For purposes of determining statutory limits that are based on the amount of a national bank's capital and/or surplus, the provisions of this section are to be used, rather than the definitions of capital contained in subparts A through J of this part.
(a) Capital. The term capital as used in provisions of law relating to the capital of national banks shall include the amount of common stock outstanding and unimpaired plus the amount of perpetual preferred stock outstanding and unimpaired.
(b) Capital Stock. The term capital stock as used in provisions of law relating to the capital stock of national banks, other than 12 U.S.C. 101, 177, and 178 shall have the same meaning as the term capital set forth in paragraph (a) of this section.
(c) Surplus. The term surplus as used in provisions of law relating to the surplus of national banks means the sum of paragraphs (c)(1), (2), (3), and (4) of this section:
(1) Capital surplus; undivided profits; reserves for contingencies and other capital reserves (excluding accrued dividends on perpetual and limited life preferred stock); net worth certificates issued pursuant to 12 U.S.C. 1823(i); minority interests in consolidated subsidiaries; and allowances for loan and lease losses; minus intangible assets;
(2) Mortgage servicing assets;
(3) Mandatory convertible debt to the extent of 20 percent of the sum of paragraphs (a) and (c) (1) and (2) of this section;
(4) Other mandatory convertible debt, limited life preferred stock and subordinated notes and debentures to the extent set forth in paragraph (f)(2) of this section.
(d) Unimpaired surplus fund. The term unimpaired surplus fund as used in provisions of law relating to the unimpaired surplus fund of national banks shall have the same meaning as the term surplus set forth in paragraph (c) of this section.
(e) Definitions. (1) Allowance for loan and lease losses means the balance of the valuation reserve on December 31, 1968, plus additions to the reserve charged to operations since that date, less losses charged against the allowance net of recoveries.
(1) Allowance for loan and lease losses means the balance of the valuation reserve on December 31, 1968, plus additions to the reserve charged to operations since that date, less losses charged against the allowance net of recoveries.
(2) Capital surplus means the total of those accounts reflecting:
(i) Amounts paid in in excess of the par or stated value of capital stock;
(ii) Amounts contributed to the national bank other than for capital stock;
(iii) Amounts transferred from undivided profits pursuant to 12 U.S.C. 60; and
(iv) Other amounts transferred from undivided profits.
(3) Intangible assets means those purchased assets that are to be reported as intangible assets in accordance with the Instructions--Consolidated Reports of Condition and Income (Call Report).
(4) Limited life preferred stock means preferred stock which has a maturity or which may be redeemed at the option of the holder.
(5) Mandatory convertible debt means subordinated debt instruments which unqualifiedly require the issuer to exchange either common or perpetual preferred stock for such instruments by a date at or before the maturity of the instrument. The maturity of these instruments must be 12 years or less. In addition, the instrument must meet the requirements of paragraphs (f)(1)(i) through (v) of this section for subordinated notes and debentures or other requirements published by the OCC.
(6) Minority interest in consolidated subsidiaries means the portion of equity capital accounts of all consolidated subsidiaries of the national bank that is allocated to minority shareholders of such subsidiaries.
(7) Mortgage servicing assets means the national bank-owned rights to service for a fee mortgage loans that are owned by others.
(8) Perpetual preferred stock means preferred stock that does not have a stated maturity date and cannot be redeemed at the option of the holder.
(f) Requirements and restrictions: Limited life preferred stock, mandatory convertible debt, and other subordinated debt--(1) Requirements. Issues of limited life preferred stock and subordinated notes and debentures (except mandatory convertible debt) shall have original weighted average maturities of at least five years to be included in the definition of surplus. In addition, a subordinated note or debenture must also:
(1) Requirements. Issues of limited life preferred stock and subordinated notes and debentures (except mandatory convertible debt) shall have original weighted average maturities of at least five years to be included in the definition of surplus. In addition, a subordinated note or debenture must also:
(i) Be subordinated to the claims of depositors;
(ii) State on the instrument that it is not a deposit and is not insured by the FDIC;
(iii) Be unsecured;
(iv) Be ineligible as collateral for a loan by the issuing national bank;
(v) Provide that once any scheduled payments of principal begin, all scheduled payments shall be made at least annually and the amount repaid in each year shall be no less than in the prior year; and
(vi) Provide that no prepayment (including payment pursuant to an acceleration clause or redemption prior to maturity) shall be made without prior OCC approval unless the national bank remains an eligible bank, as defined in 12 CFR 5.3(g), after the prepayment.
(2) Restrictions. The total amount of mandatory convertible debt not included in paragraph (c)(3) of this section, limited life preferred stock, and subordinated notes and debentures considered as surplus is limited to 50 percent of the sum of paragraphs (a) and (c) (1), (2) and (3) of this section.
(3) Reservation of authority. The OCC expressly reserves the authority to waive the requirements and restrictions set forth in paragraphs (f)(1) and (2) of this section, in order to allow the inclusion of other limited life preferred stock, mandatory convertible notes and subordinated notes and debentures in the capital base of any national bank for capital adequacy purposes or for purposes of determining statutory limits. The OCC further expressly reserves the authority to impose more stringent conditions than those set forth in paragraphs (f)(1) and (2) of this section to exclude any component of tier 1 or tier 2 capital, in whole or in part, as part of a national bank's capital and surplus for any purpose.
(g) Transitional rules. (1) Equity commitment notes approved by the OCC as capital and issued prior to April 15, 1985, may continue to be included in paragraph (c)(3) of this section. All other instruments approved by the OCC as capital and issued prior to April 15, 1985, are to be included in paragraph (c)(4) of this section.
(1) Equity commitment notes approved by the OCC as capital and issued prior to April 15, 1985, may continue to be included in paragraph (c)(3) of this section. All other instruments approved by the OCC as capital and issued prior to April 15, 1985, are to be included in paragraph (c)(4) of this section.
(2) Intangible assets (other than mortgage servicing assets) purchased prior to April 15, 1985, and accounted for in accordance with OCC instructions, may continue to be included as surplus up to 25 percent of the sum of paragraphs (a) and (c)(1) of this section.
Sec. Appendix A to Part 3--Risk-Based Capital Guidelines
Section 1. Purpose, Applicability of Guidelines, and Definitions.
(a) Purpose. (1) An important function of the Office of the Comptroller of the Currency (OCC) is to evaluate the adequacy of capital maintained by each national bank. Such an evaluation involves the consideration of numerous factors, including the riskiness of a bank's assets and off-balance sheet items. This appendix A implements the OCC's risk-based capital guidelines. The risk-based capital ratio derived from those guidelines is more systematically sensitive to the credit risk associated with various bank activities than is a capital ratio based strictly on a bank's total balance sheet assets. A bank's risk-based capital ratio is obtained by dividing its capital base (as defined in section 2 of this appendix A) by its risk-weighted assets (as calculated pursuant to section 3 of this appendix A). These guidelines were created within the framework established by the report issued by the Committee on Banking Regulations and Supervisory Practices in July 1988. The OCC believes that the risk-based capital ratio is a useful tool in evaluating the capital adequacy of all national banks, not just those that are active in the international banking system.
(1) An important function of the Office of the Comptroller of the Currency (OCC) is to evaluate the adequacy of capital maintained by each national bank. Such an evaluation involves the consideration of numerous factors, including the riskiness of a bank's assets and off-balance sheet items. This appendix A implements the OCC's risk-based capital guidelines. The risk-based capital ratio derived from those guidelines is more systematically sensitive to the credit risk associated with various bank activities than is a capital ratio based strictly on a bank's total balance sheet assets. A bank's risk-based capital ratio is obtained by dividing its capital base (as defined in section 2 of this appendix A) by its risk-weighted assets (as calculated pursuant to section 3 of this appendix A). These guidelines were created within the framework established by the report issued by the Committee on Banking Regulations and Supervisory Practices in July 1988. The OCC believes that the risk-based capital ratio is a useful tool in evaluating the capital adequacy of all national banks, not just those that are active in the international banking system.
(2) The purpose of this appendix A is to explain precisely (i) how a national bank's risk-based capital ratio is determined and (ii) how these risk-based capital guidelines are applied to national banks. The OCC will review these guidelines periodically for possible adjustments commensurate with its experience with the risk-based capital ratio and with changes in the economy, financial markets and domestic and international banking practices.
(b) Applicability. (1) The risk-based capital ratio derived from these guidelines is an important factor in the OCC's evaluation of a bank's capital adequacy. However, since this measure addresses only credit risk, the 8% minimum ratio should not be viewed as the level to be targeted, but rather as a floor. The final supervisory judgment on a bank's capital adequacy is based on an individualized assessment of numerous factors, including those listed in 12 CFR 3.10. With respect to the consideration of these factors, the OCC will give particular attention to any bank with significant exposure to declines in the economic value of its capital due to changes in interest rates. As a result, it may differ from the conclusion drawn from an isolated comparison of a bank's risk-based capital ration to the 8% minimum specified in these guidelines. In addition to the standards established by these risk-based capital guidelines, all national banks must maintain a minimum capital-to-total assets ratio in accordance with the provisions of 12 CFR part 3.
(1) The risk-based capital ratio derived from these guidelines is an important factor in the OCC's evaluation of a bank's capital adequacy. However, since this measure addresses only credit risk, the 8% minimum ratio should not be viewed as the level to be targeted, but rather as a floor. The final supervisory judgment on a bank's capital adequacy is based on an individualized assessment of numerous factors, including those listed in 12 CFR 3.10. With respect to the consideration of these factors, the OCC will give particular attention to any bank with significant exposure to declines in the economic value of its capital due to changes in interest rates. As a result, it may differ from the conclusion drawn from an isolated comparison of a bank's risk-based capital ration to the 8% minimum specified in these guidelines. In addition to the standards established by these risk-based capital guidelines, all national banks must maintain a minimum capital-to-total assets ratio in accordance with the provisions of 12 CFR part 3.
(2) Effective December 31, 1990, these risk-based capital guidelines will apply to all national banks. In the interim, banks must maintain minimum capital-to-total assets ratios as required by 12 CFR part 3, and should begin preparing for the implementation of these risk-based capital guidelines. In this regard, each national bank that does not currently meet the final minimum ratio established in section 4(b)(1) of this appendix A should begin planning for achieving that standard.
(3) These risk-based capital guidelines will not be applied to federal branches and agencies of foreign banks.
(c) Definitions. For purposes of this appendix A, the following definitions apply:
(1) Adjusted carrying value means, for purposes of section 2(c)(5) of this appendix A, the aggregate value that investments are carried on the balance sheet of the bank reduced by any unrealized gains on the investments that are reflected in such carrying value but excluded from the bank's Tier 1 capital and reduced by any associated deferred tax liabilities. For example, for investments held as available-for-sale (AFS), the adjusted carrying value of the investments would be the aggregate carrying value of the investments (as reflected on the consolidated balance sheet of the bank) less any unrealized gains on those investments that are included in other comprehensive income and that are not reflected in Tier 1 capital, and less any associated deferred tax liabilities. Unrealized losses on AFS nonfinancial equity investments must be deducted from Tier 1 capital in accordance with section 1(c)(10) of this appendix A. The treatment of small business investment companies that are consolidated for accounting purposes under generally accepted accounting principles is discussed in section 2(c)(5)(ii) of this appendix A. For investments in a nonfinancial company that is consolidated for accounting purposes, the bank's adjusted carrying value of the investment is determined under the equity method of accounting (net of any intangibles associated with the investment that are deducted from the bank's Tier 1 capital in accordance with section 2(c)(2) of this appendix A). Even though the assets of the nonfinancial company are consolidated for accounting purposes, these assets (as well as the credit equivalent amounts of the company's off-balance sheet items) are excluded from the bank's risk-weighted assets.
(2) Allowances for loan and lease losses means the balance of the valuation reserve on December 31, 1968, plus additions to the reserve charged to operations since that date, less losses charged against the allowance net of recoveries.
(3) Asset-backed commercial paper program means a program that primarily issues externally rated commercial paper backed by assets or other exposures held in a bankruptcy-remote, special-purpose entity.
(4) Asset-backed commercial paper sponsor means a bank that:
(i) Establishes an asset-backed commercial paper program;
(ii) Approves the sellers permitted to participate in an asset-backed commercial paper program;
(iii) Approves the asset pools to be purchased by an asset-backed commercial paper program; or
(iv) Administers the asset-backed commercial paper program by monitoring the assets, arranging for debt placement, compiling monthly reports, or ensuring compliance with the program documents and with the program's credit and investment policy.
(5) Associated company means any corporation, partnership, business trust, joint venture, association or similar organization in which a national bank directly or indirectly holds a 20 to 50 percent ownership interest.
(6) Banking and finance subsidiary means any subsidiary of a national bank that engages in banking- and finance-related activities.
(7) Cash items in the process of collection means checks or drafts in the process of collection that are drawn on another depository institution, including a central bank, and that are payable immediately upon presentation in the country in which the reporting bank's office that is clearing or collecting the check or draft is located; U.S. Government checks that are drawn on the United States Treasury or any other U.S. Government or Government-sponsored agency and that are payable immediately upon presentation; broker's security drafts and commodity or bill-of-lading drafts payable immediately upon presentation in the United States or the country in which the reporting bank's office that is handling the drafts is located; and unposted debits.
(8) Central government means the national governing authority of a country; it includes the departments, ministries and agencies of the central government and the central bank. The U.S. Central Bank includes the 12 Federal Reserve Banks. The definition of central government does not include the following: State, provincial, or local governments; commercial enterprises owned by the central government, which are entities engaged in activities involving trade, commerce, or profit that are generally conducted or performed in the private sector of the United States economy; and non-central government entities whose obligations are guaranteed by the central government.
(9) Commitment means any arrangement that obligates a national bank to: (i) Purchase loans or securities; or (ii) extend credit in the form of loans or leases, participations in loans or leases, overdraft facilities, revolving credit facilities, home equity lines of credit, liquidity facilities, or similar transactions.
(10) Common stockholders' equity means common stock, common stock surplus, undivided profits, capital reserves, and adjustments for the cumulative effect of foreign currency translation, less net unrealized holding losses on available-for-sale equity securities with readily determinable fair values.
(11) Conditional guarantee means a contingent obligation of the United States Government or its agencies, or the central government of an OECD country, the validity of which to the beneficiary is dependent upon some affirmative action--e.g., servicing requirements--on the part of the beneficiary of the guarantee or a third party.
(12) Deferred tax assets means the tax consequences attributable to tax carryforwards and deductible temporary differences. Tax carryforwards are deductions or credits that cannot be used for tax purposes during the current period, but can be carried forward to reduce taxable income or taxes payable in a future period or periods. Temporary differences are financial events or transactions that are recognized in one period for financial statement purposes, but are recognized in another period or periods for income tax purposes. Deductible temporary differences are temporary differences that result in a reduction of taxable income in a future period or periods.
(13) Derivative contract means generally a financial contract whose value is derived from the values of one or more underlying assets, reference rates or indexes of asset values. Derivative contracts include interest rate, foreign exchange rate, equity, precious metals and commodity contracts, or any other instrument that poses similar credit risks.
(14) Depository institution means a financial institution that engages in the business of banking; that is recognized as a bank by the bank supervisory or monetary authorities of the country of its incorporation and the country of its principal banking operations; that receives deposits to a substantial extent in the regular course of business; and that has the power to accept demand deposits. In the U.S., this definition encompasses all federally insured offices of commercial banks, mutual and stock savings banks, savings or building and loan associations (stock and mutual), cooperative banks, credit unions, and international banking facilities of domestic depository institution. Bank holding companies are excluded from this definition. For the purposes of assigning risk weights, the differentiation between OECD depository institutions and non-OECD depository institutions is based on the country of incorporation. Claims on branches and agencies of foreign banks located in the United States are to be categorized on the basis of the parent bank's country of incorporation.
(15) Equity investment means, for purposes of section 1(c)(19) and section 2(c)(5) of this appendix A, any equity instrument including warrants and call options that give the holder the right to purchase an equity instrument, any equity feature of a debt instrument (such as a warrant or call option), and any debt instrument that is convertible into equity. An investment in any other instrument, including subordinated debt or other types of debt instruments, may be treated as an equity investment if the OCC determines that the instrument is the functional equivalent of equity or exposes the bank to essentially the same risks as an equity instrument.
(16) Exchange rate contracts include: Cross-currency interest rate swaps; forward foreign exchange rate contracts; currency options purchased; and any similar instrument that, in the opinion of the OCC, gives rise to similar risks.
(17) Goodwill is an intangible asset that represents the excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed.
(18) Intangible assets include mortgage and non-mortgage servicing assets (but exclude any interest only (IO) strips receivable related to these mortgage and nonmortgage servicing assets), purchased credit card relationships, goodwill, favorable leaseholds, and core deposit value.
(19) Interest rate contracts include: Single currency interest rate swaps; basis swaps; forward rate agreements; interest rate options purchased; forward forward deposits accepted; and any similar instrument that, in the opinion of the OCC, gives rise to similar risks, including when-issued securities.
(20) Liquidity facility means a legally binding commitment to provide liquidity to various types of transactions, structures or programs. A liquidity facility that supports asset-backed commercial paper, in any amount, by lending to, or purchasing assets from any structure, program, or conduit constitutes an asset-backed commercial paper liquidity facility.
(21) Multifamily residential property means any residential property consisting of five or more dwelling units including apartment buildings, condominiums, cooperatives, and other similar structures primarily for residential use, but not including hospitals, nursing homes, or other similar facilities.
(22) Nationally recognized statistical rating organization (NRSRO) means an entity recognized by the Division of Market Regulation of the Securities and Exchange Commission (or any successor Division) (Commission or SEC) as a nationally recognized statistical rating organization for various purposes, including the Commission's uniform net capital requirements for brokers and dealers.
(23) Nonfinancial equity investment means any equity investment held by a bank in a nonfinancial company through a small business investment company (SBIC) under section 302(b) of the Small Business Investment Act of 1958 (15 U.S.C. 682(b)) or under the portfolio investment provisions of Regulation K (12 CFR 211.8(c)(3)). An equity investment made under section 302(b) of the Small Business Investment Act of 1958 in a SBIC that is not consolidated with the bank is treated as a nonfinancial equity investment in the manner provided in section 2(c)(5)(ii)(C) of this appendix A. A nonfinancial company is an entity that engages in any activity that has not been determined to be permissible for a bank to conduct directly or to be financial in nature or incidental to financial activities under section 4(k) of the Bank Holding Company Act (12 U.S.C. 1843(k)).
(24) The OECD-based group of countries comprises all full members of the Organization for Economic Cooperation and Development (OECD) regardless of entry date, as well as countries that have concluded special lending arrangements with the International Monetary Fund (IMF) associated with the IMF's General Arrangements to Borrow, \1\ but excludes any country that has rescheduled its external sovereign debt within the previous five years. These countries are hereinafter referred to as OECD countries. A rescheduling of external sovereign debt generally would include any renegotiation of terms arising from a country's inability or unwillingness to meet its external debt service obligations, but generally would not include renegotiations of debt in the normal course of business, such as a renegotiation to allow the borrower to take advantage of a decline in interest rates or other change in market conditions.---------------------------------------------------------------------------
\1\ As of November 1995, the OECD included the following countries: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Japan, Luxembourg, Mexico, the Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the United States; and Saudi Arabia had concluded special lending arrangements with the IMF associated with the IMF's General Arrangements to Borrow.---------------------------------------------------------------------------
(25) Original maturity means, with respect to a commitment, the earliest possible date after a commitment is made on which the commitment is scheduled to expire (i.e., it will reach its stated maturity and cease to be binding on either party), provided that either:
(i) The commitment is not subject to extension or renewal and will actually expire on its stated expiration date; or
(ii) If the commitment is subject to extension or renewal beyond its stated expiration date, the stated expiration date will be deemed the original maturity only if the extension or renewal must be based upon terms and conditions independently negotiated in good faith with the customer at the time of the extension or renewal and upon a new, bona fide credit analysis utilizing current information on financial condition and trends.
(26) Preferred stock includes the following instruments: (i) Convertible preferred stock, which means preferred stock that is mandatorily convertible into either common or perpetual preferred stock; (ii) Intermediate-term preferred stock, which means preferred stock with an original maturity of at least five years, but less than 20 years; (iii) Long-term preferred stock, which means preferred stock with an original maturity of 20 years or more; and (iv) Perpetual preferred stock, which means preferred stock without a fixed maturity date that cannot be redeemed at the option of the holder, and that has no other provisions that will require future redemption of the issue. For purposes of these instruments, preferred stock that can be redeemed at the option of the holder is deemed to have an original maturity of the earliest possible date on which it may be so redeemed.
(27) Public-sector entities include states, local authorities and governmental subdivisions below the central government level in an OECD country. In the United States, this definition encompasses a state, county, city, town, or other municipal corporation, a public authority, and generally any publicly-owned entity that is an instrumentality of a state or municipal corporation. This definition does not include commercial companies owned by the public sector. \1a\---------------------------------------------------------------------------
\1a\ See Definition (5), Central government, for further explanation of commercial companies owned by the public sector.---------------------------------------------------------------------------
(28) Reciprocal holdings of bank capital instruments means cross-holdings or other formal or informal arrangements in which two or more banking organizations swap, exchange, or otherwise agree to hold each other's capital instruments. This definition does not include holdings of capital instruments issued by other banking organizations that were taken in satisfaction of debts previously contracted, provided that the reporting national bank has not held such instruments for more than five years or a longer period approved by the OCC.
(29) Replacement cost means, with respect to interest rate and exchange rate contracts, the loss that would be incurred in the event of a counterparty default, as measured by the net cost of replacing the contract at the current market value. If default would result in a theoretical profit, the replacement value is considered to be zero. The mark-to-market process should incorporate changes in both interest rates and counterparty credit quality.
(30) Residential properties means houses, condominiums, cooperative units, and manufactured homes. This definition does not include boats or motor homes, even if used as a primary residence.
(31) Risk-weighted assets means the sum of total risk-weighted balance sheet assets and the total of risk-weighted off-balance sheet credit equivalent amounts. Risk-weighted balance sheet and off-balance sheet assets are calculated in accordance with section 3 of this appendix A.
(32) State means any one of the several states of the United States of America, the District of Columbia, Puerto Rico, and the territories and possessions of the United States.
(33) Subsidiary means any corporation, partnership, business trust, joint venture, association or similar organization in which a national bank directly or indirectly holds more than a 50% ownership interest. This definition does not include ownership interests that were taken in satisfaction of debts previously contracted, provided that the reporting bank has not held the interest for more than five years or a longer period approved by the OCC.
(34) Total capital means the sum of a national bank's core (Tier 1) and qualifying supplementary (Tier 2) capital elements.
(35) Unconditionally cancelable means, with respect to a commitment-type lending arrangement, that the bank may, at any time, with or without cause, refuse to advance funds or extend credit under the facility. In the case of home equity lines of credit, the bank is deemed able to unconditionally cancel the commitment if it can, at its option, prohibit additional extensions of credit, reduce the line, and terminate the commitment to the full extent permitted by relevant Federal law.
(36) United States Government or its agencies means an instrumentality of the U.S. Government whose debt obligations are fully and explicitly guaranteed as to the timely payment of principal and interest by the full faith and credit of the United States Government.
(37) United States Government-sponsored agency means an agency originally established or chartered to serve public purposes specified by the United States Congress, but whose obligations are not explicitly guaranteed by the full faith and credit of the United States Government.
