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

DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

[Docket Number 97-12]

Report to the Congress Regarding the Differences in Capital and

Accounting Standards Among the Federal Banking and Thrift Agencies

AGENCY: Office of the Comptroller of the Currency, Treasury.

ACTION: Report to the Committee on Banking, Housing, and Urban Affairs

of the United States Senate and to the Committee on Banking and

Financial Services of the United States House of Representatives

regarding differences in capital and accounting standards among the

federal banking and thrift agencies.

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SUMMARY: The Office of the Comptroller of the Currency (OCC) has

prepared this report as required by the Federal Deposit Insurance

Corporation Improvement Act of 1991 (FDICIA). FDICIA requires the OCC

to provide a report to Congress on any differences in capital standards

among the federal financial regulatory agencies. This notice is

intended to satisfy the FDICIA requirement that the report be published

in the Federal Register.

FOR FURTHER INFORMATION CONTACT: Roger Tufts, Senior Economic Advisor,

Office of the Chief National Bank Examiner (202) 874-5070, Eugene

Green, Deputy Chief Accountant, Office of the Chief Accountant (202)

874-4933, or Ronald Shimabukuro, Senior Attorney, Legislative and

Regulatory Activities Division, (202) 874-5090, Office of the

Comptroller of the Currency, 250 E Street, S.W., Washington, DC 20219.

SUPPLEMENTARY INFORMATION:

Differences in Capital and Accounting Standards Among the Federal

Banking and Thrift Agencies

Report to the Committee on Banking, Housing, and Urban Affairs of the

United States Senate and to the Committee on Banking and Financial

Services of the United States House of Representatives

Submitted by the Office of the Comptroller of the Currency

This report 1 describes the differences among the

capital requirements of the Office of the Comptroller of the Currency

(OCC) and those of the Board of Governors of the Federal Reserve System

(FRB), the Federal Deposit Insurance Corporation (FDIC) and the Office

of Thrift Supervision (OTS).2 The report is divided into

four sections. The first section provides a short overview of the

current capital requirements; the second section discusses the

differences in the capital standards; the third section briefly

discusses recent efforts of the Agencies to promote more consistent

capital standards; and the fourth section discusses the differences in

accounting standards related to capital. The report covers developments

through December 31, 1996.

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\1\ This report is made pursuant to section 121 of the Federal

Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), Pub.

L. 102-242, 105 Stat. 2236 (December 19, 1991), 12 U.S.C. 1831n(c).

Section 121 of FDICIA supersedes section 1215 of the Financial

Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA),

Pub. L. 101-73, 103 Stat. 183 (August 9, 1989), which imposed

similar reporting requirement and was repealed.

\2\ The OCC is the primary supervisor of national banks. Bank

holding companies and state-chartered banks that are members of the

Federal Reserve System are supervised by the FRB. State-chartered

nonmember banks are supervised by the FDIC. The OTS supervises

savings associations and savings and loan holding companies. In this

report, the term ``Banking Agencies'' refers to the OCC, FRB and the

FDIC; the term ``Agencies'' refers to all four of the agencies,

including the OTS.

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A. Overview of the Risk-Based Capital Standards

Since the adoption of the risk-based capital guidelines in 1989,

all of the Agencies have applied similar capital standards to the

institutions they supervise. The risk-based capital guidelines

implement the Accord on International Convergence of Capital

Measurement and Capital Standards adopted in July, 1988, by the Basle

Committee on Banking Regulations and Supervisory Practices (Basle

Accord).

The risk-based capital guidelines establish a framework for

imposing capital requirements generally based on credit risk. Under the

risk-based capital guidelines, balance sheet assets and off-balance

sheet items are categorized, or ``risk-weighted,'' according to the

relative degree of credit risk inherent in the asset or off-balance

sheet item. The risk-based capital guidelines specify four risk-weight

categories--zero percent, 20 percent, 50 percent, and 100 percent.

Assets or off-balance sheet items with the lowest levels of credit risk

are risk-weighted in the lowest risk weight category; those presenting

greater levels of credit risk receive a higher risk weight. Thus, for

example, securities issued by the U.S. government are risk-weighted at

zero percent; one- to four-family home mortgages are risk-weighted at

50 percent; unsecured commercial loans are risk-weighted at 100

percent.

Off-balance sheet items must first be translated into an on-

balance-sheet credit equivalent amount by applying the conversion

factors, or multipliers, that are specified in the risk-based capital

guidelines of the Agencies. This credit equivalent amount is then

assigned to one of the four risk-weight categories. For example, a bank

may extend to its customer a line of credit that the customer may

borrow against for up to two years. The unused portion of this two year

line of credit--that is, the amount of available credit that the

customer has not borrowed--is carried as an off-balance sheet item.

Under the agencies' risk-based capital guidelines, this unused portion

is translated to an on-balance-sheet credit equivalent amount by

applying a 50 percent conversion factor, and the resulting amount is

then assigned to the 100 percent risk-weight category based on the

credit risk of the counterparty.

Once all the assets and off-balance sheet items have been risk-

weighted, the

[[Page 26356]]

total amount of all risk-weighted assets and off-balance sheet items is

used to determine the total amount of capital required for that

institution. Specifically, the risk-based capital guidelines of the

Agencies require each institution to maintain a ratio of total capital

to risk-weighted assets of 8 percent.

Total capital is comprised of two components--Tier 1 capital (core

capital) and Tier 2 capital (supplementary capital).3 Tier 1

capital includes common stockholders' equity, noncumulative perpetual

preferred stock and related surplus, and minority interests in

consolidated subsidiaries. Tier 2 capital includes the allowance for

loan and lease losses, certain types of preferred stock, some hybrid

capital instruments, and certain subordinated debt. These Tier 2

capital instruments, as well as the total amount of Tier 2 capital, are

subject to limitations and conditions provided by the risk-based

capital guidelines of the Agencies. In addition, the risk-based capital

guidelines also require the deduction of certain assets from either

Tier 1 capital or total capital. For example, as described in section

B(6), all goodwill must be deducted from Tier 1 capital.

