to have those rights that are applicable for the type of exposure and financial collateral in question. This requirement, in combination with the definition of financial collateral—which, in part, requires a covered banking organization to have a perfected, first-priority security interest (or the legal equivalent thereof) in the collateral—and the other requirements of § __.37(b)(1) would provide a sufficient basis for recognizing the collateral under the simple approach. The requirement under the current capital rule that financial collateral be subject to a collateral agreement often prevents a covered banking organization from recognizing financial collateral as a credit risk mitigant under the simple approach if the covered banking organization's exercise of its rights may be stayed in a bankruptcy of the obligor. This has generally meant that a covered banking organization could not use the simple approach to recognize financial collateral in respect of collateralized loans because the exercise of a covered banking organization's collateral rights with respect to a loan would often be subject to a stay in the bankruptcy or insolvency of a borrower under the applicable law. Under the proposal, the fact that a covered banking organization's rights may be subject to a stay in the event of an obligor's bankruptcy would not preclude the banking organization from recognizing the credit risk mitigation benefits of financial collateral, provided the banking organization has a well-founded basis for concluding that it will be able to exercise its rights in a timely manner. The proposed change would permit covered banking organizations to recognize the credit risk mitigation benefits of financial collateral that protects exposures arising from many types of loans and traditional credit products. Other elements of the simple approach, such as the 20 percent risk-weight floor, help to address the risk of declines in the value of collateral. Typically, financial collateral in respect of a collateralized transaction is pledged by the obligor of that exposure. In some cases, collateral may be pledged or transferred by a party other than the obligor. A third-party pledgor may be the parent or an affiliate of an obligor or an unrelated party that is providing credit risk protection to the banking organization. While collateral provided by a third party may be an effective credit risk mitigant, it may also pose unique risks. In particular, depending on the laws of the applicable jurisdictions and the terms of the relevant legal agreements, the bankruptcy or insolvency of a pledgor prior to an event of default of the obligor may terminate or impair the banking organization's rights to the collateral. In these circumstances, financial collateral does not provide an effective credit risk mitigant. Consequently, the proposal would require that the bankruptcy or insolvency of a third-party pledgor not result in the termination or impairment of the covered banking organization's rights in respect of the financial collateral. There may be situations where obligors have the ability to remove collateral that they are contractually obligated to maintain when a banking organization is experiencing stress. This risk is most apparent when financial collateral takes the form of cash on deposit at a banking organization, where a banking organization's deposit systems may not reflect the obligor's contractual obligation to maintain the deposit at the banking organization. It may also arise, in respect of other types of financial collateral, depending on the custody arrangement and associated controls in respect of the collateral. Financial collateral is not an effective credit risk mitigant if a banking organization cannot appropriately safeguard its rights in respect of such financial collateral. Consequently, the proposal would also require a covered banking organization to be able to reasonably demonstrate the ability to protect and enforce its rights in respect of any financial collateral. Other safeguards relating to the simple approach are intended to sufficiently calibrate the benefits of the proposal's recognition of financial collateral for a broader scope of products. For example, the maturity mismatch adjustment, which is described in greater detail below, reduces the benefit of financial collateral based on the difference between the residual maturity of the legal mechanism by which financial collateral is pledged and that of the secured exposure. Additionally, for a situation with a maturity mismatch, the proposal would only allow for recognition of the credit risk mitigant where the original maturity of the legal mechanism is greater than or equal to one year and the residual maturity of the legal mechanism is greater than three months. These requirements, taken together with the other requirements in section __.121 of the proposal, would incentivize covered banking organizations to utilize credit risk mitigants that provide effective credit risk transfer. Question 26: Under the simple approach, the current capital rule requires that collateral be revalued at least every six months. The agencies recognize that, in practice, most collateral agreements for liquid collateral provide for more frequent valuation. The proposal would remove the requirement for collateral agreements. Given that financial collateral is generally liquid, what would be the advantages and disadvantages of requiring a more frequent minimum revaluation interval—such as quarterly—under the simple approach? Please provide rationale supporting or opposing a more frequent revaluation requirement. Question 27: The proposal would maintain the current capital rule's definition of financial collateral and allow covered banking organizations to recognize the risk-mitigating benefits of cash on deposit, including cash held by a third-party custodian or trustee. The agencies invite comment on whether the definition of financial collateral is sufficiently clear with respect to cash collateral held for a covered banking organization by a third-party custodian or trustee. What would be the advantages or disadvantages of revising the “cash on deposit” prong of the definition of financial collateral to explicitly recognize cash on deposit at any third-party depository institution, regardless of whether it is a custodian or trustee? In addition, what would be the appropriate risk weight for the collateralized exposure where the financial