Liquidity

DEPARTMENT OF THE TREASURY

Office of Thrift Supervision

12 CFR Part 566

[No. 97-44]

RIN 1550-AA77

Liquidity

AGENCY: Office of Thrift Supervision, Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: The Office of Thrift Supervision (OTS) is proposing to update,

simplify, and streamline its liquidity regulation. This proposal

follows a detailed review of the regulation to determine whether it is

necessary, imposes the least possible burden consistent with statutory

requirements and safety and soundness, and is written in a clear,

straightforward manner. Today's proposal is made pursuant to the

Regulatory Reinvention Initiative of the Vice President's National

Performance Review and section 303 of the Community Development and

Regulatory Improvement Act of 1994.

DATES: Comments on this proposed rule must be received on or before

July 14, 1997.

ADDRESSES: Send comments to Manager, Dissemination Branch, Records

Management and Information Policy, Office of Thrift Supervision, 1700 G

Street, NW, Washington, DC 20552, Attention Docket No. 97-44. These

submission may also be hand delivered to 1700 G Street, NW, from 9:00

a.m. to 5:00 p.m. on business days; they may be sent by facsimile

transmission to FAX number (202) 906-7755; or they may be sent by e-

mail: [email protected]. Those commenting by e-mail should

include their name and telephone number. Comments will be available for

inspection at 1700 G Street, NW, from 9:00 A.M. until 4:00 P.M. on

business days.

FOR FURTHER INFORMATION CONTACT: Francis Raue, Program Analyst, (202)

906-5750, Robyn Dennis, Manager, Thrift Policy, (202) 906-5751,

Supervision Policy, or Susan Miles, Senior Attorney, (202) 906-6798,

Karen Osterloh, Assistant Chief Counsel, (202) 906-6639, Regulations

and Legislation Division, Chief Counsel's Office, Office of Thrift

Supervision, 1700 G Street, NW, Washington, DC 20552.

SUPPLEMENTARY INFORMATION:

I. Background and Objectives of the Proposal

In a comprehensive review of the agency's regulations in the spring

of 1995, OTS identified numerous obsolete or redundant regulations that

could be quickly repealed. OTS also identified several key regulatory

areas for a more intensive, systematic regulatory burden review. The

first areas reviewed--lending and investment authority, subsidiaries

and equity investments, corporate governance, conflicts of interest,

corporate opportunity and hazard insurance--were selected because they

have a significant impact on thrift operations, and had not been

developed on an interagency basis or been comprehensively reviewed for

many years. OTS has issued comprehensive final regulations in all of

these areas.1

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\1\ 61 FR 50951 (September 30, 1996) (Lending and Investment);

61 FR 66561 (December 18, 1996) (Subsidiaries and Equity

Investments); 61 FR 60173 (November 27, 1996) (Conflicts of

Interest, Corporate Opportunity and Hazard Insurance); 61 FR 64007

(December 3, 1996) (Corporate Governance).

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Today's proposal is a part of the next phase of OTS's review of its

regulations. The proposed liquidity rule follows an intensive review of

the relevant statute and regulation, legal interpretations, and

requirements of other federal banking agencies. Like other OTS

reinvention efforts, this proposal was prepared in consultation with

those who use the regulation on a daily basis, including the agency's

regional examination staff.

Both the industry and OTS regulatory staff have consistently cited

the liquidity requirement and attendant calculations as an unnecessary

burden. Consequently, the review process has led to a consensus that

the statutory liquidity requirement no longer serves any useful purpose

and should be eliminated. The OTS has in the past recommended

legislative action to repeal this requirement.

In the interim, OTS has reviewed its current liquidity regulation

and has identified modifications that would reduce the burden of

compliance to the maximum extent possible, consistent with the

requirements of the statute and safety and soundness considerations.

Specifically, the burden of compliance with the liquidity regulation

would be decreased by: (1) reducing the liquidity base by excluding

withdrawable accounts payable in more than one year

[[Page 26450]]

from the definition of the term ``net withdrawable accounts''; (2)

streamlining the calculations used to measure compliance with the

liquidity requirement; (3) reducing the liquidity requirement from five

percent of net withdrawable accounts and short-term borrowings to four

percent; (4) removing the one percent short-term liquidity requirement;

and (5) expanding the categories of liquid assets that may count toward

satisfying a savings association's liquidity requirement. In addition,

a general requirement that thrifts maintain a safe and sound level of

liquidity would be added to the regulation. Each of these changes is

discussed in full below.

