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E. Derivative Contracts (Interest Rate, Exchange Rate, Commodity (including precious metal) and Equity Derivative Contracts) 1. Credit equivalent amounts are computed for each of the following off-balance-sheet derivative contracts: (a) Interest Rate Contracts (i) Single currency interest rate swaps. (ii) Basis swaps. (iii) Forward rate agreements. (iv) Interest rate options purchased (including caps, collars, and floors purchased). (v) Any other instrument linked to interest rates that gives rise to similar credit risks (including when-issued securities and forward deposits accepted). (b) Exchange Rate Contracts (i) Cross-currency interest rate swaps. (ii) Forward foreign exchange contracts. (iii) Currency options purchased. (iv) Any other instrument linked to exchange rates that gives rise to similar credit risks. (c) Commodity (including precious metal) or Equity Derivative Contracts (i) Commodity- or equity-linked swaps. (ii) Commodity- or equity-linked options purchased. (iii) Forward commodity- or equity-linked contracts. (iv) Any other instrument linked to commodities or equities that gives rise to similar credit risks. 2. Exchange rate contracts with an original maturity of 14 calendar days or less and derivative contracts traded on exchanges that require daily receipt and payment of cash variation margin may be excluded from the risk-based ratio calculation. Gold contracts are accorded the same treatment as exchange rate contracts except gold contracts with an original maturity of 14 calendar days or less are included in the risk-based calculation. Over-the-counter options purchased are included and treated in the same way as other derivative contracts. 3. Credit Equivalent Amounts for Derivative Contracts. (a) The credit equivalent amount of a derivative contract that is not subject to a qualifying bilateral netting contract in accordance with section II.E.5. of this appendix A is equal to the sum of: (i) The current exposure (which is equal to the mark-to-market value,{40} {40Mark-to-market values are measured in dollars, regardless of the currency or currencies specified in the contract and should reflect changes in both underlying rates, prices and indices, and counterparty credit quality. } if positive, and is sometimes referred to as the replacement cost) of the contract; and {{10-31-95 p.2262.03}} (ii) An estimate of the potential future credit exposure. (b) The current exposure is determined by the mark-to-market value of the contract. If the mark-to-market value is positive, then the current exposure is equal to that mark-to-market value. If the mark-to-market value is zero or negative, then the current exposure is zero. (c) The potential future credit exposure of a contract, including a contract with a negative mark-to-market value, is estimated by multiplying the notional principal amount of the contract by a credit conversion factor. Banks should, subject to examiner review, use the effective rather than the apparent or stated notional amount in this calculation. The credit conversion factors are:
(d) For contracts that are structured to settle outstanding exposure on specified dates and where the terms are reset such that the market value of the contract is zero on these specified dates, the remaining maturity is equal to the time until the next reset date. For interest rate contracts with remaining maturities of more than one year and that meet these criteria, the conversion factor is subject to a minimum value of 0.5 percent. (e) For contracts with multiple exchanges of principal, the conversion factors are to be multiplied by the number of remaining payments in the contract. Derivative contracts not explicitly covered by any of the columns of the conversion factor matrix are to be treated as "other commodities." (f) No potential future exposure is calculated for single currency interest rate swaps in which payments are made based upon two floating rate indices (so called floating/floating or basis swaps); the credit exposure on these contracts is evaluated solely on the basis of their mark-to-market values. 4. Risk Weights and Avoidance of Double Counting. (a) Once the credit equivalent amount for a derivative contract, or a group of derivative contracts subject to a qualifying bilateral netting agreement, has been determined, that amount is assigned to the risk category appropriate to the counterparty, or, if relevant, the guarantor or the nature of any collateral. However, the maximum weight that will be applied to the credit equivalent amount of such contracts is 50 percent. (b) In certain cases, credit exposures arising from the derivative contracts covered by these guidelines may already be reflected, in part, on the balance sheet. To avoid double counting such exposures in the assessment of capital adequacy and, perhaps, assigning inappropriate risk weights, counterparty credit exposures arising from the types of instruments covered by these guidelines may need to be excluded from balance sheet assets in calculating a bank's risk-based capital