46170 Federal Register / Vol. 60, No. 171 / Tuesday, September 5, 1995 / Rules and Regulations
1 The Basle Accord is a risk-based framework that
was proposed by the Basle Committee on Banking
Supervision (Basle Supervisors Committee) and
endorsed by the central bank governors of the
Group of Ten (G–10) countries in July 1988. The
Basle Supervisors Committee is comprised of
representatives of the central banks and supervisory
authorities from the G–10 countries (Belgium,
Canada, France, Germany, Italy, Japan, Netherlands,
Sweden, Switzerland, the United Kingdom, and the
United States) and Luxembourg.
2 Exchange rate contracts with an original
maturity of 14 calendar days or less and
instruments traded on exchanges that require daily
receipt and payment of cash variation margin are
excluded from the risk-based capital ratio
calculations.
3 The Board issued its amendment on December
7, 1994 (59 FR 62987), the OCC and FDIC issued
their amendments on December 28, 1994 (59 FR
66645 for the OCC final rule and 59 FR 66656 for
the FDIC final rule).
4 The notional principal amount is a reference
amount of money used to calculate payment
streams between counterparties.
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the
Currency
12 CFR Part 3
[Docket No. 95–20]
RIN 1557–AB14
FEDERAL RESERVE SYSTEM
12 CFR Parts 208 and 225
[Regulations H and Y; Docket No. R–0845]
FEDERAL DEPOSIT INSURANCE
CORPORATION
12 CFR Part 325
RIN 3064–AB43
Risk-Based Capital Standards:
Derivative Transactions
AGENCIES: Office of the Comptroller of
the Currency (OCC), Department of the
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 (the banking agencies) are
amending their respective risk-based
capital standards for banks and bank
holding companies (banking
organizations, institutions). This final
rule implements a recent revision to the
Basle Accord revising and expanding
the set of conversion factors used to
calculate the potential future exposure
of derivative contracts and recognizing
the effects of netting arrangements in
the calculation of potential future
exposure for derivative contracts subject
to qualifying bilateral netting
arrangements. The effect of this final
rule is threefold. First, long-dated
interest rate and exchange rate contracts
are subject to higher conversion factors
and new conversion factors are set forth
that specifically apply to derivative
contracts related to equities, precious
metals, and other commodities. Second,
institutions are permitted to recognize a
reduction in potential future credit
exposure for transactions subject to
qualifying bilateral netting
arrangements. Third, derivative
contracts related to equities, precious
metals and other commodities may be
recognized in bilateral netting
arrangements for risk-based capital
purposes.
EFFECTIVE DATE: October 1, 1995.
FOR FURTHER INFORMATION CONTACT:
OCC: For issues relating to netting and
the calculation of risk-based capital
ratios, Roger Tufts, Senior Economic
Advisor (202/874–5070), Office of the
Chief National Bank Examiner. For legal
issues, Eugene H. Cantor, Senior
Attorney, Securities and Corporate
Practices (202/874–5210), or Ronald
Shimabukuro, Senior Attorney,
Legislative and Regulatory Activities
Division (202/874–5090), Office of the
Comptroller of the Currency, 250 E
Street, S.W., Washington, D.C. 20219.
Board: Roger Cole, Deputy Associate
Director (202/452–2618), Norah Barger,
Manager (202/452–2402), Robert
Motyka, Supervisory Financial Analyst
(202)/452–3621), Barbara Bouchard,
Supervisory Financial Analyst (202/
452–3072), Division of Banking
Supervision and Regulation; or
Stephanie Martin, Senior Attorney (202/
452–3198), Legal Division. For the
Hearing Impaired only,
Telecommunications Device for the
Deaf, Dorothea Thompson (202/452–
3544), 20th and C Streets, N.W.,
Washington, D.C. 20551.
FDIC: William A. Stark, Assistant
Director, (202/898–6972), Curtis Wong,
Capital Markets Specialist, (202/898–
7327), Division of Supervision, or
Jeffrey M. Kopchik, Counsel, (202/898–
3872), Legal Division, FDIC, 550 17th
St., N.W., Washington, D.C. 20429.