OTS believes that these proposed changes will significantly reduce

regulatory burden with respect to the statutory liquidity requirement.

While some thrifts may choose to modify their systems to take advantage

of the new rule, thrifts need not change any systems they have in place

to comply with the current rule.

II. Historical Overview of Current Liquidity Regulation

A. Statutory Requirement and Current Regulation

Section 6 of the Home Owners' Loan Act (HOLA) 2 requires

savings associations to meet a liquidity requirement by holding liquid

assets in an amount prescribed by the Director of OTS. The Director

may, by regulation, vary the amount of the liquidity requirement, but

only within pre-established statutory limits. The requirement must be

no less than 4 percent and no greater than 10 percent of ``the

obligation of the institution on withdrawable accounts and borrowings

payable on demand or with unexpired maturities of one year or less.''

3 The law identifies the assets that are suitable for

liquidity purposes. The Director, however, has express authority to

issue regulations defining the terms used in the statute and to

prescribe or limit the extent to which certain assets included on the

statutory liquidity list may be used to meet the liquidity requirement.

The Director also has express authority to prescribe the method for

calculating the liquidity requirement.

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\2\ 12 U.S.C. 1465.

\3\ 12 U.S.C. 1465(b)(2).

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Regulations implementing the Director's authority under section 6

of the HOLA appear at 12 CFR Part 566. Among other things, these rules

define liquid assets to include cash and certain securities with

maturity limitations and marketability requirements that are set out in

detail.4 The rules currently impose a liquidity requirement

of 5 percent of an institution's liquidity base and a separate,

``short-term'' liquidity requirement of 1 percent of the liquidity

base. The liquidity base is defined as net withdrawable accounts plus

short-term borrowings. Except for institutions with less than

$25,000,000 in assets, liquidity requirements are based on the

``average daily balance'' of the liquidity base during the preceding

month. Institutions with less than $25,000,000 in assets may calculate

their liquidity using month-end figures. These requirements are

discussed more fully in Section III below.

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\4\ 12 CFR 566.1(g) (1996).

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B. Reasons for Modifying the Current Rule

When first enacted in 1950, the liquidity statute provided a

mechanism for regulating the money supply available for housing. That

purpose was reflected in the statutory text, which provides:

The purpose of this section is to provide a means for creating

effective and flexible liquidity in savings association which can be

increased when mortgage money is plentiful, maintained in easily

liquidated instruments, and reduced to add to the flow of funds to

the mortgage market in periods of credit stringency. More flexible

liquidity will help support sound mortgage credit and a more stable

supply of such credit.5

\5\ 12 U.S.C. 1465(a).

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Consistent with this purpose, for many years the OTS's predecessor,

the Federal Home Loan Bank Board, raised the liquidity requirement when

the supply of money for housing was abundant and lowered the

requirement when the supply was scarce.

Over the years, however, this mechanism for ensuring a stable flow

of housing credit has become obsolete. In recent decades, a vast

secondary market for home loans has developed. This market has become

the primary source of funding for home loans. Savings associations, as

well as other lenders, can now originate home loans without regard to

whether they themselves have the capacity to hold those loans in

portfolio.

Moreover, due largely to the development of the secondary market,

lenders other than thrifts have become major mortgage lenders. Although

savings associations are still an important source of housing credit,

they are no longer the predominant source. For example, in 1975,

thrifts were responsible for 55 percent of home mortgage originations,

with mortgage companies originating only 14 percent. Today, those

percentages are nearly reversed, with thrifts accounting for only 18

percent of home mortgage originations, while the mortgage companies'

share has increased to 56 percent. Mortgage companies, commercial banks

and other lenders, unlike savings associations, are not subject to a

statutory liquidity requirement.

