[Federal Register: January 6, 1997 (Volume 62, Number 3)]
[Notices]               
[Page 752-757]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr06ja97-65]
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FEDERAL DEPOSIT INSURANCE CORPORATION
 
Uniform Financial Institutions Rating System
AGENCY: Federal Deposit Insurance Corporation.
ACTION: Notice of adoption of policy statement.
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SUMMARY: The Board of Directors of the Federal Deposit Insurance 
Corporation (FDIC) (Board) has considered the proposed revisions to the 
Uniform Financial Institutions Rating System (UFIRS) as approved by the 
Federal Financial Institutions Examination Council (FFIEC) on December 
9, 1996. On December 20, 1996, the Board adopted the updated UFIRS as a 
policy statement of the FDIC and rescinded the 1979 statement of policy 
published in the FDIC's regulatory service (FDIC Law, Regulations and 
Related Acts) at page 5079.
EFFECTIVE DATE: January 1, 1997.
FOR FURTHER INFORMATION CONTACT: Daniel M. Gautsch, Examination 
Specialist, (202) 898-6912, Office of Policy, Division of Supervision. 
For legal issues, Linda L. Stamp, Counsel, (202) 898-7310, Supervision 
and Legislation Branch, Federal Deposit Insurance Corporation, 550 17th 
Street NW, Washington, D.C. 20429.
SUPPLEMENTARY INFORMATION: The FDIC is a Federal financial institutions 
regulatory agency under the Federal Financial Institutions Examination 
Council Act of 1978. The FFIEC adopted an updated UFIRS after a notice 
and request for comment was published in the Federal Register on July 
18, 1996 at 61 FR 37472. On December 9, 1996, the Task Force on 
Supervision of the FFIEC approved under delegated authority the updated 
UFIRS to update the rating system to address changes in the financial 
services industry and in supervisory policies and procedures occurring 
since the rating system was adopted in 1979.
    Section 303(a)(2) of the Riegle Community Development and 
Regulatory Improvement Act of 1994 (12 U.S.C. 4803(a)) (Riegle Act) 
provides that the FDIC shall, consistent with the principles of safety 
and soundness, statutory law and policy, and the public interest, work 
jointly to make uniform all regulations and guidelines implementing 
common statutory or supervisory policies. Section 303(a)(1) of the 
Riegle Act requires the FDIC to review its own regulations and written 
policies and to streamline those regulations and policies where 
possible. To fulfill the section 303 mandate, the FDIC has been 
reviewing on an interagency basis and internally, its regulations and 
written policies to identify those areas where streamlining or updating 
is appropriate. As a result of those reviews, the FDIC is adopting the 
updated UFIRS effective for examination commenced on or after January 
1, 1997.
    The text of the policy statement follows:
Uniform Financial Institutions Rating System
Introduction
    The Uniform Financial Institutions Rating System (UFIRS) was 
adopted by the Federal Financial Institutions Examination Council 
(FFIEC) on November 13, 1979. Over the years, the UFIRS has proven to 
be an effective internal supervisory tool for evaluating the soundness 
of financial institutions on a uniform basis and for identifying those 
institutions requiring special attention or concern. A number of 
changes, however, have occurred in the banking industry and in the 
Federal supervisory agencies' policies and procedures which have 
prompted a review and revision of the 1979 rating system. The revisions 
to UFIRS include the addition of a sixth component addressing 
sensitivity to market risks, the explicit reference to the quality of 
risk management processes in the management component, and the 
identification of risk elements within the composite and component 
rating descriptions.
    The revisions to UFIRS are not intended to add to the regulatory 
burden of institutions or require additional policies or processes. The 
revisions are intended to promote and complement efficient examination 
processes. The revisions have been made to update the rating system, 
while retaining the basic framework of the original rating system.
    The UFIRS takes into consideration certain financial, managerial, 
and compliance factors that are common to all institutions. Under this 
system, the supervisory agencies endeavor to ensure that all financial 
institutions are evaluated in a comprehensive and uniform manner, and 
that supervisory attention is appropriately focused on the financial 
institutions exhibiting financial and operational weaknesses or adverse 
trends.