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\3\ In addition to Tier 1 and Tier 2 capital, the risk-based

capital guidelines of the Banking Agencies also permit certain banks

to hold limited amounts of Tier 3 capital to satisfy market risk

requirements. See section C(2) for further discussion.

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Institutions generally are expected to hold capital above the

required minimum level, and most institutions usually do exceed minimum

risk-based capital requirement. For example, most national banks

currently hold capital in excess of 10 percent of risk-weighted

assets.4 However, in addition to the risk-based capital

requirement, the Agencies also impose a leverage capital requirement,

expressed as the percentage of Tier 1 capital to total assets. Unlike

the risk-based capital ratio, the leverage capital ratio is based on

total assets, not total risk-weighted assets. This means that the

leverage capital ratio is computed without regard to the risk-weight

categories assigned to the assets and without including off-balance

sheet items.

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\4\ In addition to the risk-based capital guidelines, the

Agencies have issued regulations implementing the prompt corrective

action (PCA) provisions of the Federal Deposit Insurance Corporation

Improvement Act of 1991 (FDICIA). FDICIA requires that the Agencies

take certain supervisory actions if an institution's capital

declines to unacceptable levels. See 12 U.S.C. 1831o. As required by

the statute, the PCA regulations establish four capital categories

that are defined in terms of three separate capital measures (the

risk-based capital ratio, the leverage ratio, and the ratio of Tier

1 capital to risk-weighted assets). These four categories are: well

capitalized, adequately capitalized, undercapitalized, and

significantly undercapitalized. By way of illustration, an

institution is well capitalized if its risk-based capital ratio is

10 percent or greater; its leverage ratio is 5 percent or greater;

and its ratio of Tier 1 capital to risk-weighted assets is 6 percent

or greater. A fifth PCA category--critically undercapitalized--is

defined, as the statute requires, as a 2 percent ratio of tangible

equity to total assets. See 12 CFR Part 6 (1996) (the OCC's prompt

corrective action regulations).

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B. Remaining Differences in Capital Standards of the Agencies

Although the Agencies have adopted common leverage capital

requirements and risk-based capital guidelines, there remain some

technical differences in language and interpretation of the capital

standards. These differences are described in this section. Some of

these differences, however, may be eliminated through an interagency

rulemaking conducted pursuant to section 303 of the Riegle Community

Development and Regulatory Improvement Act of 1994 (CDRI

Act).5 The items in this section for which the Agencies have

agreed to propose uniform treatment are marked with an asterisk (*) and

further discussed in section C(1)(i) of this report.

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\5\ Pub. L. 103-325, section 303, 108 Stat. 2160, 2215 (1994)

(codified at 12 U.S.C. 1835). Section 303(a)(2) required that the

Agencies ``work jointly * * * to make uniform all regulations and

guidelines implementing common statutory or supervisory policies.''

See also Board of Governors of the Federal Reserve System, Federal

Deposit Insurance Corporation, Office of the Comptroller of the

Currency, and the Office of Thrift Supervision, Joint Report:

Streamlining of Regulatory Requirements (September 23, 1996)

(Progress report submitted by the Agencies to the Congress pursuant

to section 303(a)(3) of the CDRI Act).

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1. Leverage Capital Requirements*

Under the OCC leverage capital requirement, highly-rated banks

(composite CAMELS 6 rating of 1) must maintain a minimum

leverage capital ratio of at least 3 percent of Tier 1 capital to total

assets. All other banks must maintain an additional 100 to 200 basis

points of Tier 1 capital to total assets. The OCC leverage capital

requirement is the same as the rules of the other Banking Agencies.

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\6\ On December 9, 1996, the Federal Financial Institutions

Examination Council (FFIEC) adopted the revised Uniform Financial

Institutions Rating System (UFIRS or CAMELS rating system). The

UFIRS is an internal rating system used by the federal and state

banking regulators for assessing the soundness of financial

institutions on a uniform basis and for identifying those insured

institutions requiring special supervisory attention. Among other

things, the revised UFIRS added a sixth ``S'' component called

``Sensitivity to Market Risk'' to the CAMELS rating system. This

change reflects an increased emphasis by the Agencies on the quality

of risk management practices. A final notice was published in the

Federal Register on December 19, 1996, effective January 1, 1997.

See 61 FR 67021 (December 19, 1996).

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Saving associations are subject to a leverage ratio requirement of

3 percent of core capital 7 to adjusted total assets and a

tangible capital requirement of 1.5 percent of total assets. The OTS

has not yet adopted a final rule to amend its leverage ratio

requirement to be consistent with the leverage ratio requirements of

the other Banking Agencies. See 56 FR 16238 (April 22, 1991). OTS

regulated institutions, however, must satisfy the same percentage

requirements for leverage capital as banks in order to be considered

adequately capitalized for purposes of the PCA standards applicable to

all insured depository institutions. See 12 U.S.C. 1831o.

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\7\ While the definition of core capital is generally consistent

with the definition of Tier 1 capital, there are some differences.

Mutual savings associations may include certain nonwithdrawable

accounts and pledged deposits as core capital. In addition, under

section 221 of FIRREA, 12 U.S.C. 1828(n), qualifying supervisory

goodwill was permitted to be included in core capital for savings

associations; however, supervisory goodwill was phased out of core

capital at the end of 1994.

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2. Equity Investments

To the extent that a bank is permitted to hold equity securities

(such as securities obtained in connection with debts previously

contracted), the OCC risk-based capital guidelines generally require

these investments to be risk weighted at 100 percent. However, on a

case-by-case basis, the OCC may require deduction of equity investments

from the capital of the parent bank or impose other requirements in

order to assess an appropriate capital charge above the minimum capital

requirements. The other Banking Agencies have similar rules. The

capital treatment of equity investments is also discussed in section

B(5) of this report.