ratio. (c) The FDIC notes that the conversion factors set forth in section II.E.3. of appendix A, which are based on observed volatilities of the particular types of instruments, are subject to review and modification in light of changing volatilities or market conditions. (d) Examples of the calculation of credit equivalent amounts for these types of contracts are contained in Table IV of this appendix A. 5. Netting. (a) For purposes of this appendix A, netting refers to the offsetting of positive and negative mark-to-market values when determining a current exposure to be used in the calculation of a credit equivalent amount. Any legally enforceable form of {{10-31-95 p.2262.04}}bilateral netting (that is, netting with a single counterparty) of derivative contracts is recognized for purposes of calculating the credit equivalent amount provided that: (i) The netting is accomplished under a written netting contract that creates a single legal obligation, covering all included individual contracts, with the effect that the bank would have a claim or obligation to receive or pay, respectively, only the net amount of the sum of the positive and negative mark-to-market values on included individual contracts in the event that a counterparty, or a counterparty to whom the contract has been validly assigned, fails to perform due to default, bankruptcy, liquidation, or similar circumstances; (ii) The bank obtains a written and reasoned legal opinion(s) representing that in the event of a legal challenge, including one resulting from default, insolvency, bankruptcy or similar circumstances, the relevant court and administrative authorities would find the bank's exposure to be such a net amount under: (1) The law of the jurisdiction in which the counterparty is chartered or the equivalent location in the case of noncorporate entities and, if a branch of the counterparty is involved, then also under the law of the jurisdiction in which the branch is located; (2) The law that governs the individual contracts covered by the netting contract; and (3) The law that governs the netting contract. (iii) The bank establishes and maintains procedures to ensure that the legal characteristics of netting contracts are kept under review in the light of possible changes in relevant law; and (iv) The bank maintains in its file documentation adequate to support the netting of derivative contracts, including a copy of the bilateral netting contract and necessary legal opinions. (b) A contract containing a walkaway clause is not eligible for netting for purposes of calculating the credit equivalent amount.{41} {41For purposes of this section, a walkaway clause means a provision in a neetting contract that permits a non-defaulting counterparty to make lower payments than it would make otherwise under the contract, or no payment at all, to a defaulter or to the estate of a defaulter, even if a defaulter or the estate of a defaulter is a net creditor under the contract.} (c) By netting individual contracts for the purpose of calculating its credit equivalent amount, a bank represents that it has met the requirements of this appendix A and all the appropriate documents are in the bank's files and available for inspection by the FDIC. Upon determination by the FDIC that a bank's files are inadequate or that a netting contract may not be legally enforceable under any one of the bodies of law described in paragraphs (ii)(1) through (3) of section II.E.5.(a) of this appendix A, underlying individual contracts may be treated as though they were not subject to the netting contract. (d) The credit equivalent amount of derivative contracts that are subject to a qualifying bilateral netting contract is calculated by adding: (i) The net current exposure of the netting contract; and (ii) The sum of the estimates of potential future exposure for all individual contractors subject to the netting contract, adjusted to take into account the effects of the netting contract.{42} {42For purposes of calculating potential future credit exposure for foreign exchange contracts and other similar contracts in which notional principal is equivalent to cash flows, total notional principal is defined as the net receipts to each party falling due on each value date in each currency.} (e) The net current exposure is the sum of all positive and negative mark-to-market values of the individual contracts subject to the netting contract. If the net sum of the mark-to-market values is positive, then the net current exposure is equal to that sum. If the net sum of the mark-to-market values is zero or negative, then the net current exposure is zero. (f) The effects of the bilateral netting contract on the gross potential future exposure are recognized through application of a formula, resulting in an adjusted add-on amount (Anet). The formula, which employs the ratio of net current exposure to gross current exposure (NGR) is expressed as: {{10-30-98 p.2262.05}} Anet=(0.4×Agross)+0.6(NGR×Agross) The effect of this formula is that Anetis the weighted average of Agross, and Agrossadjusted