    The UFIRS also serves as a useful vehicle for identifying problem 
or deteriorating financial institutions, as well as for categorizing 
institutions with deficiencies in particular component areas. Further, 
the rating system assists Congress in following safety and soundness 
trends and in assessing the aggregate strength and soundness of the 
financial industry. As such, the UFIRS assists the agencies in 
fulfilling their collective mission of maintaining stability and public 
confidence in the nation's financial system.
Overview
    Under the UFIRS, each financial institution is assigned a composite 
rating based on an evaluation and rating of six essential components of 
an institution's financial condition and operations. These component 
factors address the adequacy of capital, the quality of assets, the 
capability of management, the quality and level of earnings, the 
adequacy of liquidity, and the sensitivity to market risk. Evaluations 
of the components take into consideration the institution's size and 
sophistication, the nature and complexity of its activities, and its 
risk profile.
    Composite and component ratings are assigned based on a 1 to 5 
numerical scale. A 1 indicates the highest rating, strongest 
performance and risk management practices, and least degree of 
supervisory concern, while a 5 indicates the lowest rating, weakest 
performance, inadequate risk management practices and, therefore, the 
highest degree of supervisory concern.
    The composite rating generally bears a close relationship to the 
component ratings assigned. However, the composite rating is not 
derived by computing an arithmetic average of the component ratings. 
Each component rating is based on a qualitative analysis of the factors 
comprising that component and its interrelationship with the other 
components. When assigning a composite rating, some components may be 
given more weight than others depending on the situation at the 
institution. In general, assignment of a composite rating may 
incorporate any factor that bears significantly on the overall 
condition and soundness of the financial institution. Assigned 
composite and component ratings are disclosed to the institution's 
board of directors and senior management.
    The ability of management to respond to changing circumstances and 
to address the risks that may arise from
[[Page 753]]
changing business conditions, or the initiation of new activities or 
products, is an important factor in evaluating a financial 
institution's overall risk profile and the level of supervisory 
attention warranted. For this reason, the management component is given 
special consideration when assigning a composite rating.
    The ability of management to identify, measure, monitor, and 
control the risks of its operations is also taken into account when 
assigning each component rating. It is recognized, however, that 
appropriate management practices vary considerably among financial 
institutions, depending on their size, complexity, and risk profile. 
For less complex institutions engaged solely in traditional banking 
activities and whose directors and senior managers, in their respective 
roles, are actively involved in the oversight and management of day-to-
day operations, relatively basic management systems and controls may be 
adequate. At more complex institutions, on the other hand, detailed and 
formal management systems and controls are needed to address their 
broader range of financial activities and to provide senior managers 
and directors, in their respective roles, with the information they 
need to monitor and direct day-to-day activities. All institutions are 
expected to properly manage their risks. For less complex institutions 
engaging in less sophisticated risk taking activities, detailed or 
highly formalized management systems and controls are not required to 
receive strong or satisfactory component or composite ratings.
    Foreign Branch and specialty examination findings and the ratings 
assigned to those areas are taken into consideration, as appropriate, 
when assigning component and composite ratings under UFIRS. The 
specialty examination areas include: Compliance, Community 
Reinvestment, Government Security Dealers, Information Systems, 
Municipal Security Dealers, Transfer Agent, and Trust.
    The following two sections contain the composite rating 
definitions, and the descriptions and definitions for the six component 
ratings.
Composite Ratings
    Composite ratings are based on a careful evaluation of an 
institution's managerial, operational, financial, and compliance 
performance. The six key components used to assess an institution's 
financial condition and operations are: capital adequacy, asset 
quality, management capability, earnings quantity and quality, the 
adequacy of liquidity, and sensitivity to market risk. The rating scale 
ranges from 1 to 5, with a rating of 1 indicating: the strongest 
performance and risk management practices relative to the institution's 
size, complexity, and risk profile; and the level of least supervisory 
concern. A 5 rating indicates: the most critically deficient level of 
performance; inadequate risk management practices relative to the 
institution's size, complexity, and risk profile; and the greatest 
supervisory concern. The composite ratings are defined as follows:
Composite 1
    Financial institutions in this group are sound in every respect and 
generally have components rated 1 or 2. Any weaknesses are minor and 
can be handled in a routine manner by the board of directors and 
management. These financial institutions are the most capable of 
withstanding the vagaries of business conditions and are resistant to 
outside influences such as economic instability in their trade area. 