(38) Walkaway clause means a provision in a bilateral netting contract that permits a nondefaulting counterparty to make a lower payment than it would make otherwise under the bilateral netting contract, or no payment at all, to a defaulter or the estate of a defaulter, even if the defaulter or the estate of the defaulter is a net creditor under the bilateral netting contract.
Section 2. Components of Capital.
A national bank's qualifying capital base consists of two types of capital--core (Tier 1) and supplementary (Tier 2).
(a) Tier 1 Capital. The following elements comprise a national bank's Tier 1 capital:
(1) Common stockholders' equity;
(2) Noncumulative perpetual preferred stock and related surplus; and \2\---------------------------------------------------------------------------
\2\ Preferred stock issues where the dividend is reset periodically based upon current market conditions and the bank's current credit rating, including but not limited to, auction rate, money market or remarketable preferred stock, are assigned to Tier 2 capital, regardless of whether the dividends are cumulative or noncumulative.---------------------------------------------------------------------------
(3) Minority interests in the equity accounts of consolidated subsidiaries, except that the following are not included in Tier 1 capital or total capital:
(i) Minority interests in a small business investment company or investment fund that holds nonfinancial equity investments and minority interests in a subsidiary that is engaged in a nonfinancial activities and is held under one of the legal authorities listed in section 1(c)(23) of this appendix A.
(ii) [Reserved]
(b) Tier 2 Capital. The following elements comprise a national bank's Tier 2 capital:
(1) Allowance for loan and lease losses, up to a maximum of 1.25% of risk-weighted assets, \3\ subject to the transition rules in section 4(a)(2) of this appendix A;---------------------------------------------------------------------------
\3\ The amount of the allowance for loan and lease losses that may be included in capital is based on a percentage of risk-weighted assets. The gross sum of risk-weighted assets used in this calculation includes all risk-weighted assets, with the exception of the assets required to be deducted under section 3 in establishing risk-weighted assets (i.e., the assets required to be deducted from capital under section 2(c)) of this appendix. A banking organization may deduct reserves for loan and lease losses in excess of the amount permitted to be included as capital, as well as allocated transfer risk reserves and reserves held against other real estate owned, from the gross sum of risk-weighted assets in computing the denominator of the risk-based capital ratio.---------------------------------------------------------------------------
(2) Cumulative perpetual preferred stock, long-term preferred stock, convertible preferred stock, and any related surplus, without limit, if the issuing national bank has the option to defer payment of dividends on these instruments. For long-term preferred stock, the amount that is eligible to be included as Tier 2 capital is reduced by 20% of the original amount of the instrument (net of redemptions) at the beginning of each of the last five years of the life of the instrument;
(3) Hybrid capital instruments, without limit. Hybrid capital instruments are those instruments that combine certain characteristics of debt and equity, such as perpetual debt. To be included as Tier 2 capital, these instruments must meet the following criteria: \4\---------------------------------------------------------------------------
\4\ Mandatory convertible debt instruments that meet the requirements of 12 CFR 3.100(e)(5), or that have been previously approved as capital by the OCC, are treated as qualifying hybrid capital instruments.---------------------------------------------------------------------------
(i) The instrument must be unsecured, subordinated to the claims of depositors and general creditors, and fully paid-up;
(ii) The instrument must not be redeemable at the option of the holder prior to maturity, except with the prior approval of the OCC;
(iii) The instrument must be available to participate in losses while the issuer is operating as a going concern (in this regard, the instrument must automatically convert to common stock or perpetual preferred stock, if the sum of the retained earnings and capital surplus accounts of the issuer shows a negative balance); and
(iv) The instrument must provide the option for the issuer to defer principal and interest payments, if
(A) The issuer does not report a net profit for the most recent combined four quarters, and
(B) The issuer eliminates cash dividends on its common and preferred stock.
(4) Term subordinated debt instruments, and intermediate-term preferred stock and related surplus are included in Tier 2 capital, but only to a maximum of 50% of Tier 1 capital as calculated after deductions pursuant to section 2(c) of this appendix. To be considered capital, term subordinated debt instruments shall meet the requirements of Sec. 3.100(f)(1). However, pursuant to 12 CFR 5.47, the OCC may, in some cases, require that the subordinated debt be approved by the OCC before the subordinated debt may qualify as Tier 2 capital or may require prior approval for any prepayment (including payment pursuant to an acceleration clause or redemption prior to maturity) of the subordinated debt. Also, at the beginning of each of the last five years for the life of either type of instrument, the amount that is eligible to be included as Tier 2 capital is reduced by 20% of the original amount of that instrument (net of redemptions).
(5) Up to 45 percent of the pretax net unrealized holding gains (that is, the excess, if any, of the fair value over historical cost) on available-for-sale equity securities with readily determinable fair values. \5\ Unrealized gains (losses) on other types of assets, such as bank premises and available-for-sale debt securities, are not included in Tier 2 capital, but the OCC may take these unrealized gains (losses) into account as additional factors when assessing a bank's overall capital adequacy.---------------------------------------------------------------------------
\5\ The OCC reserves the authority to exclude all or a portion of unrealized gains from Tier 2 capital if the OCC determines that the equity securities are not prudently valued.---------------------------------------------------------------------------
(c) Deductions from Capital. The following items are deducted from the appropriate portion of a national bank's capital base when calculating its risk-based capital ratio:
(1) Deductions from Tier 1 Capital. The following items are deducted from Tier 1 capital before the Tier 2 portion of the calculation is made:
(i) Goodwill;
(ii) Other intangible assets, except as provided in section 2(c)(2) of this appendix A;
(iii) Deferred tax assets, except as provided in section 2(c)(3) and (2)(c)(6) of this appendix A, that are dependent upon future taxable income, which exceed the lesser of either:
(A) The amount of deferred tax assets that the bank could reasonably expect to realize within one year of the quarter-end Call Report, based on its estimate of future taxable income for that year; or
(B) 10% of Tier 1 capital, net of goodwill and all intangible assets other than purchased credit card relationships, mortgage servicing assets and non-mortgage servicing assets; and
(iv) Credit-enhancing interest-only strips (as defined in section 4(a)(2) of this appendix A), as provided in section 2(c)(4).
(v) Nonfinancial equity investments as provided by section 2(c)(5) of this appendix A.
(2) Qualifying intangible assets. Subject to the following conditions, mortgage servicing assets, nonmortgage servicing assets \6\ and purchased credit card relationships need not be deducted from Tier 1 capital:---------------------------------------------------------------------------
\6\ Intangible assets are defined to exclude IO strips receivable related to these mortgage and non-mortgage servicing assets. See section 1(c)(18) of this appendix A. Consequently, IO strips receivable related to mortgage and non-mortgage servicing assets are not required to be deducted under section 2(c)(2) of this appendix A. However, credit-enhancing interest-only strips as defined in section 4(a)(2) are deducted from Tier 1 capital in accordance with section 2(c)(4) of this appendix A. Any non credit-enhancing IO strips receivable are subject to a 100% risk weight under section 3(a)(4) of this appendix A.---------------------------------------------------------------------------
(i) The total of all intangible assets that are included in Tier 1 capital is limited to 100 percent of Tier 1 capital, of which no more than 25 percent of Tier 1 capital can consist of purchased credit card relationships and non-mortgage servicing assets in the aggregate. Calculation of these limitations must be based on Tier 1 capital net of goodwill and all other identifiable intangibles, other than purchased credit card relationships, mortgage servicing assets and non-mortgage servicing assets.
(ii) Banks must value each intangible asset included in Tier 1 capital at least quarterly at the lesser of:
(A) 90 percent of the fair value of each intangible asset, determined in accordance with section 2(c)(2)(iii) of this appendix A; or
(B) 100 percent of the remaining unamortized book value.
(iii) The quarterly determination of the current fair value of the intangible asset must include adjustments for any significant changes in original valuation assumptions, including changes in prepayment estimates.
(3) Deferred tax assets--(i) Net unrealized gains and losses on available-for-sale securities. Net unrealized gains and losses on available-for-sale securities. Before calculating the amount of deferred tax assets subject to the limit in section 2(c)(1)(iii) of this appendix A, a bank may eliminate the deferred tax effects of any net unrealized holding gains and losses on available-for-sale debt securities. Banks report these net unrealized holding gains and losses in their Call Reports as a separate component of equity capital, but exclude them from the definition of common stockholders' equity for regulatory capital purposes. A bank that adopts a policy to deduct these amounts must apply that approach consistently in all future calculations of the amount of disallowed deferred tax assets under section 2(c)(1)(iii) of this appendix A.
(i) Net unrealized gains and losses on available-for-sale securities. Net unrealized gains and losses on available-for-sale securities. Before calculating the amount of deferred tax assets subject to the limit in section 2(c)(1)(iii) of this appendix A, a bank may eliminate the deferred tax effects of any net unrealized holding gains and losses on available-for-sale debt securities. Banks report these net unrealized holding gains and losses in their Call Reports as a separate component of equity capital, but exclude them from the definition of common stockholders' equity for regulatory capital purposes. A bank that adopts a policy to deduct these amounts must apply that approach consistently in all future calculations of the amount of disallowed deferred tax assets under section 2(c)(1)(iii) of this appendix A.
(ii) Consolidated groups. The amount of deferred tax assets that a bank can realize from taxes paid in prior carryback years and from reversals of existing taxable temporary differences generally would not be deducted from capital. However, for a bank that is a member of a consolidated group (for tax purposes), the amount of carryback potential a bank may consider in calculating the limit on deferred tax assets under section 2(c)(1)(iii) of this appendix A, may not exceed the amount that the bank could reasonably expect to have refunded by its parent holding company.
(iii) Estimated future taxable income. Estimated future taxable income does not include net operating loss carryforwards to be used during that year or the amount of existing temporary differences expected to reverse within the year. A bank may use future taxable income projections for their closest fiscal year, provided it adjusts the projections for any significant changes that occur or that it expects to occur. Such projections must include the estimated effect of tax planning strategies that the bank expects to implement to realize net operating losses or tax credit carryforwards that will otherwise expire during the year.
(4) Credit-enhancing interest-only strips. Credit-enhancing interest-only strips, whether purchased or retained, that exceed 25% of Tier 1 capital must be deducted from Tier 1 capital. Purchased and retained credit-enhancing interest-only strips, on a non-tax adjusted basis, are included in the total amount that is used for purposes of determining whether a bank exceeds its Tier 1 capital.
(i) The 25% limitation on credit-enhancing interest-only strips will be based on Tier 1 capital net of goodwill and all identifiable intangibles, other than purchased credit card relationships, mortgage servicing assets and non-mortgage servicing assets.
(ii) Banks must value each credit-enhancing interest-only strip included in Tier 1 capital at least quarterly. The quarterly determination of the current fair value of the credit-enhancing interest-only strip must include adjustments for any significant changes in original valuation assumptions, including changes in prepayment estimates.
(5) Nonfinancial equity investments--(i) General. (A) A bank must deduct from its Tier 1 capital the appropriate percentage, as determined in accordance with Table A, of the adjusted carrying value of all nonfinancial equity investments held by the bank and its subsidiaries.
Table A--Deduction for Nonfinancial Equity Investments------------------------------------------------------------------------
Aggregate adjusted carrying value of all
nonfinancial equity investments held Deduction from Tier 1 Capital
directly or indirectly by banks (as a (as a percentage of the
percentage of the Tier 1 capital of the adjusted carrying value of
bank) \1\ the investment)------------------------------------------------------------------------Less than 15 percent..................... 8.0 percent.Greater than or equal to 15 percent but 12.0 percent.
less than 25 percent.Greater than or equal to 25 percent...... 25.0 percent.------------------------------------------------------------------------\1\ For purposes of calculating the adjusted carrying value of
nonfinancial equity investments as a percentage of Tier 1 capital,
Tier 1 capital is defined as the sum of the Tier 1 capital elements
net of goodwill and net of all identifiable intangible assets other
than mortgage servicing assets, nonmortgage servicing assets and
purchased credit card relationships, but prior to the deduction for
disallowed mortgage servicing assets, disallowed nonmortgage servicing
assets, disallowed purchased credit card relationships, disallowed
credit-enhancing interest only strips (both purchased and retained),
disallowed deferred tax assets, and nonfinancial equity investments.
(B) Deductions for nonfinancial equity investments must be applied on a marginal basis to the portions of the adjusted carrying value of nonfinancial equity investments that fall within the specified ranges of the bank's Tier 1 capital. For example, if the adjusted carrying value of all nonfinancial equity investments held by a bank equals 20 percent of the Tier 1 capital of the bank, then the amount of the deduction would be 8 percent of the adjusted carrying value of all investments up to 15 percent of the bank's Tier 1 capital, and 12 percent of the adjusted carrying value of all investments equal to, or in excess of, 15 percent of the bank's Tier 1 capital.
(C) The total adjusted carrying value of any nonfinancial equity investment that is subject to deduction under section 2(c)(5) of this appendix A is excluded from the bank's weighted risk assets for purposes of computing the denominator of the bank's risk-based capital ratio. For example, if 8 percent of the adjusted carrying value of a nonfinancial equity investment is deducted from Tier 1 capital, the entire adjusted carrying value of the investment will be excluded from risk-weighted assets in calculating the denominator of the risk-based capital ratio.
(D) Banks engaged in equity investment activities, including those banks with a high concentration in nonfinancial equity investments (e.g., in excess of 50 percent of Tier 1 capital), will be monitored and may be subject to heightened supervision, as appropriate, by the OCC to ensure that such banks maintain capital levels that are appropriate in light of their equity investment activities, and the OCC may impose a higher capital charge in any case where the circumstances, such as the level of risk of the particular investment or portfolio of investments, the risk management systems of the bank, or other information, indicate that a higher minimum capital requirement is appropriate.
(ii) Small business investment company investments. (A) Notwithstanding section 2(c)(5)(i) of this appendix A, no deduction is required for nonfinancial equity investments that are made by a bank or its subsidiary through a SBIC that is consolidated with the bank, or in a SBIC that is not consolidated with the bank, to the extent that such investments, in the aggregate, do not exceed 15 percent of the Tier 1 capital of the bank. Except as provided in paragraph (c)(5)(ii)(B) of this section, any nonfinancial equity investment that is held through or in a SBIC and not deducted from Tier 1 capital will be assigned to the 100 percent risk-weight category and included in the bank's consolidated risk-weighted assets.
(A) Notwithstanding section 2(c)(5)(i) of this appendix A, no deduction is required for nonfinancial equity investments that are made by a bank or its subsidiary through a SBIC that is consolidated with the bank, or in a SBIC that is not consolidated with the bank, to the extent that such investments, in the aggregate, do not exceed 15 percent of the Tier 1 capital of the bank. Except as provided in paragraph (c)(5)(ii)(B) of this section, any nonfinancial equity investment that is held through or in a SBIC and not deducted from Tier 1 capital will be assigned to the 100 percent risk-weight category and included in the bank's consolidated risk-weighted assets.
(B) If a bank has an investment in a SBIC that is consolidated for accounting purposes but the SBIC is not wholly owned by the bank, the adjusted carrying value of the bank's nonfinancial equity investments held through the SBIC is equal to the bank's proportionate share of the SBIC's adjusted carrying value of its equity investments in nonfinancial companies. The remainder of the SBIC's adjusted carrying value (i.e., the minority interest holders' proportionate share) is excluded from the risk-weighted assets of the bank.
(C) If a bank has an investment in a SBIC that is not consolidated for accounting purposes and has current information that identifies the percentage of the SBIC's assets that are equity investments in nonfinancial companies, the bank may reduce the adjusted carrying value of its investment in the SBIC proportionately to reflect the percentage of the adjusted carrying value of the SBIC's assets that are not equity investments in nonfinancial companies. The amount by which the adjusted carrying value of the bank's investment in the SBIC is reduced under this paragraph will be risk weighted at 100 percent and included in the bank's risk-weighted assets.
(D) To the extent the adjusted carrying value of all nonfinancial equity investments that the bank holds through a consolidated SBIC or in a nonconsolidated SBIC equals or exceeds, in the aggregate, 15 percent of the Tier 1 capital of the bank, the appropriate percentage of such amounts, as set forth in Table A, must be deducted from the bank's Tier 1 capital. In addition, the aggregate adjusted carrying value of all nonfinancial equity investments held through a consolidated SBIC and in a nonconsolidated SBIC (including any nonfinancial equity investments for which no deduction is required) must be included in determining, for purposes of Table A the total amount of nonfinancial equity investments held by the bank in relation to its Tier 1 capital.
(iii) Nonfinancial equity investments excluded. (A) Notwithstanding section 2(c)(5)(i) and (ii) of this appendix A, no deduction from Tier 1 capital is required for the following:
(1) Nonfinancial equity investments (or portion of such investments) made by the bank prior to March 13, 2000, and continuously held by the bank since March 13, 2000.
(2) Nonfinancial equity investments made on or after March 13, 2000, pursuant to a legally binding written commitment that was entered into by the bank prior to March 13, 2000, and that required the bank to make the investment, if the bank has continuously held the investment since the date the investment was acquired.
(3) Nonfinancial equity investments received by the bank through a stock split or stock dividend on a nonfinancial equity investment made prior to March 13, 2000, provided that the bank provides no consideration for the shares or interests received, and the transaction does not materially increase the bank's proportional interest in the nonfinancial company.
(4) Nonfinancial equity investments received by the bank through the exercise on or after March 13, 2000, of an option, warrant, or other agreement that provides the bank with the right, but not the obligation, to acquire equity or make an investment in a nonfinancial company, if the option, warrant, or other agreement was acquired by the bank prior to March 13, 2000, and the bank provides no consideration for the nonfinancial equity investments.
(B) Any excluded nonfinancial equity investments described in section 2(c)(5)(iii)(A) of this appendix A must be included in determining the total amount of nonfinancial equity investments held by the bank in relation to its Tier 1 capital for purposes of Table A. In addition, any excluded nonfinancial equity investments will be risk weighted at 100 percent and included in the bank's risk-weighted assets.
(6) Netting of Deferred Tax Liability. (i) Banks may elect to deduct the following assets from Tier 1 capital on a basis that is net of any associated deferred tax liability:
(i) Banks may elect to deduct the following assets from Tier 1 capital on a basis that is net of any associated deferred tax liability:
(A) Goodwill;
(B) Intangible assets acquired due to a nontaxable purchase business combination, except banks may not elect to deduct from Tier 1 capital on a basis that is net of any associated deferred tax liability, regardless of the method by which they were acquired:
(1) Purchased credit card relationships; and
(2) Servicing assets that are includable in Tier 1 capital;
(C) Disallowed servicing assets;
(D) Disallowed credit-enhancing interest-only strips; and
(E) Nonfinancial equity investments, as defined in section 1(c)(1) of this appendix A.
(ii) Deferred tax liabilities netted in this manner cannot also be netted against deferred tax assets when determining the amount of deferred tax assets that are dependent upon future taxable income as calculated under section 2(c)(1)(iii) of this appendix A.
(7) Deductions from total capital. The following assets are deducted from total capital:
(i) Investments, both equity and debt, in unconsolidated banking and finance subsidiaries that are deemed to be capital of the subsidiary;\7\ and---------------------------------------------------------------------------
\7\ The OCC may require deduction of investments in other subsidiaries and associated companies, on a case-by-case basis.---------------------------------------------------------------------------
(ii) Reciprocal holdings of bank capital instruments.
Section 3. Risk Categories/Weights for On-Balance Sheet Assets and Off-
Balance Sheet Items
The denominator of the risk-based capital ratio, i.e., a national bank's risk-weighted assets, \8\ is derived by assigning that bank's assets and off-balance sheet items to one of the four risk categories detailed in section 3(a) of this appendix A. Each category has a specific risk weight. Before an off-balance sheet item is assigned a risk weight, it is converted to an on-balance sheet credit equivalent amount in accordance with section 3(b) of this appendix A. The risk weight assigned to a particular asset or on-balance sheet credit equivalent amount determines the percentage of that asset/credit equivalent that is included in the denominator of the bank's risk-based capital ratio. Any asset deducted from a bank's capital in computing the numerator of the risk-based capital ratio is not included as part of the bank's risk-weighted assets.---------------------------------------------------------------------------
\8\ The OCC reserves the right to require a bank to compute its risk-based capital ratio on the basis of average, rather than period-end, risk-weighted assets when necessary to carry out the purposes of these guidelines.---------------------------------------------------------------------------
Some of the assets on a bank's balance sheet may represent an indirect holding of a pool of assets, e.g., mutual funds, that encompasses more than one risk weight within the pool. In those situations, the bank may assign the asset to the risk category applicable to the highest risk-weighted asset that pool is permitted to hold pursuant to its stated investment objectives in the fund's prospectus. Alternatively, the bank may assign the asset on a pro rata basis to different risk categories according to the investment limits in the fund's prospectus. In either case, the minimum risk weight that may be assigned to such a pool is 20%. If a bank assigns the asset on a pro rata basis, and the sum of the investment limits in the fund's prospectus exceeds 100%, the bank must assign the highest pro rata amounts of its total investment to the higher risk category. If, in order to maintain a necessary degree of liquidity, the fund is permitted to hold an insignificant amount of its assets in short-term, highly-liquid securities of superior credit quality (that do not qualify for a preferential risk weight), such securities generally will not be taken into account in determining the risk category into which the bank's holding in the overall pool should be assigned. The prudent use of hedging instruments by a fund to reduce the risk of its assets will not increase the risk weighting of the investment in that fund above the 20% category. However, if a fund engages in any activities that are deemed to be speculative in nature or has any other characteristics that are inconsistent with the preferential risk weighting assigned to the fund's assets, the bank's investment in the fund will be assigned to the 100% risk category. More detail on the treatment of mortgage-backed securities is provided in section 3(a)(3)(vi) of this appendix A.
(a) On-Balance Sheet Assets. The following are the risk categories/weights for on-balance sheet assets.
(1) Zero percent risk weight. (i) Cash, including domestic and foreign currency owned and held in all offices of a national bank or in transit. Any foreign currency held by a national bank should be converted into U.S. dollar equivalents.
(i) Cash, including domestic and foreign currency owned and held in all offices of a national bank or in transit. Any foreign currency held by a national bank should be converted into U.S. dollar equivalents.
(ii) Deposit reserves and other balances at Federal Reserve Banks.
(iii) Securities issued by, and other direct claims on, the United States Government or its agencies, or the central government of an OECD country.
(iv) That portion of assets directly and unconditionally guaranteed by the United States Government or its agencies, or the central government of an OECD country. \9\---------------------------------------------------------------------------
\9\ For the treatment of privately-issued mortgage-backed securities where the underlying pool is comprised solely of mortgage-related securities issued by GNMA, see infra note 10.---------------------------------------------------------------------------
(v) That portion of local currency claims on, or unconditionally guaranteed by, central governments of non-OECD countries, to the extent the bank has liabilities in that currency. Any amount of such claims that exceeds the amount of the bank's liabilities in that currency is assigned to the 100% risk category of section 3(a)(4) of this appendix.
(vi) Gold bullion held in the bank's own vaults or in another bank's vaults on an allocated basis, to the extent it is backed by gold bullion liabilities.
(vii) The book value of paid-in Federal Reserve Bank stock.
(viii) That portion of assets and off-balance sheet transactions \9a\ collateralized by cash or securities issued or directly and unconditionally guaranteed by the United States Government or its agencies, or the central government of an OECD country, provided that: \9b\---------------------------------------------------------------------------
\9a\ See footnote 22 in section 3(b)(5)(iii) of this appendix A (collateral held against derivative contracts).