Adjusting the amount that savings associations must invest in

liquid assets is no longer an effective means for regulating or

ensuring the stable supply of credit for housing. Thrifts, banks, and

mortgage bankers can obtain steady funding for home loans from the

secondary market. As a result, the statutory liquidity requirement for

savings associations no longer serves a useful purpose.

As indicated above, the statutory liquidity requirement was

designed as a mechanism for regulating housing credit, not safety and

soundness. Thus, although adequate liquidity is vital to the safety and

soundness of depository institutions, the OTS does not rely on the

statutory liquidity requirement to ascertain whether an institution has

adequate liquidity for purposes of safety and soundness. The statutory

requirement is far too rigid and imprecise to be an effective measure

of liquidity for safety and soundness purposes. Determining a safe

level of liquidity for any particular institution depends on the

overall asset/liability structure of the institution, the conditions of

the markets where the institution operates, the activities of the

institution's competitors and the requirements of the institution's own

deposit and loan customers. Through the examination process, the OTS

carefully reviews the process that an institution uses to allocate its

assets and structure its liabilities to ensure sufficient liquidity to

meet its needs and customer demands.

This is the same general approach that the other banking agencies

use to examine the institutions they regulate to determine the adequacy

of liquidity. For example, the Office of the Comptroller of the

Currency states,

A sound basis for evaluating funds management requires

understanding the bank, its customer mix, the nature of its assets

and liabilities, and its economic and competitive environment. The

adequacy of a bank's liquidity will vary from bank to bank. In the

same bank, at different times, similar liquidity positions may be

adequate or inadequate depending on anticipated need for funds. In

addition, a liquidity position which is adequate for one bank may be

insufficient for another bank. Determining the adequacy of a bank's

liquidity position depends upon an analysis of the bank's

[[Page 26451]]

present and anticipated asset quality, present and future earnings

capacity, historical funding requirements, current liquidity

position, anticipated future funding needs, options for reducing

funding needs or attracting additional funds, and sources of

funds.6

\6\ Comptroller's Handbook for National Bank Examiners, section

405.1, Funds Management-Introduction (March 1990). See, FDIC-DOS

Manual of Examination Policies, ``Liquidity and Funds Management,''

Section II (August 1995); and Commercial Bank Examination Manual,

section 4020.1 Asset/Liability Management (March 1994).

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It is important to emphasize that the changes the OTS is proposing

today are not intended to suggest that the OTS believes that the HOLA's

prescribed percent ratio of liquid assets to liabilities is ordinarily

a sufficient level of liquidity. As indicated above, from a safety and

soundness perspective, the appropriate level of liquidity varies

significantly from institution to institution depending upon factors

unique to each institution. Thus, compliance with the statutory

liquidity requirement does not create a presumption that an institution

has adequate liquidity for safety and soundness purposes. As indicated

above, the statutory requirement was established as a means of

regulating the supply of funds for housing credit, not as a measure of

safety and soundness. A savings association's management is responsible

for ensuring that the institution has adequate procedures in place to

maintain a safe level of liquidity. The OTS will carefully monitor this

via examinations.

III. Description of Proposal

The OTS proposes the following amendments to 12 CFR Part 566:

A. Excluding Accounts With Unexpired Maturities Exceeding One Year From

the Definition of ``Net Withdrawable Accounts''

A savings association must maintain liquid assets of not less than

a stated percentage of the amount of its liquidity base. The regulation

defines the term ``liquidity base'' as net withdrawable accounts plus

short-term borrowings. 12 CFR 566.1(c). The term ``net withdrawable

accounts'' is defined to mean, with certain exclusions, all

withdrawable accounts less the unpaid balance of all loans secured by

such accounts. 12 CFR 566.1(d). Short term borrowings are generally

defined as borrowings where any portion of the principal is payable on

demand or in one year or less. 12 CFR 566.1(e).

The OTS proposes to change the regulation's definition of the term

``net withdrawable accounts'' to exclude accounts with unexpired

maturities exceeding one year, and to delete the word ``all'' from the

phrase ``all withdrawable accounts'' in the first part of the

definition.

