39490 Federal Register / Vol. 60, No. 148 / Wednesday, August 2, 1995 / Rules and Regulations
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the
Currency
12 CFR Part 3
[Docket No. 95–17]
FEDERAL RESERVE SYSTEM
12 CFR Part 208
[Docket No. R–0802]
FEDERAL DEPOSIT INSURANCE
CORPORATION
12 CFR Part 325
RIN 3064–AB22
Risk-Based Capital Standards: Interest
Rate Risk
AGENCIES: Office of the Comptroller of
the Currency (OCC), Treasury; Board of
Governors of the Federal Reserve
System (Board); and Federal Deposit
Insurance Corporation (FDIC).
ACTION: Final rule.
SUMMARY: The OCC, the Board, and the
FDIC (collectively referred to as the
banking agencies) are issuing this final
rule to implement the portion of Section
305 of the Federal Deposit Insurance
Corporation Improvement Act of 1991
(FDICIA) that requires the banking
agencies to revise their risk-based
capital standards to ensure that those
standards take adequate account of
interest rate risk. This final rule amends
the capital standards to specify that the
banking agencies will include, in their
evaluations of a bank’s capital
adequacy, an assessment of the
exposure to declines in the economic
value of the bank’s capital due to
changes in interest rates.
Concurrent with the publication of
this final rule, the banking agencies are
issuing for comment, a joint policy
statement that describes the process the
banking agencies will use to measure
and assess the exposure of a bank’s net
economic value to changes in interest
rates. After the banking agencies and
banking industry gain sufficient
experience with the proposed
measurement process, the banking
agencies intend, through a subsequent
rulemaking process, to issue a proposed
rule that would establish an explicit
capital charge for interest rate risk that
will be based upon the level of a bank’s
measured interest rate risk exposure.
EFFECTIVE DATE: September 1, 1995.
FOR FURTHER INFORMATION CONTACT:
OCC: Christina Benson, Capital
Markets Specialist, or Lisa Lintecum,
National Bank Examiner (202/874–
5070), Office of the Chief National Bank
Examiner; Michael Carhill, Financial
Economist, Risk Analysis Division (202/
874–5700); and Ronald Shimabukuro,
Senior Attorney, Legislative and
Regulatory Activities Division (202/
874–5090), Office of the Comptroller of
the Currency, 250 E Street SW.,
Washington, DC 20219.
Board of Governors: James Houpt,
Assistant Director (202/452–3358),
William F. Treacy, Supervisory
Financial Analyst (202/452–3859),
Division of Banking Supervision and
Regulation; Gregory Baer, Managing
Senior Counsel (202/452–3236), Legal
Division, Board of Governors of the
Federal Reserve System. For the hearing
impaired only, Telecommunication
Device for the Deaf (TDD), Dorothea
Thompson (202/452–3544), Board of
Governors of the Federal Reserve
System, 20th and C Streets NW.,
Washington, DC 20551.
FDIC: William A. Stark, Assistant
Director (202/898–6972) or Phillip J.
Bond, Senior Capital Markets Specialist
(202/898–3519), Division of
Supervision, Federal Deposit Insurance
Corporation, 550 17th Street NW.,
Washington, DC 20429.
SUPPLEMENTARY INFORMATION:
I. Background
Interest rate risk is the exposure of a
bank’s current and future earnings and
equity capital arising from adverse
movements in interest rates. This risk
results from the possibility that changes
in interest rates may have an adverse
impact on a bank’s earnings and its
underlying economic value. Changes in
interest rates affect a bank’s earnings by
changing its net interest income and the
level of other interest-sensitive income
and operating expenses. The underlying
economic value of the bank’s assets,
liabilities, and off-balance sheet items
also are affected by changes in interest
rates. These changes occur because the
present value of future cash flows, and
in some cases the cash flows
themselves, change when interest rates
change. The combined effects of the
changes in these present values reflect
the change in the underlying economic
value of the bank’s capital as well as
provide an indicator of the expected
change in the bank’s future earnings
arising from the change in interest rates.
Interest rate risk is inherent in the role
of banks as financial intermediaries.