These financial institutions are in substantial compliance with laws 
and regulations. As a result, these financial institutions exhibit the 
strongest performance and risk management practices relative to the 
institution's size, complexity, and risk profile, and give no cause for 
supervisory concern.
Composite 2
    Financial institutions in this group are fundamentally sound. For a 
financial institution to receive this rating, generally no component 
rating should be more severe than 3. Only moderate weaknesses are 
present and are well within the board of directors' and management's 
capabilities and willingness to correct. These financial institutions 
are stable and are capable of withstanding business fluctuations. These 
financial institutions are in substantial compliance with laws and 
regulations. Overall risk management practices are satisfactory 
relative to the institution's size, complexity, and risk profile. There 
are no material supervisory concerns and, as a result, the supervisory 
response is informal and limited.
Composite 3
    Financial institutions in this group exhibit some degree of 
supervisory concern in one or more of the component areas. These 
financial institutions exhibit a combination of weaknesses that may 
range from moderate to severe; however, the magnitude of the 
deficiencies generally will not cause a component to be rated more 
severely than 4. Management may lack the ability or willingness to 
effectively address weaknesses within appropriate time frames. 
Financial institutions in this group generally are less capable of 
withstanding business fluctuations and are more vulnerable to outside 
influences than those institutions rated a composite 1 or 2.
    Additionally, these financial institutions may be in significant 
noncompliance with laws and regulations. Risk management practices may 
be less than satisfactory relative to the institution's size, 
complexity, and risk profile. These financial institutions require more 
than normal supervision, which may include formal or informal 
enforcement actions. Failure appears unlikely, however, given the 
overall strength and financial capacity of these institutions.
Composite 4
    Financial institutions in this group generally exhibit unsafe and 
unsound practices or conditions. There are serious financial or 
managerial deficiencies that result in unsatisfactory performance. The 
problems range from severe to critically deficient. The weaknesses and 
problems are not being satisfactorily addressed or resolved by the 
board of directors and management. Financial institutions in this group 
generally are not capable of withstanding business fluctuations. There 
may be significant noncompliance with laws and regulations. Risk 
management practices are generally unacceptable relative to the 
institution's size, complexity, and risk profile. Close supervisory 
attention is required, which means, in most cases, formal enforcement 
action is necessary to address the problems. Institutions in this group 
pose a risk to the deposit insurance fund. Failure is a distinct 
possibility if the problems and weaknesses are not satisfactorily 
addressed and resolved.
Composite 5
    Financial institutions in this group exhibit extremely unsafe and 
unsound practices or conditions; exhibit a critically deficient 
performance; often contain inadequate risk management practices 
relative to the institution's size, complexity, and risk profile; and 
are of the greatest supervisory concern. The volume and severity of 
problems are beyond management's ability or willingness to control or 
correct. Immediate outside financial or other assistance is needed in 
order for the financial institution to be viable. Ongoing supervisory 
attention is necessary. Institutions in this group
[[Page 754]]
pose a significant risk to the deposit insurance fund and failure is 
highly probable.
Component Ratings
    Each of the component rating descriptions is divided into three 
sections: an introductory paragraph; a list of the principal evaluation 
factors that relate to that component; and a brief description of each 
numerical rating for that component. Some of the evaluation factors are 
reiterated under one or more of the other components to reinforce the 
interrelationship between components. The listing of evaluation factors 
for each component rating is in no particular order of importance.
Capital Adequacy
    A financial institution is expected to maintain capital 
commensurate with the nature and extent of risks to the institution and 
the ability of management to identify, measure, monitor, and control 
these risks. The effect of credit, market, and other risks on the 
institution's financial condition should be considered when evaluating 
the adequacy of capital. The types and quantity of risk inherent in an 
institution's activities will determine the extent to which it may be 
necessary to maintain capital at levels above required regulatory 
minimums to properly reflect the potentially adverse consequences that 
these risks may have on the institution's capital.
    The capital adequacy of an institution is rated based upon, but not 
limited to, an assessment of the following evaluation factors:
    <bullet> The level and quality of capital and the overall financial 
condition of the institution.
    <bullet> The ability of management to address emerging needs for 
additional capital.
    <bullet> The nature, trend, and volume of problem assets, and the 
adequacy of allowances for loan and lease losses and other valuation 
reserves.
    <bullet> Balance sheet composition, including the nature and amount 
of intangible assets, market risk, concentration risk, and risks 
associated with nontraditional activities.