\9b\ Assets and off-balance sheet transactions collateralized by securities issued or guaranteed by the United States Government or its agencies, or the central government of an OECD country include, but are not limited to, securities lending transactions, repurchase agreements, collateralized letters of credit, such as reinsurance letters of credit, and other similar financial guarantees. Swaps, forwards, futures, and options transactions are also eligible, if they meet the collateral requirements. However, the OCC may at its discretion require that certain collateralized transactions be risk weighted at 20 percent if they involve more than a minimal risk.---------------------------------------------------------------------------
(A) The bank maintains control over the collateral:
(1) If the collateral consists of cash, the cash must be held on deposit by the bank or by a third-party for the account of the bank;
(2) If the collateral consists of OECD government securities, then the OECD government securities must be held by the bank or by a third-party acting on behalf of the bank;
(B) The bank maintains a daily positive margin of collateral fully taking into account any change in the market value of the collateral held as security;
(C) Where the bank is acting as a customer's agent in a transaction involving the loan or sale of securities that is collateralized by cash or OECD government securities delivered to the bank, any obligation by the bank to indemnify the customer is limited to no more than the difference between the market value of the securities lent and the market value of the collateral received, and any reinvestment risk associated with the collateral is borne by the customer; and
(D) The transaction involves no more than minimal risk.
(ix) Asset-backed commercial paper (ABCP) that is:
(A) Purchased by the bank on or after September 19, 2008, from a Securities and Exchange Commission (SEC)-registered open-end investment company that holds itself out as a money market mutual fund under SEC Rule 2a-7 (17 CFR 270.2a-7); and
(B) Pledged by the bank to a Federal Reserve Bank to secure financing from the ABCP lending facility (AMLF) established by the Federal Reserve Board on September 19, 2008.
(2) 20 percent risk weight. (i) All claims on depository institutions incorporated in an OECD country, and all assets backed by the full faith and credit of depository institutions incorporated in an OECD country. This includes the credit equivalent amount of participations in commitments and standby letters of credit sold to other depository institutions incorporated in an OECD country, but only if the originating bank remains liable to the customer or beneficiary for the full amount of the commitment or standby letter of credit. Also included in this category are the credit equivalent amounts of risk participations in bankers' acceptances conveyed to other depository institutions incorporated in an OECD country. However, bank-issued securities that qualify as capital of the issuing bank are not included in this risk category, but are assigned to the 100% risk category of section 3(a)(4) of this appendix A.
(i) All claims on depository institutions incorporated in an OECD country, and all assets backed by the full faith and credit of depository institutions incorporated in an OECD country. This includes the credit equivalent amount of participations in commitments and standby letters of credit sold to other depository institutions incorporated in an OECD country, but only if the originating bank remains liable to the customer or beneficiary for the full amount of the commitment or standby letter of credit. Also included in this category are the credit equivalent amounts of risk participations in bankers' acceptances conveyed to other depository institutions incorporated in an OECD country. However, bank-issued securities that qualify as capital of the issuing bank are not included in this risk category, but are assigned to the 100% risk category of section 3(a)(4) of this appendix A.
(ii) Claims on, or guaranteed by depository institutions, other than the central bank, incorporated in a non-OECD country, with a residual maturity of one year or less.
(iii) Cash items in the process of collection.
(iv) That portion of assets collateralized by cash or by securities issued or directly and unconditionally guaranteed by the United States Government or its agencies, or the central government of an OECD country, that does not qualify for the zero percent risk-weight category.
(v) That portion of assets conditionally guaranteed by the United States Government or its agencies, or the central government of an OECD country.
(vi) Securities issued by, or other direct claims on, United States Government-sponsored agencies.
(vii) That portion of assets guaranteed by United States Government-sponsored agencies. \10\---------------------------------------------------------------------------
\10\ Privately issued mortgage-backed securities, e.g., CMOs and REMICs, where the underlying pool is comprised solely of mortgage-related securities issued by GNMA, FNMA and FHLMC, will be treated as an indirect holding of the underlying assets and assigned to the 20% risk category of this section 3(a)(2). If the underlying pool is comprised of assets which attract different risk weights, e.g., FNMA securities and conventional mortgages, the bank should generally assign the security to the highest risk category appropriate for any asset in the pool. However, on a case-by-case basis, the OCC may allow the bank to assign the security proportionately to the various risk categories based on the proportion in which the risk categories are represented by the composition cash flows of the underlying pool of assets. Before the OCC will consider a request to proportionately risk-weight such a security, the bank must have current information for the reporting date that details the composition and cash flows of the underlying pool of assets. Furthermore, before a mortgage-related security will receive a risk weight lower than 100%, it must meet the criteria set forth in section 3(a)(3)(vi) of this appendix A.---------------------------------------------------------------------------
(viii) That portion of assets collateralized by the current market value of securities issued or guaranteed by United States Government-sponsored agencies.
(ix) Claims representing general obligations of any public-sector entity in an OECD country, and that portion of any claims guaranteed by any such public-sector entity. In the U.S., these obligations must meet the requirements of 12 CFR 1.2(b).
(x) Claims on, or guaranteed by, official multilateral lending institutions or regional development institutions in which the United States Government is a shareholder or contributing member. \11\---------------------------------------------------------------------------
\11\ These institutions include, but are not limited to, the International Bank for Reconstruction and Development (World Bank), the Inter-American Development Bank, the Asian Development Bank, the African Development Bank, the European Investments Bank, the International Monetary Fund and the Bank for International Settlements.---------------------------------------------------------------------------
(xi) That portion of assets collateralized by the current market value of securities issued by official multilateral lending institutions or regional development institutions in which the United States Government is a shareholder or contributing member.
(xii) That portion of local currency claims conditionally guaranteed by central governments of non-OECD countries, to the extent the bank has local currency liabilities in that country. Any amount of such claims that exceeds the amount of the bank's local currency liabilities is assigned to the 100% risk category of section 3(a)(4) of this appendix.
(xiii) Claims on, or guaranteed by, a securities firm incorporated in an OECD country, that satisfies the following conditions:
(A) If the securities firm is incorporated in the United States, then the firm must be a broker-dealer that is registered with the SEC and must be in compliance with the SEC's net capital regulation (17 CFR 240.15c3(1)).
(B) If the securities firm is incorporated in any other OECD country, then the bank must be able to demonstrate that the firm is subject to consolidated supervision and regulation, including its subsidiaries, comparable to that imposed on depository institutions in OECD countries; such regulation must include risk-based capital standards comparable to those applied to depository institutions under the Basel Capital Accord. \11a\---------------------------------------------------------------------------
\11a\ See Accord on International Convergence of Capital Measurement and Capital Standards as adopted by the Basle Committee on Banking Regulations and Supervisory Practices (renamed as the Basel Committee on Banking Supervision), dated July 1988 (amended 1998).---------------------------------------------------------------------------
(C) The securities firm, whether incorporated in the United States or another OECD country, must also have a long-term credit rating in accordance with section 3(a)(2)(xiii)(C)(1) of this appendix A; a parent company guarantee in accordance with section 3(a)(2)(xiii)(C)(2) of this appendix A; or a collateralized claim in accordance with section 3(a)(2)(xiii)(C)(3) of this appendix A. Claims representing capital of a securities firm must be risk weighted at 100 percent in accordance with section 3(a)(4) of this appendix A.
(1) Credit rating. The securities firm must have either a long-term issuer credit rating or a credit rating on at least one issue of long-term unsecured debt, from a NRSRO that is in one of the three highest investment-grade categories used by the NRSRO. If the securities firm has a credit rating from more than one NRSRO, the lowest credit rating must be used to determine the credit rating under this paragraph.
(2) Parent company guarantee. The claim on, or guaranteed by, the securities firm must be guaranteed by the firm's parent company, and the parent company must have either a long-term issuer credit rating or a credit rating on at least one issue of long-term unsecured debt, from a NRSRO that is in one of the three highest investment-grade categories used by the NRSRO.
(3) Collateralized claim. The claim on the securities firm must be collateralized subject to all of the following requirements:
(i) The claim must arise from a reverse repurchase/repurchase agreement or securities lending/borrowing contract executed using standard industry documentation.
(ii) The collateral must consist of debt or equity securities that are liquid and readily marketable.
(iii) The claim and collateral must be marked-to-market daily.
(iv) The claim must be subject to daily margin maintenance requirements under standard industry documentation.
(v) The contract from which the claim arises can be liquidated, terminated, or accelerated immediately in bankruptcy or similar proceedings, and the security or collateral agreement will not be stayed or avoided under the applicable law of the relevant jurisdiction. To be exempt from the automatic stay in bankruptcy in the United States, the claim must arise from a securities contract or a repurchase agreement under section 555 or 559, respectively, of the Bankruptcy Code (11 U.S.C. 555 or 559), a qualified financial contract under section 11(e)(8) of the Federal Deposit Insurance Act (12 U.S.C. 1821(e)(8)), or a netting contract between or among financial institutions under sections 401-407 of the Federal Deposit Insurance Corporation Improvement Act of 1991 (912 U.S.C. 4407), or the Regulation EE (12 CFR part 231).
(3) 50 percent risk weight. (i) Revenue obligations of any public-sector entity in an OECD country for which the underlying obligor is the public-sector entity, but which are repayable solely from the revenues generated by the project financed through the issuance of the obligations.
(i) Revenue obligations of any public-sector entity in an OECD country for which the underlying obligor is the public-sector entity, but which are repayable solely from the revenues generated by the project financed through the issuance of the obligations.
(ii) The credit equivalent amount of derivative contracts, calculated in accordance with section 3(b)(5) of this appendix A, that do not qualify for inclusion in a lower risk category.
(iii) Loans secured by first mortgages on one-to-four family residential properties, either owner occupied or rented, provided that such loans are not otherwise 90 days or more past due, or on nonaccrual or restructured. It is presumed that such loans will meet the prudent underwriting standards. For the purposes of the risk-based capital guidelines, a loan modified on a permanent or trial basis solely pursuant to the U.S. Department of Treasury's Home Affordable Mortgage Program will not be considered to have been restructured. If a bank holds a first lien and junior lien on a one-to-four family residential property and no other party holds an intervening lien, the transaction is treated as a single loan secured by a first lien for the purposes of both determining the loan-to-value ratio and assigning a risk weight to the transaction. Furthermore, residential property loans made for the purpose of construction financing are assigned to the 100% risk category of section 3(a)(4) of this appendix A; however, these loans may be included in the 50% risk category of this section 3(a)(3) of this appendix A if they are subject to a legally binding sales contract and satisfy the requirements of section 3(a)(3)(iv) of this appendix A.
(iv) Loans to residential real estate builders for one-to-four family residential property construction, if the bank obtains sufficient documentation demonstrating that the buyer of the home intends to purchase the home (i.e., a legally binding written sales contract) and has the ability to obtain a mortgage loan sufficient to purchase the home (i.e., a firm written commitment for permanent financing of the home upon completion), subject to the following additional criteria:
(A) The builder must incur at least the first 10% of the direct costs (i.e., actual costs of the land, labor, and material) before any drawdown is made under the construction loan and the construction loan may not exceed 80% of the sales price of the resold home;
(B) The individual purchaser has made a substantial ``earnest money deposit'' of no less than 3% of the sales price of the home that must be subject to forfeiture by the individual purchaser if the sales contract is terminated by the individual purchaser; however, the earnest money deposit shall not be subject to forfeiture by reason of breach or termination of the sales contract on the part of the builder;
(C) The earnest money deposit must be held in escrow by the bank financing the builder or by an independent party in a fiduciary capacity; the escrow agreement must provide that in the event of default the escrow funds must be used to defray any cost incurred relating to any cancellation of the sales contract by the buyer;
(D) If the individual purchaser terminates the contract or if the loan fails to satisfy any other criterion under this section, then the bank must immediately recategorize the loan at a 100% risk weight and must accurately report the loan in the bank's next quarterly Consolidated Reports of Condition and Income (Call Report);
(E) The individual purchaser must intend that the home will be owner-occupied;
(F) The loan is made by the bank in accordance with prudent underwriting standards;
(G) The loan is not more than 90 days past due, or on nonaccrual; and
(H) The purchaser is an individual(s) and not a partnership, joint venture, trust, corporation, or any other entity (including an entity acting as a sole proprietorship) that is purchasing one or more of the homes for speculative purposes.
(v) Loans secured by a first mortgage on multifamily residential properties: \11b\---------------------------------------------------------------------------
\11b\ The portion of multifamily residential property loans that is sold subject to a pro rata loss sharing arrangement may be treated by the selling bank as sold to the extent that the sales agreement provides for the purchaser of the loan to share in any loss incurred on the loan on a pro rata basis with the selling bank. The portion of multifamily residential property loans sold subject to any loss sharing arrangement other than pro rata sharing of the loss shall be accorded the same treatment as any other asset sold under an agreement to repurchase or sold with recourse under section 4(b) of this appendix A.---------------------------------------------------------------------------
(A) The amortization of principal and interest occurs in not more than 30 years;
(B) The minimum original maturity for repayment of principal is not less than 7 years;
(C) All principal and interest payments have been made on a timely basis in accordance with the terms of the loan for at least one year immediately preceding the risk weighting of the loan in the 50% risk weight category, and the loan is not otherwise 90 days or more past due, or on nonaccrual status;
(D) The loan is made in accordance with all applicable requirements and prudent underwriting standards;
(E) If the rate of interest does not change over the term of the loan:
(I) The current loan amount outstanding does not exceed 80% of the current value of the property, as measured by either the value of the property at origination of the loan (which is the lower of the purchase price or the value as determined by the initial appraisal, or if appropriate, the initial evaluation) or the most current appraisal, or if appropriate, the most current evaluation; and
(II) In the most recent fiscal year, the ratio of annual net operating income generated by the property (before payment of any debt service on the loan) to annual debt service on the loan is not less than 120%;\11c\---------------------------------------------------------------------------
\11c\ For the purposes of the debt service requirements in sections 3(a)(3)(v)(E)(II) and 3(a)(3)(v)(F)(II) of this appendix A, other forms of debt service coverage that generate sufficient cash flows to provide comparable protection to the institution may be considered for (a) a loan secured by cooperative housing or (b) a multifamily residential property loan if the purpose of the loan is for the development or purchase of multifamily residential property primarily intended to provide low- to moderate-income housing, including special operating reserve accounts or special operating subsidies provided by federal, state, local or private sources. However, the OCC reserves the right, on a case-by-case basis, to review the adequacy of any other forms of comparable debt service coverage relied on by the bank. ---------------------------------------------------------------------------
(F) If the rate of interest changes over the term of the loan:
(I) The current loan amount outstanding does not exceed 75% of the current value of the property, as measured by either the value of the property at origination of the loan (which is the lower of the purchase price or the value as determined by the initial appraisal, or if appropriate, the initial evaluation) or the most current appraisal, or if appropriate, the most current evaluation; and
(II) In the most recent fiscal year, the ratio of annual net operating income generated by the property (before payment of any debt service on the loan) to annual debt service on the loan is not less than 115%; and
(G) If the loan was refinanced by the borrower:
(I) All principal and interest payments on the loan being refinanced which were made in the preceding year prior to refinancing shall apply in determining the one-year timely payment requirement under paragraph (a)(3)(v)(C) of this section; and
(II) The net operating income generated by the property in the preceding year prior to refinancing shall apply in determining the applicable debt service requirements under paragraphs (a)(3)(v)(E) and (a)(3)(v)(F) of this section.
(vi) Privately-issued mortgage-backed securities, i.e. those that do not carry the guarantee of a government or government-sponsored agency, if the privately-issued mortgage-backed securities are at the time the mortgage-backed securities are originated fully secured by or otherwise represent a sufficiently secure interest in mortgages that qualify for the 50% risk weight under paragraphs (a)(3) (iii), (iv) and (v) of this section, \12\ provided that they meet the following criteria:---------------------------------------------------------------------------
\12\ If all of the underlying mortgages in the pool do not qualify for the 50% risk weight, the bank should generally assign the entire value of the security to the 100% risk category of section 3(a)(4) of this appendix A; however, on a case-by-case basis, the OCC may allow the bank to assign only the portion of the security which represents an interest in, and the cash flows of, nonqualifying mortgages to the 100% risk category, with the remainder being assigned a risk weight of 50%. Before the OCC will consider a request to risk weight a mortgage-backed security on a proportionate basis, the bank must have current information for the reporting date that details the composition and cash flows of the underlying pool of mortgages.---------------------------------------------------------------------------
(A) The underlying assets must be held by an independent trustee that has a first priority, perfected security interest in the underlying assets for the benefit of the holders of the security;
(B) The holder of the security must have an undivided pro rata ownership interest in the underlying assets or the trust that issues the security must have no liabilities unrelated to the issued securities;
(C) The trust that issues the security must be structured such that the cash flows from the underlying assets fully meet the cash flows requirements of the security without undue reliance on any reinvestment income; and
(D) There must not be any material reinvestment risk associated with any funds awaiting distribution to the holder of the security.
(4) 100 percent risk weight. All other assets not specified above, \12a\ including:---------------------------------------------------------------------------
\12a\ A bank subject to the market risk capital requirements pursuant to appendix B of this part 3 may calculate the capital requirement for qualifying securities borrowing transactions pursuant to section 3(a)(1)(ii) of appendix B of this part 3.---------------------------------------------------------------------------
(i) Claims on or guaranteed by depository institutions incorporated in a non-OECD country, as well as claims on the central bank of a non-OECD country, with a residual maturity exceeding one year.
(ii) All non-local currency claims on non-OECD central governments, as well as local currency claims on non-OECD central governments that are not included in section 3(a)(1)(v) of this appendix A.
(iii) Asset-or mortgage backed securities that are externally rated are risk weighted in accordance with section 4(d) of this appendix A.
(iv) All stripped mortgage-backed securities, including interest only portions (IOs), principal only portions (POs) and other similar instruments, regardless of the issuer or guarantor.
(v) Obligations issued by any state or any political subdivision thereof for the benefit of a private party or enterprise where that party or enterprise, rather than the issuing state or political subdivision, is responsible for the timely payment of principal and interest on the obligation, e.g., industrial development bonds.
(vi) Claims on commercial enterprises owned by non-OECD and OECD central governments.
(vii) Any investment in an unconsolidated subsidiary that is not required to be deducted from total capital pursuant to section 2(c)(3) of this appendix A.
(viii) Instruments issued by depository institutions incorporated in OECD and non- OECD countries that qualify as capital of the issuer.
(ix) Investments in fixed assets, premises, and other real estate owned.
(x) Claims representing capital of a securities firm notwithstanding section 3(a)(2)(xiii) of this appendix A. [Reserved]
(xi) Subject to the requirements below, a bank may assign an asset not included in the categories above to the risk weight category applicable under the capital guidelines for bank holding companies (see 12 CFR part 225, appendix A), provided that all of the following conditions apply:
(A) The bank is not authorized to hold the asset under applicable law other than debt previously contracted or similar authority; and
(B) The risks associated with the asset are substantially similar to the risks of assets that are otherwise assigned to a risk weight category less than 100 percent under this appendix.
(6) Other variable interest entities subject to consolidation. If a bank is required to consolidate the assets of a variable interest entity under generally accepted accounting principles, the bank must assess a risk-based capital charge based on the appropriate risk weight of the consolidated assets in accordance with sections 3(a) and 4 of this appendix A. Any direct credit substitutes and recourse obligations (including residual interests), and loans that a bank may provide to such a variable interest entity are not subject to a capital charge under section 4 of this appendix A.
(b) Off-Balance Sheet Activities. The risk weight assigned to an off-balance sheet item is determined by a two-step process. First, the face amount of the off-balance sheet item is multiplied by the appropriate credit conversion factor specified in this section. This calculation translates the face amount of an off-balance sheet item into an on-balance sheet credit equivalent amount. Second, the resulting credit equivalent amount is then assigned to the proper risk category using the criteria regarding obligors, guarantors, and collateral listed in section 3(a) of this appendix A, or external credit rating in accordance with section 4(d), if applicable. Collateral and guarantees are applied to the face amount of an off-balance sheet item; however, with respect to derivative contracts under section 3(b)(5) of this appendix A, collateral and guarantees are applied to the credit equivalent amounts of such derivative contracts. The following are the credit conversion factors and the off-balance sheet items to which they apply. However, direct credit substitutes, recourse obligations, and securities issued in connection with asset securitizations are treated as described in section 4 of this appendix A.
(1) 100 percent credit conversion factor. (i) [Reserved] \13\---------------------------------------------------------------------------
\13\ [Reserved]---------------------------------------------------------------------------
(ii) Risk participations purchased in bankers' acceptances;
(iii) [Reserved] \14\---------------------------------------------------------------------------
\14\ [Reserved]---------------------------------------------------------------------------
(iv) Contingent obligations with a certain draw down, e.g., legally binding agreements to purchase assets as a specified future date.
(v) Indemnification of customers whose securities the bank has lent as agent. If the customer is not indemnified against loss by the bank, the transaction is excluded from the risk-based capital calculation. \15\---------------------------------------------------------------------------
\15\ When a bank lends its own securities, the transaction is treated as a loan. When a bank lends its own securities or, acting as agent, agrees to indemnify a customer, the transaction is assigned to the risk weight appropriate to the obligor or collateral that is delivered to the lending or indemnifying institution or to an independent custodian acting on their behalf.---------------------------------------------------------------------------
(2) 50 percent credit conversion factor. (i) Transaction-related contingencies including, among other things, performance bonds and performance-based standby letters of credit related to a particular transaction. \16\ To the extent permitted by law or regulation, performance-based standby letters of credit include such things as arrangements backing subcontractors' and suppliers' performance, labor and materials contracts, and construction bids;---------------------------------------------------------------------------
\16\ For purposes of this section 3(b)(2)(i), a ``performance-based standby letter of credit'' is any letter of credit, or similar arrangement, however named or described, which represents an irrevocable obligation to the beneficiary on the part of the issuer to make payment on account of any default by the account party in the performance of a non-financial or commercial obligation. Participations in performance-based standby letters of credit are treated in accordance with section 4 of this appendix A.---------------------------------------------------------------------------
(ii) Unused portion of commitments with an original maturity exceeding one-year; \17\ however, commitments that are asset-backed commercial paper liquidity facilities must satisfy the eligibility requirements under section 3(b)(6)(ii) of this appendix A;---------------------------------------------------------------------------
\17\ Participations in commitments are treated in accordance with section 4 of this appendix A.---------------------------------------------------------------------------
(iii) Revolving underwriting facilities, note issuance facilities, and similar arrangements pursuant to which the bank's customer can issue short-term debt obligations in its own name, but for which the bank has a legally binding commitment to either:
(A) Purchase the obligations the customer is unable to sell by a stated date; or
(B) Advance funds to its customer, if the obligations cannot be sold.
(3) 20 percent credit conversion factor. (i) Trade-related contingencies. These are short-term self-liquidating instruments used to finance the movement of goods and are collateralized by the underlying shipment. A commercial letter of credit is an example of such an instrument.
(4) 10 percent credit conversion factor. Unused portion of asset-backed commercial paper liquidity facilities with an original maturity of one year or less that satisfy the eligibility requirements under section 3(b)(6)(ii) of this appendix A.