Interest rate risk, however, introduces
volatility to bank earnings and to the
economic value of the bank. A bank that
has an excessive level of interest rate
risk can face diminished future
earnings, impaired liquidity and capital
positions, and, ultimately, may
jeopardize its solvency.
Section 305 of FDICIA, Pub. L. 102–
242 (12 U.S.C. 1828 note), requires the
banking agencies to revise their risk-
based capital guidelines to take
adequate account of interest rate risk.
Section 305 of FDICIA also requires the
banking agencies to publish final
implementing regulations by June 19,
1993, and to establish transition rules to
facilitate compliance with those
regulations.
The banking agencies have not met
the June 19, 1993, statutory date for
publishing a final rule for this section of
FDICIA. This delay reflects the difficult
tradeoffs the banking agencies have
faced in developing and implementing a
rule that provides a sufficiently accurate
basis for estimating banks’ interest rate
risk exposures and their need for
capital, yet maintains enough
transparency and simplicity to allow
bank management to readily determine
their regulatory capital requirements.
The banking agencies also are mindful
of the need to avoid unnecessary
regulatory burdens associated with this
rule, consistent with Section 335 of the
Reigle Community Development and
Regulatory Improvement Act of 1994,
Pub. L. 103–325 (12 U.S.C. 1828 note).
II. September 1993 Proposal
A. Proposal
In September 1993, the banking
agencies issued a proposed rule that
solicited comments on a framework for
measuring banks’ interest rate risk
exposures and determining the amount
of capital needed by a bank to account
for interest rate risk. See 58 FR 48206
(September 14, 1993).
The framework outlined by the
banking agencies in the September 1993
proposed rule incorporated the use of a
three-level measurement process to
evaluate banks’ interest rate risk
exposures. The first measure was a
quantitative screen, based on existing
Consolidated Report of Condition and
Income (Call Report) information, that
would exempt potential low risk banks
from additional reporting requirements.
The exemption screen was based on two
criteria: (1) the amount of a bank’s off-
balance sheet interest rate contracts in
relation to its total assets, and (2) the
relation between a bank’s fixed- and
floating-rate loans and securities that
mature or reprice beyond five years and
its total capital.
Banks not meeting the proposed
exemption test would have been
required to calculate their economic
exposure by either: (1) a supervisory
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the
Currency
12 CFR Part 3
[Docket No. 95–17]
FEDERAL RESERVE SYSTEM
12 CFR Part 208
[Docket No. R–0802]
FEDERAL DEPOSIT INSURANCE
CORPORATION
12 CFR Part 325
RIN 3064–AB22
Risk-Based Capital Standards: Interest
Rate Risk
AGENCIES: Office of the Comptroller of
the Currency (OCC), Treasury; Board of
Governors of the Federal Reserve
System (Board); and Federal Deposit
Insurance Corporation (FDIC).
ACTION: Final rule.
SUMMARY: The OCC, the Board, and the
FDIC (collectively referred to as the
banking agencies) are issuing this final
rule to implement the portion of Section
305 of the Federal Deposit Insurance
Corporation Improvement Act of 1991
(FDICIA) that requires the banking
agencies to revise their risk-based
capital standards to ensure that those
standards take adequate account of
interest rate risk. This final rule amends
the capital standards to specify that the
banking agencies will include, in their
evaluations of a bank’s capital
adequacy, an assessment of the
exposure to declines in the economic
value of the bank’s capital due to
changes in interest rates.
Concurrent with the publication of
this final rule, the banking agencies are
issuing for comment, a joint policy
statement that describes the process the
banking agencies will use to measure
and assess the exposure of a bank’s net
economic value to changes in interest
rates. After the banking agencies and
banking industry gain sufficient
experience with the proposed
measurement process, the banking
agencies intend, through a subsequent
rulemaking process, to issue a proposed
rule that would establish an explicit
capital charge for interest rate risk that
will be based upon the level of a bank’s
measured interest rate risk exposure.
EFFECTIVE DATE: September 1, 1995.
