On November 5, 1997, the OCC, Federal Reserve Board, Federal Deposit Insurance Corporation, and the Office of Thrift Supervision (the agencies) published the attached joint notice of proposed rulemaking. The public comment period for this proposal closes on February 3, 1998.

The proposed rule refines the agencies' 1994 proposed rulemaking that addressed low-level recourse transactions and direct credit substitutes, as well as the 1994 advance notice of proposed rulemaking that discussed use of credit ratings in establishing capital requirements (59 FR 27116, May 25, 1994). The current proposal would amend the OCC's risk-based capital regulations to treat direct credit substitutes and recourse obligations consistently and would incorporate the use of credit ratings as an indicator of a bank's relative risk of loss. The risk-based capital requirement would be adjusted to reflect the relative riskiness of the bank's position in an asset securitization.

Specifically, the proposal would define recourse to mean any arrangement in which an institution retains risk of credit loss in connection with an asset transfer, when the risk of credit loss exceeds the pro rata share of the institution's claim on the assets. Similarly, the proposed definition of direct credit substitute is intended to mirror the definition of recourse. A direct credit substitute would be any arrangement in which a bank assumes risk of credit-related losses from assets or other claims that it has not transferred, when the risk of credit loss exceeds the institution's pro rata share of the assets or other claims.

To measure relative exposure to credit risk and to determine the associated risk-based capital requirements, a "multi-level, ratings-based approach" is proposed. Under this approach, capital requirements for recourse obligations, direct credit substitutes, and other positions in asset securitizations would be determined by reference to credit ratings from ratings agencies. It would work as follows:

A position in the highest, investment-grade rating category would receive a 20 percent risk weight. A position rated investment grade but not in the highest rating category would receive one of two alternative treatments the agencies are considering: (1) the "face value" option would apply a 100 percent risk weight to the book value or face amount of the position; or (2) the "modified gross-up" option would apply a 50 percent risk weight to the amount of the position plus all more senior positions.

Non-rated positions and positions rated below investment grade would receive "gross-up" treatment. The institution holding the position would hold capital against the amount of the position plus all more senior positions, subject to the low-level recourse rule.

Additional details of the proposed multi-level, ratings-based approach are discussed in the attached preamble, with comments requested on numerous aspects.

The proposal also discusses and requests comment on two alternatives to the use of credit ratings for non-traded positions. These alternatives would:

Use criteria developed by the agencies, based on the criteria of the rating agencies, to determine the capital requirements; or
Permit institutions to use historical loss information or internal credit risk models to determine the capital requirements for direct credit substitutes and recourse obligations.

Finally, the agencies propose that any final rules adopted in connection with this approach resulting in an increased risk-based capital requirement would apply only to transactions completed after the effective date of the final rules.

The proposal contains 25 specific questions. The OCC is interested in comments on these questions and any other aspect of the proposal and the alternatives. For further information, contact Roger Tufts, senior economic advisor, Capital Policy Division (202) 874-5070, or David Thede, senior attorney, Securities and Corporate Practices Division (202) 874-5210.

Emory W. Rushton
Senior Deputy Comptroller Bank Supervision Policy

Related Links

• Proposed Rule 62 FR 59943