(5) Zero percent credit conversion factor. (i) Unused portion of commitments with an original maturity of one year or less, but excluding any asset-backed commercial paper liquidity facilities;
(i) Unused portion of commitments with an original maturity of one year or less, but excluding any asset-backed commercial paper liquidity facilities;
(ii) Unused portion of commitments with an original maturity of greater than one year, if they are unconditionally cancelable \18\ at any time at the option of the bank and the bank has the contractual right to make, and in fact does make, either-----------------------------------------------------------------------------
\18\ See section 1(c)(26) of appendix A to this part.---------------------------------------------------------------------------
(A) A separate credit decision based upon the borrower's current financial condition, before each drawing under the lending facility; or
(B) An annual (or more frequent) credit review based upon the borrower's current financial condition to determine whether or not the lending facility should be continued; and
(iii) The unused portion of retail credit card lines or other related plans that are unconditionally cancelable by the bank in accordance with applicable law.
(6) Liquidity facility provided to asset-backed commercial paper. (i) Noneligible asset-backed commercial paper liquidity facilities treated as recourse or direct credit substitute. Unused portion of asset-backed commercial paper liquidity facilities that do not meet the criteria for an eligible liquidity facility provided to asset-backed commercial paper in accordance with section 3(b)(6)(ii) of this appendix A must be treated as recourse or as a direct credit substitute, and assessed the appropriate risk-based capital charge in accordance with section 4 of this appendix A.
(i) Noneligible asset-backed commercial paper liquidity facilities treated as recourse or direct credit substitute. Unused portion of asset-backed commercial paper liquidity facilities that do not meet the criteria for an eligible liquidity facility provided to asset-backed commercial paper in accordance with section 3(b)(6)(ii) of this appendix A must be treated as recourse or as a direct credit substitute, and assessed the appropriate risk-based capital charge in accordance with section 4 of this appendix A.
(ii) Eligible asset-backed commercial paper liquidity facility. Except as provided in section 3(b)(6)(iii) of this appendix A, in order for the unused portion of an asset-backed commercial paper liquidity facility to be eligible for either the 50 percent or 10 percent credit conversion factors under section 3(b)(2)(ii) or 3(b)(4) of this appendix A, the asset-backed commercial paper liquidity facility must satisfy the following criteria:
(A) At the time of draw, the asset-backed commercial paper liquidity facility must be subject to an asset quality test that:
(1) Precludes funding of assets that are 90 days or more past due or in default; and
(2) If the assets that an asset-backed commercial paper liquidity facility is required to fund are externally rated securities at the time they are transferred into the program, the asset-backed commercial paper liquidity facility must be used to fund only securities that are externally rated investment grade at the time of funding. If the assets are not externally rated at the time they are transferred into the program, then they are not subject to this investment grade requirement.
(B) The asset-backed commercial paper liquidity facility must provide that, prior to any draws, the bank's funding obligation is reduced to cover only those assets that satisfy the funding criteria under the asset quality test as provided in section 3(b)(6)(ii)(A) of this appendix A.
(iii) Exception to eligibility requirements for assets guaranteed by the United States Government or its agencies, or the central government of an OECD country. Notwithstanding the eligibility requirements for asset-backed commercial paper program liquidity facilities in section 3(b)(6)(ii), the unused portion of an asset-backed commercial paper liquidity facility may still qualify for either the 50 percent or 10 percent credit conversion factors under section 3(b)(2)(ii) or 3(b)(4) of this appendix A, if the assets required to be funded by the asset-back commercial paper liquidity facility are guaranteed, either conditionally or unconditionally, by the United States Government or its agencies, or the central government of an OECD country.
(iv) Transition period for asset-backed commercial paper liquidity facilities. Notwithstanding the eligibility requirements for asset-backed commercial paper program liquidity facilities in section 3(b)(6)(i) of this appendix A, the unused portion of an asset-backed commercial paper liquidity will be treated as eligible liquidity facilities pursuant to section 3(b)(6)(ii) of this appendix A regardless of their compliance with the definition of eligible liquidity facilities until September 30, 2005. On that date and thereafter, the unused portions of asset-backed commercial paper liquidity facilities that do not meet the eligibility requirements in section 3(b)(6)(i) of this appendix A will be treated as recourse obligations or direct credit substitutes.
(7) Derivative contracts--(i) Calculation of credit equivalent amounts. The credit equivalent amount of a derivative contract equals the sum of the current credit exposure and the potential future credit exposure of the derivative contract. The calculation of credit equivalent amounts must be measured in U.S. dollars, regardless of the currency or currencies specified in the derivative contract.
(i) Calculation of credit equivalent amounts. The credit equivalent amount of a derivative contract equals the sum of the current credit exposure and the potential future credit exposure of the derivative contract. The calculation of credit equivalent amounts must be measured in U.S. dollars, regardless of the currency or currencies specified in the derivative contract.
(A) Current credit exposure. The current credit exposure for a single derivative contract is determined by the mark-to-market value of the derivative contract. If the mark-to-market value is positive, then the current credit exposure equals that mark-to-market value. If the mark-to-market is zero or negative, then the current credit exposure is zero. The current credit exposure for multiple derivative contracts executed with a single counterparty and subject to a qualifying bilateral netting contract is determined as provided by section 3(b)(5)(ii)(A) of this appendix A.
(B) Potential future credit exposure. The potential future credit exposure for a single derivative contract, including a derivative contract with negative mark-to-market value, is calculated by multiplying the notional principal \19\ of the derivative contract by one of the credit conversion factors in Table A--Conversion Factor Matrix of this appendix A, for the appropriate category. \20\ The potential future credit exposure for gold contracts shall be calculated using the foreign exchange rate conversion factors. For any derivative contract that does not fall within one of the specified categories in Table A--Conversion Factor Matrix of this appendix A, the potential future credit exposure shall be calculated using the other commodity conversion factors. Subject to examiner review, banks should use the effective rather than the apparent or stated notional amount in calculating the potential future credit exposure. The potential future credit exposure for multiple derivatives contracts executed with a single counterparty and subject to a qualifying bilateral netting contract is determined as provided by section 3(b)(5)(ii)(A) of this appendix A.---------------------------------------------------------------------------
\19\ For purposes of calculating either the potential future credit exposure under section 3(b)(5)(i)(B) of this appendix A or the gross potential future credit exposure under section 3(b)(5)(ii)(A)(2) of this appendix A for foreign exchange contracts and other similar contracts in which the notional principal is equivalent to the cash flows, total notional principal is the net receipts to each party falling due on each value date in each currency.
\20\ No potential future credit exposure is calculated for single currency interest rate swaps in which payments are made based upon two floating indices, so-called floating/floating or basis swaps; the credit equivalent amount is measured solely on the basis of the current credit exposure.
Table B--Conversion Factor Matrix \1\----------------------------------------------------------------------------------------------------------------
Foreign
Interest exchange Precious Other
Remaining maturity \2\ rate rate and Equity \2\ metals commodity
gold----------------------------------------------------------------------------------------------------------------One year or less............................... 0.0 1.0 6.0 7.0 10.0Over one to five years......................... 0.5 5.0 8.0 7.0 12.0Over five years................................ 1.5 7.5 10.0 8.0 15.0----------------------------------------------------------------------------------------------------------------\1\ For derivative contracts with multiple exchanges of principal, the conversion factors are multiplied by the
number of remaining payments in the derivative contract.\2\ For derivative contracts that automatically reset to zero value following a payment, the remaining maturity
equals the time until the next payment. However, interest rate contracts with remaining maturities of greater
than one year shall be subject to a minimum conversion factor of 0.5 percent.
(ii) Derivative contracts subject to a qualifying bilateral netting contract--(A) Netting calculation. The credit equivalent amount for multiple derivative contracts executed with a single counterparty and subject to a qualifying bilateral netting contract as provided by section (3)(b)(5)(ii)(B) of this appendix A is calculated by adding the net current credit exposure and the adjusted sum of the potential future credit exposure for all derivative contracts subject to the qualifying bilateral netting contract.
(1) Net current credit exposure. The net current credit exposure is the net sum of all positive and negative mark-to-market values of the individual derivative contracts subject to a qualifying bilateral netting contract. If the net sum of the mark-to-market value is positive, then the net current credit exposure equals that net sum of the mark-to-market value. If the net sum of the mark-to-market value is zero or negative, then the net current credit exposure is zero.
(2) Adjusted sum of the potential future credit exposure. The adjusted sum of the potential future credit exposure is calculated as: Anet=0.4xAgross+(0.6xNGRxAgross) Anet is the adjusted sum of the potential future credit exposure, Agross is the gross potential future credit exposure, and NGR is the net to gross ratio. Agross is the sum of the potential future credit exposure (as determined under section 3(b)(5)(i)(B) of this appendix A) for each individual derivative contract subject to the qualifying bilateral netting contract. The NGR is the ratio of the net current credit exposure to the gross current credit exposure. In calculating the NGR, the gross current credit exposure equals the sum of the positive current credit exposures (as determined under section 3(b)(5)(i)(A) of this appendix A) of all individual derivative contracts subject to the qualifying bilateral netting contract.
(B) Qualifying bilateral netting contract. In determining the current credit exposure for multiple derivative contracts executed with a single counterparty, a bank may net derivative contracts subject to a qualifying bilateral netting contract by offsetting positive and negative mark-to-market values, provided that:
(1) The qualifying bilateral netting contract is in writing.
(2) The qualifying bilateral netting contract is not subject to a walkaway clause.
(3) The qualifying bilateral netting contract creates a single legal obligation for all individual derivative contracts covered by the qualifying bilateral netting contract. In effect, the qualifying bilateral netting contract must provide that the bank would have a single claim or obligation either to receive or to pay only the net amount of the sum of the positive and negative mark-to-market values on the individual derivative contracts covered by the qualifying bilateral netting contract. The single legal obligation for the net amount is operative in the event that a counterparty, or a counterparty to whom the qualifying bilateral netting contract has been assigned, fails to perform due to any of the following events: default, insolvency, bankruptcy, or other similar circumstances.
(4) The bank obtains a written and reasoned legal opinion(s) that represents, with a high degree of certainty, that in the event of a legal challenge, including one resulting from default, insolvency, bankruptcy, or similar circumstances, the relevant court and administrative authorities would find the bank's exposure to be the net amount under:
(i) The law of the jurisdiction in which the counterparty is chartered or the equivalent location in the case of noncorporate entities, and if a branch of the counterparty is involved, then also under the law of the jurisdiction in which the branch is located;
(ii) The law of the jurisdiction that governs the individual derivative contracts covered by the bilateral netting contract; and
(iii) The law of the jurisdiction that governs the qualifying bilateral netting contract.
(5) The bank establishes and maintains procedures to monitor possible changes in relevant law and to ensure that the qualifying bilateral netting contract continues to satisfy the requirement of this section.
(6) The bank maintains in its files documentation adequate to support the netting of a derivative contract. \21\---------------------------------------------------------------------------
\21\ By netting individual derivative contracts for the purpose of calculating its credit equivalent amount, a bank represents that documentation adequate to support the netting of a set of derivative contract is in the bank's files and available for inspection by the OCC. Upon determination by the OCC that a bank's files are inadequate or that a qualifying bilateral netting contract may not be legally enforceable in any one of the bodies of law described in section 3(b)(5)(ii)(B)(3)(i) through (iii) of this appendix A, the underlying derivative contracts may not be netted for the purposes of this section.---------------------------------------------------------------------------
(iii) Risk weighting. Once the bank determines the credit equivalent amount for a derivative contract or a set of derivative contracts subject to a qualifying bilateral netting contract, the bank assigns that amount to the risk weight category appropriate to the counterparty, or, if relevant, the nature of any collateral or guarantee. \22\ However, the maximum weight that will be applied to the credit equivalent amount of such derivative contract(s) is 50 percent.---------------------------------------------------------------------------
\22\ Derivative contracts are an exception to the general rule of applying collateral and guarantees to the face value of off-balance sheet items. The sufficiency of collateral and guarantees is determined on the basis of the credit equivalent amount of derivative contracts. However, collateral and guarantees held against a qualifying bilateral netting contract is not recognized for capital purposes unless it is legally available for all contracts included in the qualifying bilateral netting contract.---------------------------------------------------------------------------
(iv) Exceptions. The following derivative contracts are not subject to the above calculation, and therefore, are not part of the denominator of a national bank's risk-based capital ratio:
(A) An exchange rate contract with an original maturity of 14 calendar days or less;\23\ and---------------------------------------------------------------------------
\23\ Notwithstanding section 3(b)(5)(B) of this appendix A, gold contracts do not qualify for this exception.---------------------------------------------------------------------------
(B) A derivative contract that is traded on an exchange requiring the daily payment of any variations in the market value of the contract.
Section 4. Recourse, Direct Credit Substitutes and Positions in
Securitizations
(a) Definitions. For purposes of this section 4 of this appendix A, the following definitions apply:
(1) Credit derivative means a contract that allows one party (the protection purchaser) to transfer the credit risk of an asset or off- balance sheet credit exposure to another party (the protection provider). The value of a credit derivative is dependent, at least in part, on the credit performance of a ``reference asset.''
(2) Credit-enhancing interest-only strip means an on-balance sheet asset that, in form or in substance:
(i) Represents the contractual right to receive some or all of the interest due on transferred assets; and
(ii) Exposes the bank to credit risk directly or indirectly associated with the transferred assets that exceeds its pro rata claim on the assets whether through subordination provisions or other credit enhancing techniques.
(3) Credit-enhancing representations and warranties means representations and warranties that are made or assumed in connection with a transfer of assets (including loan servicing assets) and that obligate a bank to protect investors from losses arising from credit risk in the assets transferred or the loans serviced. Credit-enhancing representations and warranties include promises to protect a party from losses resulting from the default or nonperformance of another party or from an insufficiency in the value of the collateral. Credit-enhancing representations and warranties do not include:
(i) Early-default clauses and similar warranties that permit the return of, or premium refund clauses covering, 1-4 family residential first mortgage loans (as described in section 3(a)(3)(iii) of this appendix A) for a period not to exceed 120 days from the date of transfer. These warranties may cover only those loans that were originated within 1 year of the date of transfer;
(ii) Premium refund clauses that cover assets guaranteed, in whole or in part, by the U.S. Government, a U.S. Government agency, or a U.S. Government-sponsored enterprise, provided the premium refund clauses are for a period not to exceed 120 days from the date of transfer; or
(iii) Warranties that permit the return of assets in instances of fraud, misrepresentation or incomplete documentation.
(4) Direct credit substitute means an arrangement in which a bank assumes, in form or in substance, credit risk associated with an on- or off-balance sheet asset or exposure that was not previously owned by the bank (third-party asset) and the risk assumed by the bank exceeds the pro rata share of the bank's interest in the third-party asset. If a bank has no claim on the third-party asset, then the bank's assumption of any credit risk is a direct credit substitute. Direct credit substitutes include:
(i) Financial standby letters of credit that support financial claims on a third party that exceed a bank's pro rata share in the financial claim;
(ii) Guarantees, surety arrangements, credit derivatives and similar instruments backing financial claims that exceed a bank's pro rata share in the financial claim;
(iii) Purchased subordinated interests that absorb more than their pro rata share of losses from the underlying assets;
(iv) Credit derivative contracts under which the bank assumes more than its pro rata share of credit risk on a third-party asset or exposure;
(v) Loans or lines of credit that provide credit enhancement for the financial obligations of a third party;
(vi) Purchased loan servicing assets if the servicer is responsible for credit losses or if the servicer makes or assumes credit-enhancing representations and warranties with respect to the loans serviced. Mortgage servicer case advances that meet the conditions of section 4(a)(8)(i) and (ii) of this appendix A, are not direct credit substitutes;
(vii) Clean-up calls on third-party assets. Clean-up calls that are 10% or less of the original pool balance and that are exercisable at the option of the bank are not direct credit substitutes; and
(viii) Unused portion of noneligible asset-backed commercial paper liquidity facilities.
(5) Externally rated means that an instrument or obligation has received a credit rating from at least one nationally recognized statistical rating organization.
(6) Face amount means the notional principal, or face value, amount of an off-balance sheet item; the amortized cost of an asset not held for trading purposes; and the fair value of a trading asset.
(7) Financial asset means cash or other monetary instrument, evidence of debt, evidence of an ownership interest in an entity, or a contract that conveys a right to receive or exchange cash or another financial instrument from another party.
(8) Financial standby letter of credit means a letter of credit or similar arrangement that represents an irrevocable obligation to a third-party beneficiary:
(i) To repay money borrowed by, or advanced to, or for the account of, a second party (the account party); or
(ii) To make payment on behalf of the account party, in the event that the account party fails to fulfill its obligation to the beneficiary.
(9) Mortgage servicer cash advance means funds that a residential mortgage servicer advances to ensure an uninterrupted flow of payments, including advances made to cover foreclosure costs or other expenses to facilitate the timely collection of the loan. A mortgage servicer cash advance is not a recourse obligation or a direct credit substitute if:
(i) The servicer is entitled to full reimbursement and this right is not subordinated to other claims on the cash flows from the underlying asset pool; or
(ii) For any one loan, the servicer's obligation to make nonreimbursable advances is contractually limited to an insignificant amount of the outstanding principal amount of that loan.
(10) Nationally recognized statistical rating organization (NRSRO) means an entity recognized by the Division of Market Regulation of the Securities and Exchange Commission (or any successor Division) (Commission) as a nationally recognized statistical rating organization for various purposes, including the Commission's uniform net capital requirements for brokers and dealers.
(11) Recourse means a bank's retention, in form or in substance, of any credit risk directly or indirectly associated with an asset it has sold that exceeds a pro rata share of that bank's claim on the asset. If a bank has no claim on a sold asset, then the retention of any credit risk is recourse. A recourse obligation typically arises when a bank transfers assets and retains an explicit obligation to repurchase assets or to absorb losses due to a default on the payment of principal or interest or any other deficiency in the performance of the underlying obligor or some other party. Recourse may also exist implicitly if a bank provides credit enhancement beyond any contractual obligation to support assets it has sold. The following are examples of recourse arrangements:
(i) Credit-enhancing representations and warranties made on transferred assets;
(ii) Loan servicing assets retained pursuant to an agreement under which the bank will be responsible for losses associated with the loans serviced. Mortgage servicer cash advances that meet the conditions of section 4(a)(9)(i) and (ii) of this appendix A, are not recourse arrangements;
(iii) Retained subordinated interests that absorb more than their pro rata share of losses from the underlying assets;
(iv) Assets sold under an agreement to repurchase, if the assets are not already included on the balance sheet;
(v) Loan strips sold without contractual recourse where the maturity of the transferred portion of the loan is shorter than the maturity of the commitment under which the loan is drawn;
(vi) Credit derivatives issued that absorb more than the bank's pro rata share of losses from the transferred assets;
(vii) Clean-up calls. Clean-up calls that are 10% or less of the original pool balance and that are exercisable at the option of the bank are not recourse arrangements; and
(viii) Noneligible asset-backed commercial paper liquidity facilities.
(12) Residual interest means any on-balance sheet asset that represents an interest (including a beneficial interest) created by a transfer that qualifies as a sale (in accordance with generally accepted accounting principles) of financial assets, whether through a securitization or otherwise, and that exposes a bank to any credit risk directly or indirectly associated with the transferred asset that exceeds a pro rata share of that bank's claim on the asset, whether through subordination provisions or other credit enhancement techniques. Residual interests generally include credit-enhancing interest-only strips, spread accounts, cash collateral accounts, retained subordinated interests (and other forms of overcollateralization) and similar assets that function as a credit enhancement. Residual interests further include those exposures that, in substance, cause the bank to retain the credit risk of an asset or exposure that had qualified as a residual interest before it was sold. Residual interests generally do not include interests purchased from a third party.
(13) Risk participation means a participation in which the originating party remains liable to the beneficiary for the full amount of an obligation (e.g. a direct credit substitute) notwithstanding that another party has acquired a participation in that obligation.
(14) Securitization means the pooling and repackaging by a special purpose entity of assets or other credit exposures that can be sold to investors. Securitization includes transactions that create stratified credit risk positions whose performance is dependent upon an underlying pool of credit exposures, including loans and commitments.
(15) Structured finance program means a program where receivable interests and asset-backed securities issued by multiple participants are purchased by a special purpose entity that repackages those exposures into securities that can be sold to investors. Structured finance programs allocate credit risks, generally, between the participants and credit enhancement provided to the program.
(16) Traded position means a position retained, assumed or issued in connection with a securitization that is externally rated, where there is a reasonable expectation that, in the near future, the rating will be relied upon by:
(i) Unaffiliated investors to purchase the position; or
(ii) An unaffiliated third party to enter into a transaction involving the position, such as a purchase, loan or repurchase agreement.
(b) Credit equivalent amounts and risk weights of recourse obligations and direct credit substitutes--(1) Credit-equivalent amount. Except as otherwise provided, the credit-equivalent amount for a recourse obligation or direct credit substitute is the full amount of the credit-enhanced assets for which the bank directly or indirectly retains or assumes credit risk multiplied by a 100% conversion factor.
(1) Credit-equivalent amount. Except as otherwise provided, the credit-equivalent amount for a recourse obligation or direct credit substitute is the full amount of the credit-enhanced assets for which the bank directly or indirectly retains or assumes credit risk multiplied by a 100% conversion factor.
(2) Risk-weight factor. To determine the bank's risk-weighted assets for off-balance sheet recourse obligations and direct credit substitutes, the credit equivalent amount is assigned to the risk category appropriate to the obligor in the underlying transaction, after considering any associated guarantees or collateral. For a direct credit substitute that is an on-balance sheet asset (e.g., a purchased subordinated security), a bank must calculate risk-weighted assets using the amount of the direct credit substitute and the full amount of the assets it supports, i.e., all the more senior positions in the structure.
(c) Credit equivalent amount and risk weight of participations in, and syndications of, direct credit substitutes. The credit equivalent amount for a participation interest in, or syndication of, a direct credit substitute is calculated and risk weighted as follows:
(1) In the case of a direct credit substitute in which a bank has conveyed a risk participation, the full amount of the assets that are supported by the direct credit substitute is converted to a credit equivalent amount using a 100% conversion factor. The pro rata share of the credit equivalent amount that has been conveyed through a risk participation is then assigned to whichever risk-weight category is lower: the risk-weight category appropriate to the obligor in the underlying transaction, after considering any associated guarantees or collateral, or the risk-weight category appropriate to the party acquiring the participation. The pro rata share of the credit equivalent amount that has not been participated out is assigned to the risk-weight category appropriate to the obligor after considering any associated guarantees or collateral.
(2) In the case of a direct credit substitute in which the bank has acquired a risk participation, the acquiring bank's pro rata share of the direct credit substitute is multiplied by the full amount of the assets that are supported by the direct credit substitute and converted using a 100% credit conversion factor. The resulting credit equivalent amount is then assigned to the risk-weight category appropriate to the obligor in the underlying transaction, after considering any associated guarantees or collateral.
(3) In the case of a direct credit substitute that takes the form of a syndication where each bank or participating entity is obligated only for its pro rata share of the risk and there is no recourse to the originating entity, each bank's credit equivalent amount will be calculated by multiplying only its pro rata share of the assets supported by the direct credit substitute by a 100% conversion factor. The resulting credit equivalent amount is then assigned to the risk-weight category appropriate to the obligor in the underlying transaction, after considering any associated guarantees or collateral.