The effect of changing the ``net withdrawable accounts'' definition

will be to reduce a savings association's liquidity base by the amount

of its outstanding savings accounts payable in more than one year, and

to reduce the association's liquid asset requirement accordingly. The

OTS believes that this proposed reduced liquid asset requirement is

warranted and appropriate to the purpose of the liquidity statute. This

change is consistent with the regulation's present exclusion from the

liquidity base of borrowings payable in more than one year.

B. Streamlining the Average Balance Calculations of Liquid Assets and

Liquidity Base

Under the current rule, for every calendar month, every savings

association (other than certain small institutions and mutual

institutions that are discussed below) must calculate its average daily

balance of its liquid assets and liquidity base. This requires the

calculation of the institution's liquid assets and liquidity base as of

the close of each business day, from which the daily average balance of

liquid assets and liquidity base for each month is computed. The OTS

proposes to amend the regulation to require that while institutions

must continually satisfy their liquidity requirements, the liquidity

base must be calculated only on the last day of the preceding calendar

quarter. This eliminates the necessity for savings associations to

determine average daily balances for each month.

This change is consistent with other OTS regulations, including the

loans-to-one-borrower rule and the capital rule, that use a quarter-end

calculation to measure compliance with an ongoing requirement.

The current rule permits a savings association with less than $25

million in total assets at the beginning of a fiscal year, by

resolution of its board of directors, to compute its liquid asset

requirement as a percentage of its liquidity base at the end of the

preceding calendar month (rather than as a percentage of the average

daily balance of its liquidity base during the preceding calendar

month). 12 CFR 566.2(b). Because the proposed rule would base the

liquidity requirement on the institution's liquidity base at the end of

the preceding quarter, the exception for small institutions would be

more burdensome than the proposal. Accordingly, the OTS proposes to

eliminate this provision.

The current rule also contains a provision that grants mutual

savings banks an alternative election for satisfying the liquidity

requirement. 12 CFR 566.2(e). Although in prior years the election

permitted such institutions to maintain a lower percentage of liquid

assets than other savings associations, the election is currently no

more lenient than the requirement for all savings associations, and

would be more burdensome than the proposal. Therefore this provision

would also be eliminated.

C. Reducing the Liquid Asset Requirement From Five to Four Percent and

Removing the One Percent Short-term Requirement

The OTS proposes to reduce the liquidity requirement from five

percent of an institution's liquidity base to four percent. The four

percent floor is the lowest the OTS may prescribe under section 6(b)(2)

of the HOLA.7 As noted above, this change would minimize the

regulatory burden associated with the statutory liquidity requirement,

and is not intended to suggest that OTS considers four percent

liquidity sufficient for most institutions. The OTS is aware that most

savings associations maintain more than four percent liquidity in order

to operate in a safe and sound manner. The OTS will continue to require

a savings association to maintain a level of liquidity that is prudent

given its particular circumstances. The OTS also encourages

institutions to diversify their investments in qualifying liquid

assets. Unsafe and unsound concentrations may occur in a securities

portfolio, as well as in a loan portfolio.

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\7\ 12 U.S.C. 1465(b)(2).

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Section 566.2(a) also requires a savings association, other than a

mutual savings bank, to maintain an average daily balance of short-term

liquid assets 8 of not less than one percent of the average

daily balance of its liquidity base during the preceding calendar

month. The original intent of this provision was to require savings

associations to have sufficient short-term, easily convertible assets

that may be used to meet a portion of the liquidity requirement. With

the expansion of the secondary mortgage

[[Page 26452]]

market and the resultant increase in the sources and amount of funds

available for mortgages, the one percent short-term liquid asset

requirement is no longer necessary. Accordingly, the OTS proposes to

eliminate the requirement.

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\8\ This term is currently defined at Sec. 566.1(h)(1996). These

assets include cash and liquid assets with short maturities, such as

government obligations that will mature in 12 months or less, and

corporate debt obligations that will mature in six months or less.

The removal of the requirement will also eliminate the need for this

definition.