After the enactment of FIRREA, savings associations were required

to deduct equity investments that are impermissible for national banks

from capital gradually during a phase-in period. The phase-in period

ended July 1, 1996.

3. Assets subject to Guarantee Arrangements by the Federal Savings and

Loan Insurance Corporation (FSLIC)/Federal Deposit Insurance

Corporation

The OCC risk-based capital guidelines assign assets with FSLIC or

FDIC guarantees to the 20 percent risk-weight category, the same

category to which claims on depository institutions and government-

sponsored agencies are assigned. The other Banking Agencies also assign

these assets to the 20 percent weight category. The OTS assigns these

[[Page 26357]]

assets to the zero percent risk-weight category.

4. Limitation on Subordinated Debt and Limited-Life Preferred Stock

The OCC limits the amount of Tier 2 capital that may be included in

total capital to no more than 100 percent of Tier 1 capital. Consistent

with the Basle Accord, the OCC further limits the amount of

subordinated debt and limited-life preferred stock that may be included

in Tier 2 capital to 50 percent of Tier 1 capital. In addition, the OCC

risk-based capital guidelines require that subordinated debt and

limited-life preferred stock be discounted 20 percent in each of the

five years prior to maturity. The other Banking Agencies have similar

rules.

The OTS risk-based capital rules also limit Tier 2 capital to 100

percent of Tier 1 capital, but do not contain any sublimit on the total

amount of limited-life instruments that may be included within Tier 2

capital. In addition, the OTS allows savings associations the option of

either (1) discounting maturing capital instruments (issued on or after

November 7, 1989) by 20 percent a year over the last five years of

their term, or (2) including the full amount of such instruments,

provided that the amount maturing in any of the next seven years does

not exceed 20 percent of the total capital of the savings association.

5. Subsidiaries*

Consistent with the Basle Accord, the Banking Agencies generally

require that significant 8 majority-owned subsidiaries be

consolidated with the parent institution for both regulatory reporting

and capital purposes. If a subsidiary is not consolidated, the bank's

investment in the subsidiary constitutes a capital investment in the

subsidiary. The OCC risk-based capital guidelines specifically provide

that capital investments in an unconsolidated banking or financial

subsidiary must be deducted from the total capital of the bank. The OCC

risk-based capital guidelines also permit the OCC to require the

deduction of investments in other subsidiaries and associated companies

on a case-by-case basis. In addition, Part 5 of the OCC's regulations

requires deconsolidation of any subsidiary that engages as principal in

activities not permitted to be conducted in the bank directly, and

requires the bank's equity investment in that subsidiary to be deducted

from the capital of the bank. See 61 FR 60342 (November 27, 1996).

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\8\ A significant majority-owned subsidiary is a subsidiary in

which the investment by the parent bank represents a significant

financial interest of the parent bank as evidenced by (1) the bank

investment or advances to the subsidiary equals 5 percent or more of

the total equity capital of the bank, (2) the bank's proportional

share of the gross income or revenue of the subsidiary equals 5

percent or more of the gross income or revenue of the bank, (3) the

income (or loss before taxes) of the subsidiary amount to 5 percent

or more of the income (or loss before taxes) of the bank, or (4) the

subsidiary is the parent of a subsidiary that is considered a

significant subsidiary.

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The FRB risk-based capital guidelines for state member banks

generally require the deduction of investments in unconsolidated

banking and finance subsidiaries. The FRB may require an investment in

unconsolidated subsidiaries other than banking and finance subsidiaries

or joint ventures and associated companies, (1) to be deducted, (2) to

be appropriately risk-weighted against the proportionate share of the

assets of the entity, or (3) to be consolidated line-by-line with the

entity. In addition, the FRB may require the parent organization to

maintain capital above the minimum standard sufficient to compensate

for any risks associated with the investment.

The FRB risk-based capital guidelines also explicitly permit the

deduction of investments in certain subsidiaries that, while

consolidated for accounting purposes, are not consolidated for certain

specified supervisory or regulatory purposes. For example, the FRB

deducts investments in, and unsecured advances to, ``Section 20''

securities subsidiaries from the capital of the parent bank holding

company.

The FDIC accords similar treatment to certain type of securities

subsidiaries of state-chartered nonmember banks. Moreover, under the

FDIC rules, investments in, and extensions of credit to, certain

mortgage banking subsidiaries are also deducted in computing the

capital of the parent bank. Neither the OCC nor the FRB has a similar

requirement with regard to mortgage banking subsidiaries.

Under OTS risk-based capital guidelines, a distinction is made

between saving associations subsidiaries engaged in activities

permissible for national banks and their subsidiaries and saving

association subsidiaries engaged in activities ``impermissible'' for

national banks. This distinction is mandated by FIRREA. Subsidiaries of

savings associations that engage only in activities permissible for

national banks are consolidated on a line-for-line basis if majority-

owned and on a pro rata basis if ownership is between 5 percent and 50

percent. As a general rule, investments, including loans, in

subsidiaries that engage in national bank-impermissible activities are

deducted in computing tangible and core capital of the parent

association. The remaining assets (the percent of assets corresponding

to the nondeducted portion of the investment in the subsidiary) are

consolidated with the assets of the parent association. However,

investments, including loans outstanding as of April 12, 1989, to

subsidiaries that were engaged in impermissible activities prior to

that date, are grandfathered. These investments were required to be

phased-out of capital by July 1, 1994; however, the transition period

for investments made prior to April 12, 1989, in nonincludable real

estate subsidiaries could be extended, in certain circumstances, to

July 1, 1996. See 12 U.S.C. 1464(t)(5)(D). During this transition

period, investments in subsidiaries engaged in impermissible activities

that had not been phased out of capital were consolidated on a pro rata

basis.