(d) Externally rated positions: credit-equivalent amounts and risk weights--(1) Traded positions. With respect to a recourse obligation, direct credit substitute, residual interest (other than a credit-enhancing interest-only strip) or asset- or mortgage-backed security that is a ``traded position'' and that has received an external rating on a long-term position that is one grade below investment grade or better or a short-term position that is investment grade, the bank may multiply the face amount of the position by the appropriate risk weight, determined in accordance with Tables C or D of this appendix A. \24\ If a traded position receives more than one external rating, the lowest single rating will apply.---------------------------------------------------------------------------
\24\ Stripped mortgage-backed securities or other similar instruments, such as interest-only or principal-only strips, that are not credit enhancing must be assigned to the 100% risk category.
Table C------------------------------------------------------------------------
Risk weight
Long-term rating category Examples (In percent)------------------------------------------------------------------------Highest or second highest AAA, AA............. 20
investment grade.Third highest investment grade.... A................... 50Lowest investment grade........... BBB................. 100One category below investment BB.................. 200
grade.------------------------------------------------------------------------
Table D------------------------------------------------------------------------
Risk weight
Short-term rating category Examples (In percent)------------------------------------------------------------------------Highest investment grade.......... A-1, P-1............ 20Second highest investment grade... A-2, P-2............ 50Lowest investment grade........... A-3, P-3............ 100------------------------------------------------------------------------
(2) Non-traded positions. A recourse obligation, direct credit substitute, residual interest (but not a credit-enhancing interest-only strip) or asset- or mortgage-backed security extended in connection with a securitization that is not a ``traded position'' may be assigned a risk weight in accordance with section 4(d)(1) of this appendix A if:
(i) It has been externally rated by more than one NRSRO;
(ii) It has received an external rating on a long-term position that is one category below investment grade or better or a short-term position that is investment grade by all NRSROs providing a rating;
(iii) The ratings are publicly available; and
(iv) The ratings are based on the same criteria used to rate traded positions. If the ratings are different, the lowest rating will determine the risk category to which the recourse obligation, residual interest or direct credit substitute will be assigned.
(e) Senior positions not externally rated. For a recourse obligation, direct credit substitute, residual interest or asset- or mortgage-backed security that is not externally rated but is senior or preferred in all features to a traded position (including collateralization and maturity), a bank may apply a risk weight to the face amount of the senior position in accordance with section 4(d)(1) of this appendix A, based upon the traded position, subject to any current or prospective supervisory guidance and the bank satisfying the OCC that this treatment is appropriate. This section will apply only if the traded position provides substantive credit support to the unrated position until the unrated position matures.
(f) Residual Interests--(1) Concentration limit on credit-enhancing interest-only strips. In addition to the capital requirement provided by section 4(f)(2) of this appendix A, a bank must deduct from Tier 1 capital all credit-enhancing interest-only strips in excess of 25 percent of Tier 1 capital in accordance with section 2(c)(2)(iv) of this appendix A.
(1) Concentration limit on credit-enhancing interest-only strips. In addition to the capital requirement provided by section 4(f)(2) of this appendix A, a bank must deduct from Tier 1 capital all credit-enhancing interest-only strips in excess of 25 percent of Tier 1 capital in accordance with section 2(c)(2)(iv) of this appendix A.
(2) Credit-enhancing interest-only strip capital requirement. After applying the concentration limit to credit-enhancing interest-only strips in accordance with section (f)(1), a bank must maintain risk-based capital for a credit-enhancing interest-only strip equal to the remaining amount of the credit-enhancing interest-only strip (net of any existing associated deferred tax liability), even if the amount of risk-based capital required to be maintained exceeds the full risk-based capital requirement for the assets transferred. Transactions that, in substance, result in the retention of credit risk associated with a transferred credit-enhancing interest-only strip will be treated as if the credit-enhancing interest-only strip was retained by the bank and not transferred.
(3) Other residual interests capital requirement. Except as provided in sections (d) or (e) of this section, a bank must maintain risk-based capital for a residual interest (excluding a credit-enhancing interest-only strip) equal to the face amount of the residual interest that is retained on the balance sheet (net of any existing associated deferred tax liability), even if the amount of risk-based capital required to be maintained exceeds the full risk-based capital requirement for the assets transferred. Transactions that, in substance, result in the retention of credit risk associated with a transferred residual interest will be treated as if the residual interest was retained by the bank and not transferred.
(4) Residual interests and other recourse obligations. Where the aggregate capital requirement for residual interests (including credit-enhancing interest-only strips) and recourse obligations arising from the same transfer of assets exceed the full risk-based capital requirement for those assets, a bank must maintain risk-based capital equal to the greater of the risk-based capital requirement for the residual interest as calculated under sections 4(f)(1) through (3) of this appendix A or the full risk-based capital requirement for the assets transferred.
(g) Positions that are not rated by an NRSRO. A position (but not a residual interest) extended in connection with a securitization and that is not rated by an NRSRO may be risk-weighted based on the bank's determination of the credit rating of the position, as specified in Table E of this appendix A, multiplied by the face amount of the position. In order to qualify for this treatment, the bank's system for determining the credit rating of the position must meet one of the three alternative standards set out in section 4(g)(1)through (3) of this appendix A.
Table E------------------------------------------------------------------------
Risk weight
Rating category Examples (In percent)------------------------------------------------------------------------Investment grade.................. BBB, or better...... 100One category below investment BB.................. 200
grade.------------------------------------------------------------------------
(1) Internal risk rating used for asset-backed programs. A direct credit substitute (but not a purchased credit-enhancing interest-only strip) is assumed by a bank in connection with an asset-backed commercial paper program sponsored by the bank and the bank is able to demonstrate to the satisfaction of the OCC, prior to relying upon its use, that the bank's internal credit risk rating system is adequate. Adequate internal credit risk rating systems usually contain the following criteria:
(i) The internal credit risk system is an integral part of the bank's risk management system that explicitly incorporates the full range of risks arising from a bank's participation in securitization activities;
(ii) Internal credit ratings are linked to measurable outcomes, such as the probability that the position will experience any loss, the position's expected loss given default, and the degree of variance in losses given default on that position;
(iii) The bank's internal credit risk system must separately consider the risk associated with the underlying loans or borrowers, and the risk associated with the structure of a particular securitization transaction;
(iv) The bank's internal credit risk system must identify gradations of risk among ``pass'' assets and other risk positions;
(v) The bank must have clear, explicit criteria that are used to classify assets into each internal risk grade, including subjective factors;
(vi) The bank must have independent credit risk management or loan review personnel assigning or reviewing the credit risk ratings;
(vii) An internal audit procedure should periodically verify that internal risk ratings are assigned in accordance with the bank's established criteria.
(viii) The bank must monitor the performance of the internal credit risk ratings assigned to nonrated, nontraded direct credit substitutes over time to determine the appropriateness of the initial credit risk rating assignment and adjust individual credit risk ratings, or the overall internal credit risk ratings system, as needed; and
(ix) The internal credit risk system must make credit risk rating assumptions that are consistent with, or more conservative than, the credit risk rating assumptions and methodologies of NRSROs.
(2) Program Ratings. A direct credit substitute or recourse obligation (but not a residual interest) is assumed or retained by a bank in connection with a structured finance program and a NRSRO has reviewed the terms of the program and stated a rating for positions associated with the program. If the program has options for different combinations of assets, standards, internal credit enhancements and other relevant factors, and the NRSRO specifies ranges of rating categories to them, the bank may apply the rating category applicable to the option that corresponds to the bank's position. In order to rely on a program rating, the bank must demonstrate to the OCC's satisfaction that the credit risk rating assigned to the program meets the same standards generally used by NRSROs for rating traded positions. The bank must also demonstrate to the OCC's satisfaction that the criteria underlying the NRSRO's assignment of ratings for the program are satisfied for the particular position. If a bank participates in a securitization sponsored by another party, the OCC may authorize the bank to use this approach based on a program rating obtained by the sponsor of the program.
(3) Computer Program. The bank is using an acceptable credit assessment computer program to determine the rating of a direct credit substitute or recourse obligation (but not a residual interest) extended in connection with a structured finance program. A NRSRO must have developed the computer program and the bank must demonstrate to the OCC's satisfaction that ratings under the program correspond credibly and reliably with the rating of traded positions.
(h) Limitations on risk-based capital requirements--(1) Low-level exposure rule. If the maximum contractual exposure to loss retained or assumed by a bank is less than the effective risk-based capital requirement, as determined in accordance with section 4(b) of this appendix A, for the asset supported by the bank's position, the risk based capital required under this appendix A is limited to the bank's contractual exposure, less any recourse liability account established in accordance with generally accepted accounting principles. This limitation does not apply when a bank provides credit enhancement beyond any contractual obligation to support assets that it has sold.
(1) Low-level exposure rule. If the maximum contractual exposure to loss retained or assumed by a bank is less than the effective risk-based capital requirement, as determined in accordance with section 4(b) of this appendix A, for the asset supported by the bank's position, the risk based capital required under this appendix A is limited to the bank's contractual exposure, less any recourse liability account established in accordance with generally accepted accounting principles. This limitation does not apply when a bank provides credit enhancement beyond any contractual obligation to support assets that it has sold.
(2) Related on-balance sheet assets. If an asset is included in the calculation of the risk-based capital requirement under this section 4 of this appendix A and also appears as an asset on a bank's balance sheet, the asset is risk-weighted only under this section 4 of this appendix A, except in the case of loan servicing assets and similar arrangements with embedded recourse obligations or direct credit substitutes. In that case, both the on-balance sheet servicing assets and the related recourse obligations or direct credit substitutes must both be separately risk weighted and incorporated into the risk-based capital calculation.
(i) Alternative Capital Calculation for Small Business Obligations--(1) Definitions. For purposes of this section 4(i):
(1) Definitions. For purposes of this section 4(i):
(i) Qualified bank means a bank that:
(A) Is well capitalized as defined in 12 CFR 6.4 without applying the capital treatment described in this section 4(i), or
(B) Is adequately capitalized as defined in 12 CFR 6.4 without applying the capital treatment described in this section 4(i) and has received written permission from the appropriate district office of the OCC to apply the capital treatment described in this section 4(i).
(ii) Recourse has the meaning given to such term under generally accepted accounting principles.
(iii) Small business means a business that meets the criteria for a small business concern established by the Small Business Administration in 13 CFR part 121 pursuant to 15 U.S.C. 632.
(2) Capital and reserve requirements. Notwithstanding the risk-based capital treatment outlined in section 2(c)(4) and any other subsection (other than subsection (i)) of this section 4, with respect to a transfer of a small business loan or a lease of personal property with recourse that is a sale under generally accepted accounting principles, a qualified bank may elect to apply the following treatment:
(i) The bank establishes and maintains a non-capital reserve under generally accepted accounting principles sufficient to meet the reasonable estimated liability of the bank under the recourse arrangement; and
(ii) For purposes of calculating the bank's risk-based capital ratio, the bank includes only the face amount of its recourse in its risk-weighted assets.
(3) Limit on aggregate amount of recourse. The total outstanding amount of recourse retained by a qualified bank with respect to transfers of small business loans and leases of personal property and included in the risk-weighted assets of the bank as described in section 4(i)(2) of this appendix A may not exceed 15 percent of the bank's total capital after adjustments and deductions, unless the OCC specifies a greater amount by order.
(4) Bank that ceases to be qualified or that exceeds aggregate limit. If a bank ceases to be a qualified bank or exceeds the aggregate limit in section 4(i)(3) of this appendix A, the bank may continue to apply the capital treatment described in section 4(i)(2) of this appendix A to transfers of small business loans and leases of personal property that occurred when the bank was qualified and did not exceed the limit.
(5) Prompt Corrective Action not affected. (i) A bank shall compute its capital without regard to this section 4(i) for purposes of prompt corrective action (12 U.S.C. 1831o and 12 CFR part 6) unless the bank is an adequately or well capitalized bank (without applying the capital treatment described in this section 4(i)) and, after applying the capital treatment described in this section 4(i), the bank would be well capitalized.
(i) A bank shall compute its capital without regard to this section 4(i) for purposes of prompt corrective action (12 U.S.C. 1831o and 12 CFR part 6) unless the bank is an adequately or well capitalized bank (without applying the capital treatment described in this section 4(i)) and, after applying the capital treatment described in this section 4(i), the bank would be well capitalized.
(ii) A bank shall compute its capital without regard to this section 4(i) for purposes of 12 U.S.C. 1831o(g) regardless of the bank's capital level. Section 5. Optional transition provisions related to the implementation
of consolidation requirements under FAS 167.
(a) This section 5 provides optional transition provisions for a national bank that is required for financial and regulatory reporting purposes, as a result of its implementation of Statement of Financial Accounting Standards No. 167, Amendments to FASB Interpretation No. 46(R) (FAS 167), to consolidate certain variable interest entities (VIEs) as defined under United States generally accepted accounting principles (GAAP). These transition provisions apply through the end of the fourth quarter following the date of a bank's implementation of FAS 167 (implementation date).
(b) Exclusion period. (1) Exclusion of risk-weighted assets for the first and second quarters. For the first two quarters after the implementation date (exclusion period), including for the two calendar quarter-end regulatory report dates within those quarters, a bank may exclude from risk-weighted assets:
(1) Exclusion of risk-weighted assets for the first and second quarters. For the first two quarters after the implementation date (exclusion period), including for the two calendar quarter-end regulatory report dates within those quarters, a bank may exclude from risk-weighted assets:
(i) Subject to the limitations in paragraph (d) of this section 5, assets held by a VIE, provided that the following conditions are met:
(A) The VIE existed prior to the implementation date;
(B) The bank did not consolidate the VIE on its balance sheet for calendar quarter-end regulatory report dates prior to the implementation date;
(C) The bank must consolidate the VIE on its balance sheet beginning as of the implementation date as a result of its implementation of FAS 167; and
(D) The bank excludes all assets held by VIEs described in paragraphs (b)(1)(i)(A) through (C) of this section 5; and
(ii) Subject to the limitations of paragraph (d) of this section 5, assets held by a VIE that is a consolidated asset-backed commercial paper (ABCP) program, provided that the following conditions are met:
(A) The bank is the sponsor of the ABCP program;
(B) Prior to the implementation date, the bank consolidated the VIE onto its balance sheet under GAAP and excluded the VIE's assets from the bank's risk-weighted assets; and
(C) The bank chooses to exclude all assets held by ABCP program VIEs described in paragraphs (b)(1)(ii)(A) and (B) of this section 5.
(2) Risk-weighted assets during exclusion period. During the exclusion period, including the two calendar quarter-end regulatory report dates within the exclusion period, a bank adopting the optional provisions of this paragraph (b) of this section 5 must calculate risk-weighted assets for its contractual exposures to the VIEs referenced in paragraph (b)(1) of this section 5 on the implementation date and include this calculated amount in its risk-weighted assets. Such contractual exposures may include direct-credit substitutes, recourse obligations, residual interests, liquidity facilities, and loans.
(3) Inclusion of ALLL in Tier 2 capital for the first and second quarters. During the exclusion period, including for the two calendar quarter-end regulatory report dates within the exclusion period, a bank that excludes VIE assets from risk-weighted assets pursuant to paragraph (b)(1) of this section may include in Tier 2 capital the full amount of the allowance for loan and lease losses (ALLL) calculated as of the implementation date that is attributable to the assets it excludes pursuant to paragraph (b)(1) of this section 5 (inclusion amount). The amount of ALLL includable in Tier 2 capital in accordance with this paragraph shall not be subject to the limitations set forth in section 2(b)(1) of this appendix A.
(c) Phase-in period. (1) Exclusion amount. For purposes of this paragraph (c), exclusion amount is defined as the amount of risk-weighted assets excluded in paragraph (b)(1) of this section as of the implementation date.
(1) Exclusion amount. For purposes of this paragraph (c), exclusion amount is defined as the amount of risk-weighted assets excluded in paragraph (b)(1) of this section as of the implementation date.
(2) Risk-weighted assets during the third and fourth quarters. A bank that excludes assets of consolidated VIEs from risk-weighted assets pursuant to paragraph (b)(1) of this section may, for the third and fourth quarters after the implementation date (phase-in period), including for the two calendar quarter-end regulatory report dates within those quarters, exclude from risk-weighted assets 50 percent of the exclusion amount, provided that the bank may not include in risk-weighted assets pursuant to this paragraph an amount less than the aggregate risk-weighted assets calculated pursuant to paragraph (b)(2) of this section.
(3) Inclusion of ALLL in Tier 2 capital during the third and fourth quarters. A bank that excludes assets of consolidated VIEs from risk-weighted assets pursuant to paragraph (c)(2) of this section may, for the phase-in period, include in Tier 2 capital 50 percent of the inclusion amount it included in Tier 2 capital during the exclusion period, notwithstanding the limit on including ALLL in Tier 2 capital in section 2(b)(1) of this appendix A.
(d) Implicit recourse limitation. Notwithstanding any other provision in this section 5, assets held by a VIE to which the bank has provided recourse through credit enhancement beyond any contractual obligation to support assets it has sold may not be excluded from risk-weighted assets. [54 FR 4177, Jan. 27, 1989]
Editorial Note: For Federal Register citations affecting appendix A to part 3 of title 12, see the List of CFR Sections Affected, which appears in the Finding Aids section of the printed volume and at www.fdsys.gov.
Sec. Appendix B to Part 3--Risk-Based Capital Guidelines; Market Risk Section 1 Purpose, Applicability, and Reservation of AuthoritySection 2 DefinitionsSection 3 Requirements for Application of the Market Risk Capital RuleSection 4 Adjustments to the Risk-Based Capital Ratio CalculationsSection 5 VaR-based MeasureSection 6 Stressed VaR-based MeasureSection 7 Specific RiskSection 8 Incremental RiskSection 9 Comprehensive RiskSection 10 Standardized Measurement Method for Specific RiskSection 11 Simplified Supervisory Formula ApproachSection 12 Market Risk Disclosures
Section 1. Purpose, Applicability, and Reservation of Authority
(a) Purpose. This appendix establishes risk-based capital requirements for banks with significant exposure to market risk and provides methods for these banks to calculate their risk-based capital requirements for market risk. This appendix supplements and adjusts the risk-based capital calculations under appendix A to this part and appendix C to this part and establishes public disclosure requirements.
(b) Applicability. (1) This appendix applies to any bank with aggregate trading assets and trading liabilities (as reported in the bank's most recent quarterly Consolidated Reports of Condition and Income (Call Report)), equal to:
(1) This appendix applies to any bank with aggregate trading assets and trading liabilities (as reported in the bank's most recent quarterly Consolidated Reports of Condition and Income (Call Report)), equal to:
(i) 10 percent or more of quarter-end total assets as reported on the most recent quarterly Call Report; or
(ii) $1 billion or more.
(2) The OCC may apply this appendix to any bank if the OCC deems it necessary or appropriate because of the level of market risk of the bank or to ensure safe and sound banking practices.
(3) The OCC may exclude a bank that meets the criteria of paragraph (b)(1) of this section from application of this appendix if the OCC determines that the exclusion is appropriate based on the level of market risk of the bank and is consistent with safe and sound banking practices.
(c) Reservation of authority. (1) The OCC may require a bank to hold an amount of capital greater than otherwise required under this appendix if the OCC determines that the bank's capital requirement for market risk as calculated under this appendix is not commensurate with the market risk of the bank's covered positions. In making determinations under paragraphs (c)(1) through (c)(3) of this section, the OCC will apply notice and response procedures generally in the same manner as the notice and response procedures set forth in [12 CFR 3.12, 12 CFR 263.202, 12 CFR 325.6(c), 12 CFR 567.3(d)].
(1) The OCC may require a bank to hold an amount of capital greater than otherwise required under this appendix if the OCC determines that the bank's capital requirement for market risk as calculated under this appendix is not commensurate with the market risk of the bank's covered positions. In making determinations under paragraphs (c)(1) through (c)(3) of this section, the OCC will apply notice and response procedures generally in the same manner as the notice and response procedures set forth in [12 CFR 3.12, 12 CFR 263.202, 12 CFR 325.6(c), 12 CFR 567.3(d)].
(2) If the OCC determines that the risk-based capital requirement calculated under this appendix by the bank for one or more covered positions or portfolios of covered positions is not commensurate with the risks associated with those positions or portfolios, the OCC may require the bank to assign a different risk-based capital requirement to the positions or portfolios that more accurately reflects the risk of the positions or portfolios.
(3) The OCC may also require a bank to calculate risk-based capital requirements for specific positions or portfolios under this appendix, or under appendix C to this part or appendix A to this part, as appropriate, to more accurately reflect the risks of the positions.
(4) Nothing in this appendix limits the authority of the OCC under any other provision of law or regulation to take supervisory or enforcement action, including action to address unsafe or unsound practices or conditions, deficient capital levels, or violations of law.
Section 2. Definitions
For purposes of this appendix, the following definitions apply:
Affiliate with respect to a company means any company that controls, is controlled by, or is under common control with, the company.
Backtesting means the comparison of a bank's internal estimates with actual outcomes during a sample period not used in model development. For purposes of this appendix, backtesting is one form of out-of-sample testing.
Bank holding company is defined in section 2(a) of the Bank Holding Company Act of 1956 (12 U.S.C. 1841(a)).
Commodity position means a position for which price risk arises from changes in the price of a commodity.
Company means a corporation, partnership, limited liability company, depository institution, business trust, special purpose entity, association, or similar organization.
Control A person or company controls a company if it:
(1) Owns, controls, or holds with power to vote 25 percent or more of a class of voting securities of the company; or
(2) Consolidates the company for financial reporting purposes.
Corporate debt position means a debt position that is an exposure to a company that is not a sovereign entity, the Bank for International Settlements, the European Central Bank, the European Commission, the International Monetary Fund, a multilateral development bank, a depository institution, a foreign bank, a credit union, a public sector entity, a government-sponsored entity, or a securitization.
Correlation trading position means:
(1) A securitization position for which all or substantially all of the value of the underlying exposures is based on the credit quality of a single company for which a two-way market exists, or on commonly traded indices based on such exposures for which a two-way market exists on the indices; or
(2) A position that is not a securitization position and that hedges a position described in paragraph (1) of this definition; and
(3) A correlation trading position does not include:
(i) A resecuritization position;
(ii) A derivative of a securitization position that does not provide a pro rata share in the proceeds of a securitization tranche; or
(iii) A securitization position for which the underlying assets or reference exposures are retail exposures, residential mortgage exposures, or commercial mortgage exposures.
Country risk classification (CRC) for a sovereign entity means the consensus CRC published from time to time by the Organization for Economic Cooperation and Development that provides a view of the likelihood that the sovereign entity will service its external debt.
Covered position means the following positions:
(1) A trading asset or trading liability (whether on- or off-balance sheet), \43\ as reported on Schedule RC-D of the Call Report or Schedule HC-D of the FR Y-9C, that meets the following conditions:---------------------------------------------------------------------------
\43\ Securities subject to repurchase and lending agreements are included as if they are still owned by the lender.---------------------------------------------------------------------------
(i) The position is a trading position or hedges another covered position; \44\ and---------------------------------------------------------------------------
\44\ A position that hedges a trading position must be within the scope of the bank's hedging strategy as described in paragraph (a)(2) of section 3 of this appendix.---------------------------------------------------------------------------
(ii) The position is free of any restrictive covenants on its tradability or the bank is able to hedge the material risk elements of the position in a two-way market;
(2) A foreign exchange or commodity position, regardless of whether the position is a trading asset or trading liability (excluding any structural foreign currency positions that the bank chooses to exclude with prior supervisory approval); and
(3) Notwithstanding paragraphs (1) and (2) of this definition, a covered position does not include:
(i) An intangible asset, including any servicing asset;
(ii) Any hedge of a trading position that the OCC determines to be outside the scope of the bank's hedging strategy required in paragraph (a)(2) of section 3 of this appendix;
(iii) Any position that, in form or substance, acts as a liquidity facility that provides support to asset-backed commercial paper;
(iv) A credit derivative the bank recognizes as a guarantee for risk-weighted asset amount calculation purposes under appendix C to this part or appendix A to this part;
(v) Any equity position that is not publicly traded, other than a derivative that references a publicly traded equity;
(vi) Any position a bank holds with the intent to securitize; or
(vii) Any direct real estate holding.