by the NGR. (g) The NGR may be calculated in either one of two ways--referred to as the counterparty-by-counterparty approach and the aggregate approach. (i) Under the counterparty-by-counterparty approach, the NGR is the ratio of the net current exposure of the netting contract to the gross current exposure of the netting contract. The gross current exposure is the sum of the current exposure of all individual contracts subject to the netting contract calculated in accordance with section II.E. of this appendix A. (ii) Under the aggregate approach, the NGR is the ratio of the sum of all of the net current exposures for qualifying bilateral netting contracts to the sum of all of the gross current exposures for those netting contracts (each gross current exposure is calculated in the same manner as in section II.E.5(g)(i) of this appendix A). Net negative mark-to-market values to individual counterparties cannot be used to offset net positive current exposures to other counterparties. (iii) A bank must use consistently either the counterparty-by-counterparty approach or the aggregate approach to calculate the NGR. Regardless of the approach used, the NGR should be applied individually to each qualifying bilateral netting contract to determine the adjusted add-on for that netting contract. A. Minimum Risk-Based Capital Ratio After Transition Period Banks generally will be expected to meet a minimum ratio of qualifying total capital to risk-weighted assets of 8 percent, of which at least 4 percentage points should be in the form of core capital (Tier 1). Any bank that does not meet the minimum risk-based capital ratio, or whose capital is otherwise considered inadequate, generally will be expected to develop and implement a capital plan for achieving an adequate level of capital, consistent with the provisions of this risk-based capital framework, the specific circumstances affecting the individual bank, and the requirements of any related agreements between the bank and the FDIC. B. Transitional Arrangements The transition period commences with the adoption of this statement of policy and ends on December 31, 1992. Initially, this risk-based capital framework does not establish a minimum level of capital. However, by year-end 1990, banks generally will be expected to meet a minimum total capital to risk-weighted assets ratio of 7.25 percent, at least one-half of which should be in the form of Tier 1 capital. For purposes of calculating this interim minimum ratio, the amount of the allowance for loan and lease losses that may be included as a supplementary capital element is limited to 1.5 percent of risk-weighted assets. In addition, up to 10 percent of a bank's Tier 1 capital (before any deduction for disallowed intangibles) may consist of supplementary capital elements. Thus, the 7.25 percent interim ratio implies a minimum ratio of Tier 1 capital to risk-weighted assets of approximately 3.6 percent (or one-half of 7.25) and a minimum ratio of core capital elements to risk-weighted assets of 3.25 percent (or nine-tenths of the Tier 1 capital ratio). By the end of 1992, a state nonmember bank's Tier 1 capital should consist solely of core capital elements. During the transition period, banks should monitor their risk-based capital ratios and work toward achieving the interim and final risk-based capital ratios. Any bank that has risk-based capital ratios of less than 4 percent Tier 1 capital and 8 percent total capital should develop and implement a capital plan for achieving those minimum standards by December 31, 1992, and for achieving the interim minimum ratio of 7.25 percent by December 31, 1990. Banks that at present have a risk-based capital ratio in excess of 8 percent generally should not take any action that would cause the ratio to fall below 8 percent. {{10-30-98 p.2262.06}}
1 No express limits are placed on the amounts of nonvoting common, noncumulative perpetual preferred stock and minority interests that may be recognized as part of Tier 1 capital. However, voting common stockholders' equity capital generally will be expected to be the dominant form of Tier 1 capital and banks should avoid undue reliance on other Tier 1 capital elements. 2 The amounts of mortgage servicing assets, nonmortgage servicing assets and purchased credit card relationships that can be recognized for purposes of calculating Tier 1 capital are subject to the limitations set forth in § 325.5(f). All deductions are for capital purposes only; deductions would not affect accounting treatment. 3 Deferred tax assets are subject to the capital limitations set forth in § 325.5(g). 4 Amounts in excess of limitations are permitted but do not qualify as capital. 5 Unrealized gains on equity securities are subject to the capital limitations set forth in paragraph 1.A.2.