    <bullet> Risk exposure represented by off-balance sheet activities.
    <bullet> The quality and strength of earnings, and the 
reasonableness of dividends.
    <bullet> Prospects and plans for growth, as well as past experience 
in managing growth.
    <bullet> Access to capital markets and other sources of capital, 
including support provided by a parent holding company.
Ratings
    1  A rating of 1 indicates a strong capital level relative to the 
institution's risk profile.
    2  A rating of 2 indicates a satisfactory capital level relative to 
the financial institution's risk profile.
    3  A rating of 3 indicates a less than satisfactory level of 
capital that does not fully support the institution's risk profile. The 
rating indicates a need for improvement, even if the institution's 
capital level exceeds minimum regulatory and statutory requirements.
    4  A rating of 4 indicates a deficient level of capital. In light 
of the institution's risk profile, viability of the institution may be 
threatened. Assistance from shareholders or other external sources of 
financial support may be required.
    5  A rating of 5 indicates a critically deficient level of capital 
such that the institution's viability is threatened. Immediate 
assistance from shareholders or other external sources of financial 
support is required.
Asset Quality
    The asset quality rating reflects the quantity of existing and 
potential credit risk associated with the loan and investment 
portfolios, other real estate owned, and other assets, as well as off- 
balance sheet transactions. The ability of management to identify, 
measure, monitor, and control credit risk is also reflected here. The 
evaluation of asset quality should consider the adequacy of the 
allowance for loan and lease losses and weigh the exposure to 
counterparty, issuer, or borrower default under actual or implied 
contractual agreements. All other risks that may affect the value or 
marketability of an institution's assets, including, but not limited 
to, operating, market, reputation, strategic, or compliance risks, 
should also be considered.
    The asset quality of a financial institution is rated based upon, 
but not limited to, an assessment of the following evaluation factors:
    <bullet> The adequacy of underwriting standards, soundness of 
credit administration practices, and appropriateness of risk 
identification practices.
    <bullet> The level, distribution, severity, and trend of problem, 
classified, nonaccrual, restructured, delinquent, and nonperforming 
assets for both on- and off-balance sheet transactions.
    <bullet> The adequacy of the allowance for loan and lease losses 
and other asset valuation reserves.
    <bullet> The credit risk arising from or reduced by off-balance 
sheet transactions, such as unfunded commitments, credit derivatives, 
commercial and standby letters of credit, and lines of credit.
    <bullet> The diversification and quality of the loan and investment 
portfolios.
    <bullet> The extent of securities underwriting activities and 
exposure to counterparties in trading activities.
    <bullet> The existence of asset concentrations.
    <bullet> The adequacy of loan and investment policies, procedures, 
and practices.
    <bullet> The ability of management to properly administer its 
assets, including the timely identification and collection of problem 
assets.
    <bullet> The adequacy of internal controls and management 
information systems.
    <bullet> The volume and nature of credit documentation exceptions.
Ratings
    1  A rating of 1 indicates strong asset quality and credit 
administration practices. Identified weaknesses are minor in nature and 
risk exposure is modest in relation to capital protection and 
management's abilities. Asset quality in such institutions is of 
minimal supervisory concern.
    2  A rating of 2 indicates satisfactory asset quality and credit 
administration practices. The level and severity of classifications and 
other weaknesses warrant a limited level of supervisory attention. Risk 
exposure is commensurate with capital protection and management's 
abilities.
    3  A rating of 3 is assigned when asset quality or credit 
administration practices are less than satisfactory. Trends may be 
stable or indicate deterioration in asset quality or an increase in 
risk exposure. The level and severity of classified assets, other 
weaknesses, and risks require an elevated level of supervisory concern. 
There is generally a need to improve credit administration and risk 
management practices.
    4  A rating of 4 is assigned to financial institutions with 
deficient asset quality or credit administration practices. The levels 
of risk and problem assets are significant, inadequately controlled, 
and subject the financial institution to potential losses that, if left 
unchecked, may threaten its viability.
    5  A rating of 5 represents critically deficient asset quality or 
credit administration practices that present an imminent threat to the 
institution's viability.