Credit derivative means a financial contract executed under standard industry documentation that allows one party (the protection purchaser) to transfer the credit risk of one or more exposures (reference exposure(s)) to another party (the protection provider).
Credit union means an insured credit union as defined under the Federal Credit Union Act (12 U.S.C. 1752).
Default by a sovereign entity means noncompliance by the sovereign entity with its external debt service obligations or the inability or unwillingness of a sovereign entity to service an existing obligation according to its original contractual terms, as evidenced by failure to pay principal and interest timely and fully, arrearages, or restructuring.
Debt position means a covered position that is not a securitization position or a correlation trading position and that has a value that reacts primarily to changes in interest rates or credit spreads.
Depository institution is defined in section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813).
Equity position means a covered position that is not a securitization position or a correlation trading position and that has a value that reacts primarily to changes in equity prices.
Event risk means the risk of loss on equity or hybrid equity positions as a result of a financial event, such as the announcement or occurrence of a company merger, acquisition, spin-off, or dissolution.
Foreign bank means a foreign bank as defined in Sec. 211.2 of the Federal Reserve Board's Regulation K (12 CFR 211.2), other than a depository institution.
Foreign exchange position means a position for which price risk arises from changes in foreign exchange rates.
General market risk means the risk of loss that could result from broad market movements, such as changes in the general level of interest rates, credit spreads, equity prices, foreign exchange rates, or commodity prices.
General obligation means a bond or similar obligation that is guaranteed by the full faith and credit of states or other political subdivisions of a sovereign entity.
Government-sponsored entity (GSE) means an entity established or chartered by the U.S. government to serve public purposes specified by the U.S. Congress but whose debt obligations are not explicitly guaranteed by the full faith and credit of the U.S. government.
Hedge means a position or positions that offset all, or substantially all, of one or more material risk factors of another position.
Idiosyncratic risk means the risk of loss in the value of a position that arises from changes in risk factors unique to that position.
Incremental risk means the default risk and credit migration risk of a position. Default risk means the risk of loss on a position that could result from the failure of an obligor to make timely payments of principal or interest on its debt obligation, and the risk of loss that could result from bankruptcy, insolvency, or similar proceeding. Credit migration risk means the price risk that arises from significant changes in the underlying credit quality of the position.
Investment grade means that the entity to which the bank is exposed through a loan or security, or the reference entity with respect to a credit derivative, has adequate capacity to meet financial commitments for the projected life of the asset or exposure. Such an entity or reference entity has adequate capacity to meet financial commitments if the risk of its default is low and the full and timely repayment of principal and interest is expected.
Market risk means the risk of loss on a position that could result from movements in market prices.
Multilateral development bank means the International Bank for Reconstruction and Development, the Multilateral Investment Guarantee Agency, the International Finance Corporation, the Inter-American Development Bank, the Asian Development Bank, the African Development Bank, the European Bank for Reconstruction and Development, the European Investment Bank, the European Investment Fund, the Nordic Investment Bank, the Caribbean Development Bank, the Islamic Development Bank, the Council of Europe Development Bank, and any other multilateral lending institution or regional development bank in which the U.S. government is a shareholder or contributing member or which the OCC determines poses comparable credit risk.
Nth-to-default credit derivative means a credit derivative that provides credit protection only for the nth-defaulting reference exposure in a group of reference exposures.
Over-the-counter (OTC) derivative means a derivative contract that is not traded on an exchange that requires the daily receipt and payment of cash-variation margin.
Public sector entity (PSE) means a state, local authority, or other governmental subdivision below the sovereign entity level.
Publicly traded means traded on:
(1) Any exchange registered with the SEC as a national securities exchange under section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f); or
(2) Any non-U.S.-based securities exchange that:
(i) Is registered with, or approved by, a national securities regulatory authority; and
(ii) Provides a liquid, two-way market for the instrument in question.
Qualifying securities borrowing transaction means a cash-collateralized securities borrowing transaction that meets the following conditions:
(1) The transaction is based on liquid and readily marketable securities;
(2) The transaction is marked-to-market daily;
(3) The transaction is subject to daily margin maintenance requirements; and
(4)(i) The transaction is a securities contract for the purposes of section 555 of the Bankruptcy Code (11 U.S.C. 555), a qualified financial contract for the purposes of section 11(e)(8) of the Federal Deposit Insurance Act (12 U.S.C. 1821(e)(8)), or a netting contract between or among financial institutions for the purposes of sections 401-407 of the Federal Deposit Insurance Corporation Improvement Act of 1991 (12 U.S.C. 4401-4407) or the Board's Regulation EE (12 CFR part 231); or
(i) The transaction is a securities contract for the purposes of section 555 of the Bankruptcy Code (11 U.S.C. 555), a qualified financial contract for the purposes of section 11(e)(8) of the Federal Deposit Insurance Act (12 U.S.C. 1821(e)(8)), or a netting contract between or among financial institutions for the purposes of sections 401-407 of the Federal Deposit Insurance Corporation Improvement Act of 1991 (12 U.S.C. 4401-4407) or the Board's Regulation EE (12 CFR part 231); or
(ii) If the transaction does not meet the criteria in paragraph (4)(i) of this definition, either:
(A) The bank has conducted sufficient legal review to reach a well-founded conclusion that:
(1) The securities borrowing agreement executed in connection with the transaction provides the bank the right to accelerate, terminate, and close-out on a net basis all transactions under the agreement and to liquidate or set off collateral promptly upon an event of counterparty default, including in a bankruptcy, insolvency, or other similar proceeding of the counterparty; and
(2) Under applicable law of the relevant jurisdiction, its rights under the agreement are legal, valid, binding, and enforceable and any exercise of rights under the agreement will not be stayed or avoided; or
(B) The transaction is either overnight or unconditionally cancelable at any time by the bank, and the bank has conducted sufficient legal review to reach a well-founded conclusion that:
(1) The securities borrowing agreement executed in connection with the transaction provides the bank the right to accelerate, terminate, and close-out on a net basis all transactions under the agreement and to liquidate or set off collateral promptly upon an event of counterparty default; and
(2) Under the law governing the agreement, its rights under the agreement are legal, valid, binding, and enforceable.
Resecuritization means a securitization in which one or more of the underlying exposures is a securitization position.
Resecuritization position means a covered position that is:
(1) An on- or off-balance sheet exposure to a resecuritization; or
(2) An exposure that directly or indirectly references a resecuritization exposure in paragraph (1) of this definition.
Revenue obligation means a bond or similar obligation, including loans and leases, that is an obligation of a state or other political subdivision of a sovereign entity, but for which the government entity is committed to repay with revenues from the specific project financed rather than with general tax funds.
SEC means the U.S. Securities and Exchange Commission.
Securitization means a transaction in which:
(1) All or a portion of the credit risk of one or more underlying exposures is transferred to one or more third parties;
(2) The credit risk associated with the underlying exposures has been separated into at least two tranches that reflect different levels of seniority;
(3) Performance of the securitization exposures depends upon the performance of the underlying exposures;
(4) All or substantially all of the underlying exposures are financial exposures (such as loans, commitments, credit derivatives, guarantees, receivables, asset-backed securities, mortgage-backed securities, other debt securities, or equity securities);
(5) For non-synthetic securitizations, the underlying exposures are not owned by an operating company;
(6) The underlying exposures are not owned by a small business investment company described in section 302 of the Small Business Investment Act of 1958 (15 U.S.C. 682); and
(7) The underlying exposures are not owned by a firm an investment in which qualifies as a community development investment under 12 U.S.C. 24 (Eleventh).
(8) The OCC may determine that a transaction in which the underlying exposures are owned by an investment firm that exercises substantially unfettered control over the size and composition of its assets, liabilities, and off-balance sheet exposures is not a securitization based on the transaction's leverage, risk profile, or economic substance.
(9) The OCC may deem an exposure to a transaction that meets the definition of a securitization, notwithstanding paragraph (5), (6), or (7) of this definition, to be a securitization based on the transaction's leverage, risk profile, or economic substance.
Securitization position means a covered position that is:
(1) An on-balance sheet or off-balance sheet credit exposure (including credit-enhancing representations and warranties) that arises from a securitization (including a resecuritization); or
(2) An exposure that directly or indirectly references a securitization exposure described in paragraph (1) of this definition.
Sovereign debt position means a direct exposure to a sovereign entity.
Sovereign entity means a central government (including the U.S. government) or an agency, department, ministry, or central bank of a central government.
Sovereign of incorporation means the country where an entity is incorporated, chartered, or similarly established.
Specific risk means the risk of loss on a position that could result from factors other than broad market movements and includes event risk, default risk, and idiosyncratic risk.
Structural position in a foreign currency means a position that is not a trading position and that is:
(1) Subordinated debt, equity, or minority interest in a consolidated subsidiary that is denominated in a foreign currency;
(2) Capital assigned to foreign branches that is denominated in a foreign currency;
(3) A position related to an unconsolidated subsidiary or another item that is denominated in a foreign currency and that is deducted from the bank's tier 1 and tier 2 capital; or
(4) A position designed to hedge a bank's capital ratios or earnings against the effect on paragraphs (1), (2), or (3) of this definition of adverse exchange rate movements.
Term repo-style transaction means a repurchase or reverse repurchase transaction, or a securities borrowing or securities lending transaction, including a transaction in which the bank acts as agent for a customer and indemnifies the customer against loss, that has an original maturity in excess of one business day, provided that:
(1) The transaction is based solely on liquid and readily marketable securities or cash;
(2) The transaction is marked-to-market daily and subject to daily margin maintenance requirements;
(3) The transaction is executed under an agreement that provides the bank the right to accelerate, terminate, and close-out the transaction on a net basis and to liquidate or set off collateral promptly upon an event of default (including bankruptcy, insolvency, or similar proceeding) of the counterparty, provided that, in any such case, any exercise of rights under the agreement will not be stayed or avoided under applicable law in the relevant jurisdictions; \45\ and---------------------------------------------------------------------------
\45\ This requirement is met where all transactions under the agreement are (i) executed under U.S. law and (ii) constitute ``securities contracts'' or ``repurchase agreements'' under section 555 or 559, respectively, of the Bankruptcy Code (11 U.S.C. 555 or 559), qualified financial contracts under section 11(e)(8) of the Federal Deposit Insurance Act (12 U.S.C. 1821(e)(8)), or netting contracts between or among financial institutions under sections 401-407 of the Federal Deposit Insurance Corporation Improvement Act of 1991 (12 U.S.C. 4407), or the Federal Reserve Board's Regulation EE (12 CFR part 231).---------------------------------------------------------------------------
(4) The bank has conducted and documented sufficient legal review to conclude with a well-founded basis that the agreement meets the requirements of paragraph (3) of this definition and is legal, valid, binding, and enforceable under applicable law in the relevant jurisdictions.
Tier 1 capital is defined in appendix A to this part or appendix C to this part, as applicable.
Tier 2 capital is defined in appendix A to this part or appendix C to this part, as applicable.
Trading position means a position that is held by the bank for the purpose of short-term resale or with the intent of benefiting from actual or expected short-term price movements, or to lock in arbitrage profits.
Two-way market means a market where there are independent bona fide offers to buy and sell so that a price reasonably related to the last sales price or current bona fide competitive bid and offer quotations can be determined within one day and settled at that price within a relatively short time frame conforming to trade custom.
Underlying exposure means one or more exposures that have been securitized in a securitization transaction.
Value-at-Risk (VaR) means the estimate of the maximum amount that the value of one or more positions could decline due to market price or rate movements during a fixed holding period within a stated confidence interval.
Section 3. Requirements for Application of the Market Risk Capital Rule
(a) Trading positions. (1) Identification of trading positions. A bank must have clearly defined policies and procedures for determining which of its trading assets and trading liabilities are trading positions and which of its trading positions are correlation trading positions. These policies and procedures must take into account:
(1) Identification of trading positions. A bank must have clearly defined policies and procedures for determining which of its trading assets and trading liabilities are trading positions and which of its trading positions are correlation trading positions. These policies and procedures must take into account:
(i) The extent to which a position, or a hedge of its material risks, can be marked- to-market daily by reference to a two-way market; and
(ii) Possible impairments to the liquidity of a position or its hedge.
(2) Trading and hedging strategies. A bank must have clearly defined trading and hedging strategies for its trading positions that are approved by senior management of the bank.
(i) The trading strategy must articulate the expected holding period of, and the market risk associated with, each portfolio of trading positions.
(ii) The hedging strategy must articulate for each portfolio of trading positions the level of market risk the bank is willing to accept and must detail the instruments, techniques, and strategies the bank will use to hedge the risk of the portfolio.
(b) Management of covered positions. (1) Active management. A bank must have clearly defined policies and procedures for actively managing all covered positions. At a minimum, these policies and procedures must require:
(1) Active management. A bank must have clearly defined policies and procedures for actively managing all covered positions. At a minimum, these policies and procedures must require:
(i) Marking positions to market or to model on a daily basis;
(ii) Daily assessment of the bank's ability to hedge position and portfolio risks, and of the extent of market liquidity;
(iii) Establishment and daily monitoring of limits on positions by a risk control unit independent of the trading business unit;
(iv) Daily monitoring by senior management of information described in paragraphs (b)(1)(i) through (b)(1)(iii) of this section;
(v) At least annual reassessment of established limits on positions by senior management; and
(vi) At least annual assessments by qualified personnel of the quality of market inputs to the valuation process, the soundness of key assumptions, the reliability of parameter estimation in pricing models, and the stability and accuracy of model calibration under alternative market scenarios.
(2) Valuation of covered positions. The bank must have a process for prudent valuation of its covered positions that includes policies and procedures on the valuation of positions, marking positions to market or to model, independent price verification, and valuation adjustments or reserves. The valuation process must consider, as appropriate, unearned credit spreads, close-out costs, early termination costs, investing and funding costs, liquidity, and model risk.
(c) Requirements for internal models. (1) A bank must obtain the prior written approval of the OCC before using any internal model to calculate its risk-based capital requirement under this appendix.
(1) A bank must obtain the prior written approval of the OCC before using any internal model to calculate its risk-based capital requirement under this appendix.
(2) A bank must meet all of the requirements of this section on an ongoing basis. The bank must promptly notify the OCC when:
(i) The bank plans to extend the use of a model that the OCC has approved under this appendix to an additional business line or product type;
(ii) The bank makes any change to an internal model approved by the OCC under this appendix that would result in a material change in the bank's risk-weighted asset amount for a portfolio of covered positions; or
(iii) The bank makes any material change to its modeling assumptions.
(3) The OCC may rescind its approval of the use of any internal model (in whole or in part) or of the determination of the approach under section 9(a)(2)(ii) of this appendix for a bank's modeled correlation trading positions and determine an appropriate capital requirement for the covered positions to which the model would apply, if the OCC determines that the model no longer complies with this appendix or fails to reflect accurately the risks of the bank's covered positions.
(4) The bank must periodically, but no less frequently than annually, review its internal models in light of developments in financial markets and modeling technologies, and enhance those models as appropriate to ensure that they continue to meet the OCC's standards for model approval and employ risk measurement methodologies that are most appropriate for the bank's covered positions.
(5) The bank must incorporate its internal models into its risk management process and integrate the internal models used for calculating its VaR-based measure into its daily risk management process.
(6) The level of sophistication of a bank's internal models must be commensurate with the complexity and amount of its covered positions. A bank's internal models may use any of the generally accepted approaches, including but not limited to variance-covariance models, historical simulations, or Monte Carlo simulations, to measure market risk.
(7) The bank's internal models must properly measure all the material risks in the covered positions to which they are applied.
(8) The bank's internal models must conservatively assess the risks arising from less liquid positions and positions with limited price transparency under realistic market scenarios.
(9) The bank must have a rigorous and well-defined process for re-estimating, re-evaluating, and updating its internal models to ensure continued applicability and relevance.
(10) If a bank uses internal models to measure specific risk, the internal models must also satisfy the requirements in paragraph (b)(1) of section 7 of this appendix.
(d) Control, oversight, and validation mechanisms. (1) The bank must have a risk control unit that reports directly to senior management and is independent from the business trading units.
(1) The bank must have a risk control unit that reports directly to senior management and is independent from the business trading units.
(2) The bank must validate its internal models initially and on an ongoing basis. The bank's validation process must be independent of the internal models' development, implementation, and operation, or the validation process must be subjected to an independent review of its adequacy and effectiveness. Validation must include:
(i) An evaluation of the conceptual soundness of (including developmental evidence supporting) the internal models;
(ii) An ongoing monitoring process that includes verification of processes and the comparison of the bank's model outputs with relevant internal and external data sources or estimation techniques; and
(iii) An outcomes analysis process that includes backtesting. For internal models used to calculate the VaR-based measure, this process must include a comparison of the changes in the bank's portfolio value that would have occurred were end-of-day positions to remain unchanged (therefore, excluding fees, commissions, reserves, net interest income, and intraday trading) with VaR-based measures during a sample period not used in model development.
(3) The bank must stress test the market risk of its covered positions at a frequency appropriate to each portfolio, and in no case less frequently than quarterly. The stress tests must take into account concentration risk (including but not limited to concentrations in single issuers, industries, sectors, or markets), illiquidity under stressed market conditions, and risks arising from the bank's trading activities that may not be adequately captured in its internal models.
(4) The bank must have an internal audit function independent of business-line management that at least annually assesses the effectiveness of the controls supporting the bank's market risk measurement systems, including the activities of the business trading units and independent risk control unit, compliance with policies and procedures, and calculation of the bank's measures for market risk under this appendix. At least annually, the internal audit function must report its findings to the bank's board of directors (or a committee thereof).
(e) Internal assessment of capital adequacy. The bank must have a rigorous process for assessing its overall capital adequacy in relation to its market risk. The assessment must take into account risks that may not be captured fully in the VaR-based measure, including concentration and liquidity risk under stressed market conditions.
(f) Documentation. The bank must adequately document all material aspects of its internal models, management and valuation of covered positions, control, oversight, validation and review processes and results, and internal assessment of capital adequacy.
Section 4. Adjustments to the Risk-Based Capital Ratio Calculations
(a) Risk-based capital ratio denominators. A bank must calculate its general risk-based capital ratio denominator by following the steps described in paragraphs (a)(1) through (a)(4) of this section. A bank subject to appendix C to this part must use its general risk-based capital ratio denominator for purposes of determining its total risk-based capital ratio and its tier 1 risk-based capital ratio under section 3(a)(2)(ii) and section 3(a)(3)(ii), respectively, of appendix C to this part, provided that the bank may not use the supervisory formula approach (SFA) in section 10(b)(2)(vii)(B) of this appendix for purposes of this calculation. A bank subject to appendix C to this part also must calculate an advanced risk-based capital ratio denominator by following the steps in paragraphs (a)(1) through (a)(4) of this section for purposes of determining its total risk-based capital ratio and its tier 1 risk-based capital ratio under sections 3(a)(2)(i) and section 3(a)(3)(i), respectively, of appendix C to this part.
(1) Adjusted risk-weighted assets. (i) The bank must calculate:
(i) The bank must calculate:
(A) General adjusted risk-weighted assets, which equals risk-weighted assets as determined in accordance with appendix A to this part with the adjustments in paragraphs (a)(1)(ii) and, if applicable, (a)(1)(iii) of this section; and
(B) For a bank subject to appendix C to this part, advanced adjusted risk-weighted assets, which equal risk-weighted assets as determined in accordance with appendix C to this part with the adjustments in paragraph (a)(1)(ii) of this section.
(ii) For purposes of calculating its general and advanced adjusted risk-weighted assets under paragraphs (a)(1)(i)(A) and (a)(1)(i)(B) of this section, respectively, the bank must exclude the risk-weighted asset amounts of all covered positions (except foreign exchange positions that are not trading positions and over-the-counter derivative positions).
(iii) For purposes of calculating its general adjusted risk-weighted assets under paragraph (a)(1)(i)(A) of this section, a bank may exclude receivables that arise from the posting of cash collateral and are associated with qualifying securities borrowing transactions to the extent the receivable is collateralized by the market value of the borrowed securities.
(2) Measure for market risk. The bank must calculate the general measure for market risk (except, as provided in paragraph (a) of this section, that the bank may not use the SFA in section 10(b)(2)(vii)(B) of this appendix for purposes of this calculation), which equals the sum of the VaR-based capital requirement, stressed VaR-based capital requirement, specific risk add-ons, incremental risk capital requirement, comprehensive risk capital requirement, and capital requirement for de minimis exposures all as defined under this paragraph (a)(2). A bank subject to appendix C to this part also must calculate the advanced measure for market risk, which equals the sum of the VaR-based capital requirement, stressed VaR-based capital requirement, specific risk add-ons, incremental risk capital requirement, comprehensive risk capital requirement, and capital requirement for de minimis exposures as defined under this paragraph (a)(2).
(i) VaR-based capital requirement. A bank's VaR-based capital requirement equals the greater of:
(A) The previous day's VaR-based measure as calculated under section 5 of this appendix; or
(B) The average of the daily VaR-based measures as calculated under section 5 of this appendix for each of the preceding 60 business days multiplied by three, except as provided in paragraph (b) of this section.
(ii) Stressed VaR-based capital requirement. A bank's stressed VaR-based capital requirement equals the greater of:
(A) The most recent stressed VaR-based measure as calculated under section 6 of this appendix; or
(B) The average of the stressed VaR-based measures as calculated under section 6 of this appendix for each of the preceding 12 weeks multiplied by three, except as provided in paragraph (b) of this section.
(iii) Specific risk add-ons. A bank's specific risk add-ons equal any specific risk add-ons that are required under section 7 of this appendix and are calculated in accordance with section 10 of this appendix.
(iv) Incremental risk capital requirement. A bank's incremental risk capital requirement equals any incremental risk capital requirement as calculated under section 8 of this appendix.
(v) Comprehensive risk capital requirement. A bank's comprehensive risk capital requirement equals any comprehensive risk capital requirement as calculated under section 9 of this appendix.
(vi) Capital requirement for de minimis exposures. A bank's capital requirement for de minimis exposures equals:
(A) The absolute value of the market value of those de minimis exposures that are not captured in the bank's VaR-based measure or under paragraph (a)(2)(vi)(B) of this section; and
(B) With the prior written approval of the OCC, the capital requirement for any de minimis exposures using alternative techniques that appropriately measure the market risk associated with those exposures.
(3) Market risk equivalent assets. The bank must calculate general market risk equivalent assets as the general measure for market risk (as calculated in paragraph (a)(2) of this section) multiplied by 12.5. A bank subject to appendix C to this part also must calculate advanced market risk equivalent assets as the advanced measure for market risk (as calculated in paragraph (a)(2) of this section) multiplied by 12.5.
(4) Denominator calculation. (i) The bank must add general market risk equivalent assets (as calculated in paragraph (a)(3) of this section) to general adjusted risk-weighted assets (as calculated in paragraph (a)(1)(i) of this section). The resulting sum is the bank's general risk-based capital ratio denominator.