(f) of Appendix A to part 325. {{10-31-95 p.2262.06-A}} Calculation of the Risk-Based Capital Ratio When calculating the risk-based capital ratio under the framework set forth in this statement of policy, qualifying total capital (the numerator) is divided by risk-weighted assets (the denominator). The process of determining the numerator for the ratio is summarized in Table I. The calculation of the denominator is based on the risk weights and conversion factors that are summarized in Tables II and III. When determining the amount of risk-weighted assets, balance sheet assets are assigned an appropriate risk weight (see Table II) and off-balance sheet items are first converted to a credit equivalent amount (see Table III) and then assigned to one of the risk weight categories set forth in Table II. The balance sheet assets and the credit equivalent amount of off-balance sheet items are then multiplied by the appropriate risk weight percentages and the sum of these risk-weighted amounts is the gross risk-weighted asset figure used in determining the denominator of the risk-based capital ratio. Any items deducted from capital when computing the amount of qualifying capital may also be excluded from risk-weighted assets when calculating the denominator for the risk-based capital ratio. Category 1—Zero Percent Risk Weight (1) Cash (domestic and foreign). (2) Balances due from Federal Reserve banks and central banks in other OECD countries. (3) Direct claims on, and portions of claims unconditionally guaranteed by, the U.S. Treasury, U.S. Government agencies,{1} {1 For the purpose of calculating the risk-based capital ratio, a U.S. Government agency is defined as an instrumentality of the U.S. Government whose obligations are fully and explicitly guaranteed as to the timely repayment of principal and interest by the full faith and credit of the U.S. Government.} or central governments in other OECD countries. (4) Portions of local currency claims on, or unconditionally guaranteed by, non-OECD central governments (including non-OECD central banks), to the extent the bank has liabilities booked in that currency. (5) Gold bullion held in the bank's own vaults or in another bank's vaults on an allocated basis, to the extent that it is offset by gold bullion liabilities. (6) Federal Reserve bank stock. Category 2—20 Percent Risk Weight (1) Cash items in the process of collection. (2) All claims (long- and short-term) on, and portions of claims (long- and short-term) guaranteed by, U.S. depository institutions and OECD banks. (3) Short-term (remaining maturity of one year or less) claims on, and portions of short-term claims guaranteed by, non-OECD banks. (4) Portions of loans and other claims conditionally guaranteed by the U.S. Treasury, U.S. Government agencies,1 or central governments in other OECD countries and portions of local currency claims conditionally guaranteed by non-OECD central governments to the extent that the bank has liabilities booked in that currency. (5) Securities and other claims on, and portions of claims guaranteed by, U.S. Government-sponsored agencies.{2} {2 For the purpose of calculating the risk-based capital ratio, a U.S. Government-sponsored agency is defined as an agency originally established or chartered to serve public purposes specified by the U.S. Congress but whose obligations are not explicitly guaranteed by the full faith and credit of the U.S. Government.} (6) Portions of loans and other claims (including repurchase agreements) collateralized{3} {3 Degree of collateralization is determined by current market value.} by securities issued or guaranteed by the U.S. Treasury, U.S. Government agencies, U.S. Government-sponsored agencies or central governments in other OECD countries. {{10-31-95 p.2262.06-B}} (7) Portions of loans and other claims collateralized3 by cash on deposit in the lending bank. (8) General obligation claims on, and portions of claims guaranteed by, the full faith and credit of states or other political subdivisions of OECD countries, including U.S. state and local governments. (9) Claims on, and portions of claims guaranteed by, official multilateral lending institutions or regional development institutions in which the U.S. Government is a shareholder or a contributing member. (10) Portions of claims collateralized3 by securities issued by official multilateral lending institutions or regional development institutions in which the U.S. Government is a shareholder or contributing member. (11) Privately issued mortgage-backed securities representing indirect ownership of U.S. Government agency or U.S. Government-sponsored agency securities. (12) Investments in shares of mutual funds whose portfolios are permitted to hold only assets that qualify for the zero or 20 percent risk categories. Category 3—50 Percent Risk Weight (1) Loans fully secured by first liens on one-to-four family residential properties (including certain presold residential construction loans), provided that the loans were approved in accordance with prudent underwriting standards and are not past due 90 days or more or carried on a nonaccrual status. (2) Loans fully secured by first liens on multifamily residential properties that have been prudently underwritten and meet specified requirements with respect to loan-to-value ration, level of annual net operating income to required