SUPPLEMENTARY INFORMATION:
I. Background
The Basle Accord 1 established a risk-
based capital framework for assessing
capital adequacy that was implemented
in the United States by the banking
agencies in 1989. Under this framework,
off-balance-sheet transactions are
incorporated into the risk-based
structure by converting each item into a
credit equivalent amount that is then
assigned to the appropriate credit risk
category according to the identity of the
obligor or counterparty, or if relevant,
the guarantor or the nature of collateral.
The credit equivalent amount of an
off-balance-sheet interest rate or
exchange rate contract (rate contract) is
determined by adding together the
current replacement cost (current
exposure) of the contract and an
estimate of the possible increase in
future replacement cost (potential future
exposure, also referred to as the add-on)
in view of the volatility of the current
exposure of the contract. The maximum
risk category for rate contracts is 50
percent.2
Current Exposure
For risk-based capital purposes, a rate
contract with a positive mark-to-market
value has a current exposure equal to
that market value. If the mark-to-market
value is zero or negative, then the
current exposure is zero. The sum of
current exposures for a defined set of
contracts is sometimes referred to as the
gross current exposure for that set of
contracts. When they were initially
issued, the Basle Accord and the
banking agencies’ risk-based capital
standards provided, generally, that
current exposure would be determined
individually for each rate contract
entered into by a banking organization.
In July 1994 the Basle Accord was
revised to permit institutions to net, that
is, offset, positive and negative mark-to-
market values of rate contracts entered
into with a single counterparty subject
to a qualifying, legally enforceable,
bilateral netting arrangement. Effective
at year-end 1994, the banking agencies
each amended, in a uniform manner,
their risk-based capital standards to
implement the revision to the Accord.3
Accordingly, U.S. banking organizations
with qualifying, legally enforceable,
bilateral netting arrangements may
replace the gross current exposure of a
set of contracts included in such an
arrangement with a single net current
exposure for purposes of determining
the credit equivalent amount for the
included contracts.
Potential Future Exposure
The potential future exposure portion
of the credit equivalent amount for rate
contracts is an estimate of the additional
credit exposure that may arise as a
result of fluctuations in prices or rates.
The add-on for potential future
exposure is estimated by multiplying
the notional principal amount 4 of the
contract by a credit conversion factor
that is determined by the remaining
maturity of the contract and the type of
1 The Basle Accord is a risk-based framework that
was proposed by the Basle Committee on Banking
Supervision (Basle Supervisors Committee) and
endorsed by the central bank governors of the
Group of Ten (G–10) countries in July 1988. The
Basle Supervisors Committee is comprised of
representatives of the central banks and supervisory
authorities from the G–10 countries (Belgium,
Canada, France, Germany, Italy, Japan, Netherlands,
Sweden, Switzerland, the United Kingdom, and the
United States) and Luxembourg.
2 Exchange rate contracts with an original
maturity of 14 calendar days or less and
instruments traded on exchanges that require daily
receipt and payment of cash variation margin are
excluded from the risk-based capital ratio
calculations.
3 The Board issued its amendment on December
7, 1994 (59 FR 62987), the OCC and FDIC issued
their amendments on December 28, 1994 (59 FR
66645 for the OCC final rule and 59 FR 66656 for
the FDIC final rule).
4 The notional principal amount is a reference
amount of money used to calculate payment
streams between counterparties.