Management
    The capability of the board of directors and management, in their
[[Page 755]]
respective roles, to identify, measure, monitor, and control the risks 
of an institution's activities and to ensure a financial institution's 
safe, sound, and efficient operation in compliance with applicable laws 
and regulations is reflected in this rating. Generally, directors need 
not be actively involved in day-to-day operations; however, they must 
provide clear guidance regarding acceptable risk exposure levels and 
ensure that appropriate policies, procedures, and practices have been 
established. Senior management is responsible for developing and 
implementing policies, procedures, and practices that translate the 
board's goals, objectives, and risk limits into prudent operating 
standards.
    Depending on the nature and scope of an institution's activities, 
management practices may need to address some or all of the following 
risks: credit, market, operating or transaction, reputation, strategic, 
compliance, legal, liquidity, and other risks. Sound management 
practices are demonstrated by: active oversight by the board of 
directors and management; competent personnel; adequate policies, 
processes, and controls taking into consideration the size and 
sophistication of the institution; maintenance of an appropriate audit 
program and internal control environment; and effective risk monitoring 
and management information systems. This rating should reflect the 
board's and management's ability as it applies to all aspects of 
banking operations as well as other financial service activities in 
which the institution is involved.
    The capability and performance of management and the board of 
directors is rated based upon, but not limited to, an assessment of the 
following evaluation factors:
    <bullet> The level and quality of oversight and support of all 
institution activities by the board of directors and management.
    <bullet> The ability of the board of directors and management, in 
their respective roles, to plan for, and respond to, risks that may 
arise from changing business conditions or the initiation of new 
activities or products.
    <bullet> The adequacy of, and conformance with, appropriate 
internal policies and controls addressing the operations and risks of 
significant activities.
    <bullet> The accuracy, timeliness, and effectiveness of management 
information and risk monitoring systems appropriate for the 
institution's size, complexity, and risk profile.
    <bullet> The adequacy of audits and internal controls to: promote 
effective operations and reliable financial and regulatory reporting; 
safeguard assets; and ensure compliance with laws, regulations, and 
internal policies.
    <bullet> Compliance with laws and regulations.
    <bullet> Responsiveness to recommendations from auditors and 
supervisory authorities.
    <bullet> Management depth and succession.
    <bullet> The extent that the board of directors and management is 
affected by, or susceptible to, dominant influence or concentration of 
authority.
    <bullet> Reasonableness of compensation policies and avoidance of 
self-dealing.
    <bullet> Demonstrated willingness to serve the legitimate banking 
needs of the community.
    <bullet> The overall performance of the institution and its risk 
profile.
Ratings
    1  A rating of 1 indicates strong performance by management and the 
board of directors and strong risk management practices relative to the 
institution's size, complexity, and risk profile. All significant risks 
are consistently and effectively identified, measured, monitored, and 
controlled. Management and the board have demonstrated the ability to 
promptly and successfully address existing and potential problems and 
risks.
    2  A rating of 2 indicates satisfactory management and board 
performance and risk management practices relative to the institution's 
size, complexity, and risk profile. Minor weaknesses may exist, but are 
not material to the safety and soundness of the institution and are 
being addressed. In general, significant risks and problems are 
effectively identified, measured, monitored, and controlled.
    3  A rating of 3 indicates management and board performance that 
need improvement or risk management practices that are less than 
satisfactory given the nature of the institution's activities. The 
capabilities of management or the board of directors may be 
insufficient for the type, size, or condition of the institution. 
Problems and significant risks may be inadequately identified, 
measured, monitored, or controlled.
    4  A rating of 4 indicates deficient management and board 
performance or risk management practices that are inadequate 
considering the nature of an institution's activities. The level of 
problems and risk exposure is excessive. Problems and significant risks 
are inadequately identified, measured, monitored, or controlled and 
require immediate action by the board and management to preserve the 
soundness of the institution. Replacing or strengthening management or 
the board may be necessary.
    5  A rating of 5 indicates critically deficient management and 
board performance or risk management practices. Management and the 
board of directors have not demonstrated the ability to correct 
problems and implement appropriate risk management practices. Problems 
and significant risks are inadequately identified, measured, monitored, 
or controlled and now threaten the continued viability of the 
institution. Replacing or strengthening management or the board of 
directors is necessary.