debt service, maximum amortization period, minimum original maturity, and demonstrated timely repayment performance. (3) Certain privately-issued mortgage-backed securities representing indirect ownership of a pool of residential loans that meet the criteria for a 50 percent risk weight. (4) Revenue bonds or similar obligations, including loans and leases, that are obligations of U.S. state or political subdivisions of the United States or other OECD countries but for which the government entity is committed to repay the debt only out of revenues from the specific projects financed. (5) Credit equivalent amounts of interest rate and foreign exchange rate related contracts, except for those assigned to a lower risk category. Category 4—100 Percent Risk Weight (1) All other claims on private obligors. (2) Claims on, or guaranteed by, non-OECD banks with a remaining maturity exceeding one year. (3) Claims on non-OECD central governments that are not included in item 4 of category 1 or item 3 of category 2, and all claims on non-OECD state and local governments. (4) Obligations issued by U.S. state or local governments or other OECD local governments (including industrial development authorities and similar entities) that are repayable solely by a private party or enterprise. (5) Premises, plant, and equipment; other fixed assets; and other real estate owned. (6) Investments in any unconsolidated subsidiaries, joint ventures, or associated companies--if not deducted from capital. (7) Instruments issued by other banking organizations that qualify as capital. (8) Claims on commercial firms owned by the U.S. Government or foreign governments. {{10-31-95 p.2262.06-C}} (9) All other assets, including any intangible assets that are not deducted from capital, and the credit equivalent amounts{4} {4 For each off-balance sheet item, a conversion factor (see Table III) must be applied to determine the "credit equivalent amount" prior to assigning the off-balance sheet item to a risk weight category.} of off-balance sheet items not assigned to a lower risk category. 100 Percent Conversion Factor (1) Direct credit substitutes, including general guarantees of indebtedness and guarantee-type instruments, such as standby letters of credit that serve as financial guarantees for, or support the repayment of, loans, securities or commercial letters of credit. (2) Acquisitions of risk participations in bankers acceptances and in such direct credit substitutes and financial standby letters of credit. (3) Sale and repurchase agreements and asset sales with recourse, if not already included on the balance sheet. (4) Forward agreements representing contractual obligations to purchase assets, including financing facilities, with drawdown certain at a specified future date. (5) Securities lent, if the lending bank is exposed to risk of loss. 50 Percent Conversion Factor (1) Transaction-related contingencies, including bid bonds, performance bonds, warranties, and performance standby letters of credit backing the nonfinancial performance of other parties. (2) Unused portions of commitments with an original maturity{1} {1 Remaining maturity may be used until year-end 1990.} exceeding one year, including underwriting commitments and commercial credit lines. (3) Revolving underwriting facilities (RUFs), note issuance facilities (NIFs) and other similar arrangements. 20 Percent Conversion Factor (1) Short-term, self-liquidating, trade-related contingencies, including commercial letters of credit. Zero Percent Conversion Factor (1) Unused portions of commitments with an original maturity1 of one year or less. (2) Unused portions of commitments (regardless of maturity) which are unconditionally cancelable at any time, provided a separate credit decision is made before each drawing. Credit Conversion for Derivative Contracts The total replacement cost of contracts (obtained by summing the positive mark-tomarket values of contracts) is added to a measure of future potential increases in credit exposure. This future potential credit exposure measure is calculated by multiplying the total notional value of contracts by one of the following credit conversion factors, as appropriate:
{{10-31-95 p.2262.06-D}} No potential exposure is calculated for single currency interest rate contracts on which payments are made based on two floating rate indices (floating/floating or basis swaps); the credit exposure on these contracts is evaluated solely on the basis of their mark-to-market values. In the event a netting contract covers transactions that are normally not included in the risk-based ratio calculation--for example, exchange rate contracts with an original maturity of fourteen calendar days or less or instruments traded on exchanges that require daily payment of variation margin--an institution may elect to consistently either include or exclude all mark-to-market values of such transactions when determining a net current exposure. Multiple contract with the same counterparty may be netted for risk-based capital purposes pursuant to section II.E.3. of this appendix.
