Federal Deposit
Insurance Corporation

The federal bank regulatory agencies (the agencies) have jointly issued the attached Notice of Proposed Rulemaking (proposed rule) that would revise the measurement of risk-weighted assets by implementing changes made by the Basel Committee on Banking Supervision (BCBS) to international regulatory capital standards and by implementing aspects of the Dodd-Frank Act.

Statement of Applicability to Institutions with Total Assets Under $1 Billion: This Financial Institution Letter is applicable to all banks. Attached to this FIL is an addendum that also is included in the proposed rule. The addendum offers a summary of the proposed rule designed to clearly and succinctly describe how it would typically apply to smaller, less complex banking organizations. Additional technical assistance explaining the proposed rule also will be made available.

Highlights:

The proposed rule:

• Revises risk weights for exposures to foreign sovereign entities, foreign banking organizations, and foreign public sector entities.
• Revises risk weights for residential mortgages based on loan-to-value ratios and certain product and underwriting features.
• Increases capital requirements for past-due loans, high volatility commercial real estate exposures, and certain short-term loan commitments.
• Expands the recognition of collateral and guarantors in determining risk-weighted assets.
• Removes references to credit ratings consistent with Section 939A of the Dodd-Frank Act.
• Establishes due diligence requirements for securitization exposures.

Distribution:
FDIC-Supervised Banks (Commercial and Savings)

Suggested Routing:
Chief Executive Officer
Chief Financial Officer
Chief Risk Officer

Related Topics:
Risk-Based Capital Rules
12 CFR Part 325
Basel III

Attachment:
Regulatory Capital Rules: Standardized Approach for Risk-Weighted Assets; Market Discipline and Disclosure Requirements (PDF Help)

Contact:
Bobby Bean, Associate Director, Capital Markets Branch, at bbean@fdic.gov or (202) 898-6705
Ryan Billingsley, Senior Policy Analyst, at rbillingsley@fdic.gov or (202) 898-3797
Karl Reitz, Senior Policy Analyst, at kreitz@fdic.gov or (202) 898-6775

Note:
FDIC Financial Institution Letters (FILs) may be accessed from the FDIC's Web site at www.fdic.gov/news/news/financial/2012/index.html.

To receive FILs electronically, please visit http://www.fdic.gov/about/subscriptions/fil.html.

Paper copies may be obtained through the FDIC's Public Information Center, 3501 Fairfax Drive, E-1002, Arlington, VA 22226 (1-877-275-3342 or 703-562-2200).

Key Aspects of the Proposed Rule on Regulatory Capital Rules: Standardized Approach for Risk-weighted Assets; Market Discipline and Disclosure Requirements

Overview

The agencies are issuing a notice of proposed rulemaking (NPR, proposal, or proposed rule) to harmonize and address shortcomings in the measurement of risk-weighted assets that became apparent during the recent financial crisis, in part by implementing in the United States changes made by the Basel Committee on Banking Supervision (BCBS) to international regulatory capital standards and by implementing aspects of the Dodd-Frank Act. Among other things, the proposed rule would:

• revise risk weights for residential mortgages based on loan-to-value ratios and certain product and underwriting features;
• increase capital requirements for past-due loans, high volatility commercial real estate exposures, and certain short-term loan commitments;
• expand the recognition of collateral and guarantors in determining risk-weighted assets;
• remove references to credit ratings; and
• establish due diligence requirements for securitization exposures.

 
This addendum presents a summary of the proposal in this NPR that is most relevant for smaller, less complex banking organizations banking organization that are not subject to the market risk capital rule or the advanced approaches capital rule, and that have under $50 billion in total assets. The agencies intend for this addendum to act as a guide for these banking organizations, helping them to navigate the proposed rule and identify the changes most relevant to them. The addendum does not, however, by itself provide a complete understanding of the proposed rules and the agencies expect and encourage all institutions to review the proposed rule in its entirety.  