FOR FURTHER INFORMATION CONTACT:
OCC: Christina Benson, Capital
Markets Specialist, or Lisa Lintecum,
National Bank Examiner (202/874–
5070), Office of the Chief National Bank
Examiner; Michael Carhill, Financial
Economist, Risk Analysis Division (202/
874–5700); and Ronald Shimabukuro,
Senior Attorney, Legislative and
Regulatory Activities Division (202/
874–5090), Office of the Comptroller of
the Currency, 250 E Street SW.,
Washington, DC 20219.
Board of Governors: James Houpt,
Assistant Director (202/452–3358),
William F. Treacy, Supervisory
Financial Analyst (202/452–3859),
Division of Banking Supervision and
Regulation; Gregory Baer, Managing
Senior Counsel (202/452–3236), Legal
Division, Board of Governors of the
Federal Reserve System. For the hearing
impaired only, Telecommunication
Device for the Deaf (TDD), Dorothea
Thompson (202/452–3544), Board of
Governors of the Federal Reserve
System, 20th and C Streets NW.,
Washington, DC 20551.
FDIC: William A. Stark, Assistant
Director (202/898–6972) or Phillip J.
Bond, Senior Capital Markets Specialist
(202/898–3519), Division of
Supervision, Federal Deposit Insurance
Corporation, 550 17th Street NW.,
Washington, DC 20429.
SUPPLEMENTARY INFORMATION:
I. Background
Interest rate risk is the exposure of a
bank’s current and future earnings and
equity capital arising from adverse
movements in interest rates. This risk
results from the possibility that changes
in interest rates may have an adverse
impact on a bank’s earnings and its
underlying economic value. Changes in
interest rates affect a bank’s earnings by
changing its net interest income and the
level of other interest-sensitive income
and operating expenses. The underlying
economic value of the bank’s assets,
liabilities, and off-balance sheet items
also are affected by changes in interest
rates. These changes occur because the
present value of future cash flows, and
in some cases the cash flows
themselves, change when interest rates
change. The combined effects of the
changes in these present values reflect
the change in the underlying economic
value of the bank’s capital as well as
provide an indicator of the expected
change in the bank’s future earnings
arising from the change in interest rates.
Interest rate risk is inherent in the role
of banks as financial intermediaries.
Interest rate risk, however, introduces
volatility to bank earnings and to the
economic value of the bank. A bank that
has an excessive level of interest rate
risk can face diminished future
earnings, impaired liquidity and capital
positions, and, ultimately, may
jeopardize its solvency.
Section 305 of FDICIA, Pub. L. 102–
242 (12 U.S.C. 1828 note), requires the
banking agencies to revise their risk-
based capital guidelines to take
adequate account of interest rate risk.
Section 305 of FDICIA also requires the
banking agencies to publish final
implementing regulations by June 19,
1993, and to establish transition rules to
facilitate compliance with those
regulations.
The banking agencies have not met
the June 19, 1993, statutory date for
publishing a final rule for this section of
FDICIA. This delay reflects the difficult
tradeoffs the banking agencies have
faced in developing and implementing a
rule that provides a sufficiently accurate
basis for estimating banks’ interest rate
risk exposures and their need for
capital, yet maintains enough
transparency and simplicity to allow
bank management to readily determine
their regulatory capital requirements.
The banking agencies also are mindful
of the need to avoid unnecessary
regulatory burdens associated with this
rule, consistent with Section 335 of the
Reigle Community Development and
Regulatory Improvement Act of 1994,
Pub. L. 103–325 (12 U.S.C. 1828 note).
II. September 1993 Proposal
A. Proposal
In September 1993, the banking
agencies issued a proposed rule that
solicited comments on a framework for
measuring banks’ interest rate risk
exposures and determining the amount
of capital needed by a bank to account
for interest rate risk. See 58 FR 48206
(September 14, 1993).
The framework outlined by the
banking agencies in the September 1993
proposed rule incorporated the use of a
three-level measurement process to
evaluate banks’ interest rate risk
exposures. The first measure was a
quantitative screen, based on existing
Consolidated Report of Condition and
Income (Call Report) information, that
would exempt potential low risk banks
from additional reporting requirements.