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the
Currency
12 CFR Part 3
[Docket No. 95–20]
RIN 1557–AB14
FEDERAL RESERVE SYSTEM
12 CFR Parts 208 and 225
[Regulations H and Y; Docket No. R–0845]
FEDERAL DEPOSIT INSURANCE
CORPORATION
12 CFR Part 325
RIN 3064–AB43
Risk-Based Capital Standards:
Derivative Transactions
AGENCIES: Office of the Comptroller of
the Currency (OCC), Department of the
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 (the banking agencies) are
amending their respective risk-based
capital standards for banks and bank
holding companies (banking
organizations, institutions). This final
rule implements a recent revision to the
Basle Accord revising and expanding
the set of conversion factors used to
calculate the potential future exposure
of derivative contracts and recognizing
the effects of netting arrangements in
the calculation of potential future
exposure for derivative contracts subject
to qualifying bilateral netting
arrangements. The effect of this final
rule is threefold. First, long-dated
interest rate and exchange rate contracts
are subject to higher conversion factors
and new conversion factors are set forth
that specifically apply to derivative
contracts related to equities, precious
metals, and other commodities. Second,
institutions are permitted to recognize a
reduction in potential future credit
exposure for transactions subject to
qualifying bilateral netting
arrangements. Third, derivative
contracts related to equities, precious
metals and other commodities may be
recognized in bilateral netting
arrangements for risk-based capital
purposes.
EFFECTIVE DATE: October 1, 1995.
FOR FURTHER INFORMATION CONTACT:
OCC: For issues relating to netting and
the calculation of risk-based capital
ratios, Roger Tufts, Senior Economic
Advisor (202/874–5070), Office of the
Chief National Bank Examiner. For legal
issues, Eugene H. Cantor, Senior
Attorney, Securities and Corporate
Practices (202/874–5210), or Ronald
Shimabukuro, Senior Attorney,
Legislative and Regulatory Activities
Division (202/874–5090), Office of the
Comptroller of the Currency, 250 E
Street, S.W., Washington, D.C. 20219.
Board: Roger Cole, Deputy Associate
Director (202/452–2618), Norah Barger,
Manager (202/452–2402), Robert
Motyka, Supervisory Financial Analyst
(202)/452–3621), Barbara Bouchard,
Supervisory Financial Analyst (202/
452–3072), Division of Banking
Supervision and Regulation; or
Stephanie Martin, Senior Attorney (202/
452–3198), Legal Division. For the
Hearing Impaired only,
Telecommunications Device for the
Deaf, Dorothea Thompson (202/452–
3544), 20th and C Streets, N.W.,
Washington, D.C. 20551.
FDIC: William A. Stark, Assistant
Director, (202/898–6972), Curtis Wong,
Capital Markets Specialist, (202/898–
7327), Division of Supervision, or
Jeffrey M. Kopchik, Counsel, (202/898–
3872), Legal Division, FDIC, 550 17th
St., N.W., Washington, D.C. 20429.
SUPPLEMENTARY INFORMATION:
I. Background
The Basle Accord 1 established a risk-
based capital framework for assessing
capital adequacy that was implemented
in the United States by the banking
agencies in 1989. Under this framework,
off-balance-sheet transactions are
incorporated into the risk-based
structure by converting each item into a
credit equivalent amount that is then
assigned to the appropriate credit risk
category according to the identity of the
obligor or counterparty, or if relevant,
the guarantor or the nature of collateral.
The credit equivalent amount of an
off-balance-sheet interest rate or
exchange rate contract (rate contract) is
determined by adding together the
current replacement cost (current
exposure) of the contract and an
estimate of the possible increase in
future replacement cost (potential future
exposure, also referred to as the add-on)
in view of the volatility of the current
exposure of the contract. The maximum
risk category for rate contracts is 50
percent.2
Current Exposure
For risk-based capital purposes, a rate
contract with a positive mark-to-market
value has a current exposure equal to
that market value. If the mark-to-market
value is zero or negative, then the
current exposure is zero. The sum of
current exposures for a defined set of
contracts is sometimes referred to as the
gross current exposure for that set of
contracts. When they were initially
issued, the Basle Accord and the
banking agencies’ risk-based capital
standards provided, generally, that
current exposure would be determined
individually for each rate contract
entered into by a banking organization.