A. Zero Percent Risk-Weighted Items

The following exposures would receive a zero percent risk weight under the proposal:

• Cash;
• Gold bullion;
• Direct and unconditional claims on the U.S. government, its central bank, or a U.S. government agency;
• Exposures unconditionally guaranteed by the U.S. government, its central bank, or a U.S. government agency;
• Claims on certain supranational entities (such as the International Monetary Fund) and certain multilateral development banking organizations
• Claims on and exposures unconditionally guaranteed by sovereign entities that meet certain criteria (as discussed below).

For more information, please refer to sections 32(a) and 37(b)(3)(iii) of the proposal. For exposures to foreign governments and their central banks, see section L below.

B. 20 Percent Risk-Weighted Items

The following exposures would receive a twenty percent risk weight under the proposal:

• Cash items in the process of collection;
• Exposures conditionally guaranteed by the U.S. government, its central bank, or a U.S. government agency;
• Claims on government sponsored entities (GSEs);
• Claims on U.S. depository institutions and NCUA-insured credit unions;
• General obligation claims on, and claims guaranteed by the full faith and credit of state and local governments (and any other public sector entity, as defined in the proposal) in the United States;
• Claims on and exposures guaranteed by foreign banks and public sector entities if the sovereign of incorporation of the foreign bank or public sector entity meets certain criteria (as described below).

A conditional guarantee is one that requires the satisfaction of certain conditions, for example servicing requirements.

For more information, please refer to sections 32(a) through 32(e), and section 32(l) of the proposal. For exposures to foreign banks and public sector entities, see section L below.

C. 50 Percent Risk-Weighted Exposures
 
The following exposures would receive a 50 percent risk weight under the proposal:

• “Statutory” multifamily mortgage loans meeting certain criteria;
• Presold residential construction loans meeting certain criteria;
• Revenue bonds issued by state and local governments in the United States.
• Claims on and exposures guaranteed by sovereign entities, foreign banks, and foreign public sector entities that meet certain criteria (as described below).

The criteria for multifamily loans and presold residential construction loans are generally the same as in the existing general risk-based capital rules. These criteria are required under federal law. ¹ Consistent with the general risk-based capital rules and requirements of the statute, the proposal would assign a 100 percent risk weight to pre-sold construction loans where the contract is cancelled.

For more information, please refer to sections 32(e), 32(h), and 32(i) of the proposal. Also refer to section 2 of the proposal for relevant definitions:

• Pre-sold construction loan
• Revenue obligation
• Statutory multifamily mortgage

D. 1-4 Family Residential Mortgage Loans

Under the proposed rule, 1-4 family residential mortgages would be separated into two risk categories (“category 1 residential mortgage exposures” and “category 2 residential mortgage exposures”) based on certain product and underwriting characteristics. The proposed definition of category 1 residential mortgage exposures would generally include traditional, first-lien, prudently underwritten mortgage loans. The proposed definition of category 2 residential mortgage exposures would generally include junior-liens and non-traditional mortgage products.

The proposal would not recognize private mortgage insurance (PMI) for purposes of calculating the LTV ratio. Therefore, the LTV levels in the table below represent only the borrower’s equity in the mortgaged property.

The table below shows the proposed risk weights for 1-4 family residential mortgage loans, based on the LTV ratio and risk category of the exposure:
 

 Definitions:
Category 1 residential mortgage exposure would mean a residential mortgage exposure with the following characteristics:

• The term of the mortgage loan does not exceed 30 years;
• The terms of the mortgage loan provide for regular periodic payments that do not:
• Result in an increase of the principal balance;
• Allow the borrower to defer repayment of principal of the residential mortgage exposure; or,
• Result in a balloon payment;
• The standards used to underwrite the residential mortgage loan:
• Took into account all of the borrower’s obligations, including for mortgage obligations, principal, interest, taxes, insurance, and assessments; and
• Resulted in a conclusion that the borrower is able to repay the loan using:
• The maximum interest rate that may apply during the first five years after the date of the closing of the residential mortgage loan; and
• The amount of the residential mortgage loan as of the date of the closing of the transaction;
• The terms of the residential mortgage loan allow the annual rate of interest to increase no more than two percentage points in any twelve month period and no more than six percentage points over the life of the loan;
• For a first-lien home equity line of credit (HELOC), the borrower must be qualified using the principal and interest payments based on the maximum contractual exposure under the terms of the HELOC;
• The determination of the borrower’s ability to repay is based on documented, verified income;
• The residential mortgage loan is not 90 days or more past due or on non-accrual status; and
• The residential mortgage loan is not a junior-lien residential mortgage exposure.

