Federal Deposit
Insurance Corporation

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FEDERAL DEPOSIT INSURANCE CORPORATION

Differences in Capital and Accounting Standards Among the Federal
Banking and Thrift Agencies; Report to Congressional Committees

AGENCY: Federal Deposit Insurance Corporation (FDIC).

ACTION: Report to the Committee on Banking and Financial Services of
the U.S. House of Representatives and to the Committee on Banking,
Housing, and Urban Affairs of the United States Senate regarding
differences in capital and accounting standards among the Federal
banking and thrift agencies.

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SUMMARY: This report has been prepared by the FDIC pursuant to Section
37(c) of the Federal Deposit Insurance Act (12 U.S.C. 1831n(c)).
Section 37(c) requires each federal banking agency to report to the
Committee on Banking and Financial Services of the House of
Representatives and to the Committee on Banking, Housing, and Urban
Affairs of the Senate any differences between any accounting or capital
standard used by such agency and any accounting or capital standard
used by any other such agency. The report must also contain an
explanation of the reasons for any discrepancy in such accounting and
capital standards and must be published in the Federal Register.

FOR FURTHER INFORMATION CONTACT: Robert F. Storch, Chief, Accounting
Section, Division of Supervision, Federal Deposit Insurance
Corporation, 550 17th Street, NW., Washington, D.C. 20429, telephone
(202) 898-8906.

SUPPLEMENTARY INFORMATION: The text of the report follows:

Report to the Committee on Banking and Financial Services of the
U.S. House of Representatives and to the Committee on Banking,
Housing, and Urban Affairs of the United States Senate Regarding
Differences in Capital and Accounting Standards Among the Federal
Banking and Thrift Agencies

A. Introduction

The Federal Deposit Insurance Corporation (FDIC) has prepared this
report pursuant to Section 37(c) of the Federal Deposit Insurance Act.
Section 37(c) requires the agency to submit a report to specified
Congressional Committees describing any differences in regulatory
capital and accounting standards among the federal banking and thrift
agencies, including an explanation of the reasons for these
differences. Section 37(c) also requires the FDIC to publish this
report in the Federal Register. This report covers differences existing
during 1999 and developments affecting these differences.
The FDIC, the Board of Governors of the Federal Reserve System
(FRB), and the Office of the Comptroller of the Currency (OCC)
(hereafter, the banking agencies) have substantially similar leverage
and risk-based capital standards. While the Office of Thrift
Supervision (OTS) employs a regulatory capital framework that also
includes leverage and risk-based capital requirements, it differs in
some respects from that of the banking agencies. Nevertheless, the
agencies view the leverage and risk-based capital requirements as
minimum standards and most institutions are expected to operate with
capital levels well above the minimums, particularly those institutions
that are expanding or experiencing unusual or high levels of risk.
The banking agencies, under the auspices of the Federal Financial
Institutions Examination Council (FFIEC), have developed uniform
Reports of Condition and Income (Call Reports) for all insured
commercial banks and FDIC-supervised savings banks. The OTS requires
each savings association to file the Thrift Financial Report (TFR). The
reporting standards for recognition and measurement in both the Call
Report and the TFR are consistent with generally accepted accounting
principles (GAAP). Thus, there are no significant differences in
reporting standards among the agencies. However, two minor differences
remain between the standards of the banking agencies and those of the
OTS.
Section 303 of the Riegle Community Development and Regulatory

[[Page 40665]]

Improvement Act of 1994 (12 U.S.C. 4803) requires the banking agencies
and the OTS to conduct a systematic review of their regulations and
written policies in order to improve efficiency, reduce unnecessary
costs, and eliminate inconsistencies. It also directs the four agencies
to work jointly to make uniform all regulations and guidelines
implementing common statutory or supervisory policies. The results of
these efforts must be ``consistent with the principles of safety and
soundness, statutory law and policy, and the public interest.''
Effective April 1, 1999, the four agencies amended their capital
standards to adopt a uniform minimum leverage capital requirement and
uniform risk-based capital standards for the treatment of presold
residential construction loans, junior liens on one-to-four family
residential properties, and investments in mutual funds.\1\ The four
agencies' ongoing efforts to eliminate other differences among their
regulatory capital standards are discussed in the following section.
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\1\ For further information on these previous differences in
capital standards, please refer to the FDIC's Report Regarding
Capital and Accounting Differences Among the Federal Banking and
Thrift Agencies for 1998 (64 FR 26962).
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B. Differences in Capital Standards Among the Federal Banking and
Thrift Agencies