collateral is, directly or indirectly, in the form of a deposit claim on a third-party depository institution and why? What would be the advantages and disadvantages of subjecting the collateralized exposure to the 20 percent risk weight floor? What, if any, other alternative approaches should the agencies consider and why? b. Collateral Haircut Approach Under the proposal, as under the current capital rule, a covered banking organization would be permitted to recognize the credit risk-mitigation benefits of collateral supporting repo-style transactions, eligible margin loans, collateralized derivative contracts, and single product 65 netting sets of such transactions by adjusting its exposure amount to its counterparty to recognize financial collateral received and any collateral posted to the counterparty. The collateral haircut approach would continue to require a covered banking organization to adjust the fair value of the collateral received and posted to account for any potential market price volatility in the value of the collateral during the margin period of risk, as well as to address any currency mismatch. To increase the risk-sensitivity of the collateral haircut approach, the proposal would modify certain of the standard market price volatility haircuts. At the same time, to reduce unwarranted divergence in risk-weighted assets, the proposal would no longer allow a covered banking organization to use its own internal estimates for calculating haircuts. 65 SA-CCR is proposed for use under Subpart D § 217.34(a)(3) and § 217.37(f) for repo-style transactions that are subject to a qualifying cross-product master netting agreement with derivative contracts i. Formula for Determining Exposure Amount The proposal would introduce a new formula for calculating the exposure amount of eligible margin loans, repo-style transactions, or netting sets thereof. The proposed exposure amount equation is revised from the current formula to improve the recognition of the risk-mitigating benefits of netting and portfolio diversification. The proposed formula would revert to the current collateral haircut approach formula in cases where there are no variables to populate the second and the third components as described below. The modification would increase the risk sensitivity of the capital requirement for such transactions relative to the current collateral haircut approach. Under the proposal, the exposure amount (E*) of a netting set of eligible margin loans or repo-style transactions or an individual transaction that is not part of a netting set would be determined according to the following formula: EP27MR26.019 Where: • E * is the exposure amount of the eligible margin loan, repo-style transaction, or netting set after credit risk mitigation. • E i is the current fair value of the instrument, cash, or gold the banking organization has lent, sold subject to repurchase, or posted as collateral to the counterparty. • C i is the current fair value of the instrument, cash, or gold the banking organization has borrowed, purchased subject to resale, or taken as collateral from the counterparty. • net exposure = |Σ s E s H s | • gross exposure = Σ s E s |H s | • E s is the absolute value of the net position in a given instrument or in gold (where the net position in a given instrument or gold equals the sum of the current fair values of the instrument or gold the banking organization has lent, sold subject to repurchase, or posted as collateral to the counterparty, minus the sum of the current fair values of that same instrument or gold the banking organization has borrowed, purchased subject to resale, or taken as collateral from the counterparty). • H s is the haircut appropriate to E s as described in Table 1 to § __.37, as applicable. H s has a positive sign if the instrument or gold is net lent, sold subject to repurchase, or posted as collateral to the counterparty; H s has a negative sign if the instrument or gold is net borrowed, purchased subject to resale, or taken as collateral from the counterparty. • N is the number of instruments with a unique Committee on Uniform Securities Identification Procedures (CUSIP) designation or foreign equivalent, with certain exceptions. N includes any instrument with a unique CUSIP that the banking organization lends, sells subject to repurchase, or posts as collateral, as well as any instrument with a unique CUSIP that the banking organization borrows, purchases subject to resale, or takes as collateral. However, N would not include collateral instruments that the banking organization is not permitted to include within the credit risk mitigation framework (such as nonfinancial collateral that is not part of a repo-style transaction included in the banking organization's market risk weighted assets) or elects not to include within the credit risk mitigation framework. The number of instruments for N would also not include any instrument (or gold) for which the value E s is less than one-tenth of the value of the largest E s in the netting set. Any amount of gold would be given a value of one. • E fx is the absolute value of the net position in each currency fx different from the settlement currency. • H fx is the haircut appropriate for currency mismatch of currency fx. The first component in the above formula (Σ i E i −Σ i C i ) would capture the baseline exposure of eligible margin loans, repo-style transactions, or netting sets thereof, after accounting for the value of any collateral received. The second (0.4 × net exposure ) and third (0.6 × (gross exposure / √N )) components in the above formula would allow for the partial recognition of the netting and diversification benefit of instruments exchanged between a covered banking organization and a given counterparty within a netting set. The net exposure component partially recognizes the offsetting of gross exposures between a given instrument that is both lent and received as collateral within a netting set. Additionally, because the contribution from the gross exposure component to the exposure amount would decrease proportionally with an increase in the number of unique instruments by CUSIP designations or foreign equivalent, the gross exposure component would capture the impact of diversification in the types of instruments lent or received. The fourth component (Σ fx ( E fx × H fx )) would captu [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2026-05960. Public record. Not legal advice.