Fed Releases Proposed Risk-Based Capital Guidelines

The Fed and related US agencies have released:

a proposed regulatory capital rule related to the Financial Accounting Standards Board’s adoption of Statements of Financial Accounting Standards Nos. 166 and 167. Beginning in 2010, these accounting standards will make substantive changes to how banking organizations account for many items, including securitized assets, that are currently excluded from these organizations’ balance sheets.
The agencies are issuing the proposal to better align regulatory capital requirements with the actual risks of certain exposures. Banking organizations affected by the new accounting standards generally will be subject to higher minimum regulatory capital requirements. The agencies’ proposal seeks comment and supporting data on whether a phase-in of the increase in regulatory capital requirements is needed. It also seeks comment and supporting data on the features and characteristics of transactions that, although consolidated under the new accounting standards, might merit an alternative capital treatment, as well as on the potential impact of the new accounting standards on lending, provisioning, and other activities.

Comments on all aspects of the proposed rule are due within 30 days after its publication in the Federal Register, which is expected shortly.

Note to OSFI: This is how professionals do it. They release a draft and ask for comments.

The text of the proposal explains:

The Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System (Board), Federal Deposit Insurance Corporation (FDIC), and the Office of Thrift Supervision (OTS) (collectively, the agencies) are requesting comment on a proposal to (i) modify their general risk-based and advanced risk-based capital adequacy frameworks to eliminate the exclusion of certain consolidated asset-backed commercial paper programs from risk-weighted assets and (ii) provide a reservation of authority in their general risk-based and advanced risk-based capital adequacy frameworks to permit the agencies to require banking organizations to treat entities that are not consolidated under accounting standards as if they were consolidated for risk-based capital purposes, commensurate with the risk relationship of the banking organization to the structure. The agencies are issuing this proposal and request for comment to better align capital requirements with the actual risk of certain exposures and to obtain information and views from the public on the effect on regulatory capital that will result from the implementation of the Financial Accounting Standard Board’s (FASB) Statement of Financial Accounting Standards No. 166, Accounting for Transfers of Financial Assets, an Amendment of FASB Statement No. 140 and Statement of Financial Accounting Standards No 167, Amendments to FASB Interpretation No. 46(R).

They point out:

In the case of some structures that banking organizations were not required to consolidate prior to the 2009 GAAP modifications, the recent turmoil in the financial markets has demonstrated the extent to which the credit risk exposure of the sponsoring banking organization to such structures (and their related assets) has in fact been greater than the agencies estimated, and more associated with non-contractual considerations than the agencies had expected. For example, recent performance data on structures involving revolving assets [footnote] show that banking organizations have often provided non-contractual (implicit) support to prevent senior securities of the structure from being downgraded, thereby mitigating reputational risk and the associated alienation of investors, and preserving access to cost-efficient funding.

Footnote: Typical structures of this type include securitizations that are backed by credit card or HELOC receivables, single and multi-seller ABCP conduits, and structured investment vehicles.

Question 2: Are there features and characteristics of securitization transactions or other transactions with VIEs, other SPEs, or other entities that are more or less likely to elicit banking organizations’ provision of non-contractual (implicit) support under stressed or other circumstances due to reputational risk, business model, or other reasons? Commenters should describe such features and characteristics and the methods of support that may be provided. The agencies are particularly interested in comments regarding credit card securitizations, structured investment vehicles, money market funds, hedge funds, and other entities that are likely beneficiaries of non-contractual support.

It is of particular interest that they are particularly interested in money market funds as beneficiaries of non-contractual support. OSFI refuses to consider the question. I have repeatedly urged that money market funds be considered securitizations; another article on the topic is, by the way, in press.

Of further interest to Canadians is:

The agencies propose to eliminate existing provisions in the risk-based capital rules that permit a banking organization that is required to consolidate under GAAP an ABCP program for which the banking organization acts as sponsor, to exclude the consolidated ABCP program assets from risk-weighted assets and instead assess the risk-based capital requirement against any contractual exposures of the organization arising from such ABCP programs. The agencies also propose to eliminate the associated provision in the general risk-based capital rules (incorporated by reference in the advanced approaches) that excludes from tier 1 capital the minority interest in a consolidated ABCP program not included in a banking organization’s riskweighted assets.

The agencies initially implemented these provisions in the general risk-based capital rules in 2004 in response to changes in GAAP that required consolidation of certain ABCP conduits by sponsors. The provisions were driven largely by the agencies’ belief at the time that banking organizations sponsoring ABCP conduits generally faced limited risk exposures to ABCP programs, because these exposures generally were confined to the credit enhancements and liquidity facility arrangements banking organizations provide to these programs.

Additionally, the agencies believed previously that operational controls and structural provisions, as well as over-collateralization or other credit enhancements provided by the companies that sell assets into ABCP programs, could further mitigate the risk to which sponsoring banking organizations were exposed. However, in light of the increased incidence of banking organizations providing non-contractual support to these programs, as well as the general credit risk concerns discussed above, the agencies have reconsidered the appropriateness of excluding consolidated ABCP program assets from risk-weighted assets and have determined that continuing the exclusion is no longer justified. Under the proposal, if a banking organization is required to consolidate an entity associated with an ABCP program under GAAP, it must hold regulatory capital against the assets of the entity. It would not be permitted to calculate its risk-based capital requirements with respect to the entity based on its contractual exposure to the entity.

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