Earnings
    This rating reflects not only the quantity and trend of earnings, 
but also factors that may affect the sustainability or quality of 
earnings. The quantity as well as the quality of earnings can be 
affected by excessive or inadequately managed credit risk that may 
result in loan losses and require additions to the allowance for loan 
and lease losses, or by high levels of market risk that may unduly 
expose an institution's earnings to volatility in interest rates. The 
quality of earnings may also be diminished by undue reliance on 
extraordinary gains, nonrecurring events, or favorable tax effects. 
Future earnings may be adversely affected by an inability to forecast 
or control funding and operating expenses, improperly executed or ill-
advised business strategies, or poorly managed or uncontrolled exposure 
to other risks.
    The rating of an institution's earnings is based upon, but not 
limited to, an assessment of the following evaluation factors:
    <bullet> The level of earnings, including trends and stability.
    <bullet> The ability to provide for adequate capital through 
retained earnings.
    <bullet> The quality and sources of earnings.
    <bullet> The level of expenses in relation to operations.
    <bullet> The adequacy of the budgeting systems, forecasting 
processes, and management information systems in general.
    <bullet> The adequacy of provisions to maintain the allowance for 
loan and lease losses and other valuation allowance accounts.
    <bullet> The earnings exposure to market risk such as interest 
rate, foreign exchange, and price risks.
Ratings
    1  A rating of 1 indicates earnings that are strong. Earnings are 
more than sufficient to support operations and maintain adequate 
capital and allowance levels after consideration is
[[Page 756]]
given to asset quality, growth, and other factors affecting the 
quality, quantity, and trend of earnings.
    2  A rating of 2 indicates earnings that are satisfactory. Earnings 
are sufficient to support operations and maintain adequate capital and 
allowance levels after consideration is given to asset quality, growth, 
and other factors affecting the quality, quantity, and trend of 
earnings. Earnings that are relatively static, or even experiencing a 
slight decline, may receive a 2 rating provided the institution's level 
of earnings is adequate in view of the assessment factors listed above.
    3  A rating of 3 indicates earnings that need to be improved. 
Earnings may not fully support operations and provide for the accretion 
of capital and allowance levels in relation to the institution's 
overall condition, growth, and other factors affecting the quality, 
quantity, and trend of earnings.
    4  A rating of 4 indicates earnings that are deficient. Earnings 
are insufficient to support operations and maintain appropriate capital 
and allowance levels. Institutions so rated may be characterized by 
erratic fluctuations in net income or net interest margin, the 
development of significant negative trends, nominal or unsustainable 
earnings, intermittent losses, or a substantive drop in earnings from 
the previous years.
    5  A rating of 5 indicates earnings that are critically deficient. 
A financial institution with earnings rated 5 is experiencing losses 
that represent a distinct threat to its viability through the erosion 
of capital.
Liquidity
    In evaluating the adequacy of a financial institution's liquidity 
position, consideration should be given to the current level and 
prospective sources of liquidity compared to funding needs, as well as 
to the adequacy of funds management practices relative to the 
institution's size, complexity, and risk profile. In general, funds 
management practices should ensure that an institution is able to 
maintain a level of liquidity sufficient to meet its financial 
obligations in a timely manner and to fulfill the legitimate banking 
needs of its community. Practices should reflect the ability of the 
institution to manage unplanned changes in funding sources, as well as 
react to changes in market conditions that affect the ability to 
quickly liquidate assets with minimal loss. In addition, funds 
management practices should ensure that liquidity is not maintained at 
a high cost, or through undue reliance on funding sources that may not 
be available in times of financial stress or adverse changes in market 
conditions.
    Liquidity is rated based upon, but not limited to, an assessment of 
the following evaluation factors:
    <bullet> The adequacy of liquidity sources compared to present and 
future needs and the ability of the institution to meet liquidity needs 
without adversely affecting its operations or condition.
    <bullet> The availability of assets readily convertible to cash 
without undue loss.
    <bullet> Access to money markets and other sources of funding.
    <bullet> The level of diversification of funding sources, both on- 
and off-balance sheet.
    <bullet> The degree of reliance on short-term, volatile sources of 
funds, including borrowings and brokered deposits, to fund longer term 
assets.
    <bullet> The trend and stability of deposits.
    <bullet> The ability to securitize and sell certain pools of 
assets.
    <bullet> The capability of management to properly identify, 
measure, monitor, and control the institution's liquidity position, 
including the effectiveness of funds management strategies, liquidity 
policies, management information systems, and contingency funding 
plans.