Category 2 residential mortgage exposure would mean a residential mortgage exposure that is not a Category 1 residential mortgage exposure and is not guaranteed by the U.S. government.

LTV ratio would equal the loan amount divided by the value of the property.

Loan Amount: 

• For a first-lien residential mortgage, the loan amount would be the maximum contractual principal amount of the loan. For a traditional mortgage loan where the loan balance will not increase under the terms of the mortgage, the loan amount is the current loan balance. However, for a loan whose balance may increase under the terms of the mortgage, such as pay-option adjustable loan that can negatively amortize or for a HELOC, the loan amount is the maximum contractual principal amount of the loan.
• For a junior-lien mortgage, the loan amount would be the maximum contractual principal amount of the loan plus the maximum contractual principal amounts of all more senior loans secured by the same residential property on the date of origination of the junior-lien residential mortgage.

The value of the property is the lesser of the acquisition cost (for a purchase transaction) or the estimate of the property’s value at the origination of the loan or the time of restructuring. The banking organization must base all estimates of a property’s value on an appraisal or evaluation of the property that meets the requirements of the primary federal supervisor’s appraisal regulations. ²

If a banking organization holds a first mortgage and junior-lien mortgage on the same residential property and there is no intervening lien, the proposal treats the combined exposure as a single first-lien mortgage exposure.

If a banking organization holds two or more mortgage loans on the same residential property, and one of the loans is category 2, then the banking organization would be required to treat all of the loans on the property as category 2.

Additional Notes:

• FHA and VA loans would continue to receive zero percent risk weight due to their unconditional government guarantee.
• 1-4 family mortgage loans sold with recourse are converted to an on-balance sheet credit equivalent amount using a 100 percent conversion factor. There is no grace period, such as the 120-day exception under the current general risk-based capital rules.
• Restructured and modified mortgages would be assigned risk weights based on their LTVs and classification as category 1 or category 2 residential mortgage exposures based on the modified contractual terms. If the LTV is not updated at the time of modification or restructuring, a category 1 residential mortgage would receive a risk weight of 100 percent and a category 2 residential mortgage would receive a risk weight of 200 percent.
• Similar to the current capital rules, loans modified or restructured under the Treasury’s HAMP program would not be considered modified or restructured for the purposes of the proposal.

For more information, please refer to section 32(g) of the proposal. Also refer to section 2 for relevant definitions:

• Category 1 residential mortgage exposure
• Category 2 residential mortgage exposure
• First lien residential mortgage exposure
• Junior-lien residential mortgage
• Residential mortgage exposure 

E. Past-Due Exposures

The proposal would assign a 150 percent risk weight to loans and other exposures that are 90 days or more past due. This applies to all exposure categories except for the following:

• 1-4 family residential exposures (1-4 family loans over 90 days past due and are in Category 2 and would be risk weighted as described in Section D.) 
• A sovereign exposure where the sovereign has experienced a sovereign default.

For more information, please refer to section 32(k) of the proposal.

F. High Volatility Commercial Real Estate Loans (HVCRE)

The proposal would assign a 150 percent risk weight to HVCRE exposures.  The proposal defines an HVCRE exposure as a credit facility that finances or has financed the acquisition, development, or construction (ADC) of real property, unless the facility finances:

• One- to four-family residential properties; or
• Commercial real estate projects in which:
• The LTV ratio is less than or equal to the applicable maximum supervisory LTV ratio;
• The borrower has contributed capital to the project in the form of cash or unencumbered readily marketable assets (or has paid development expenses out-of-pocket) of at least 15 percent of the real estate’s appraised “as completed” value; and
• The borrower contributed the amount of capital required by this definition before the banking organization advances funds under the credit facility, and the capital contributed by the borrower, or internally generated by the project, is contractually required to remain in the project throughout the life of the project. The life of a project concludes only when the credit facility is converted to permanent financing or is sold or paid in full. Permanent financing may be provided by the banking organization that provided the ADC facility as long as the permanent financing conforms with the banking organization’s underwriting criteria for long-term mortgage loans.