6. Nonresidential Construction and Land Loans

Under the OCC risk-based capital guidelines, loans for real estate

development and construction are assigned to the 100 percent risk-

weight category. Reserves or charge-offs are required for such loans

when weaknesses or losses develop. The OCC has no requirement for an

automatic charge-off when the amount of a loan exceeds the fair value

of the property pledged as collateral for the loan. The other Banking

Agencies have similar rules.

OTS generally also assigns these loans to the 100 percent risk-

weight category. However, if the amount of the loan exceeds 80 percent

of the fair value of the property, savings associations must deduct the

full amount of the excess portion from total capital.9

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\9\ Prior to July 1, 1994, only a percentage (as provided by a

phase-in schedule) of the excess portion was required to be deducted

from total capital.

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7. Mortgage-Backed Securities (MBS)

The OCC risk-based capital guidelines generally assign a risk

weight to privately-issued MBSs according to the underlying assets, but

in no case is a privately-issued MBS assigned to the zero percent risk-

weight category. Privately-issued MBSs, where the direct underlying

assets are mortgages, are generally assigned a risk weight of 50

percent or 100 percent. Privately-issued MBSs that have government

agency or government-sponsored agency securities as their direct

underlying assets are generally assigned to the 20 percent risk-weight

category. The other Banking Agencies have similar rules.

[[Page 26358]]

Similarly, the OTS assigns privately issued MBSs backed by

securities issued or guaranteed by government agencies or government-

sponsored enterprises to the 20 percent risk-weight category. However,

unlike the Banking Agencies, the OTS also assigns certain privately-

issued high quality mortgage-related securities with AA or better

investment ratings to the 20 percent risk-weight category. Like the

Banking Agencies, the OTS does not assign any privately issued MBS to

the zero percent category.

With respect to other MBSs, the Agencies assign to the 100 percent

risk-weight category certain MBSs, including interest-only strips,

residuals, and similar instruments that can absorb more than their pro

rata share of loss.

8. Agricultural Loan Loss Amortization

In determining regulatory capital, those banks accepted into the

agricultural loan loss amortization program pursuant to Title VIII of

the Competitive Equality Banking Act of 1987 are permitted to defer and

amortize losses incurred on agricultural loans between January 1, 1984,

and December 31, 1991.10 The program also applies to losses

incurred between January 1, 1983, and December 31, 1991, as a result of

reappraisals and sales of agricultural other real estate owned and

agricultural personal property. These losses must be fully amortized

over a period not to exceed seven years and, in any case, must be fully

amortized by year-end 1998. Savings associations are not eligible to

participate in the agricultural loan loss amortization program

established by this statute.

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\10\ This program will sunset January 1, 1999. See 60 FR 27401

(May 24, 1995).

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9. Treatment of Junior Liens on One- to Four-Family Properties*

In some cases, a banking organization may make two loans secured by

the same residential property; one loan is secured by a first lien, the

other by a second lien. The OCC and the FDIC generally assign first

liens on one-to four-family properties to the 50 percent risk-weight

category. The assignment of first lien mortgages to the 50 percent

risk-weight category is based upon the expectation that banks will

adhere to the requirement for prudent underwriting standards with

respect to the maximum loan-to-value ratio, the borrower's paying

capacity and the long-term expectations for the real estate market in

which the bank is lending.

The OCC assigns all second liens on residential property to the 100

percent risk-weight category, regardless of whether the institution

also holds the first lien. The FDIC similarly assigns all second liens

to the 100 percent risk-weight category. However, in determining the

risk-weight of the first lien, the FDIC considers the first and second

liens together to assess whether the first lien satisfies prudent

underwriting standards. When evaluated together, if the first and

second liens are within the prudent loan-to-value ratio and satisfy all

other underwriting standards, then the first lien will be assigned to

the 50 percent risk-weight category; otherwise, it will be assigned to

the 100 percent risk-weight category.

The FRB and OTS consider the first and second liens as a single

loan, provided there are no intervening liens. Therefore, the total

amount of these transactions may be assigned to the 100 percent risk-

weight category, if, in the aggregate, the two loans exceed a prudent

loan-to-value ratio and, therefore, do not qualify for the 50 percent

risk-weight category. This approach is intended to avoid possible

circumvention of the capital requirements and capture the risks

associated with the combined transactions. However, if the total amount

of the transaction does satisfy a prudent loan-to-value ratio and other

underwriting standards, then both the first and second liens may be

assigned to the 50 percent risk-weight category.

10. Pledged Deposits and Nonwithdrawable Accounts

Pledged deposits and nonwithdrawable accounts that satisfy

specified OTS criteria may be included in core capital by mutual

savings associations. Pledged deposits and nonwithdrawable accounts

generally represent capital investments in mutual saving associations

under the same terms as perpetual noncumulative preferred stock. These

mutual saving associations accept capital investments in the form of

pledged deposits and nonwithdrawable accounts because mutual

associations are not legally authorized to issue common or preferred

stock. Income capital certificates and mutual capital certificates that

were issued by savings associations under applicable statutory

authority and regulations and held by the FDIC may be included in Tier

2 capital by savings associations.

These instruments are unique to savings associations and are not

held by commercial banks. Consequently, these instruments are not

addressed in the OCC risk-based capital guidelines.

11. Mutual Funds*

The OCC and the other Banking Agencies generally assign all of the

holdings of a bank in a mutual fund to the risk category appropriate to

the asset with the highest risk that a particular mutual fund is

permitted to hold under its operating rules. This approach takes into

account the maximum degree of risk to which a bank may be exposed when

investing in a mutual fund. On a case-by-case basis, however, the OCC

may permit a bank to risk weight the investments in a mutual fund on a

pro rata basis relative to the maximum risk weights of the assets the

mutual fund is permitted to hold but limited to no lower than a 20

percent risk weight.