In July 1994 the Basle Accord was
revised to permit institutions to net, that
is, offset, positive and negative mark-to-
market values of rate contracts entered
into with a single counterparty subject
to a qualifying, legally enforceable,
bilateral netting arrangement. Effective
at year-end 1994, the banking agencies
each amended, in a uniform manner,
their risk-based capital standards to
implement the revision to the Accord.3
Accordingly, U.S. banking organizations
with qualifying, legally enforceable,
bilateral netting arrangements may
replace the gross current exposure of a
set of contracts included in such an
arrangement with a single net current
exposure for purposes of determining
the credit equivalent amount for the
included contracts.
Potential Future Exposure
The potential future exposure portion
of the credit equivalent amount for rate
contracts is an estimate of the additional
credit exposure that may arise as a
result of fluctuations in prices or rates.
The add-on for potential future
exposure is estimated by multiplying
the notional principal amount 4 of the
contract by a credit conversion factor
that is determined by the remaining
maturity of the contract and the type of
46171Federal Register / Vol. 60, No. 171 / Tuesday, September 5, 1995 / Rules and Regulations
5 The proposed revisions are contained in a
document entitled ‘‘The capital adequacy treatment
of the credit risk associated with certain off-
balance-sheet items’’ that is available upon request
from the Board’s or OCC’s Freedom of Information
Offices or the FDIC’s Office of the Executive
Secretary.
6 In general terms, these are off-balance-sheet
derivative contracts that have a return, or a portion
of their return, linked to the price or an index of
prices for a particular commodity, precious metal,
or equity. These types of transactions were not
specifically addressed in the 1988 Accord (or in the
banking agencies’ original risk-based capital
standards) because they were not prevalent in the
derivatives markets at that time.
7 The Board issued its proposal on August 24,
1994 (59 FR 43508), the OCC issued its proposal on
September 1, 1994 (59 FR 45243), and the FDIC
issued its proposal on October 19, 1994 (59 FR
52714).
8 This formula may also be expressed as: Anet =
(1–P)Agross + P(NGR × Agross) [P or policy factor =
0.5].
contract. The original conversion factors
in the Basle Accord and the banking
agencies’ risk-based capital standards
are set forth in the following matrix:
Remaining maturity Interest
rate (in
percent)
Exchange
rate (in
percent)
One year or less ....... 0 1.0
Over one year ........... 0.5 5.0
An individual add-on for potential
future exposure is calculated for all rate
contracts regardless of whether the
market value is zero, positive, or
negative, or whether the current
exposure is calculated on a gross or net
basis. The banking agencies’ recent
amendments to expand the recognition
of bilateral netting arrangements did not
revise the calculation of the add-on for
potential future exposure. Accordingly,
an add-on is calculated separately for
each individual contract subject to a
qualifying bilateral netting arrangement.
These individual potential future
exposures are added together to arrive at
a gross add-on amount. The gross add-
on amount is added to the net current
exposure to determine one credit
equivalent amount for the contracts
subject to the qualifying bilateral netting
arrangement.
Commenters to the Basle proposal to
expand the recognition of bilateral
netting arrangements urged regulators to
also recognize reductions in potential
future credit exposure arising from such
arrangements. They also commented
that commodity and equity derivative
transactions should be eligible for
netting for risk-based capital purposes.
Accordingly, in July 1994 the Basle
Supervisors Committee proposed
revisions to the Basle Accord regarding
the risk-based capital treatment of
derivative transactions.5 Under the
proposed revision, the matrix of
conversion factors used to calculate
potential future exposure would be
expanded to take into account
innovations in the derivatives markets.
Specifically, the Basle Committee
proposed that higher conversion factors
be added to address long-dated
transactions (that is, contracts with
remaining maturities over five years)
and new conversion factors be added to
explicitly cover certain types of
derivatives transactions not directly
mentioned by the Accord when it was
endorsed in 1988. These include
commodity-, precious metal-, and
equity-linked derivative transactions.6
The proposed revision also would have
formally extended the recognition of
qualifying bilateral netting arrangements
to commodity, precious metal, and
equity derivative contracts so that these
types of transactions could be netted
when determining current exposure for
the netting contract. In addition, the
proposed revision set forth a formula for
institutions to employ in recognizing
reductions in the potential future
exposure of derivatives contracts that
can result from entering into qualifying
bilateral netting arrangements.