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D. Expanding the Categories of Liquid Assets That Count Toward

Satisfaction of the Liquidity Requirement

Under sections 6(b)(1)(C)(vi) and (vii) of the HOLA,9 as

added in 1989 by the Financial Institutions Reform, Recovery, and

Enforcement Act of 1989 (FIRREA),10 certain mortgage-related

securities and mortgage loans now qualify as liquid assets to the

extent approved by the Director of the OTS. The first category consists

of mortgage-related securities that are defined in section 3(a)(41) of

the Securities Exchange Act of 1934. The second category consists of

mortgage loans on the security of a first lien on residential real

property, if the mortgage loans qualify as backing for mortgage-backed

securities issued by the Federal National Mortgage Association or the

Federal Home Loan Mortgage Corporation or are guaranteed by the

Government National Mortgage Association. The qualifying mortgage-

related securities and mortgage loans must have one year or less

remaining until maturity, or be subject to an agreement (including a

repurchase agreement, put option, right of redemption, or takeout

commitment) that requires another person to purchase the securities

within a period that does not exceed one year. In addition, the person

that agrees to purchase the securities must be an insured depository

institution (as defined in section 3 of the Federal Deposit Insurance

Act) that is in compliance with applicable capital standards, a primary

dealer in United States Government securities, or a broker or dealer

registered under the Securities Exchange Act of 1934.

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\9\ 12 U.S.C. 1465(b)(1)(C)(vi), (vii).

\10\ Pub. L. 101-73, 103 Stat. 183, 313-314 (1989).

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The OTS liquidity regulation has never been amended to reflect the

foregoing FIRREA provision. The OTS proposes to update the liquidity

regulation to reflect this statutory provision.

E. Adding a General Safety and Soundness Requirement

The OTS also proposes to add a general requirement that savings

associations must maintain a safe and sound level of liquidity at all

times. This is not a new position. The minimum level of liquidity

required by the statutory liquidity provision does not necessarily

constitute a safe level of liquidity. As explained above, savings

associations have always been required to maintain a safe level of

liquidity and the statutory liquidity provision has not been viewed as

indicative of what constitutes a safe level of liquidity.

The OTS views the statutory liquidity provision as a rigid and

imprecise measure of the sufficiency of an institution's liquidity. For

this reason, the OTS is seeking to reduce the burden imposed by the

rigid statutory formula, while making clear that the statutory

liquidity requirement and its implementing regulations do not

constitute a safe harbor for demonstrating a safe and sound level of

liquidity. As indicated above, safety and soundness determinations must

be made on a case-by-case basis in light of the particular

circumstances of each institution.

IV. Request for Comment

Comments are sought on all aspects of this proposed rulemaking.

V. Paperwork Reduction Act

The OTS invites comments on:

(1) Whether the proposed collection of information contained in

this notice of proposed rulemaking is necessary for the proper

performance of the agency's functions, including whether the

information has practical utility;

(2) The accuracy of the agency's estimate of the burden of the

proposed information collection;

(3) Ways to enhance the quality, utility, and clarity of the

information to be collected; and

(4) Ways to minimize the burden of the information collection

including the use of automated collection techniques or other forms of

information technology.

Recordkeepers are not required to respond to this collection of

information unless it displays a currently valid OMB control number.

The recordkeeping requirements contained in this notice of proposed

rulemaking have been submitted to the Office of Management and Budget

for review in accordance with the Paperwork Reduction Act of 1995 (44

U.S.C. 3507(d)). Comments on all aspects of this information collection

should be sent to the Office of Management and Budget, Paperwork

Reduction Project (1550), Washington, D.C. 20503 with copies to the

OTS, 1700 G Street, NW., Washington, D.C. 20552.

The recordkeeping requirements contained in this notice of proposed

rulemaking are found at 12 CFR 566.4. The information is needed by the

OTS in order to ensure that associations comply with a statutory

liquidity requirement. The likely recordkeepers are OTS-regulated

savings associations.

Estimated number of recordkeepers: 1,372.

Estimated average annual burden hours per recordkeeper: 2.

Estimated total annual recordkeeping burden: 2,744.

Start-up costs to recordkeepers: None.

Records are to be maintained in accordance with basic business

practices, but not less than a period of three years.

VI. Executive Order 12866

The Director of the OTS has determined that this proposal does not

constitute a ``significant regulatory action'' for purposes of

Executive Order 12866.