For more information please refer to section 32 of the proposal. Also refer to section 2 for relevant definitions:

• High volatility commercial real estate exposure (HVCRE)

G.   Commercial Loans / Corporate Exposures 

The proposal would assign a 100 percent risk weight to all corporate exposures. The definition of a corporate exposure would exclude exposures that are specifically covered elsewhere in the proposal, such as HVCRE, pre-sold residential construction loans, and statutory multifamily mortgages.

For more information please refer to section 32(f) of the proposal, and section 33 for off-balance sheet exposures.

H. Consumer Loans and Credit Cards

Under the proposed rule, consumer loans and credit cards would continue to receive a 100 percent risk weight. The proposal does not specifically list these assets, but they fall into the “other assets” category that would receive a 100 percent risk weight.

For more information, please refer to section 32(l) of the proposal.

I. Basel III Risk Weight Items

As described in the Basel III NPR, the amounts of the threshold deduction items (mortgage servicing assets, certain deferred tax assets, and investments in the common equity of financial institutions) that are not deducted would be assigned a risk weight of 250 percent. In addition, certain high-risk exposures such as credit enhancing interest-only strips would receive 1,250 percent risk weight.

J. Other Assets and Exposures

Where the proposal does not assign a specific risk weight to an asset or exposure type, the applicable risk weight would be 100 percent. For example, premises, fixed assets, and other real estate owned receive a risk weight of 100 percent. Section 32(m) of the proposal for bank holding companies and savings and loan holding companies provides specific risk weights for certain insurance-related assets.

For more information, please refer to section 32(l) of the proposal.  

K. Conversion Factors for Off-Balance Sheet Items

Similar to the current rules, under the proposal, a banking organization would be required to calculate the exposure amount of an off-balance sheet exposure using the credit conversion factors (CCFs) below. The proposal increases the CCR for commitments with an original maturity of one year or less from zero percent to 20 percent.
 

• Zero percent CCF. A banking organization would apply a zero percent CCF to the unused portion of commitments that are unconditionally cancelable by the banking organization.

• 20 percent CCF. A banking organization would apply a 20 percent CCF to:
• Commitments with an original maturity of one year or less that are not unconditionally cancelable by the banking organization.
• Self-liquidating, trade-related contingent items that arise from the movement of goods, with an original maturity of one year or less.

• 50 percent CCF. A banking organization would apply a 50 percent CCF to:
• Commitments with an original maturity of more than one year that are not unconditionally cancelable by the banking organization.
• Transaction-related contingent items, including performance bonds, bid bonds, warranties, and performance standby letters of credit.

• 100 percent CCF. A banking organization would apply a 100 percent CCF to the following off-balance-sheet items and other similar transactions:
• Guarantees;
• Repurchase agreements (the off-balance sheet component of which equals the sum of the current market values of all positions the banking organization has sold subject to repurchase);
• Off-balance sheet securities lending transactions (the off-balance sheet component of which equals the sum of the current market values of all positions the banking organization has lent under the transaction);
• Off-balance sheet securities borrowing transactions (the off-balance sheet component of which equals the sum of the current market values of all non-cash positions the banking organization has posted as collateral under the transaction);
• Financial standby letters of credit; and
• Forward agreements.

For more information please refer to section 33 of the proposal. Also refer to section 2 the definition of unconditionally cancellable.

L. Over-the-Counter (OTC) Derivative Contracts
 
The proposal provides a method for determining the risk-based capital requirement for a derivative contract that is similar to the general risk-based capital rules. Under the proposed rule, the banking organization would determine the exposure amount and then assign a risk weight based on the counterparty or collateral. The exposure amount is the sum of current exposure plus potential future credit exposure (PFE). In contrast to the general risk-based capital rules, which place a 50 percent risk weight cap on derivatives, the proposal does not include a risk weight cap and introduces specific credit conversion factors for credit derivatives.

The current credit exposure is the greater of zero or the mark-to-market value of the derivative contract.