The OTS applies a capital charge based on the riskiest asset that

is actually held by the mutual fund at a particular time. In addition,

the OTS and OCC guidelines also permit, on a case-by-case basis,

investments in mutual funds to be risk weighted on a pro rata basis

dependent on the actual composition of the fund.

12. Collateralized Transactions*

Both the OCC and FRB permit certain loans and transactions

collateralized by cash and OECD government securities to qualify for a

zero percent risk weight. The FDIC and OTS risk weight loans and

transactions collateralized by cash and OECD government securities at

20 percent. See discussion in section C(1)(i) of this report.

C. Recent Interagency Rulemaking Projects

The three Banking Agencies have amended their capital adequacy

rules in several significant ways since they were originally adopted.

First, the credit risk framework of the risk-based capital guidelines

has been expanded to cover derivative contracts. Second, the risk-based

capital guidelines have been amended to incorporate a market risk

component which serves to supplement credit risk. Third, all four

Agencies have added an interest rate risk component to their capital

adequacy rules. In amending the capital adequacy rules, the practice of

the Agencies is to consult closely with one another even in instances

where joint rulemaking is not statutorily required. This ensures that

all insured depository institutions are subject to the same standards

to the maximum extent feasible. The following describes the most

significant rulemaking projects undertaken during the period covered by

this report.

[[Page 26359]]

1. Amendments to the Risk-Based Capital Credit Risk Framework

This section discusses regulatory efforts of the Agencies to amend

the credit risk framework of the risk-based capital guidelines.

a. Expanded Matrix for Derivative Contracts

On September 5, 1995, the OCC and the other Banking Agencies issued

a joint final rule on derivative contracts which amended the risk-based

capital guidelines to cover derivative contracts. See 60 FR 46170

(September 5, 1995); see also 59 FR 45243 (September 1, 1994) (OCC

proposed rule). Specifically, the rule expanded and revised the set of

off-balance sheet credit conversion factors used to calculate the

potential future credit exposure on derivative contracts and permitted

banks to net multiple derivative contracts executed with a single

counterparty that are subject to a qualifying bilateral netting

contract when calculating the potential future credit exposure.

b. Membership in the Organization for Economic Cooperation and

Development (OECD)

Under the risk-based capital guidelines, claims on, or guarantees

by, certain entities in OECD-based countries generally are subject to a

lower capital charge. See 12 CFR Part 3, Appendix A 3(a)(1)(iii)

(securities issued by the United States or the central government of an

OECD country subject to zero percent risk weight). On December 20,

1995, the OCC and the other Banking Agencies amended the definition of

``OECD-based country'' to exclude any country that has rescheduled its

external sovereign debt within the previous five years. See 60 FR 66042

(December 20, 1995). This rule was issued in response to a change by

the Basle Committee on Banking Regulations and Supervisory Practices to

the Basle Accord.

c. Unrealized Gains and Losses on Securities Available for Sale

The Agencies have all issued final rules on unrealized gains and

losses on securities available for sale. The final rules were developed

jointly by the OCC and the other Agencies in response to Financial

Accounting Standard (FAS) 115, which generally requires net unrealized

gains and losses on securities available for sale to be included in

capital. See Financial Accounting Standards Board, Statement of

Financial Accounting Standards Number 115 (Accounting for Certain

Investments in Debt and Equity Securities), No. 126-D (May 1993). The

Federal Financial Institutions Examination Council adopted FAS 115 for

regulatory reporting purposes beginning December 15, 1993.

The proposed rules of the Agencies would have adopted FAS 115 for

regulatory capital purposes by amending the definition of ``common

stockholders' equity'' in the capital guidelines to include both

unrealized gains and losses on securities available for sale. However,

after careful consideration of the comments received, the OCC, along

with the other Agencies, decided not to adopt the proposed rule because

of the potential volatility that could result if FAS 115 unrealized

gains and losses are required to be included in regulatory capital.

Consequently, the OCC final rule does not require national banks to use

FAS 115 for the purposes of computing regulatory capital. See 59 FR

60552 (November 25, 1994). The FDIC, the OTS and the FRB issued similar

final rules. See 59 FR 66662 (December 28, 1994) (FDIC final rule); 60

FR 42025 (August 15, 1995) (OTS final rule); and 59 FR 63641 (December

8, 1994) (FRB final rule).

d. Concentrations of Credit and Nontraditional Activities

The Agencies have implemented section 305 of FDICIA by amending

their capital adequacy rules to explicitly identify concentrations of

credit risk and certain risks arising from nontraditional activities as

important factors in assessing each institution's overall capital

adequacy. The four Agencies issued a joint final rule on the risks from

concentrations of credit and nontraditional activities. The final rule

was published in the Federal Register on December 15, 1994. See 59 FR

64561 (December 15, 1994).

e. Bilateral Netting Contracts

On December 28, 1994, the OCC and the OTS issued a joint final rule

on bilateral netting contracts. This final rule amended the risk-based

capital guidelines to permit netting of certain interest rate and

foreign exchange rate contracts in calculating the current exposure

portion of the credit equivalent amount of these contracts for risk-

based capital purposes. See 59 FR 66645 (December 28, 1994). The FRB

and the FDIC issued similar final rules. See 59 FR 62987 (December 7,

1994) (FRB final rule); and 59 FR 66656 (December 28, 1994) (FDIC final

rule).

f. Collateralized Transactions

The rule on collateralized transactions amended the OCC risk-based

capital guidelines to lower the risk weight from 20 percent to zero

percent on certain loans and transactions collateralized by cash or

government securities. The OCC issued its final rule on collateralized

transactions on December 28, 1994. See 59 FR 66642 (December 28, 1994).