VII. Regulatory Flexibility Act

Pursuant to section 605(b) of the Regulatory Flexibility Act (Pub.

L. 96-354, 5 U.S.C. 601), the OTS certifies that this regulation will

not have a significant economic impact on a substantial number of small

entities. It reduces the liquidity requirement from 5 percent to 4

percent, which should increase all savings associations' abilities to

manage their assets. Additionally, the proposed regulation should ease

the administrative burden of calculating compliance with liquidity

requirements for all savings associations, including small savings

associations.

VIII. Unfunded Mandates Act of 1995

Section 202 of the Unfunded Mandates Reform Act of 1995, Pub. L.

104-4 (Unfunded Mandates Act), requires that an agency prepare a

budgetary impact statement before promulgating a rule that includes a

federal mandate that may result in expenditure by state, local, and

tribal governments, in the aggregate, or by the private sector, of $100

million or more in any one year. If a budgetary impact statement is

required, Section 205 of the Unfunded Mandates Act also requires an

agency to identify and consider a reasonable number of regulatory

alternatives before promulgating a rule. As discussed in the preamble,

this proposed rule reduces regulatory burden. OTS has determined that

the proposed rule will not result in expenditures by state, local, or

tribal governments or by the private sector of $100 million or more.

Accordingly, this rulemaking is not subject to Sec. 202 of the Unfunded

Mandates Act.

[[Page 26453]]

List of Subjects in 12 CFR Part 566

Liquidity, Reporting and recordkeeping requirements, Savings

associations.

Accordingly, the Office of Thrift Supervision hereby proposes to

amend part 566, chapter V, title 12, Code of Federal Regulations, as

set forth below:

PART 566--LIQUIDITY

1. The authority section for part 566 continues to read as follows:

Authority: 12 U.S.C. 1462, 1462a, 1463, 1464, 1465, 1467a; 15

U.S.C. 1691, 1691a.

2. Section 566.1 is amended by revising paragraphs (d) and (g)(8),

by adding paragraphs (g)(12) and (g)(13), and by removing paragraph (h)

to read as follows:

Sec. 566.1 Definitions.

* * * * *

(d) Net withdrawable accounts. The term net withdrawable accounts

means withdrawable accounts having unexpired maturities not exceeding

one year, less the unpaid balance of all loans secured by such

accounts, but not including tax and loan accounts, note accounts,

accounts to the extent that security has been given upon them pursuant

to any applicable regulations, U.S. Treasury General Accounts, or U.S.

Time Deposit Open Accounts.

* * * * *

(g) * * *

(8) Shares or certificates in any open-end management investment

company registered with the Securities and Exchange Commission under

the Investment Company Act of 1940, while the portfolio of such company

is restricted by its investment policy, changeable only by vote of the

shareholders, to investments described in the other provisions of

paragraphs (g)(1) through (g)(7), (g)(9), (g)(12), and (g)(13) of this

section.

* * * * *

(12) Mortgage-related securities as described in 12 U.S.C.

1465(b)(1)(C)(vi).

(13) Mortgage loans on the security of a first lien on residential

real property as described in 12 U.S.C. 1465(b)(1)(C)(vii).

3. Section 566.2 is amended by removing paragraphs (b), (c), and

(e), by redesignating paragraph (a) as paragraph (b) and paragraph (d)

as paragraph (c), by adding a new paragraph (a), by revising newly

designated paragraph (b), and by removing the phrase ``paragraph (a)''

where it appears in newly designated paragraph (c) and adding in lieu

thereof the phrase ``paragraph (b)'' to read as follows:

Sec. 566.2 Requirements.

(a) Safety and soundness. Each savings association must maintain

sufficient liquidity to ensure its safe and sound operation.

(b) Liquidity. Except as otherwise provided in paragraph (c) of

this section, each savings association shall maintain liquid assets of

not less than 4 percent of the amount of its liquidity base at the end

of the preceding calendar quarter.

* * * * *

Dated: May 7, 1997.

By the Office of Thrift Supervision.

Nicolas P. Retsinas,

Director.

[FR Doc. 97-12574 Filed 5-13-97; 8:45 am]

BILLING CODE 6720-01-P