II. The Agencies’ Proposals
After the Basle Supervisors
Committee issued its proposed revisions
to the Basle Accord, the banking
agencies each issued for public
comment proposals to amend their
respective risk-based capital standards
based on the international proposal.7
The agencies’ proposed conversion
factor matrix is set forth below:
CONVERSION FACTOR MATRIX 1
[Amounts in percent]
Residual maturity Interest rate Foreign ex-
change and
gold Equity 2 Precious
metals, ex-
cept gold
Other com-
modities
Less than one year .................................................................................. 0.0 1.0 6.0 7.0 12.0
One to five years ...................................................................................... 0.5 5.0 8.0 7.0 12.0
Five years or more ................................................................................... 1.5 7.5 10.0 8.0 15.0
1 For contracts with multiple exchanges of principal, the factors are to be multiplied by the number of remaining payments in the contract.
2 For contracts that automatically reset to zero value following a payment, the remaining maturity is set equal to the time remaining until the
next payment.
The proposed matrix was designed to
accommodate a variety of contracts and
was intended to provide a reasonable
balance between precision, on the one
hand, and complexity and burden, on
the other.
The agencies also proposed the same
methodology as the Basle Supervisors
Committee to calculate a reduction in
the add-on amount for contacts subject
to qualifying bilateral netting
arrangements. Under the agencies’
proposals, institutions would apply the
following formula 8 to adjust the amount
of the add-on for potential future
exposure:
Anet = 0.5(Agross +(NGR x Agross))
Where Anet is the adjusted add-on for
all contracts subject to the netting
arrangement, Agross is the amount of the
add-on as calculated under the current
agency standards, and NGR is the ratio
of the net current exposure of the set of
contracts included in the netting
arrangement to the gross current
exposure of those contracts. The
proposals would have given partial
credit to the effect of the NGR by
applying a weighted averaging factor of
0.5.
Under the proposals, institutions
would calculate a separate NGR for each
counterparty with which it has a
qualifying bilateral netting contract. The
proposals requested general comments
as well as specific comment as to
whether the NGR should be calculated
on a counterparty-by-counterparty basis
or on an aggregate basis for all contracts
subject to qualifying bilateral netting
arrangements.
5 The proposed revisions are contained in a
document entitled ‘‘The capital adequacy treatment
of the credit risk associated with certain off-
balance-sheet items’’ that is available upon request
from the Board’s or OCC’s Freedom of Information
Offices or the FDIC’s Office of the Executive
Secretary.
6 In general terms, these are off-balance-sheet
derivative contracts that have a return, or a portion
of their return, linked to the price or an index of
prices for a particular commodity, precious metal,
or equity. These types of transactions were not
specifically addressed in the 1988 Accord (or in the
banking agencies’ original risk-based capital
standards) because they were not prevalent in the
derivatives markets at that time.
7 The Board issued its proposal on August 24,
1994 (59 FR 43508), the OCC issued its proposal on
September 1, 1994 (59 FR 45243), and the FDIC
issued its proposal on October 19, 1994 (59 FR
52714).
8 This formula may also be expressed as: Anet =
(1–P)Agross + P(NGR × Agross) [P or policy factor =
0.5].
contract. The original conversion factors
in the Basle Accord and the banking
agencies’ risk-based capital standards
are set forth in the following matrix:
Remaining maturity Interest
rate (in
percent)
Exchange
rate (in
percent)
One year or less ....... 0 1.0
Over one year ........... 0.5 5.0
An individual add-on for potential
future exposure is calculated for all rate
contracts regardless of whether the
market value is zero, positive, or
negative, or whether the current
exposure is calculated on a gross or net
basis. The banking agencies’ recent
amendments to expand the recognition
of bilateral netting arrangements did not
revise the calculation of the add-on for
potential future exposure. Accordingly,
an add-on is calculated separately for
each individual contract subject to a
qualifying bilateral netting arrangement.