The PFE is generally the notional amount of the derivative contract multiplied by a credit conversion factor for the type of derivative contract. The table below shows the credit conversion factors for derivative contracts:

For more information please refer to section 34 of the proposal.  Also refer to section 2 for relevant definitions:

• Effective notional amount
• Eligible credit derivative
• Eligible derivative contract
• Exposure amount
• Interest rate derivative contract

M. Securitization Exposures

Section 42 of the proposal introduces due diligence requirements for banking organizations that own, originate or purchase securitization exposures and introduces a new definition of securitization exposure. If a banking organization is unable to demonstrate to the satisfaction of its primary federal supervisor a comprehensive understanding of the features of a securitization exposure that would materially affect the performance of the exposure, the banking organization would be required to assign the securitization exposure a risk weight of 1,250 percent. The banking organization’s analysis would be required to be commensurate with the complexity of the securitization exposure and the materiality of the exposure in relation to capital.

Note that mortgage-backed pass-through securities (for example, those guaranteed by FHLMC or FNMA) do not meet the proposed definition of a securitization exposure because they do not involve a tranching of credit risk. Rather, only those mortgage-backed securities that involve tranching of credit risk would be securitization exposures. For securitization exposures guaranteed by the U.S. Government or GSEs, there are no changes relative to the existing treatment:

• The Government National Mortgage Association (Ginnie Mae) securities receive a zero percent risk-weight to the extent they are unconditionally guaranteed.
• The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) guaranteed securities receive a 20 percent risk weight.
• Fannie Mae and Freddie Mac non-credit enhancing IO securities receive a 100 percent risk weight.

  The risk-based capital requirements for securitizations under the proposed rule would be as follows:

• A banking organization would deduct any after-tax gain-on-sale of a securitization. (This requirement would usually pertain to banking organizations that are securitizers rather than purchasers of securitization exposures);
• A banking organization would assign a 1,250 percent risk weight to a credit-enhancing interest-only strip (CEIO).
• A banking organization would assign a 100 percent risk weight to non-credit enhancing interest-only mortgage-backed securities (IOs).

For privately-issued mortgage securities and all other securitization exposures, a banking organization would be able choose among the following approaches, provided that the banking organization consistently applies such approach to all securitization exposures: ⁴

• A banking organization may use the existing gross-up approach to risk weight all of its securitizations. Under the existing gross-up approach, senior securitization tranches are assigned the risk weight associated with the underlying exposures. A banking organization must hold capital for the senior tranche based on the risk weight of the underlying exposures. For subordinate securitization tranches, a banking organization must hold capital for the subordinate tranche, as well as all more senior tranches for which the subordinate tranche provides credit support.  
• A banking organization may determine the risk weight for the securitization exposure using the simplified supervisory formula approach (SSFA) described in section 43 of the proposal. The SSFA formula would require a banking organization to apply a supervisory formula that requires various data inputs including the risk weight applicable to the underlying exposures; the attachment and detachment points of the securitization tranche, which is the relative position of the securitization position in the structure (subordination); and the current percentage of the underlying exposures that are 90 days or more past due, in default, or in foreclosure. Banking organizations considering the SSFA approach should carefully read and consider section 43 of the proposal.

Alternatively, a banking organization may apply a 1,250 percent risk weight to any of its securitization exposures.

For more information, please refer to sections 42-45 of the proposal. Also refer to section 2 for the following definitions:

• Credit-enhancing interest-only strip
• Gain-on-sale
• Resecuritization
• Resecuritization exposure
• Securitization exposure
• Securitization special purpose entity (securitization SPE)
• Synthetic securitization
• Traditional securitization
• Underlying exposure

N. Equity Exposures

Under section 52 of the proposal, a banking organization would apply a simple risk-weight approach (SRWA) to determine the risk weight for equity exposures that are not exposures to an investment fund. The following table indicates the risk weights that would apply to equity exposures under the SRWA:

For more information, please refer to sections 51 and 52 of the proposal, and any related definitions in section 2:

• Equity exposure
• Equity derivative contract

O. Equity Exposures to Investment Funds

The proposals described in this section would apply to equity exposures to investment funds such as mutual funds, but not to hedge funds or other leveraged investment funds (refer to section above). For exposures to investment funds other than community development exposures, a banking organization must use one of three risk-weighting approaches described below:

1. Full look-through approach: 
For this two-step approach, a banking organization would be required to obtain information regarding the asset pool underlying the investment fund as of the date of the calculation, as well as the banking organization’s proportional share of ownership in the fund. For the first step the banking organization would assign risk weights to the assets of the entire investment fund and calculates the sum of those risk-weighted assets. For the second step, the banking organization would multiply the sum of the fund’s risk-weighted assets by the banking organization’s proportional ownership in the fund.   
 
2. Simple modified look-through approach: 
Similar to  the current capital rules, under this approach a banking organization would multiply the adjusted carrying value of its investment in the fund by the highest risk weight that applies to any exposure the fund is permitted to hold as described in the prospectus or fund documents.

3. Alternative modified look-through approach: 
Similar to the current capital rules, under this approach a banking organization would assign the adjusted carrying value of an equity exposure to an investment fund on a pro rata basis to different risk weight categories based on the investment limits described in the fund’s prospectus.  The banking organization’s risk-weighted asset amount is the sum of each portion of the adjusted carrying value assigned to an exposure type multiplied by the applicable risk weight under section 32 of the proposal. For purposes of the calculation the banking organization must assume the fund is invested in assets with the highest risk weight permitted by its prospectus and to the maximum amounts permitted.  
 
For community development exposures, a banking organization’s risk-weighted asset amount is equal to its adjusted carrying value for the fund.

For more information please refer to section 53 of the proposal. Also refer to section 2 for relevant definitions:

• Adjusted carrying value
• Investment fund

 P. Treatment of Guarantees

The proposal would allow a banking organization to substitute the risk weight of an eligible guarantor for the risk weight otherwise applicable to the guaranteed exposure. This treatment would apply only to eligible guarantees and eligible credit derivatives, and would provide certain adjustments for maturity mismatches, currency mismatches, and situations where restructuring is not treated as a credit event.
 
Under the proposal, eligible guarantors would include sovereign entities, certain supranational entities such as the International Monetary Fund, Federal Home Loan Banks, Farmer Mac, a multilateral development bank, a depository institution, a bank holding company, a savings and loan holding company, a foreign bank, or an entity that has investment grade debt, whose creditworthiness is not positively correlated with the credit risk of the exposures for which it provides guarantees. Eligible guarantors would not include monoline insurers, re-insurers, or special purpose entities.

To be an eligible guarantee, the guarantee would be required to be from an eligible guarantor and must meet the requirements of the proposal, including that the guarantee must:

• Be written;
• Be either:
• Unconditional, or
• A contingent obligation of the U.S. government or its agencies, the enforceability of which to the beneficiary is dependent upon some affirmative action on the part of the beneficiary of the guarantee or a third party (for example, servicing requirements);
• Cover all or a pro rata portion of all contractual payments of the obligor on the reference exposure;
• Give the beneficiary a direct claim against the protection provider;
• And meet other requirements of the rule.

For more information please refer to section 36 of the proposal. Also refer to section 2 for relevant definitions:

• Eligible guarantee
• Eligible guarantor

Q. Treatment of Collateralized Transactions

The proposal allows banking organizations to recognize the risk mitigating benefits of financial collateral in risk-weighted assets, and defines financial collateral to include:

• cash on deposit at the bank or third-party custodian;
• gold;
• investment grade long-term securities (excluding resecuritizations);
• investment grade short-term instruments (excluding resecuritizations);
• publicly-traded equity securities;
• publicly-traded convertible bonds; and,
• money market mutual fund shares; and other mutual fund shares if a price is quoted daily.

In all cases the banking organization would be required to have a perfected, first priority interest in the financial collateral.