B.1. Capital Requirements for Recourse Arrangements

B.1.a. Senior-Subordinated Structures--Some asset securitization
structures involve the creation of senior and subordinated classes of
securities or other financial instruments. When a bank originates such
a transaction and retains a subordinated interest, the banking agencies
generally require that the bank maintain risk-based capital against its
subordinated interest plus all more senior interests unless the low-
level recourse rule applies.\2\ However, when a bank purchases a
subordinated interest in a pool of assets that it did not own, the
banking agencies assign the investment in the subordinated interest to
the 100 percent risk weight category.
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\2\ When assets are sold with limited recourse, the banking and
thrift agencies' risk-based capital standards limit the amount of
capital that must be maintained against this exposure to the less of
the amount of the recourse retained (e.g., through the retention of
a subordinated interest) or the amount of risk-based capital that
would otherwise be required to be held against the assets that were
sold, i.e., the full effective risk-based capital charge. This is
known as the ``low-level recourse'' rule.
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In general, unless the low-level recourse rule applies, the OTS
requires a thrift that holds the subordinated interest in a senior-
subordinated structure to maintain capital against the subordinated
interest plus all more senior interests regardless of whether the
subordinated interest has been retained or has been purchased.
On March 8, 2000, the banking and thrift agencies published a
proposal that, among other provisions, generally would treat both
retained and purchased subordinated interests similarly for risk-based
capital purposes, i.e., banks and thrifts would be required to hold
capital against the subordinated interest plus all more senior
interests unless the low-level recourse rule applies. The proposal also
includes a multi-level approach for determining the capital
requirements for asset securitizations. The multi-level approach would
vary the risk-based capital requirements for positions in
securitizations, including subordinated interests, according to their
relative risk exposure. The comment period for the proposal ended on
June 7, 2000. After the agencies evaluate the comments received, they
will determine how to proceed with their joint proposal.
B.1.b. Recourse Servicing--The right to service loans and other
financial assets may be retained when the assets are sold. This right
also may be acquired from another entity. Regardless of whether
servicing rights are retained or acquired, recourse is present whenever
the servicer must absorb credit losses on the assets being serviced.
The banking agencies and the OTS require an institution to maintain
risk-based capital against the full amount of assets sold by the
institution if the institution, as servicer, must absorb credit losses
on those assets. Additionally, the OTS applies a capital charge to the
full amount of assets being serviced by a thrift that has purchased the
servicing from another party if the thrift is required to absorb credit
losses on the assets being serviced.
The agencies' March 2000 risk-based capital proposal would require
banks that purchase loan servicing rights which provide loss protection
to the owners of the serviced loans to begin to hold capital against
those loans, thereby making the risk-based capital treatment of these
servicing rights uniform for banks and savings associations. As
mentioned above, after evaluating the comments received on the
proposal, the agencies will determine how to proceed with the proposal.

B.2. Interest Rate Risk

Section 305 of the FDIC Improvement Act of 1991 mandates that the
agencies' risk-based capital standards take adequate account of
interest rate risk. In August 1995, each of the banking agencies
amended its capital standards to specifically include an assessment of
a bank's interest rate risk, as measured by its exposure to declines in
the economic value of its capital due to changes in interest rates, in
the evaluation of bank capital adequacy. In June 1996, the banking
agencies issued a Joint Agency Policy Statement on Interest Rate Risk
that provides guidance on sound practices for managing interest rate
risk. This policy statement does not establish a standardized measure
of interest rate risk nor does it create an explicit capital charge for
interest rate risk. Instead, the policy statement identifies the
standards that the banking agencies will use to evaluate the adequacy
and effectiveness of a bank's interest rate risk management.
In 1993, the OTS adopted a final rule that adds an interest rate
risk component to its risk-based capital standards. Under this rule,
savings associations with a greater than normal interest rate exposure
must take a deduction from the total capital available to meet their
risk-based capital requirement. The deduction is equal to one half of
the difference between the institution's actual measured exposure and
the normal level of exposure. The OTS has partially implemented this
rule by formalizing the review of interest rate risk; however, no
deductions from capital are being made. Thus, the regulatory capital
approach to interest rate risk adopted by the OTS differs from that of
the banking agencies.

B.3. Subsidiaries

The banking agencies generally consolidate all significant
majority-owned subsidiaries of the parent bank for regulatory capital
purposes. The purpose of this practice is to assure that capital
requirements are related to all of the risks to which the bank is
exposed. For subsidiaries that are not consolidated on a line-for-line
basis, their balance sheets may be consolidated on a pro-rata basis,
bank investments in such subsidiaries may be deducted entirely from
capital, or the investments may be risk-weighted at 100 percent,
depending upon the circumstances. These options for handling
subsidiaries for purposes of determining the capital adequacy of the
parent bank provide the banking agencies with the flexibility necessary
to ensure that institutions maintain capital levels that are
commensurate with the actual risks involved.
Under the OTS' capital guidelines, a statutorily mandated
distinction is drawn between subsidiaries engaged in activities that
are permissible for

[[Page 40666]]

national banks and subsidiaries engaged in ``impermissible'' activities
for national banks. For regulatory capital purposes, subsidiaries of
savings associations that engage only in permissible activities are
consolidated on a line-for-line basis, if majority-owned, and on a pro
rata basis, if ownership is between 5 percent and 50 percent. For
subsidiaries that engage in impermissible activities, investments in,
and loans to, such subsidiaries are deducted from assets and capital
when determining the capital adequacy of the parent.