(1) If contracts (1) through (5) above are subject to a qualifying bilateral netting contract, then the following applies:
*The total of the mark-to-market values from above is –1,370,000. Since this is a negative amount, the net current exposure is zero. (2) To recognize the effects of netting on potential future exposure, the following formula applies: Anet=(0.4×Agross)+0.6(NGR×Agross) {{4-30-99 p.2262.06-E}} (3) In the above example: NGR=0=(0/300,000) Anet=(0.4×2,900,000)+0.6(0×2,900,000) Anet=1,160,000 Credit Equivalent Amount: 1,160,000+0=1,160,000 (4) If the net current exposure was a positive amount, for example, $200,000, the credit equivalent amount would be calculated as follows: NGR=.67=(200,000/300,000) Anet=(0.4×2,900,000)+0.6(.67×2,900,000) Anet=2,325,800 Credit Equivalent Amount: 2,325,800+200,000=2,525,800 [Codified to 12 C.F.R. Part 325, Appendix A] [Appendix A added at 54 Fed. Reg. 11509, March 21, 1989, effective April 20, 1989; amended at 55 Fed. Reg. 53147, December 27, 1990, effective January 28, 1991; 56 Fed. Reg. 10165, March 11, 1991, effective April 10, 1991; 58 Fed. Reg. 6369, January 28, 1993, effective March 1, 1993; 58 Fed. Reg. 8219, February 12, 1993, effective March 15, 1993; 58 Fed. Reg. 12149, March 3, 1993, effective December 31, 1992; 58 Fed. Reg. 60103, November 15, 1993; 59 Fed. Reg. 3784, January 27, 1994; 59 Fed. Reg. 64564, December 15, 1994, effective January 17, 1995; 59 Fed. Reg. 66660 and 66666, December 28, 1994, effective December 28, 1994 and January 27, 1995, respectively; 60 Fed. Reg. 8188, February 13, 1995, effective April 1, 1995; 59 Fed. Reg. 15861, March 28, 1995, effective April 27, 1995; 60 Fed. Reg. 39232, August 1, 1995; 60 Fed. Reg. 39493, August 2, 1995, effective September 1, 1995; 60 Fed. Reg. 45609, August 31, 1995; 60 Fed. Reg. 46182, September 5, 1995, effective October 1, 1995; 60 Fed. Reg. 66045, December 20, 1995, effective April 1, 1996; 61 Fed. Reg. 47375, September 6, 1996, effective January 1, 1997; 62 Fed. Reg. 55493, October 24, 1997, effective January 1, 1998; 63 Fed. Reg. 42677, August 10, 1998, effective October 1, 1998; 63 Fed. Reg. 46523, September 1, 1998, effective October 1, 1998; 64 Fed. Reg. 10200, March 2, 1999, effective April 1, 1999]
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