See section C(1)(i) for a description of the plan of the Agencies to

issue uniform rules with respect to collateralized transactions.

g. Deferred Tax Assets

The OCC final rule on deferred tax assets amended the risk-based

capital guidelines to limit the amount of certain deferred tax assets

that may be included in an institution's Tier 1 capital to the lesser

of (1) the amount of deferred tax assets the institution expects to

realize within one year or (2) 10 percent of Tier 1 capital. This final

rule was developed jointly by the Agencies in response to FAS 109,

which was adopted for regulatory reporting purposes beginning January

1, 1993. See Financial Accounting Standards Board, Statement of

Financial Accounting Standards Number 109 (Accounting for Income

Taxes), No. 112-A (February 1992). FAS 109 provides guidance on the

accounting treatment of income taxes and generally allows banks to

report certain deferred tax assets they could not previously recognize.

The OCC issued its final rule on February 10, 1994. See 60 FR 7903

(February 10, 1994). The FRB and the FDIC issued similar final rules.

See 59 FR 65920 (December 22, 1994) (FRB); and 60 FR 8182 (February 13,

1995) (FDIC). The OTS had adopted this general approach through the

issuance of a Thrift Bulletin. See TB-56 (January 1993).

h. Mortgage Servicing Rights

On August 1, 1995, the OCC, the other Banking Agencies, and the OTS

issued a joint interim rule with request for comment on the capital

treatment of originated mortgage servicing rights (OMSR). See 60 FR

39266 (August 1, 1995). The interim rule was developed in response to

FAS 122 on mortgage servicing rights which eliminates the accounting

distinction between OMSRs and purchased mortgage servicing rights

(PMSR). See Financial Accounting Standards Board, Statement of

Financial Accounting Standards Number 122 (Accounting for Mortgage

Servicing Rights). Specifically, the interim rule amends the capital

adequacy rules to treat OMSRs the same as PMSRs for regulatory capital

purposes. Therefore, subject to an overall 50 percent limit of Tier 1

capital, both OMSRs and PMSRs may be included in capital for regulatory

capital and PCA purposes.

[[Page 26360]]

i. CDRI Act Section 303(a)(2) Capital Amendments

In addition to the general ongoing efforts of the Agencies to

achieve uniform capital and accounting standards, as part of the

interagency review of regulations under section 303(a)(2) of the

RCDRIA, the Agencies currently are evaluating the capital and

accounting differences in this report in contemplation of changes to

achieve greater uniformity. The Agencies already have issued a joint

proposed rule on collateralized transactions as part of their efforts

under section 303(a)(2) of the CDRI Act. See 61 FR 42565 (August 16,

1996). Under this joint proposed rule, the FDIC and OTS would adopt a

collateralized transactions rule lowering the risk weight from 20

percent to zero percent on certain loans and transactions

collateralized by cash or government securities; the OCC and FRB would

revise their current collateralized transactions rule to use more

uniform language.

In addition to collateralized transactions, the Agencies have

identified several other provisions as appropriate for revision under

section 303(a)(2) of the CDRI Act. These provisions include the capital

treatment of presold residential construction loans, junior liens on

one to four-family residential properties, and mutual funds,

investments in subsidiaries and the minimum leverage capital

requirement. See Joint Report: Streamlining of Regulatory Requirements,

pages I-6 through I-9.

2. Market Risk Component

The joint final rule issued by the Banking Agencies on market risk

amended the risk-based capital guidelines to incorporate a measure for

market risk in foreign exchange and commodity activities and in the

trading of debt and equity instruments. Market risk generally

represents the risk of loss attributable to on and off-balance sheet

positions caused by movements in market prices. The effect of the final

rule is to require certain banks with relatively large amounts of

trading activities to hold additional capital based on the measure of

their market risk exposure as determined by the banks own internal

value-at-risk model. The final rule also establishes a third capital

category, Tier 3 capital, which generally consists of certain short

term subordinated debt subject to a lock-in clause that prevent the

issuer from repayment if the bank's risk-based capital ratio falls

below 8 percent. Tier 3 capital can only be used to satisfy market risk

capital requirements. The joint final rule was issued by the Banking

Agencies on September 6, 1996. See 61 FR 47358 (September 6, 1996).

3. Interest Rate Risk Component

The joint final rule issued by the Banking Agencies on interest

rate risk amended the capital adequacy rules to clarify the authority

of the Banking Agencies to specifically include in their evaluation of

bank capital an assessment of the exposure to declines to bank's

capital due to changes in interest rates. The final rule on interest

rate risk was issued jointly by the OCC and the other Banking Agencies

on August 2, 1995. See 60 FR 39490 (August 2, 1995). The Banking

Agencies also have issued a joint policy statement on interest rate

risk on June 26, 1996. See 61 FR 33166 (June 26, 1996). The joint

policy statement provides guidance to banks on measuring and managing

their interest rate risk exposure.

The OTS has adopted an interest rate risk component to its risk-

based capital guidelines, which became effective on January 1, 1994.

Once fully implemented, under the OTS rule thrift institutions with an

above normal level of interest rate risk will be subject to a capital

charge commensurate to their risk exposure. Unlike the interest rate

risk rules of the Banking Agencies, the OTS rule, when implemented,

would impose an automatic capital charge for interest rate risk over a

specified level. In addition, under the OTS rule, the OTS collects data

and computes the interest rate risk exposure and corresponding capital

charge for all thrift institutions required to report.