B.4. Servicing Assets and Intangible Assets

The four agencies' capital rules permit servicing assets and
purchased credit card relationships to count toward capital
requirements, subject to certain limits. The aggregate regulatory
capital limit on these two categories of assets is 100 percent of Tier
1 capital. However, within this overall limit, nonmortgage servicing
assets are combined with purchased credit card relationships and this
combined amount is limited to no more than 25 percent of an
institution's Tier 1 capital. Before applying these Tier 1 capital
limits, mortgage servicing assets, nonmortgage servicing assets, and
purchased credit card relationships are each first limited to the
lesser of 90 percent of their fair value or 100 percent of their book
value (net of any valuation allowances). Any servicing assets and
purchased credit card relationships that exceed the relevant limits, as
well as all other intangible assets such as goodwill and core deposit
intangibles, are deducted from capital and assets in calculating an
institution's Tier 1 capital.
Although the four agencies' regulatory capital treatment of
servicing assets and intangible assets is fundamentally the same, the
OTS' capital rules contain two differences from the banking agencies'
rules in this area. However, with the passage of time, these two
differences have become relatively insignificant. Under its rules, the
OTS has grandfathered, i.e., does not deduct from regulatory capital,
(a) core deposit intangibles acquired before February 1994 up to 25
percent of Tier 1 capital and (b) all purchased mortgage servicing
rights acquired before February 1990.

B.5. Collateralized Transactions

The FRB and the OCC assign a zero percent risk weight to claims
collateralized by cash on deposit in the institution or by securities
issued or guaranteed by the U.S. Government or the central governments
of countries that are members of the Organization of Economic
Cooperation and Development (OECD), provided a positive margin of
collateral protection is maintained daily.
The FDIC and the OTS assign a 20 percent risk weight to claims
collateralized by cash on deposit in the institution or by securities
issued or guaranteed by the U.S. Government or OECD central
governments.
As part of the Section 303 review of their capital standards, the
banking and thrift agencies issued a joint proposal in August 1996 that
would permit collateralized claims that meet criteria that are uniform
among all four agencies to be eligible for a zero percent risk weight,
thereby eliminating the current difference among the agencies. In
general, this proposal would allow institutions supervised by the FDIC
and the OTS to hold less capital for transactions collateralized by
cash or U.S. or OECD government securities. The agencies are continuing
to discuss how they should proceed in order to implement a uniform
risk-based capital treatment for collateralized transactions. However,
due to the amount of time since the issuance of their 1996 joint
proposal, the agencies would likely need to issue another proposed rule
for collateralized transactions before they could move forward with a
final rule.

B.6. Noncumulative Perpetual Preferred Stock

Under the banking and thrift agencies' capital standards,
noncumulative perpetual preferred stock is a component of Tier 1
capital. The FDIC's capital standards define noncumulative perpetual
preferred stock as perpetual preferred stock where the issuer has the
option to waive the payment of dividends and where the dividends so
waived do not accumulate to future periods and do not represent a
contingent claim on the issuer. Under the FRB's capital standards,
perpetual preferred stock is noncumulative if the issuer has the
ability and legal right to defer or eliminate preferred dividends. For
these two agencies, for a perpetual preferred stock issue to be
considered noncumulative, the issue may not permit the accruing or
payment of unpaid dividends in any form, including the form of
dividends payable in common stock. Thus, if the issuer of perpetual
preferred stock is required to pay dividends in a form other than cash
when cash dividends are not or cannot be paid, the issuer does not have
the option to waive or eliminate dividends and the stock would not
qualify as noncumulative. The OCC's capital standards do not explicitly
define noncumulative perpetual preferred stock, but the OCC normally
has not considered perpetual preferred stock issues with this type of
dividend requirement to be noncumulative.
The OTS defines as noncumulative those issues of perpetual
preferred stock where the unpaid dividends are not carried over to
subsequent dividend periods. This definition does not address the
issuer's ability to waive dividends. As a result, the OTS has permitted
perpetual preferred stock issues that require the payment of dividends
in the form of stock in the issuer when cash dividends are not paid to
qualify as noncumulative.