(i) The bank must add general market risk equivalent assets (as calculated in paragraph (a)(3) of this section) to general adjusted risk-weighted assets (as calculated in paragraph (a)(1)(i) of this section). The resulting sum is the bank's general risk-based capital ratio denominator.
(ii) A bank subject to appendix C to this part must add advanced market risk equivalent assets (as calculated in paragraph (a)(3) of this section) to advanced adjusted risk-weighted assets (as calculated in paragraph (a)(1)(i) of this section). The resulting sum is the bank's advanced risk-based capital ratio denominator.
(b) Backtesting. A bank must compare each of its most recent 250 business days' trading losses (excluding fees, commissions, reserves, net interest income, and intraday trading) with the corresponding daily VaR-based measures calibrated to a one-day holding period and at a one-tail, 99.0 percent confidence level. A bank must begin backtesting as required by this paragraph no later than one year after the later of January 1, 2013, and the date on which the bank becomes subject to this appendix. In the interim, consistent with safety and soundness principles, a bank subject to this appendix as of its effective date should continue to follow backtesting procedures in accordance with the OCC's supervisory expectations.
(1) Once each quarter, the bank must identify the number of exceptions (that is, the number of business days for which the actual daily net trading loss, if any, exceeds the corresponding daily VaR-based measure) that have occurred over the preceding 250 business days.
(2) A bank must use the multiplication factor in table 1 of this appendix that corresponds to the number of exceptions identified in paragraph (b)(1) of this section to determine its VaR-based capital requirement for market risk under paragraph (a)(2)(i) of this section and to determine its stressed VaR-based capital requirement for market risk under paragraph (a)(2)(ii) of this section until it obtains the next quarter's backtesting results, unless the OCC notifies the bank in writing that a different adjustment or other action is appropriate.
Table 1--Multiplication Factors Based on Results of Backtesting------------------------------------------------------------------------
Multiplication
Number of exceptions factor------------------------------------------------------------------------4 or fewer............................................ 3.005..................................................... 3.406..................................................... 3.507..................................................... 3.658..................................................... 3.759..................................................... 3.8510 or more............................................ 4.00------------------------------------------------------------------------
Section 5. VaR-Based Measure
(a) General requirement. A bank must use one or more internal models to calculate daily a VaR-based measure of the general market risk of all covered positions. The daily VaR-based measure also may reflect the bank's specific risk for one or more portfolios of debt and equity positions, if the internal models meet the requirements of paragraph (b)(1) of section 7 of this appendix. The daily VaR-based measure must also reflect the bank's specific risk for any portfolio of correlation trading positions that is modeled under section 9 of this appendix. A bank may elect to include term repo-style transactions in its VaR-based measure, provided that the bank includes all such term repo-style transactions consistently over time.
(1) The bank's internal models for calculating its VaR-based measure must use risk factors sufficient to measure the market risk inherent in all covered positions. The market risk categories must include, as appropriate, interest rate risk, credit spread risk, equity price risk, foreign exchange risk, and commodity price risk. For material positions in the major currencies and markets, modeling techniques must incorporate enough segments of the yield curve--in no case less than six--to capture differences in volatility and less than perfect correlation of rates along the yield curve.
(2) The VaR-based measure may incorporate empirical correlations within and across risk categories, provided the bank validates and demonstrates the reasonableness of its process for measuring correlations. If the VaR-based measure does not incorporate empirical correlations across risk categories, the bank must add the separate measures from its internal models used to calculate the VaR-based measure for the appropriate market risk categories (interest rate risk, credit spread risk, equity price risk, foreign exchange rate risk, and/or commodity price risk) to determine its aggregate VaR-based measure.
(3) The VaR-based measure must include the risks arising from the nonlinear price characteristics of options positions or positions with embedded optionality and the sensitivity of the market value of the positions to changes in the volatility of the underlying rates, prices, or other material risk factors. A bank with a large or complex options portfolio must measure the volatility of options positions or positions with embedded optionality by different maturities and/or strike prices, where material.
(4) The bank must be able to justify to the satisfaction of the OCC the omission of any risk factors from the calculation of its VaR-based measure that the bank uses in its pricing models.
(5) The bank must demonstrate to the satisfaction of the OCC the appropriateness of any proxies used to capture the risks of the bank's actual positions for which such proxies are used.
(b) Quantitative requirements for VaR-based measure. (1) The VaR-based measure must be calculated on a daily basis using a one-tail, 99.0 percent confidence level, and a holding period equivalent to a 10-business-day movement in underlying risk factors, such as rates, spreads, and prices. To calculate VaR-based measures using a 10-business-day holding period, the bank may calculate 10-business-day measures directly or may convert VaR-based measures using holding periods other than 10 business days to the equivalent of a 10-business-day holding period. A bank that converts its VaR-based measure in such a manner must be able to justify the reasonableness of its approach to the satisfaction of the OCC.
(1) The VaR-based measure must be calculated on a daily basis using a one-tail, 99.0 percent confidence level, and a holding period equivalent to a 10-business-day movement in underlying risk factors, such as rates, spreads, and prices. To calculate VaR-based measures using a 10-business-day holding period, the bank may calculate 10-business-day measures directly or may convert VaR-based measures using holding periods other than 10 business days to the equivalent of a 10-business-day holding period. A bank that converts its VaR-based measure in such a manner must be able to justify the reasonableness of its approach to the satisfaction of the OCC.
(2) The VaR-based measure must be based on a historical observation period of at least one year. Data used to determine the VaR-based measure must be relevant to the bank's actual exposures and of sufficient quality to support the calculation of risk-based capital requirements. The bank must update data sets at least monthly or more frequently as changes in market conditions or portfolio composition warrant. For a bank that uses a weighting scheme or other method for the historical observation period, the bank must either:
(i) Use an effective observation period of at least one year in which the average time lag of the observations is at least six months; or
(ii) Demonstrate to the OCC that its weighting scheme is more effective than a weighting scheme with an average time lag of at least six months representing the volatility of the bank's trading portfolio over a full business cycle. A bank using this option must update its data more frequently than monthly and in a manner appropriate for the type of weighting scheme.
(c) A bank must divide its portfolio into a number of significant subportfolios approved by the OCC for subportfolio backtesting purposes. These subportfolios must be sufficient to allow the bank and the OCC to assess the adequacy of the VaR model at the risk factor level; the OCC will evaluate the appropriateness of these subportfolios relative to the value and composition of the bank's covered positions. The bank must retain and make available to the OCC the following information for each subportfolio for each business day over the previous two years (500 business days), with no more than a 60-day lag:
(1) A daily VaR-based measure for the subportfolio calibrated to a one-tail, 99.0 percent confidence level;
(2) The daily profit or loss for the subportfolio (that is, the net change in price of the positions held in the portfolio at the end of the previous business day); and
(3) The p-value of the profit or loss on each day (that is, the probability of observing a profit that is less than, or a loss that is greater than, the amount reported for purposes of paragraph (c)(2) of this section based on the model used to calculate the VaR-based measure described in paragraph (c)(1) of this section).
Section 6. Stressed VaR-Based Measure
(a) General requirement. At least weekly, a bank must use the same internal model(s) used to calculate its VaR-based measure to calculate a stressed VaR-based measure.
(b) Quantitative requirements for stressed VaR-based measure. (1) A bank must calculate a stressed VaR-based measure for its covered positions using the same model(s) used to calculate the VaR-based measure, subject to the same confidence level and holding period applicable to the VaR-based measure under section 5 of this appendix, but with model inputs calibrated to historical data from a continuous 12-month period that reflects a period of significant financial stress appropriate to the bank's current portfolio.
(1) A bank must calculate a stressed VaR-based measure for its covered positions using the same model(s) used to calculate the VaR-based measure, subject to the same confidence level and holding period applicable to the VaR-based measure under section 5 of this appendix, but with model inputs calibrated to historical data from a continuous 12-month period that reflects a period of significant financial stress appropriate to the bank's current portfolio.
(2) The stressed VaR-based measure must be calculated at least weekly and be no less than the bank's VaR-based measure.
(3) A bank must have policies and procedures that describe how it determines the period of significant financial stress used to calculate the bank's stressed VaR-based measure under this section and must be able to provide empirical support for the period used. The bank must obtain the prior approval of the OCC for, and notify the OCC if the bank makes any material changes to, these policies and procedures. The policies and procedures must address:
(i) How the bank links the period of significant financial stress used to calculate the stressed VaR-based measure to the composition and directional bias of its current portfolio; and
(ii) The bank's process for selecting, reviewing, and updating the period of significant financial stress used to calculate the stressed VaR-based measure and for monitoring the appropriateness of the period to the bank's current portfolio.
(4) Nothing in this section prevents the OCC from requiring a bank to use a different period of significant financial stress in the calculation of the stressed VaR-based measure.
Section 7. Specific Risk
(a) General requirement. A bank must use one of the methods in this section to measure the specific risk for each of its debt, equity, and securitization positions with specific risk.
(b) Modeled specific risk. A bank may use models to measure the specific risk of covered positions as provided in paragraph (a) of section 5 of this appendix (therefore, excluding securitization positions that are not modeled under section 9 of this appendix). A bank must use models to measure the specific risk of correlation trading positions that are modeled under section 9 of this appendix.
(1) Requirements for specific risk modeling. (i) If a bank uses internal models to measure the specific risk of a portfolio, the internal models must:
(i) If a bank uses internal models to measure the specific risk of a portfolio, the internal models must:
(A) Explain the historical price variation in the portfolio;
(B) Be responsive to changes in market conditions;
(C) Be robust to an adverse environment, including signaling rising risk in an adverse environment; and
(D) Capture all material components of specific risk for the debt and equity positions in the portfolio. Specifically, the internal models must:
(1) Capture event risk and idiosyncratic risk;
(2) Capture and demonstrate sensitivity to material differences between positions that are similar but not identical and to changes in portfolio composition and concentrations.
(ii) If a bank calculates an incremental risk measure for a portfolio of debt or equity positions under section 8 of this appendix, the bank is not required to capture default and credit migration risks in its internal models used to measure the specific risk of those portfolios.
(2) Specific risk fully modeled for one or more portfolios. If the bank's VaR-based measure captures all material aspects of specific risk for one or more of its portfolios of debt, equity, or correlation trading positions, the bank has no specific risk add-on for those portfolios for purposes of paragraph (a)(2)(iii) of section 4 of this appendix.
(c) Specific risk not modeled.
(1) If the bank's VaR-based measure does not capture all material aspects of specific risk for a portfolio of debt, equity, or correlation trading positions, the bank must calculate a specific-risk add-on for the portfolio under the standardized measurement method as described in section 10 of this appendix.
(2) A bank must calculate a specific risk add-on under the standardized measurement method as described in section 10 of this appendix for all of its securitization positions that are not modeled under section 9 of this appendix.
Section 8. Incremental Risk
(a) General requirement. A bank that measures the specific risk of a portfolio of debt positions under section 7(b) of this appendix using internal models must calculate at least weekly an incremental risk measure for that portfolio according to the requirements in this section. The incremental risk measure is the bank's measure of potential losses due to incremental risk over a one-year time horizon at a one-tail, 99.9 percent confidence level, either under the assumption of a constant level of risk, or under the assumption of constant positions. With the prior approval of the OCC, a bank may choose to include portfolios of equity positions in its incremental risk model, provided that it consistently includes such equity positions in a manner that is consistent with how the bank internally measures and manages the incremental risk of such positions at the portfolio level. If equity positions are included in the model, for modeling purposes default is considered to have occurred upon the default of any debt of the issuer of the equity position. A bank may not include correlation trading positions or securitization positions in its incremental risk measure.
(b) Requirements for incremental risk modeling. For purposes of calculating the incremental risk measure, the incremental risk model must:
(1) Measure incremental risk over a one-year time horizon and at a one-tail, 99.9 percent confidence level, either under the assumption of a constant level of risk, or under the assumption of constant positions.
(i) A constant level of risk assumption means that the bank rebalances, or rolls over, its trading positions at the beginning of each liquidity horizon over the one-year horizon in a manner that maintains the bank's initial risk level. The bank must determine the frequency of rebalancing in a manner consistent with the liquidity horizons of the positions in the portfolio. The liquidity horizon of a position or set of positions is the time required for a bank to reduce its exposure to, or hedge all of its material risks of, the position(s) in a stressed market. The liquidity horizon for a position or set of positions may not be less than the shorter of three months or the contractual maturity of the position.
(ii) A constant position assumption means that the bank maintains the same set of positions throughout the one-year horizon. If a bank uses this assumption, it must do so consistently across all portfolios.
(iii) A bank's selection of a constant position or a constant risk assumption must be consistent between the bank's incremental risk model and its comprehensive risk model described in section 9 of this appendix, if applicable.
(iv) A bank's treatment of liquidity horizons must be consistent between the bank's incremental risk model and its comprehensive risk model described in section 9 of this appendix, if applicable.
(2) Recognize the impact of correlations between default and migration events among obligors.
(3) Reflect the effect of issuer and market concentrations, as well as concentrations that can arise within and across product classes during stressed conditions.
(4) Reflect netting only of long and short positions that reference the same financial instrument.
(5) Reflect any material mismatch between a position and its hedge.
(6) Recognize the effect that liquidity horizons have on dynamic hedging strategies. In such cases, a bank must:
(i) Choose to model the rebalancing of the hedge consistently over the relevant set of trading positions;
(ii) Demonstrate that the inclusion of rebalancing results in a more appropriate risk measurement;
(iii) Demonstrate that the market for the hedge is sufficiently liquid to permit rebalancing during periods of stress; and
(iv) Capture in the incremental risk model any residual risks arising from such hedging strategies.
(7) Reflect the nonlinear impact of options and other positions with material nonlinear behavior with respect to default and migration changes.
(8) Maintain consistency with the bank's internal risk management methodologies for identifying, measuring, and managing risk.
(c) Calculation of incremental risk capital requirement. The incremental risk capital requirement is the greater of:
(1) The average of the incremental risk measures over the previous 12 weeks; or
(2) The most recent incremental risk measure.
Section 9. Comprehensive Risk
(a) General requirement. (1) Subject to the prior approval of the OCC, a bank may use the method in this section to measure comprehensive risk, that is, all price risk, for one or more portfolios of correlation trading positions.
(1) Subject to the prior approval of the OCC, a bank may use the method in this section to measure comprehensive risk, that is, all price risk, for one or more portfolios of correlation trading positions.
(2) A bank that measures the price risk of a portfolio of correlation trading positions using internal models must calculate at least weekly a comprehensive risk measure that captures all price risk according to the requirements of this section. The comprehensive risk measure is either:
(i) The sum of:
(A) The bank's modeled measure of all price risk determined according to the requirements in paragraph (b) of this section; and
(B) A surcharge for the bank's modeled correlation trading positions equal to the total specific risk add-on for such positions as calculated under section 10 of this appendix multiplied by 8.0 percent; or
(ii) With approval of the OCC and provided the bank has met the requirements of this section for a period of at least one year and can demonstrate the effectiveness of the model through the results of ongoing model validation efforts including robust benchmarking, the greater of:
(A) The bank's modeled measure of all price risk determined according to the requirements in paragraph (b) of this section; or
(B) The total specific risk add-on that would apply to the bank's modeled correlation trading positions as calculated under section 10 of this appendix multiplied by 8.0 percent.
(b) Requirements for modeling all price risk. If a bank uses an internal model to measure the price risk of a portfolio of correlation trading positions:
(1) The internal model must measure comprehensive risk over a one-year time horizon at a one-tail, 99.9 percent confidence level, either under the assumption of a constant level of risk, or under the assumption of constant positions.
(2) The model must capture all material price risk, including but not limited to the following:
(i) The risks associated with the contractual structure of cash flows of the position, its issuer, and its underlying exposures;
(ii) Credit spread risk, including nonlinear price risks;
(iii) The volatility of implied correlations, including nonlinear price risks such as the cross-effect between spreads and correlations;
(iv) Basis risk;
(v) Recovery rate volatility as it relates to the propensity for recovery rates to affect tranche prices; and
(vi) To the extent the comprehensive risk measure incorporates the benefits of dynamic hedging, the static nature of the hedge over the liquidity horizon must be recognized. In such cases, a bank must:
(A) Choose to model the rebalancing of the hedge consistently over the relevant set of trading positions;
(B) Demonstrate that the inclusion of rebalancing results in a more appropriate risk measurement;
(C) Demonstrate that the market for the hedge is sufficiently liquid to permit rebalancing during periods of stress; and
(D) Capture in the comprehensive risk model any residual risks arising from such hedging strategies;
(3) The bank must use market data that are relevant in representing the risk profile of the bank's correlation trading positions in order to ensure that the bank fully captures the material risks of the correlation trading positions in its comprehensive risk measure in accordance with this section; and
(4) The bank must be able to demonstrate that its model is an appropriate representation of comprehensive risk in light of the historical price variation of its correlation trading positions.
(c) Requirements for stress testing.
(1) A bank must at least weekly apply specific, supervisory stress scenarios to its portfolio of correlation trading positions that capture changes in:
(i) Default rates;
(ii) Recovery rates;
(iii) Credit spreads;
(iv) Correlations of underlying exposures; and
(v) Correlations of a correlation trading position and its hedge.
(2) Other requirements. (i) A bank must retain and make available to the OCC the results of the supervisory stress testing, including comparisons with the capital requirements generated by the bank's comprehensive risk model.
(i) A bank must retain and make available to the OCC the results of the supervisory stress testing, including comparisons with the capital requirements generated by the bank's comprehensive risk model.
(ii) A bank must report to the OCC promptly any instances where the stress tests indicate any material deficiencies in the comprehensive risk model.
(d) Calculation of comprehensive risk capital requirement. The comprehensive risk capital requirement is the greater of:
(1) The average of the comprehensive risk measures over the previous 12 weeks; or
(2) The most recent comprehensive risk measure.
Section 10. Standardized Measurement Method for Specific Risk
(a) General requirement. A bank must calculate a total specific risk add-on for each portfolio of debt and equity positions for which the bank's VaR-based measure does not capture all material aspects of specific risk and for all securitization positions that are not modeled under section 9 of this appendix. A bank must calculate each specific risk add-on in accordance with the requirements of this section. Notwithstanding any other definition or requirement in this appendix, a position that would have qualified as a debt position or an equity position but for the fact that it qualifies as a correlation trading position under paragraph (2) of the definition of correlation trading position, shall be considered a debt position or an equity position, respectively, for purposes of this section 10.
(1) The specific risk add-on for an individual debt or securitization position that represents sold credit protection is capped at the notional amount of the credit derivative contract. The specific risk add-on for an individual debt or securitization position that represents purchased credit protection is capped at the current market value of the transaction plus the absolute value of the present value of all remaining payments to the protection seller under the transaction. This sum is equal to the value of the protection leg of the transaction.
(2) For debt, equity, or securitization positions that are derivatives with linear payoffs, a bank must assign a specific risk-weighting factor to the market value of the effective notional amount of the underlying instrument or index portfolio, except for a securitization position for which the bank directly calculates a specific risk add-on using the SFA in paragraph (b)(2)(vii)(B) of this section. A swap must be included as an effective notional position in the underlying instrument or portfolio, with the receiving side treated as a long position and the paying side treated as a short position. For debt, equity, or securitization positions that are derivatives with nonlinear payoffs, a bank must risk weight the market value of the effective notional amount of the underlying instrument or portfolio multiplied by the derivative's delta.
(3) For debt, equity, or securitization positions, a bank may net long and short positions (including derivatives) in identical issues or identical indices. A bank may also net positions in depositary receipts against an opposite position in an identical equity in different markets, provided that the bank includes the costs of conversion.
(4) A set of transactions consisting of either a debt position and its credit derivative hedge or a securitization position and its credit derivative hedge has a specific risk add-on of zero if:
(i) The debt or securitization position is fully hedged by a total return swap (or similar instrument where there is a matching of swap payments and changes in market value of the debt or securitization position);
(ii) There is an exact match between the reference obligation of the swap and the debt or securitization position;
(iii) There is an exact match between the currency of the swap and the debt or securitization position; and
(iv) There is either an exact match between the maturity date of the swap and the maturity date of the debt or securitization position; or, in cases where a total return swap references a portfolio of positions with different maturity dates, the total return swap maturity date must match the maturity date of the underlying asset in that portfolio that has the latest maturity date.
(5) The specific risk add-on for a set of transactions consisting of either a debt position and its credit derivative hedge or a securitization position and its credit derivative hedge that does not meet the criteria of paragraph (a)(4) of this section is equal to 20.0 percent of the capital requirement for the side of the transaction with the higher specific risk add-on when:
(i) The credit risk of the position is fully hedged by a credit default swap or similar instrument;
(ii) There is an exact match between the reference obligation of the credit derivative hedge and the debt or securitization position;
(iii) There is an exact match between the currency of the credit derivative hedge and the debt or securitization position; and
(iv) There is either an exact match between the maturity date of the credit derivative hedge and the maturity date of the debt or securitization position; or, in the case where the credit derivative hedge has a standard maturity date:
(A) The maturity date of the credit derivative hedge is within 30 business days of the maturity date of the debt or securitization position; or
(B) For purchased credit protection, the maturity date of the credit derivative hedge is later than the maturity date of the debt or securitization position, but is no later than the standard maturity date for that instrument that immediately follows the maturity date of the debt or securitization position. The maturity date of the credit derivative hedge may not exceed the maturity date of the debt or securitization position by more than 90 calendar days.
(6) The specific risk add-on for a set of transactions consisting of either a debt position and its credit derivative hedge or a securitization position and its credit derivative hedge that does not meet the criteria of either paragraph (a)(4) or (a)(5) of this section, but in which all or substantially all of the price risk has been hedged, is equal to the specific risk add-on for the side of the transaction with the higher specific risk add-on.
(b) Debt and securitization positions. (1) The total specific risk add-on for a portfolio of debt or securitization positions is the sum of the specific risk add-ons for individual debt or securitization positions, as computed under this section. To determine the specific risk add-on for individual debt or securitization positions, a bank must multiply the absolute value of the current market value of each net long or net short debt or securitization position in the portfolio by the appropriate specific risk-weighting factor as set forth in paragraphs (b)(2)(i) through (b)(2)(vii) of this section.
(1) The total specific risk add-on for a portfolio of debt or securitization positions is the sum of the specific risk add-ons for individual debt or securitization positions, as computed under this section. To determine the specific risk add-on for individual debt or securitization positions, a bank must multiply the absolute value of the current market value of each net long or net short debt or securitization position in the portfolio by the appropriate specific risk-weighting factor as set forth in paragraphs (b)(2)(i) through (b)(2)(vii) of this section.
(2) For the purpose of this section, the appropriate specific risk-weighting factors include:
(i) Sovereign debt positions. (A) In general. A bank must assign a specific risk-weighting factor to a sovereign debt position based on the CRC applicable to the sovereign entity and, as applicable, the remaining contractual maturity of the position, in accordance with table 2. Sovereign debt positions that are backed by the full faith and credit of the United States are treated as having a CRC of 0.
Table 2--Specific Risk-Weighting Factors for Sovereign Debt Positions----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Specific risk-weighting factor Percent----------------------------------------------------------------------------------------------------------------
0-1 0.0
----------------------------------------------------------------
Remaining contractual maturity of 0.25
6 months or less.
--------------------------------------------------CRC of Sovereign............................... 2-3 Remaining contractual maturity of 1.0
greater than 6 and up to and
including 24 months.
--------------------------------------------------
Remaining contractual maturity 1.6
exceeds 24 months.