The exemption screen was based on two
criteria: (1) the amount of a bank’s off-
balance sheet interest rate contracts in
relation to its total assets, and (2) the
relation between a bank’s fixed- and
floating-rate loans and securities that
mature or reprice beyond five years and
its total capital.
Banks not meeting the proposed
exemption test would have been
required to calculate their economic
exposure by either: (1) a supervisory
39491Federal Register / Vol. 60, No. 148 / Wednesday, August 2, 1995 / Rules and Regulations
1 A threshold level representing a decline in
economic value equal to 1.0 percent of assets was
proposed by the banking agencies.
2 The exposure of a bank’s economic value is
generally the change in the present value of its
assets, less the change in the present value of its
liabilities, plus the change in the value of its
interest rate off-balance-sheet contracts. It
represents the change in the underlying economic
value of the bank’s capital.
model that measured the change in the
economic value of the bank for a
specified change in interest rates; or (2)
the bank’s own interest rate risk model,
provided that the model was deemed
adequate by examiners for the nature
and scope of the bank’s activities and
that it measured the bank’s economic
exposure using the interest rate
scenarios specified by the banking
agencies.
The September 1993 proposed rule
also sought comment on two alternative
methods for determining the amount of
capital a bank may need for interest rate
risk. Both approaches proposed to focus
supervisory attention and need for
capital on those banks whose measured
exposure exceeded a proposed
supervisory threshold level.1 One
method (Minimum Capital Standard)
proposed to establish an explicit
minimum capital standard for interest
rate risk. This approach would have
relied on the results of either the
supervisory model or banks’ own
models and would have required banks
to have capital sufficient to cover the
amount by which their measured
exposure exceeded a supervisory
threshold level. The second approach
(Risk Assessment) proposed to use
model results as one of several factors
that examiners would consider when
determining a bank’s capital needs for
interest rate risk. Under this approach,
a bank’s need for capital would be
determined on a case-by-case basis as
part of each banking agency’s
examination process. In determining the
need for capital, examiners would
consider the quality of the bank’s
interest rate risk management, internal
controls and the overall financial
condition of the bank. Banks that had
measured exposures in excess of the
supervisory threshold and weak interest
rate risk management systems would
generally be required to hold additional
capital for interest rate risk.
B. Comments
The banking agencies collectively
received a total of 133 comments on the
September 1993 proposed rule. The
majority of commenters were banks.
Thrifts, trade associations, bank
consultants, other government-
sponsored agencies and other regulators
also commented. The majority of
commenters responded favorably to
modifications that the banking agencies
made from the earlier advance notice of
proposed rulemaking published in the
Federal Register on August 10, 1992.
See 57 FR 35507 (August 10, 1992). In
particular, most commenters expressed
strong support for using the results of
banks’ own interest rate risk models to
determine their levels of exposure and
corresponding need for capital.
Commenters noted the potential
inaccuracies of standardized regulatory
models, such as the proposed
supervisory model, as one reason for
allowing the use of internal models.
Internal models, they believed, would
better capture the unique characteristics
of individual bank portfolios. Many
commenters also stated that permitting
the use of internal models would
provide banks with incentives to
improve their internal risk measurement
systems.
The vast majority of commenters also
urged the banking agencies to adopt a
‘‘Risk Assessment’’ approach for
determining capital adequacy. Among
the reasons cited for this approach were
concerns about the accuracy of the
proposed supervisory model and the
need to consider qualitative factors,
such as the quality of a bank’s risk
management process and its ability to
respond to changing market conditions,
in evaluating capital. Many commenters
believed that by considering such
factors, the banking agencies would
reward banks that have superior risk
management capabilities.
Some commenters believed that the
banking agencies’ primary focus when
evaluating the level of a bank’s interest
rate risk exposure should be on the
exposure of the bank’s near-term (one-
to two-year) reported earnings, rather
than on its exposure to economic value.