4. Recourse

In general, recourse is the risk of loss retained by an institution

when it sells an asset. Recourse arrangements allow the purchaser of an

asset to seek recovery against the institution that sold the asset

under the conditions in the agreement. Under the current risk-based

capital guidelines of the Banking Agencies, sales of assets involving

recourse generally must be reported as financings which means that the

assets are retained on the balance sheet of the selling bank. The OTS

treats sales with recourse as sales for regulatory reporting and

leverage ratio purposes if they meet the criteria under generally

accepted accounting principles (GAAP) for sales treatment, including

the establishment of a recourse liability account for reasonably

estimated losses from the recourse obligation.

a. Low Level Recourse

Prior to the adoption of the final rule on low level recourse, the

risk-based capital guidelines of the Banking Agencies had the effect of

requiring a full leverage and risk-based capital charge whenever assets

are sold with recourse, even if the institution's maximum exposure

under the recourse obligation is less than the capital charge on the

asset sold. On April 10, 1995, the OCC issued a final rule on low level

recourse. See 60 FR 17986 (April 10, 1995). This final rule amends the

risk-based capital guidelines to limit the amount of capital that a

bank must hold to the maximum contractual loss exposure retained by the

bank under the recourse obligation if that amount is less than the

amount of the effective capital requirement for the underlying asset.

This final rule implements the requirements of section 350 of the CDRI

Act (12 U.S.C. 4808), which generally limits the risk-based capital

charge for assets transferred with recourse to the amount of recourse

the bank is contractually liable under the recourse agreement. The FRB

and the FDIC issued similar final rules. See 60 FR 8177 (February 13,

1995) (FRB final rule); and 60 FR 15858 (March 28, 1995) (FDIC final

rule). The OTS capital rules already reflected this position on low

level recourse.

b. Recourse and Direct Credit Substitutes

On May 25, 1994, the Agencies jointly issued an advance notice of

proposed rulemaking (ANPR) on recourse. See 59 FR 27116 (May 25, 1995).

The ANPR proposed an approach that would use credit ratings to more

closely match the risk-based capital assessment to an institution's

relative risk of loss in certain asset securitizations.

c. Small Business Loan Recourse

Section 208 of the CDRI Act (12 U.S.C. 1835) generally reduces the

amount of capital required to be held by certain qualified institutions

for recourse retained in certain transfers of small business loans and

leases of personal property. Currently, the Agencies are engaged in

rulemaking to implement section 208. The FRB issued a final rule on

August 31, 1995. See 60 FR 45612 (August 31, 1995). The FDIC, OTS, and

the OCC, have issued interim rules with request for comment. See 60 FR

45606 (August 31, 1995) (FDIC interim rule); 60 FR 45618 (August 31,

1995) (OTS interim rule); and 60 FR 47455 (September 13, 1995) (OCC

interim rule).

[[Page 26361]]

D. Interagency Differences in Accounting Principles

The regulatory reporting standards for all commercial banks,

whether regulated by the OCC, the FRB, or the FDIC, are prescribed in

the instructions to the Call Report. The Call Report instructions are

prepared by the Federal Financial Institutions Examination Council

(FFIEC) and require banks to follow generally accepted accounting

principles (GAAP) for reports of condition and income required to be

filed with the Banking Agencies except as permitted under section 121

of FDICIA. Under section 121 of FDICIA, the Banking Agencies must

require financial institutions to use accounting principles ``no less

stringent than GAAP'' for reports of condition and income to be filed

with the Banking Agencies. Reporting in accordance with GAAP generally

satisfies this statutory requirement.

Although the accounting and reporting requirements imposed by the

Banking Agencies were, for the most part, already consistent with GAAP,

on November 3, 1995, the FFIEC announced the full adoption of GAAP as

the reporting basis for the Call Report. Proposed Call Report changes

to further conform the Call Report with GAAP were published for comment

on September 16, 1996. See 61 FR 48687 (September 16, 1996). The final

Call Report changes were published on February 21, 1997. See 62 FR 8078

(February 21, 1997).

The OTS requires each savings association to file the Thrift

Financial Report. That report is filed on a basis consistent with GAAP

as it is applied by savings associations, which differs in a few

respects from GAAP as GAAP applies to banks. These current differences

in accounting principles between the banks and thrift institutions

result in some differences in financial statement presentation and in

amounts of regulatory capital required to be maintained by these

institutions. The following summarizes the significant differences

between the Thrift Financial Report and the Call Report as of year-end

1996. However, the implementation of the current Call Report changes to

move toward the full adoption of GAAP by the Banking Agencies will

essentially eliminate substantive accounting differences among the

Agencies. As a result most of the accounting differences discussed in

this section will be eliminated. To the degree, any accounting

differences remain, the Agencies will continue to work toward

reconciling those remaining differences.

1. Futures and Forward Contracts

Differences in this area result because the Banking Agencies

generally require future and forward contracts to be marked to market,

whereas under GAAP savings associations may defer gains and losses

resulting from certain hedging activities.

The Banking Agencies do not follow GAAP, but require banks to

report changes in the market value of futures and forward contracts,

even when used as hedges, in current income. However, futures contracts

used to hedge mortgage banking operations are reported in accordance

with GAAP. The accounting for futures and forward contracts is being

reexamined by the Financial Accounting Standards Board (FASB) as part

of an ongoing project on accounting for derivatives.

The OTS requires savings associations to follow GAAP to account for

futures contracts. Accordingly, when specified hedging criteria are

satisfied, the accounting for the futures contract is matched with the

accounting for the hedged item. Changes in the market value of the

futures contract are recognized in income when the income effects of

the hedged item are recognized. This reporting can result in the

deferral of both gains and losses. Although there is no specific GAAP

for forward contracts, the OTS applies these same principles to forward

contracts.

2. Push-Down Accounting

When a depository institution is acquired in a purchase

transaction, the holding company is required to revalue all of the

assets and liabilities of the depository institution at fair value at

the time of acquisition. When push-down accounting is applied, the same

fair value adjustments recorded by the parent holding company are also

recorded at the depository institution level.

All of the agencies require the use of push-down accounting when

there has been a substantial change in the ownership of the

institution. However, differing standards have been applied to

determine when this substantial change has occurred.

The Banking Agencies require push-down accounting when there is at

least a 95 percent change in ownership of the institution. This

approach is consistent with interpretations of the Securities and

Exchange Commission.

The OTS requires push-down accounting when there is at least a 90

percent change of ownership.