----------------------------------------------------------------
4-6 8.0
----------------------------------------------------------------
7 12.0----------------------------------------------------------------------------------------------------------------No CRC....................................................... 8.0----------------------------------------------------------------------------------------------------------------Default by the Sovereign Entity.............................. 12.0----------------------------------------------------------------------------------------------------------------
(B) Notwithstanding paragraph (b)(2)(i)(A) of this section, a bank may assign to a sovereign debt position a specific risk-weighting factor that is lower than the applicable specific risk-weighting factor in table 2 if:
(1) The position is denominated in the sovereign entity's currency;
(2) The bank has at least an equivalent amount of liabilities in that currency; and
(3) The sovereign entity allows banks under its jurisdiction to assign the lower specific risk-weighting factor to the same exposures to the sovereign entity.
(C) A bank must assign a 12.0 percent specific risk-weighting factor to a sovereign debt position immediately upon determination that a default has occurred; or if a default has occurred within the previous five years.
(D) A bank must assign an 8.0 percent specific risk-weighting factor to a sovereign debt position if the sovereign entity does not have a CRC assigned to it, unless the sovereign debt position must be assigned a higher specific risk-weighting factor under paragraph (b)(2)(i)(C) of this section.
(ii) Certain supranational entity and multilateral development bank debt positions. A bank may assign a 0.0 percent specific risk-weighting factor to a debt position that is an exposure to the Bank for International Settlements, the European Central Bank, the European Commission, the International Monetary Fund, or an MDB.
(iii) GSE debt positions. A bank must assign a 1.6 percent specific risk-weighting factor to a debt position that is an exposure to a GSE. Notwithstanding the foregoing, a bank must assign an 8.0 percent specific risk-weighting factor to preferred stock issued by a GSE.
(iv) Depository institution, foreign bank, and credit union debt positions. (A) Except as provided in paragraph (b)(2)(iv)(B) of this section, a bank must assign a specific risk-weighting factor to a debt position that is an exposure to a depository institution, a foreign bank, or a credit union using the specific risk-weighting factor that corresponds to that entity's sovereign of incorporation and, as applicable, the remaining contractual maturity of the position, in accordance with table 3.
Table 3--Specific Risk-Weighting Factors for Depository Institution, Foreign Bank, and Credit Union Debt
Positions----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Specific risk-weighting factor Percent----------------------------------------------------------------------------------------------------------------
Remaining contractual maturity of 0.25
6 months or less.
--------------------------------------------------CRC of Sovereign............................... 0-2 Remaining contractual maturity of 1.0
greater than 6 and up to and
including 24 months.
--------------------------------------------------
Remaining contractual maturity 1.6
exceeds 24 months.
----------------------------------------------------------------
3 8.0
----------------------------------------------------------------
4-7 12.0----------------------------------------------------------------------------------------------------------------No CRC....................................................... 8.0----------------------------------------------------------------------------------------------------------------Default by the Sovereign Entity.............................. 12.0----------------------------------------------------------------------------------------------------------------
(B) A bank must assign a specific risk-weighting factor of 8.0 percent to a debt position that is an exposure to a depository institution or a foreign bank that is includable in the depository institution's or foreign bank's regulatory capital and that is not subject to deduction as a reciprocal holding under the appendix A to this part.
(C) A bank must assign a 12.0 percent specific risk-weighting factor to a debt position that is an exposure to a foreign bank immediately upon determination that a default by the foreign bank's sovereign of incorporation has occurred or if a default by the foreign bank's sovereign of incorporation has occurred within the previous five years.
(v) PSE debt positions. (A) Except as provided in paragraph (b)(2)(v)(B) of this section, a bank must assign a specific risk-weighting factor to a debt position that is an exposure to a PSE based on the specific risk-weighting factor that corresponds to the PSE's sovereign of incorporation and to the position's categorization as a general obligation or revenue obligation and, as applicable, the remaining contractual maturity of the position, as set forth in tables 4 and 5.
(A) Except as provided in paragraph (b)(2)(v)(B) of this section, a bank must assign a specific risk-weighting factor to a debt position that is an exposure to a PSE based on the specific risk-weighting factor that corresponds to the PSE's sovereign of incorporation and to the position's categorization as a general obligation or revenue obligation and, as applicable, the remaining contractual maturity of the position, as set forth in tables 4 and 5.
(B) A bank may assign a lower specific risk-weighting factor than would otherwise apply under tables 4 and 5 to a debt position that is an exposure to a foreign PSE if:
(1) The PSE's sovereign of incorporation allows banks under its jurisdiction to assign a lower specific risk-weighting factor to such position; and
(2) The specific risk-weighting factor is not lower than the risk weight that corresponds to the PSE's sovereign of incorporation in accordance with tables 4 and 5.
(C) A bank must assign a 12.0 percent specific risk-weighting factor to a PSE debt position immediately upon determination that a default by the PSE's sovereign of incorporation has occurred or if a default by the PSE's sovereign of incorporation has occurred within the previous five years.
Table 4--Specific Risk-Weighting Factors for PSE General Obligation Debt Positions----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
General obligation specific risk- Percent
weighting factor (in percent)----------------------------------------------------------------------------------------------------------------
Remaining contractual maturity of 0.25
6 months or less.
--------------------------------------------------CRC of Sovereign............................... 0-2 Remaining contractual maturity of 1.0
greater than 6 and up to and
including 24 months.
--------------------------------------------------
Remaining contractual maturity 1.6
exceeds 24 months.
----------------------------------------------------------------
3 8.0
----------------------------------------------------------------
4-7 12.0----------------------------------------------------------------------------------------------------------------No CRC....................................................... 8.0----------------------------------------------------------------------------------------------------------------Default by the Sovereign Entity.............................. 12.0----------------------------------------------------------------------------------------------------------------
Table 5--Specific Risk-Weighting Factors for PSE Revenue Obligation Debt Positions----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Revenue obligation specific risk- Percent
weighting factor----------------------------------------------------------------------------------------------------------------
Remaining contractual maturity of 0.25
6 months or less.
--------------------------------------------------
CRC of Sovereign............................... 0-1 Remaining contractual maturity of 1.0
greater than 6 and up to and
including 24 months.
--------------------------------------------------
Remaining contractual maturity 1.6
exceeds 24 months.
----------------------------------------------------------------
2-3 8.0
----------------------------------------------------------------
4-7 12.0----------------------------------------------------------------------------------------------------------------No CRC....................................................... 8.0----------------------------------------------------------------------------------------------------------------Default by the Sovereign Entity.............................. 12.0----------------------------------------------------------------------------------------------------------------
(vi) Corporate debt positions. Except as otherwise provided in paragraph (b)(2)(vi)(B), a bank must assign a specific risk-weighting factor to a corporate debt position in accordance with the investment grade methodology in paragraph (b)(2)(vi)(A) of this section.
(A) Investment grade methodology. (1) For corporate debt positions that are exposures to entities that have issued and outstanding publicly traded instruments, a bank must assign a specific risk-weighting factor based on the category and remaining contractual maturity of the position, in accordance with table 6. For purposes of this paragraph (A), the bank must determine whether the position is in the investment grade or not investment grade category.
Table 6--Specific Risk-Weighting Factors for Corporate Debt Positions
Under the Investment Grade Methodology------------------------------------------------------------------------
Specific risk-
Remaining contractual weighting
Category maturity factor (in
percent)------------------------------------------------------------------------Investment Grade............... 6 months or less....... 0.50
Greater than 6 and up 2.00
to and including 24
months.
Greater than 24 months. 4.00Not-investment Grade........... ....................... 12.00------------------------------------------------------------------------
(2) A bank must assign an 8.0 percent specific risk-weighting factor for corporate debt positions that are exposures to entities that do not have publicly traded instruments outstanding.
(B) Limitations. (1) A bank must assign a specific risk-weighting factor of at least 8.0 percent to an interest-only mortgage-backed security that is not a securitization position.
(2) A bank shall not assign a corporate debt position a specific risk-weighting factor that is lower than the specific risk-weighting factor that corresponds to the CRC of the issuer's sovereign of incorporation in table 1.
(vii) Securitization positions. (A) General requirements. (1) A bank that does not use the appendix C to this part must assign a specific risk-weighting factor to a securitization position using either the simplified supervisory formula approach (SSFA) in accordance with section 11 of this appendix or assign a specific risk-weighting factor of 100 percent to the position.
(2) A bank that uses appendix C to this part must calculate a specific risk add-on for a securitization position using the SFA in section 45 of appendix C to this part and in accordance with paragraph (b)(2)(vii)(B) of this section if the bank and the securitization position each qualifies to use the SFA under appendix C to this part. A bank that uses appendix C to this part and that has a securitization position that does not qualify for the SFA may assign a specific risk-weighting factor to the securitization position using the SSFA in accordance with section 11 of this appendix or assign a specific risk-weighting factor of 100 percent to the position.
(3) A bank must treat a short securitization position as if it is a long securitization position solely for calculation purposes when using the SFA in paragraph (b)(2)(vii)(B) or the SSFA in section 11 of this appendix.
(B) SFA. To calculate the specific risk add-on for a securitization position using the SFA, a bank that is subject to appendix C to this part must set the specific risk add-on for the position equal to the risk-based capital requirement, calculated under section 45 of appendix C to this part.
(C) SSFA. To use the SSFA to determine the specific risk-weighting factor for a securitization position, a bank must calculate the specific risk-weighting factor in accordance with section 11 of this appendix.
(D) Nth-to-default credit derivatives. A bank must determine a specific risk add-on using the SFA in paragraph (b)(2)(vii)(B), or assign a specific risk-weighting factor using the SSFA in section 11 of this appendix to an nth-to-default credit derivative in accordance with this paragraph (D), irrespective of whether the bank is a net protection buyer or net protection seller. A bank must determine its position in the nth-to-default credit derivative as the largest notional dollar amount of all the underlying exposures.
(1) For purposes of determining the specific risk add-on using the SFA in paragraph (b)(2)(vii)(B) or the specific risk-weighting factor for an nth-to-default credit derivative using the SSFA in section 11 of this appendix, the bank must calculate the attachment point and detachment point of its position as follows:
(i) The attachment point (parameter A) is the ratio of the sum of the notional amounts of all underlying exposures that are subordinated to the bank's position to the total notional amount of all underlying exposures. For purposes of using the SFA to calculate the specific add-on for its position in an nth-to-default credit derivative, parameter A must be set equal to the credit enhancement level (L) input to the SFA formula. In the case of a first-to-default credit derivative, there are no underlying exposures that are subordinated to the bank's position. In the case of a second-or-subsequent-to-default credit derivative, the smallest (n-1) notional amounts of the underlying exposure(s) are subordinated to the bank's position.
(ii) The detachment point (parameter D) equals the sum of parameter A plus the ratio of the notional amount of the bank's position in the nth-to-default credit derivative to the total notional amount of all underlying exposures. For purposes of using the SFA to calculate the specific risk add-on for its position in an nth-to-default credit derivative, parameter D must be set to equal L plus the thickness of tranche (T) input to the SFA formula.
(2) A bank that does not use the SFA to determine a specific risk-add on, or the SSFA to determine a specific risk-weighting factor for its position in an nth-to-default credit derivative must assign a specific risk-weighting factor of 100 percent to the position.
(c) Modeled correlation trading positions. For purposes of calculating the comprehensive risk measure for modeled correlation trading positions under either paragraph (a)(2)(i) or (a)(2)(ii) of section 9 of this appendix, the total specific risk add-on is the greater of:
(1) The sum of the bank's specific risk add-ons for each net long correlation trading position calculated under this section; or
(2) The sum of the bank's specific risk add-ons for each net short correlation trading position calculated under this section.
(d) Non-modeled securitization positions. For securitization positions that are not correlation trading positions and for securitizations that are correlation trading positions not modeled under section 9 of this appendix, the total specific risk add-on is the greater of:
(1) The sum of the bank's specific risk add-ons for each net long securitization position calculated under this section; or
(2) The sum of the bank's specific risk add-ons for each net short securitization position calculated under this section.
(e) Equity positions. The total specific risk add-on for a portfolio of equity positions is the sum of the specific risk add-ons of the individual equity positions, as computed under this section. To determine the specific risk add-on of individual equity positions, a bank must multiply the absolute value of the current market value of each net long or net short equity position by the appropriate specific risk-weighting factor as determined under this paragraph:
(1) The bank must multiply the absolute value of the current market value of each net long or net short equity position by a specific risk-weighting factor of 8.0 percent. For equity positions that are index contracts comprising a well-diversified portfolio of equity instruments, the absolute value of the current market value of each net long or net short position is multiplied by a specific risk-weighting factor of 2.0 percent. \46\---------------------------------------------------------------------------
\46\ A portfolio is well-diversified if it contains a large number of individual equity positions, with no single position representing a substantial portion of the portfolio's total market value.---------------------------------------------------------------------------
(2) For equity positions arising from the following futures-related arbitrage strategies, a bank may apply a 2.0 percent specific risk-weighting factor to one side (long or short) of each position with the opposite side exempt from an additional capital requirement:
(i) Long and short positions in exactly the same index at different dates or in different market centers; or
(ii) Long and short positions in index contracts at the same date in different, but similar indices.
(3) For futures contracts on main indices that are matched by offsetting positions in a basket of stocks comprising the index, a bank may apply a 2.0 percent specific risk-weighting factor to the futures and stock basket positions (long and short), provided that such trades are deliberately entered into and separately controlled, and that the basket of stocks is comprised of stocks representing at least 90.0 percent of the capitalization of the index. A main index refers to the Standard & Poor's 500 Index, the FTSE All-World Index, and any other index for which the bank can demonstrate to the satisfaction of the OCC that the equities represented in the index have liquidity, depth of market, and size of bid-ask spreads comparable to equities in the Standard & Poor's 500 Index and FTSE All-World Index.
(f) Due diligence requirements. (1) A bank must demonstrate to the satisfaction of the OCC a comprehensive understanding of the features of a securitization position that would materially affect the performance of the position by conducting and documenting the analysis set forth in paragraph (f)(2) of this section. The bank's analysis must be commensurate with the complexity of the securitization position and the materiality of the position in relation to capital.
(1) A bank must demonstrate to the satisfaction of the OCC a comprehensive understanding of the features of a securitization position that would materially affect the performance of the position by conducting and documenting the analysis set forth in paragraph (f)(2) of this section. The bank's analysis must be commensurate with the complexity of the securitization position and the materiality of the position in relation to capital.
(2) To support the demonstration of its comprehensive understanding, for each securitization position a bank must:
(i) Conduct an analysis of the risk characteristics of a securitization position prior to acquiring the position and document such analysis within three business days after acquiring the position, considering:
(A) Structural features of the securitization that would materially impact the performance of the position, for example, the contractual cash flow waterfall, waterfall-related triggers, credit enhancements, liquidity enhancements, market value triggers, the performance of organizations that service the position, and deal-specific definitions of default;
(B) Relevant information regarding the performance of the underlying credit exposure(s), for example, the percentage of loans 30, 60, and 90 days past due; default rates; prepayment rates; loans in foreclosure; property types; occupancy; average credit score or other measures of creditworthiness; average loan-to-value ratio; and industry and geographic diversification data on the underlying exposure(s);
(C) Relevant market data of the securitization, for example, bid-ask spreads, most recent sales price and historical price volatility, trading volume, implied market rating, and size, depth and concentration level of the market for the securitization; and
(D) For resecuritization positions, performance information on the underlying securitization exposures, for example, the issuer name and credit quality, and the characteristics and performance of the exposures underlying the securitization exposures; and
(ii) On an on-going basis (no less frequently than quarterly), evaluate, review, and update as appropriate the analysis required under paragraph (f)(1) of this section for each securitization position.
Section 11. Simplified Supervisory Formula Approach
(a) General requirements. To use the SSFA to determine the specific risk-weighting factor for a securitization position, a bank must have data that enables it to assign accurately the parameters described in paragraph (b) of this section. Data used to assign the parameters described in paragraph (b) of this section must be the most currently available data and no more than 91 calendar days old. A bank that does not have the appropriate data to assign the parameters described and defined, for purposes of this section, in paragraph (b) of this section must assign a specific risk-weighting factor of 100 percent to the position.
(b) SSFA parameters. To calculate the specific risk-weighting factor for a securitization position using the SSFA, a bank must have accurate information on the five inputs to the SSFA calculation described in paragraphs (b)(1) through (b)(5) of this section:
(1) KG is the weighted-average (with unpaid principal used as the weight for each exposure) total capital requirement of the underlying exposures calculated using appendix A to this part. KG is expressed as a decimal value between zero and 1 (that is, an average risk weight of 100 percent represents a value of KG equal to .08).
(2) Parameter W is expressed as a decimal value between zero and one. Parameter W is the ratio of the sum of the dollar amounts of any underlying exposures within the securitized pool that meet any of the criteria as set forth in paragraphs (i) through (vi) of this paragraph (b)(2) to the ending balance, measured in dollars, of underlying exposures:
(i) Ninety days or more past due;
(ii) Subject to a bankruptcy or insolvency proceeding;
(iii) In the process of foreclosure;
(iv) Held as real estate owned;
(v) Has contractually deferred interest payments for 90 days or more; or
(vi) Is in default.
(3) Parameter A is the attachment point for the position, which represents the threshold at which credit losses will first be allocated to the position. Parameter A equals the ratio of the current dollar amount of underlying exposures that are subordinated to the position of the bank to the current dollar amount of underlying exposures. Any reserve account funded by the accumulated cash flows from the underlying exposures that is subordinated to the position that contains the bank's securitization exposure may be included in the calculation of parameter A to the extent that cash is present in the account. Parameter A is expressed as a decimal value between zero and one.
(4) Parameter D is the detachment point for the position, which represents the threshold at which credit losses of principal allocated to the position would result in a total loss of principal. Parameter D equals parameter A plus the ratio of the current dollar amount of the securitization positions that are pari passu with the position (that is, have equal seniority with respect to credit risk) to the current dollar amount of the underlying exposures. Parameter D is expressed as a decimal value between zero and one.
(5) A supervisory calibration parameter, p, is equal to 0.5 for securitization positions that are not resecuritization positions and equal to 1.5 for resecuritization positions.
(c) Mechanics of the SSFA. KG and W are used to calculate KA, the augmented value of KG, which reflects the observed credit quality of the underlying pool of exposures. KA is defined in paragraph (d) of this section. The values of parameters A and D, relative to KA determine the specific risk-weighting factor assigned to a position as described in this paragraph and paragraph (d) of this section. The specific risk-weighting factor assigned to a securitization position, or portion of a position, as appropriate, is the larger of the specific risk-weighting factor determined in accordance with this paragraph and paragraph (d) of this section and a specific risk-weighting factor of 1.6 percent.
(1) When the detachment point, parameter D, for a securitization position is less than or equal to KA, the position must be assigned a specific risk-weighting factor of 100 percent.
(2) When the attachment point, parameter A, for a securitization position is greater than or equal to KA, the bank must calculate the specific risk-weighting factor in accordance with paragraph (d) of this section.
(3) When A is less than KA and D is greater than KA, the specific risk-weighting factor is a weighted-average of 1.00 and KSSFA calculated in accordance with paragraph (d) of this section, but with the parameter A revised to be set equal to KA. For the purpose of this weighted-average calculation: [GRAPHIC] [TIFF OMITTED] TR30AU12.005
Section 12. Market Risk Disclosures
(a) Scope. A bank must comply with this section unless it is a consolidated subsidiary of a bank holding company or a depository institution that is subject to these requirements or of a non-U.S. banking organization that is subject to comparable public disclosure requirements in its home jurisdiction. A bank must make quantitative disclosures publicly each calendar quarter. If a significant change occurs, such that the most recent reporting amounts are no longer reflective of the bank's capital adequacy and risk profile, then a brief discussion of this change and its likely impact must be provided as soon as practicable thereafter. Qualitative disclosures that typically do not change each quarter may be disclosed annually, provided any significant changes are disclosed in the interim. If a bank believes that disclosure of specific commercial or financial information would prejudice seriously its position by making public certain information that is either proprietary or confidential in nature, the bank is not required to disclose these specific items, but must disclose more general information about the subject matter of the requirement, together with the fact that, and the reason why, the specific items of information have not been disclosed.
(b) Disclosure policy. The bank must have a formal disclosure policy approved by the board of directors that addresses the bank's approach for determining its market risk disclosures. The policy must address the associated internal controls and disclosure controls and procedures. The board of directors and senior management must ensure that appropriate verification of the disclosures takes place and that effective internal controls and disclosure controls and procedures are maintained. One or more senior officers of the bank must attest that the disclosures meet the requirements of this appendix, and the board of directors and senior management are responsible for establishing and maintaining an effective internal control structure over financial reporting, including the disclosures required by this section.
(c) Quantitative disclosures.
(1) For each material portfolio of covered positions, the bank must disclose publicly the following information at least quarterly:
(i) The high, low, and mean VaR-based measures over the reporting period and the VaR-based measure at period-end;
(ii) The high, low, and mean stressed VaR-based measures over the reporting period and the stressed VaR-based measure at period-end;
(iii) The high, low, and mean incremental risk capital requirements over the reporting period and the incremental risk capital requirement at period-end;
(iv) The high, low, and mean comprehensive risk capital requirements over the reporting period and the comprehensive risk capital requirement at period-end, with the period-end requirement broken down into appropriate risk classifications (for example, default risk, migration risk, correlation risk);
(v) Separate measures for interest rate risk, credit spread risk, equity price risk, foreign exchange risk, and commodity price risk used to calculate the VaR-based measure; and
(vi) A comparison of VaR-based estimates with actual gains or losses experienced by the bank, with an analysis of important outliers.
(2) In addition, the bank must disclose publicly the following information at least quarterly:
(i) The aggregate amount of on-balance sheet and off-balance sheet securitization positions by exposure type; and
(ii) The aggregate amount of correlation trading positions.
(d) Qualitative disclosures. For each material portfolio of covered positions, the bank must disclose publicly the following information at least annually, or more frequently in the event of material changes for each portfolio:
(1) The composition of material portfolios of covered positions;
(2) The bank's valuation policies, procedures, and methodologies for covered positions including, for securitization positions, the methods and key assumptions used for valuing such positions, any significant changes since the last reporting period, and the impact of such change;
(3) The characteristics of the internal models used for purposes of this appendix. For the incremental risk capital requirement and the comprehensive risk capital requirement, this must include:
(i) The approach used by the bank to determine liquidity horizons;
(ii) The methodologies used to achieve a capital assessment that is consistent with the required soundness standard; and
(iii) The specific approaches used in the validation of these models;
(4) A description of the approaches used for validating and evaluating the accuracy of internal models and modeling processes for purposes of this appendix;
(5) For each market risk category (that is, interest rate risk, credit spread risk, equity price risk, foreign exchange risk, and commodity price risk), a description of the stress tests applied to the positions subject to the factor;
(6) The results of the comparison of the bank's internal estimates for purposes of this appendix with actual outcomes during a sample period not used in model development;
(7) The soundness standard on which the bank's internal capital adequacy assessment under this appendix is based, including a description of the methodologies used to achieve a capital adequacy assessment that is consistent with the soundness standard;
(8) A description of the bank's processes for monitoring changes in the credit and market risk of securitization positions, including how those processes differ for resecuritization positions; and
(8) A description of the bank's policy governing the use of credit risk mitigation to mitigate the risks of securitization and resecuritization positions. [77 FR 53112, Aug. 30, 2012]