These individual potential future
exposures are added together to arrive at
a gross add-on amount. The gross add-
on amount is added to the net current
exposure to determine one credit
equivalent amount for the contracts
subject to the qualifying bilateral netting
arrangement.
Commenters to the Basle proposal to
expand the recognition of bilateral
netting arrangements urged regulators to
also recognize reductions in potential
future credit exposure arising from such
arrangements. They also commented
that commodity and equity derivative
transactions should be eligible for
netting for risk-based capital purposes.
Accordingly, in July 1994 the Basle
Supervisors Committee proposed
revisions to the Basle Accord regarding
the risk-based capital treatment of
derivative transactions.5 Under the
proposed revision, the matrix of
conversion factors used to calculate
potential future exposure would be
expanded to take into account
innovations in the derivatives markets.
Specifically, the Basle Committee
proposed that higher conversion factors
be added to address long-dated
transactions (that is, contracts with
remaining maturities over five years)
and new conversion factors be added to
explicitly cover certain types of
derivatives transactions not directly
mentioned by the Accord when it was
endorsed in 1988. These include
commodity-, precious metal-, and
equity-linked derivative transactions.6
The proposed revision also would have
formally extended the recognition of
qualifying bilateral netting arrangements
to commodity, precious metal, and
equity derivative contracts so that these
types of transactions could be netted
when determining current exposure for
the netting contract. In addition, the
proposed revision set forth a formula for
institutions to employ in recognizing
reductions in the potential future
exposure of derivatives contracts that
can result from entering into qualifying
bilateral netting arrangements.
II. The Agencies’ Proposals
After the Basle Supervisors
Committee issued its proposed revisions
to the Basle Accord, the banking
agencies each issued for public
comment proposals to amend their
respective risk-based capital standards
based on the international proposal.7
The agencies’ proposed conversion
factor matrix is set forth below:
CONVERSION FACTOR MATRIX 1
[Amounts in percent]
Residual maturity Interest rate Foreign ex-
change and
gold Equity 2 Precious
metals, ex-
cept gold
Other com-
modities
Less than one year .................................................................................. 0.0 1.0 6.0 7.0 12.0
One to five years ...................................................................................... 0.5 5.0 8.0 7.0 12.0
Five years or more ................................................................................... 1.5 7.5 10.0 8.0 15.0
1 For contracts with multiple exchanges of principal, the factors are to be multiplied by the number of remaining payments in the contract.
2 For contracts that automatically reset to zero value following a payment, the remaining maturity is set equal to the time remaining until the
next payment.
The proposed matrix was designed to
accommodate a variety of contracts and
was intended to provide a reasonable
balance between precision, on the one
hand, and complexity and burden, on
the other.
The agencies also proposed the same
methodology as the Basle Supervisors
Committee to calculate a reduction in
the add-on amount for contacts subject
to qualifying bilateral netting
arrangements. Under the agencies’
proposals, institutions would apply the
following formula 8 to adjust the amount
of the add-on for potential future
exposure:
Anet = 0.5(Agross +(NGR x Agross))
Where Anet is the adjusted add-on for
all contracts subject to the netting
arrangement, Agross is the amount of the
add-on as calculated under the current
agency standards, and NGR is the ratio
of the net current exposure of the set of
contracts included in the netting
arrangement to the gross current
exposure of those contracts. The
proposals would have given partial
credit to the effect of the NGR by
applying a weighted averaging factor of
0.5.
Under the proposals, institutions
would calculate a separate NGR for each
counterparty with which it has a
qualifying bilateral netting contract. The
proposals requested general comments
as well as specific comment as to
whether the NGR should be calculated
on a counterparty-by-counterparty basis
or on an aggregate basis for all contracts
subject to qualifying bilateral netting
arrangements.