Ratings
    1  A rating of 1 indicates strong liquidity levels and well-
developed funds management practices. The institution has reliable 
access to sufficient sources of funds on favorable terms to meet 
present and anticipated liquidity needs.
    2  A rating of 2 indicates satisfactory liquidity levels and funds 
management practices. The institution has access to sufficient sources 
of funds on acceptable terms to meet present and anticipated liquidity 
needs. Modest weaknesses may be evident in funds management practices.
    3  A rating of 3 indicates liquidity levels or funds management 
practices in need of improvement. Institutions rated 3 may lack ready 
access to funds on reasonable terms or may evidence significant 
weaknesses in funds management practices.
    4  A rating of 4 indicates deficient liquidity levels or inadequate 
funds management practices. Institutions rated 4 may not have or be 
able to obtain a sufficient volume of funds on reasonable terms to meet 
liquidity needs.
    5  A rating of 5 indicates liquidity levels or funds management 
practices so critically deficient that the continued viability of the 
institution is threatened. Institutions rated 5 require immediate 
external financial assistance to meet maturing obligations or other 
liquidity needs.
Sensitivity to Market Risk
    The sensitivity to market risk component reflects the degree to 
which changes in interest rates, foreign exchange rates, commodity 
prices, or equity prices can adversely affect a financial institution's 
earnings or economic capital. When evaluating this component, 
consideration should be given to: management's ability to identify, 
measure, monitor, and control market risk; the institution's size; the 
nature and complexity of its activities; and the adequacy of its 
capital and earnings in relation to its level of market risk exposure.
    For many institutions, the primary source of market risk arises 
from nontrading positions and their sensitivity to changes in interest 
rates. In some larger institutions, foreign operations can be a 
significant source of market risk. For some institutions, trading 
activities are a major source of market risk.
    Market risk is rated based upon, but not limited to, an assessment 
of the following evaluation factors:
    <bullet> The sensitivity of the financial institution's earnings or 
the economic value of its capital to adverse changes in interest rates, 
foreign exchange rates, commodity prices, or equity prices.
    <bullet> The ability of management to identify, measure, monitor, 
and control exposure to market risk given the institution's size, 
complexity, and risk profile.
    <bullet> The nature and complexity of interest rate risk exposure 
arising from nontrading positions.
    <bullet> Where appropriate, the nature and complexity of market 
risk exposure arising from trading and foreign operations.
Ratings
    1  A rating of 1 indicates that market risk sensitivity is well 
controlled and that there is minimal potential that the earnings 
performance or capital position will be adversely affected. Risk 
management practices are strong for the size, sophistication, and 
market risk accepted by the institution. The level of earnings and 
capital provide substantial support for the degree of market risk taken 
by the institution.
    2  A rating of 2 indicates that market risk sensitivity is 
adequately controlled and that there is only moderate potential that 
the earnings performance or capital position will be adversely 
affected. Risk management practices are satisfactory for the size, 
sophistication, and market risk accepted by the
[[Page 757]]
institution. The level of earnings and capital provide adequate support 
for the degree of market risk taken by the institution.
    3  A rating of 3 indicates that control of market risk sensitivity 
needs improvement or that there is significant potential that the 
earnings performance or capital position will be adversely affected. 
Risk management practices need to be improved given the size, 
sophistication, and level of market risk accepted by the institution. 
The level of earnings and capital may not adequately support the degree 
of market risk taken by the institution.
    4  A rating of 4 indicates that control of market risk sensitivity 
is unacceptable or that there is high potential that the earnings 
performance or capital position will be adversely affected. Risk 
management practices are deficient for the size, sophistication, and 
level of market risk accepted by the institution. The level of earnings 
and capital provide inadequate support for the degree of market risk 
taken by the institution.
    5  A rating of 5 indicates that control of market risk sensitivity 
is unacceptable or that the level of market risk taken by the 
institution is an imminent threat to its viability. Risk management 
practices are wholly inadequate for the size, sophistication, and level 
of market risk accepted by the institution.
    By Order of the Board of Directors dated at Washington, D.C., 
this 20th day of December, 1996.
Federal Deposit Insurance Corporation.
Jerry L. Langley,
Executive Secretary.
[FR Doc. 97-155 Filed 1-3-97; 8:45 am]
BILLING CODE 6714-01-P

Last Updated 04/25/1997 regs@fdic.gov