1. Simple approach: A banking organization may apply a risk weight to the portion of an exposure that is secured by the market value of financial collateral by using the risk weight of the collateral – subject to a risk weight floor of 20 percent. To apply the simple approach, the collateral must be subject to a collateral agreement for at least the life of the exposure; the collateral must be revalued at least every 6 months; and the collateral (other than gold) must be in the same currency. There would be a few limited exceptions to the 20 percent risk weight floor:

• A banking organization may assign a zero percent risk weight to the collateralized portion of an exposure where:
• The financial collateral is cash on deposit; or
• The financial collateral is an exposure to a sovereign that qualifies for a zero percent risk weight (including the United States) and the banking organization has discounted the market value of the collateral by 20 percent.
• A banking organization would be permitted to assign a zero percent risk weight to an exposure to an OTC derivative contract that is marked to market on a daily basis and subject to a daily margin maintenance requirement, to the extent the contract is collateralized by cash on deposit.
• A banking organization would be permitted to assign a 10 percent risk weight to an exposure to an OTC derivative contract that is marked to market on a daily basis and subject to a daily margin maintenance requirement, to the extent the contract is collateralized by U.S. government securities or an exposure to a sovereign that qualifies for a zero percent risk weight under the proposal.

2. Collateral Haircut Approach: For an eligible margin loan, a repo-style transaction, a collateralized derivative contract, or a single-product netting set of such transactions, a banking organization may instead decide to use the collateral haircut approach to recognize the credit risk mitigation benefits of eligible collateral by reducing the amount of the exposure to be risk weighted rather than by substituting the risk weight of the collateral. Banking organizations considering the collateral haircut approach should carefully read section 37 of the proposal. The collateral haircut approach takes into account the value of the banking organization’s exposure, the value of the collateral, and haircuts to account for potential volatility in position values and foreign exchange rates. The haircuts may be determined using one of two methodologies.

A banking organization may use standard haircuts based on the table below and a standard foreign exchange rate haircut of 8 percent.  

Alternatively, a banking organization may, with supervisory approval, use own estimates of collateral haircuts when calculating the appropriate capital charge for an eligible margin loan, a repo-style transaction, or a collateralized derivative contract. Section 37 of the proposal provides the requirements for calculating own estimates, including the requirement that such estimates be determined based on an period of market stress appropriate for the collateral under this approach.

For more information, please refer to section 37 of the proposal. Also refer to section 2 for relevant definitions:

• Financial collateral
• Repo-style transaction

R. Treatment of Cleared Transactions

The proposal introduces a specific capital treatment for exposures to central counterparties (CCPs), including certain transactions conducted through clearing members by banking organizations that are not themselves clearing members of a CCP. Section 35 of the proposal describes the capital treatment of cleared transactions and of default fund exposures to CCPs, including more favorable capital treatment for cleared transactions through CCPs that meet certain criteria.

S. Unsettled Transactions

The proposal provides for a separate risk-based capital requirement for transactions involving securities, foreign exchange instruments, and commodities that have a risk of delayed settlement or delivery. The proposed capital requirement would not, however, apply to certain types of transactions, including cleared transactions that are marked-to-market daily and subject to daily receipt and payment of variation margin. The proposal contains separate treatments for delivery-versus-payment (DvP) and payment-versus-payment (PvP) transactions with a normal settlement period, and non-DvP/non-PvP transactions with a normal settlement period.

T. Foreign Exposures

Under the proposal a banking organization would risk weight an exposure to a foreign government, foreign public sector entity (PSE), and a foreign bank based on the Country Risk Classification (CRC) that is applicable to the foreign government, or the home country of the foreign PSE or foreign bank.

Country risk classification (CRC) for a sovereign means the CRC published by the Organization for Economic Cooperation and Development.

The risk weights for foreign sovereigns, foreign banks, and foreign PSEs are shown in the tables below:

• A sovereign exposure would be assigned a 150 percent risk weight immediately upon determining that an event of sovereign default has occurred, or if an event of sovereign default has occurred during the previous five years.

For more information, please refer to section 32(a), 32(d), and 32(e) of the proposal. Also refer to section 2 for relevant definitions:

• Home country
• Public sector entity (PSE)
• Sovereign
• Sovereign exposure

Attached is a table summarizing the proposed changes to the general risk-based capital rules for risk weighting assets.
Attachment: Comparison of Current Rules vs. Proposal