While recognizing the importance of
understanding the degree to which a
bank’s reported earnings are vulnerable
to changing interest rates, the banking
agencies have concluded that the
economic value perspective more
effectively identifies the risks that the
bank’s current business activities pose
to its financial condition, its longer-term
earnings and solvency, and hence the
adequacy of its capital levels. Economic
value measures the effect of a change in
interest rates on the value of all future
cash flows generated by a bank’s current
financial instruments, not just those that
affect earnings over the next few months
or quarters. Indeed, an earnings analysis
provides information only on positions
repricing within the forecast horizon,
and thus would not take account of the
full magnitude of risk. As a result, the
effect of embedded and explicit options
can be significantly understated by such
an analysis. In contrast, an economic
value perspective captures the effect of
changing interest rates for all time
periods, and offers a superior vehicle for
assessing the effect of those rate changes
on positions that have option
characteristics. In addition, an economic
value perspective offers important
insights into the effect of changing
interest rates on the liquidity of a bank’s
assets.
Many commenters also raised
common concerns about various
elements of the measurement process
outlined in the September 1993
proposed rule. Most commenters believe
that the proposed treatment of non-
maturity deposits understate their
effective maturity. Others raised
concerns about the accuracy of the
proposed supervisory model and the
appropriateness of the proposed
exemption test criteria. The
measurement system, proposed in
today’s joint policy statement, includes
a discussion of these comments and
incorporates a number of changes to the
September 1993 proposed rule in
response to commenters’ concerns.
III. Final Rule and Two-Step Process
for Establishing Minimum Capital
Standards
After careful consideration of all the
comments, the banking agencies have
decided to implement minimum capital
standards for interest rate risk exposures
in a two-step process.
This final rule implements the first
step of that process by revising the
capital standards of the banking
agencies to explicitly include a bank’s
exposure to declines in the economic
value of its capital due to changes in
interest rates as a factor that the banking
agencies will consider in evaluating a
bank’s capital adequacy.2 This final rule
does not codify a measurement
framework for assessing the level of a
bank’s interest rate risk exposure. The
information and exposure estimates
collected through a new proposed
supervisory measurement process,
described in the banking agencies’ joint
policy statement on interest rate risk,
would be one quantitative factor used
by examiners to determine the adequacy
of an individual bank’s capital for
interest rate risk. The focus of that
proposed process is on a bank’s
economic value exposure. Other
quantitative factors that examiners will
consider include the bank’s historical
financial performance and its earnings
exposure to interest rate movements.
Examiners also will consider qualitative
1 A threshold level representing a decline in
economic value equal to 1.0 percent of assets was
proposed by the banking agencies.
2 The exposure of a bank’s economic value is
generally the change in the present value of its
assets, less the change in the present value of its
liabilities, plus the change in the value of its
interest rate off-balance-sheet contracts. It
represents the change in the underlying economic
value of the bank’s capital.
model that measured the change in the
economic value of the bank for a
specified change in interest rates; or (2)
the bank’s own interest rate risk model,
provided that the model was deemed
adequate by examiners for the nature
and scope of the bank’s activities and
that it measured the bank’s economic
exposure using the interest rate
scenarios specified by the banking
agencies.
The September 1993 proposed rule
also sought comment on two alternative
methods for determining the amount of
capital a bank may need for interest rate
risk. Both approaches proposed to focus
supervisory attention and need for
capital on those banks whose measured
exposure exceeded a proposed
supervisory threshold level.1 One
method (Minimum Capital Standard)
proposed to establish an explicit
minimum capital standard for interest
rate risk. This approach would have
relied on the results of either the
supervisory model or banks’ own
models and would have required banks
to have capital sufficient to cover the
amount by which their measured
exposure exceeded a supervisory
threshold level. The second approach
(Risk Assessment) proposed to use
model results as one of several factors
that examiners would consider when
determining a bank’s capital needs for
interest rate risk. Under this approach,
a bank’s need for capital would be
determined on a case-by-case basis as
part of each banking agency’s
examination process. In determining the
need for capital, examiners would
consider the quality of the bank’s
interest rate risk management, internal
controls and the overall financial
condition of the bank. Banks that had
measured exposures in excess of the
supervisory threshold and weak interest
rate risk management systems would
generally be required to hold additional
capital for interest rate risk.
