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November 2004 update to the Commercial Bank Examination Manual.

The November 2004 update to the Commercial Bank Examination Manual has been published (supplement no. 22). The new supplement includes supervisory and examination guidance on the following subjects:

1. The May 2004 Recommended Practices Document for the Seamless Supervision of State-Chartered Banks. The "Examination Strategy and Risk-Focused Examinations" section incorporates this recommended-practices document, which was promulgated by the interagency State-Federal Working Group. The working group consists of state bank commissioners and senior officials from the Federal Reserve Board and the Federal Deposit Insurance Corporation. The recommended practices highlight the importance of communication and coordination between state and federal banking agencies in the planning and execution of supervisory activities over state-chartered banking organizations. The recommended practices are the common courtesies and practices that examination and supervisory staff should follow in the implementation and execution of their agencies' supervisory activities. The practices apply to institutions that operate in a single state or in more than one state. See SR letters 04-12 and 96-33.

2. Uniform Agreement on the Classification of Assets and Appraisal of Securities Held by Banks and Thrift Institutions. The "Investment Securities and End-User Activities" section incorporates this June 15, 2004, revised Uniform Agreement (the uniform agreement) that was jointly issued by the federal banking and thrift institution agencies. The uniform agreement sets forth the definitions of the classification categories and the specific examination procedures and information for classifying bank assets, including securities. The June 2004 revision did not change the classification of loans in the uniform agreement. The uniform agreement addresses, among other items, the treatment of rating differences, multiple security ratings, and split or partially rated securities. It also eliminates the automatic classification for sub-investment-grade debt securities. See SR letter 04-9. The examination procedures incorporate the supervisory guidance provided in the uniform agreement.

3. Tying Arrangements. The "Loan Portfolio Management" section has been revised to incorporate a detailed discussion on tying arrangements. Section 106 of the Bank Holding Company Act Amendments of 1970 generally prohibits a bank from conditioning the availability or price of one product or service (the tying product or the desired product) on a requirement that a customer obtain another product or service (the tied product) from the bank or an affiliate of the bank. Section 106 contains several exceptions to its general prohibitions, and it authorizes the Board to grant, by regulation or order, additional exceptions from the prohibitions when the Board determines an exception "will not be contrary to the purposes" of the statute.

The "Loan Portfolio Management" section also includes the Board or Board staff interpretations on tying arrangements, including those issued on August 18, 2003, and February 2, 2004. These two interpretations state that bank customers that receive securities-based credit can be required to hold their pledged securities as collateral at an account of a bank holding company's or bank's broker-dealer affiliate. The section's examination objectives and examination procedures also have been revised to further address tying arrangements.

4. Guidance on Accepting Accounts from Foreign Governments, Foreign Embassies, and Foreign Political Figures. The "Deposit Accounts" section has been revised to incorporate this June 15, 2004, interagency advisory that was issued in response to inquiries the agencies received on whether financial institutions should do business and establish account relationships with those foreign customers cited in the advisory. Banking organizations are advised that the decision to accept or reject such foreign-account relationships is theirs alone to make. Financial institutions should be aware that there are varying degrees of risk associated with these accounts, depending on the customer and the nature of the services provided. Institutions should take appropriate steps to manage these risks, consistent with sound practices and applicable anti-money-laundering laws and regulations. See SR letter 04-10. The examination objectives, examination procedures, and internal control questionnaire were also revised to incorporate the advisory's supervisory guidance.

5. Risk-Based Capital Requirements for Asset-Backed Commercial Paper Programs. The "Assessment of Capital Adequacy" and the "Asset Securitization" sections have been updated to discuss the Board's July 17, 2004, approval (effective September 30, 2004) of its revisions to the risk-based capital requirements for asset-backed commercial paper (ABCP) programs. See appendix A of Regulation H (12 CFR 208, appendix A). Under the Board's revised risk-based capital rule, a bank that qualifies as a primary beneficiary and must consolidate an ABCP program that is defined as a variable interest entity under generally accepted accounting principles (See FIN 46-R) may exclude the consolidated ABCP program's assets from risk-weighted assets provided that the bank is the sponsor of the ABCP program. Banks must also hold risk-based capital against eligible ABCP liquidity facilities with an original maturity of one year or less that provide liquidity support to ABCP by applying a new 10 percent credit-conversion factor to such facilities. Eligible ABCP liquidity facilities with an original maturity exceeding one year remain subject to the rule's current 50 percent credit-conversion factor. Ineligible liquidity facilities are treated as direct-credit substitutes or recourse obligations, which are subject to a 100 percent credit-conversion factor. When calculating the bank's tier 1 and total capital, any associated minority interests must also be excluded from tier 1 capital. The examination procedures also were revised to incorporate the revised risk-based capital requirements.

6. Policy on Payments System Risk. The "Payment System Risk and Electronic Funds Transfer Activities" section incorporates the Board's changes to its Policy on Payments System Risk (the PSR policy). See 69 Federal Register 57917, September 28, 2004, and 69 Federal Register 69926, December 1, 2004. Effective July 20, 2006, the PSR policy requires Reserve Banks (1) to release interest and redemption payments on securities issued by government-sponsored enterprises (GSEs) and certain international organizations (institutions for which the Reserve Banks act as fiscal agents but whose securities are not obligations of, or fully guaranteed as to principal and interest by, the United States) only if the issuer's Federal Reserve account contains sufficient funds to cover them and (2) to align the treatment of the general corporate account activity of GSEs and certain international organizations with the treatment of the activity of other account holders that do not have regular access to the discount window and those account holders not eligible for intraday credit. The examination procedures have been updated to incorporate these revisions.

A more detailed summary of changes is included with the update package. Copies of the new supplement were shipped directly by the publisher to the Reserve Banks for distribution to examiners and other System staff members. The public may obtain the Manual and the updates (including pricing information) from Publications Fulfillment, Mail Stop 127, Board of Governors of the Federal Reserve System, 20th and C Streets, N.W., Washington, DC 20551; telephone (202) 452-3244; or send facsimile to (202) 728-5886). The Manual is also available on the Board's public web site at boarddocs/supmanual/.
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Title Annotation:Federal Reserve Board
Publication:Federal Reserve Bulletin
Geographic Code:1USA
Date:Jan 1, 2005
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