B.7. Limitation on Subordinated Debt and Limited-Life Preferred Stock

Consistent with the Basel Accord, the internationally agreed-upon
risk-based capital framework which the banking agencies' risk-based
capital standards implement, the banking agencies limit the amount of
subordinated debt and intermediate-term preferred stock that may be
treated as part of Tier 2 capital to an amount not to exceed 50 percent
of Tier 1 capital. In addition, all maturing capital instruments must
be discounted by 20 percent in each of the last five years before
maturity. The banking agencies adopted this approach in order to
emphasize equity versus debt in the assessment of capital adequacy.
The OTS has no limitation on the ratio of maturing capital
instruments as part of Tier 2 capital. Furthermore, for all maturing
instruments issued after November 7, 1989, thrifts have the option of
using either (a) the discounting approach used by the banking
regulators, or (b) an approach which allows for the full inclusion of
all such instruments provided that the amount maturing in any one year
does not exceed 20 percent of the thrift's total capital. As for
maturing capital instruments issued on or before November 7, 1989, the
OTS has grandfathered them with respect to the discounting requirement.

B.8. Privately-Issued Mortgage-Backed Securities

The banking agencies, in general, place privately-issued mortgage-
backed securities in either the 50 percent or 100 percent risk-weight
category, depending upon the appropriate risk category of the
underlying assets. However, privately-issued mortgage-backed
securities, if collateralized by government agency or government-
sponsored agency securities, are generally assigned to the 20 percent
risk weight category.
The OTS assigns privately-issued high-quality mortgage-related
securities

[[Page 40667]]

to the 20 percent risk weight category. In general, these are
privately-issued mortgage-backed securities that are rated in one of
the two highest rating categories, e.g., AA or better, by at least one
nationally recognized statistical rating organization.
The four agencies' previously mentioned March 8, 2000, proposed
risk-based capital amendments include a multi-level approach for
determining the capital requirements for positions in securitizations,
including privately-issued mortgage-backed securities, according to
their relative risk exposure. Under this approach, mortgage-backed
securities in the two highest rating categories would be assigned to
the 20 percent risk category. If the agencies were to adopt this
approach in any final rule resulting from the proposal, this
interagency difference would be eliminated.

B.9. Nonresidential Construction and Land Loans

The banking agencies assign loans for nonresidential real estate
development and construction purposes to the 100 percent risk weight
category. The OTS generally assigns these loans to the same 100 percent
risk category. However, if the amount of the loan exceeds 80 percent of
the fair value of the property, the OTS deducts the excess portion from
assets and total capital.

B.10. ``Covered Assets''

The banking agencies generally place assets subject to guarantee
arrangements by the FDIC or the former Federal Savings and Loan
Insurance Corporation in the 20 percent risk weight category. The OTS
places these ``covered assets'' in the zero percent risk-weight
category.

B.11. Pledged Deposits and Nonwithdrawable Accounts

The OTS' capital standards permit savings associations to include
pledged deposits and nonwithdrawable accounts that meet OTS' criteria,
Income Capital Certificates, and Mutual Capital Certificates in
regulatory capital.
Instruments such as pledged deposits, nonwithdrawable accounts,
Income Capital Certificates, and Mutual Capital Certificates do not
exist in the banking industry and are not addressed in the banking
agencies' capital standards.

C. Differences in Accounting Standards Among the Federal Banking
and Thrift Agencies

C.1. Push Down Accounting

Push down accounting is the establishment of a new accounting basis
for a depository institution in its separate financial statements as a
result of a substantive change in control. Under push down accounting,
when a depository institution is acquired in a purchase (but not in a
pooling of interests), yet retains its separate corporate existence,
the assets and liabilities of the acquired institution are restated to
their fair values as of the acquisition date. These values, including
any goodwill, are reflected in the separate financial statements of the
acquired institution as well as in any consolidated financial
statements of the institution's parent.
The banking agencies require push down accounting when there is at
least a 95 percent change in ownership. This approach is generally
consistent with accounting interpretations issued by the staff of the
Securities and Exchange Commission.
The OTS requires push down accounting when there is at least a 90
percent change in ownership.

C.2. Negative Goodwill

Under Accounting Principles Board Opinion No. 16, ``Business
Combinations,'' negative goodwill arises when the fair value of the net
assets acquired in a purchase business combination exceeds the cost of
the acquisition and a portion of this excess remains after the values
otherwise assignable to the acquired noncurrent assets have been
reduced to zero.
The banking agencies require negative goodwill to be reported as a
liability on the balance sheet and do not permit it to be netted
against any goodwill that is included as an asset. This ensures that
all goodwill assets are deducted in regulatory capital calculations
consistent with the Basel Accord.
The OTS permits negative goodwill to offset goodwill assets on the
balance sheet.

Dated at Washington, D.C., this 26th day of June, 2000.