B. Comments
The banking agencies collectively
received a total of 133 comments on the
September 1993 proposed rule. The
majority of commenters were banks.
Thrifts, trade associations, bank
consultants, other government-
sponsored agencies and other regulators
also commented. The majority of
commenters responded favorably to
modifications that the banking agencies
made from the earlier advance notice of
proposed rulemaking published in the
Federal Register on August 10, 1992.
See 57 FR 35507 (August 10, 1992). In
particular, most commenters expressed
strong support for using the results of
banks’ own interest rate risk models to
determine their levels of exposure and
corresponding need for capital.
Commenters noted the potential
inaccuracies of standardized regulatory
models, such as the proposed
supervisory model, as one reason for
allowing the use of internal models.
Internal models, they believed, would
better capture the unique characteristics
of individual bank portfolios. Many
commenters also stated that permitting
the use of internal models would
provide banks with incentives to
improve their internal risk measurement
systems.
The vast majority of commenters also
urged the banking agencies to adopt a
‘‘Risk Assessment’’ approach for
determining capital adequacy. Among
the reasons cited for this approach were
concerns about the accuracy of the
proposed supervisory model and the
need to consider qualitative factors,
such as the quality of a bank’s risk
management process and its ability to
respond to changing market conditions,
in evaluating capital. Many commenters
believed that by considering such
factors, the banking agencies would
reward banks that have superior risk
management capabilities.
Some commenters believed that the
banking agencies’ primary focus when
evaluating the level of a bank’s interest
rate risk exposure should be on the
exposure of the bank’s near-term (one-
to two-year) reported earnings, rather
than on its exposure to economic value.
While recognizing the importance of
understanding the degree to which a
bank’s reported earnings are vulnerable
to changing interest rates, the banking
agencies have concluded that the
economic value perspective more
effectively identifies the risks that the
bank’s current business activities pose
to its financial condition, its longer-term
earnings and solvency, and hence the
adequacy of its capital levels. Economic
value measures the effect of a change in
interest rates on the value of all future
cash flows generated by a bank’s current
financial instruments, not just those that
affect earnings over the next few months
or quarters. Indeed, an earnings analysis
provides information only on positions
repricing within the forecast horizon,
and thus would not take account of the
full magnitude of risk. As a result, the
effect of embedded and explicit options
can be significantly understated by such
an analysis. In contrast, an economic
value perspective captures the effect of
changing interest rates for all time
periods, and offers a superior vehicle for
assessing the effect of those rate changes
on positions that have option
characteristics. In addition, an economic
value perspective offers important
insights into the effect of changing
interest rates on the liquidity of a bank’s
assets.
Many commenters also raised
common concerns about various
elements of the measurement process
outlined in the September 1993
proposed rule. Most commenters believe
that the proposed treatment of non-
maturity deposits understate their
effective maturity. Others raised
concerns about the accuracy of the
proposed supervisory model and the
appropriateness of the proposed
exemption test criteria. The
measurement system, proposed in
today’s joint policy statement, includes
a discussion of these comments and
incorporates a number of changes to the
September 1993 proposed rule in
response to commenters’ concerns.
III. Final Rule and Two-Step Process
for Establishing Minimum Capital
Standards
After careful consideration of all the
comments, the banking agencies have
decided to implement minimum capital
standards for interest rate risk exposures
in a two-step process.
This final rule implements the first
step of that process by revising the
capital standards of the banking
agencies to explicitly include a bank’s
exposure to declines in the economic
value of its capital due to changes in
interest rates as a factor that the banking
agencies will consider in evaluating a
bank’s capital adequacy.2 This final rule
does not codify a measurement
framework for assessing the level of a
bank’s interest rate risk exposure. The
information and exposure estimates
collected through a new proposed
supervisory measurement process,
described in the banking agencies’ joint
policy statement on interest rate risk,
would be one quantitative factor used
by examiners to determine the adequacy
of an individual bank’s capital for
interest rate risk. The focus of that
proposed process is on a bank’s
economic value exposure. Other
quantitative factors that examiners will
consider include the bank’s historical
financial performance and its earnings
exposure to interest rate movements.
Examiners also will consider qualitative