3. Excess Service Fees

Excess service fees are created when a bank sells mortgage loans,

but retains the servicing rights. Excess service fees represent the

present value of the servicing fees in excess of the normal servicing

fee. Savings associations consider excess servicing fees in the

determination of the gain or loss on a loan sale, whereas banks

generally recognize the excess fee over the life of the loan.

The Banking Agencies require banks to follow GAAP for residential

first mortgage loans. This requires that when loans are sold with

servicing retained and the stated servicing fee is sufficiently higher

than a normal servicing fee, the sales price is adjusted to determine

the gain or loss from the sale. This allows additional gain recognition

for the excess servicing fee at the time of sale and recognizes a

normal servicing fee in each subsequent year. This gain cannot exceed

the gain assuming the loans were sold with servicing released. In

addition, the Banking Agencies allow limited recognition at the time of

sale of excess servicing fees for SBA loans.

For all other loans, the Banking Agencies require that excess

servicing fees retained on loans sold be recognized over the

contractual life of the transferred assets.

The OTS follows GAAP in valuing all excess service fees. Therefore,

the accounting stated above for sales of mortgage loans with excess

servicing at banking institutions would apply to all loan sales with

excess servicing at savings associations.

4. In-substance Defeasance of Debt

The Banking Agencies do not permit banks to defease their

liabilities in accordance with FAS 76, whereas saving associations may

eliminate defeased liabilities from the balance sheet. FAS 76 concerns

the extinguishment of debt. Specifically, FAS 76 specifies that debt is

to be considered extinguished if the debtor is relieved of primary

liability for the debt by the creditor and it is probable that the

debtor will not be required to make future payments as guarantor of the

debt. In addition, even though the creditor does not relieve the debtor

of its primary obligation, debt is to be considered extinguished if (1)

the debtor irrevocably places cash or other essentially risk-free

monetary assets in a trust solely for satisfying that debt and (2) the

possibility that the debtor will be required to make further payments

is remote. The Banking Agencies report in-substance defeased debt as a

liability and the securities contributed to the trust as assets with no

recognition of any gain or loss on the transaction.

[[Page 26362]]

The OTS accounts for debt that has been in-substance defeased in

accordance with GAAP. Therefore, when a debtor irrevocably places risk-

free monetary assets in a trust solely for satisfying the debt and the

possibility that the debtor will be required to make further payments

is remote, the debt is considered extinguished. The transfer can result

in a gain or loss in the current period.

5. Sales of Assets with Recourse

Banks generally do not report sales of receivables if any risk of

loss is retained. Savings associations report sales when the risk of

loss can be estimated in accordance with FAS 77.

The Banking Agencies generally allow banks to report transfers of

receivables as sales only when the transferring institution: (1)

retains no risk of loss from the assets transferred and (2) has no

obligation for the payment of principal or interest on the assets

transferred. As a result, assets transferred with recourse are reported

as financings, not sales.

However, this rule does not apply to the transfer of mortgage loans

under certain government programs (GNMA, FNMA, etc.). Transfers of

mortgages under one of these programs are automatically treated as

sales. Furthermore, private transfers of pools of mortgages are also

reported as sales if the transferring institution does not retain more

than an insignificant risk of loss on the assets transferred.

The OTS follows GAAP to account for a transfer of all receivables

with recourse. A transfer of receivables with recourse is recognized as

a sale if: (1) the seller surrenders control of the future economic

benefits, (2) the transferor's obligation under the recourse provisions

can be reasonably estimated, and (3) the transferee cannot require

repurchase of the receivables except pursuant to the recourse

provisions.

6. Negative Goodwill

The Banking Agencies require that negative goodwill be reported as

a liability, and not netted against the goodwill asset.

The OTS permits negative goodwill to offset the goodwill assets

resulting from other acquisitions.

7. Offsetting of Amounts Related to Certain Contracts

Financial Accounting Standards Board Interpretation Number (FIN) 39

became effective in 1994. FIN 39 allows the offsetting of assets and

liabilities on the balance sheet (e.g., loans, deposits, etc.), as well

as the netting of assets and liabilities arising from off-balance sheet

derivatives instruments, when four conditions are met. These conditions

relate to whether a valid right of offset exists. FIN 41, which also

became effective in 1994, provides for the netting of repurchase and

reverse repurchase agreements when certain conditions are met.

The Banking Agencies have adopted FIN 39 solely for on-balance

sheet amounts arising from conditional and exchange contracts (e.g.,

interest rate swaps, options, etc.). The Banking Agencies have not

adopted FIN 41. The Call Report's existing guidance, which generally

prohibits netting of assets and liabilities, is currently followed in

all other cases. The OTS policy on netting of assets and liabilities is

consistent with GAAP.

8. Specific Valuation Allowance for and Charge-offs of Troubled Loans

The Banking Agencies generally consider real estate loans that lack

acceptable cash flows or other repayment sources to be ``collateral

dependent.'' When the fair value of the collateral of such a loan has

declined below book value, the loan is reduced to fair value. This

approach is consistent with GAAP applicable to banks and FAS 114.

The OTS requires a specific valuation allowance against or partial

charge-off of a loan when its book value exceeds its ``value.'' The

``value'' is defined as either the present value of the expected future

cash flows discounted at the loan's effective interest rate, the

observable market price, or the fair value of the collateral. This

policy is also consistent with the requirements of FAS 114.

Effective March 31, 1995, the OTS required that losses on

collateral dependent loans be measured based on the fair value of the

collateral. Accordingly, after March 31, 1995, the OTS policy regarding

the recognition of losses on collateral dependent loans became

comparable to that of the Bank Agencies.

Dated: May 6, 1997.

Eugene A. Ludwig,

Comptroller of the Currency.

[FR Doc. 97-12515 Filed 5-12-97; 8:45 am]

BILLING CODE 4810-33-P