Release of minutes of discount rate meetings. (Announcements).
PUBLICATION OF THE NOVEMBER 2002 UPDATE TO THE COMMERCIAL BANK EXAMINATION MANUAL
The November 2002 update to the Commercial Bank Examination Manual, Supplement No. 17, has been published and is now available. The Manual comprises the Federal Reserve System's regulatory, supervisory, and examination guidance for state member banks. The new supplement includes the following:
1. Host State Loan-to-Deposit Ratios. The examination strategy and risk-focused examinations section is revised to discuss (a) Section 109 of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, which prohibits any bank from establishing or acquiring a branch or branches outside of its home state for the purpose of deposit production; and (b) an amendment (approved by the Board and the Federal Financial Institutions Examination Council (FFIEC), effective October 1, 2002) that conforms the uniform rule (see Regulation H, section 208.7(b)(2)) to section 109. Section 109 sets forth a process that is based on published loan-to-deposit ratios that can be used to test compliance with the statutory requirements. (See the Board's June 24, 2002, announcement of the published host-state loan-to-deposit ratios.) A noncompliant bank is subject to sanctions.
2. Allowance for Loan and Lease Losses (ALLL). A new section contains supervisory guidance on ALLL methodologies and documentation practices. (See the July 2, 2001, FFIEC policy statement). An institution's board of directors is responsible for ensuring that controls are in place to determine the appropriate level of the ALLL. The institution should maintain and support the ALLL with documentation that is consistent with its stated policies and procedures, generally accepted accounting principles (GAAP), and applicable supervisory guidance. The institution's ALLL methodology must be a thorough, disciplined, and consistently applied process that incorporates management's current judgment about the credit quality of the loan portfolio. Examination objectives and procedures are provided. See SR letter 01-17.
3. Subprime Lending. A new section identifies subprime lending as the extension of credit to borrowers who exhibit characteristics indicating a significantly higher risk of default than traditional bank lending customers. The section discusses March 1, 1999, interagency subprime lending guidance that emphasizes that institutions engaged in subprime lending need to have strong risk-management practices and internal controls, as well as Board-approved policies and procedures, that' appropriately identify, measure, monitor, and control all associated risks. The various risks inherent in this type of activity are identified. See SR letter 99-6.
Supplemental interagency subprime lending guidance issued in January 2001 is also discussed, including supervisory expectations for the ALLL, regulatory capital, examination review of subprime activities, classification of risk, and documentation for re-aging, renewing, or extending delinquent accounts. This guidance is directed primarily to those institutions that have subprime-lending programs that equal or exceed 25 percent of tier I regulatory capital. Institutions are expected to recognize that the elevated levels of credit and other risks arising from these activities require more intensive risk management and, often, additional capital. Questions and answers pertaining to the January 2001 guidance are provided. The examination objectives and procedures are also revised. See SR letter 01-4.
4. Capital Adequacy. This revised section on the assessment of capital adequacy includes various rule changes and clarifying interpretations.
a. The Board approved on March 27, 2002, a limited risk-based capital rule change, effective July 1, 2002. (See the Federal Reserve's joint press release of April 9, 2002, and its attachment.) The modification lowered, from 100 percent to 20 percent, the risk weight that is applied to certain securities claims on, or guaranteed by, a qualifying securities firm in the United States and in other countries that are members of the Organization for Economic Cooperation and Development.
b. Joint interagency interpretive guidance was issued on September 5, 2002, discussing the appropriate applications of the November 29, 2001, joint final ruling on the capital treatment of recourse obligations, direct-credit substitutes, and residual interests in asset securitizations. The guidance addresses risk-based capital treatment pertaining to (1) split or partially rated instruments, (2) nonqualification of corporate bonds or other securities for the ratings-based approach, (3) spread accounts that function as credit-enhancing interest-only strips, (4) audits of internal credit-risk rating systems, and (5) cleanup calls. See SR letter 02-16.
c. The risk-based capital treatment of accrued interest receivables (AIR) related to credit card securitizations, as discussed in a May 17, 2002, interagency advisory. An AIR represents a subordinated retained interest in the cash initially allocated to the investors' portion of a credit card securitization, meeting the definition of a "residual interest" and the capital requirements under the November 2001 rule amendment, effective January 1, 2002. When accounting for the sale of credit card receivables, the gain or loss on sale, the seller should include the AIR as a subordinated retained interest. Based on GAAP, the value of the AIR at the date of transfer must be adjusted based on its relative fair (market) value. See SR letters 02-12 and 02-22.
d. The tier 1 leverage measure of the capital adequacy guidelines was revised for state member banks. A revised rule, Regulation H (12 CFR 208, appendix B), was approved by the Board on November 8, 2001 (effective January 1, 2002), and issued in a joint agency press release dated November 29, 2001. The rule was revised for agreements involving recourse, direct-credit substitutes, and residual interests. Also included is another final rule revision for nonfinancial equity investments, approved by the Board on January 7, 2002 (effective April 1, 2002). See the January 8, 2002, joint interagency press release and SR letter 02-4.
5. Asset Securitization. This revised section addresses the following issues:
a. An interagency advisory issued May 23, 2002, on covenants in asset-securitization contracts that are linked to supervisory thresholds or adverse supervisory actions as triggers for early amortization events or the transfer of servicing. Such covenants are considered unsafe and unsound banking practices that undermine the objective of supervisory actions. A bank's boards of directors and senior management are encouraged to amend, modify, or remove these types of covenants in existing transactions. Such covenants could create or exacerbate any liquidity and earnings problems for a bank, possibly leading to a further deterioration in its financial condition. See SR letter 02-14.
b. Interagency guidance issued May 23, 2002, on implicit recourse provided to asset securitizations. Implicit recourse occurs when a banking institution provides post-sale credit support beyond its contractual obligation to one or more of its securitizations. Implicit recourse is of supervisory concern because it demonstrates that the securitizing institution is re-assuming risk associated with the securitized asset that the institution initially transferred to the marketplace. Illustrative examples are provided and several supervisory actions are discussed that the Federal Reserve may take upon a determination that an institution has provided implicit recourse. See SR letter 02-15.
6. Parallel-Owned Banking Organizations. The Bank-Related Organizations section includes a discussion of the April 23, 2002, joint-agency statement for parallel-owned banking organizations. A parallel-owned banking organization is created when at least one U.S. depository institution and one foreign bank are controlled, either directly or indirectly, by the same person or group of persons who are closely associated in their business dealings or otherwise acting in concert, The statement discusses the risks of, and supervisory approach for, those organizations.
7. Fiduciary Activities. A new section discusses the Federal Reserve's integration of its supervisory assessment of a bank's fiduciary activities into the overall safety-and-soundness supervision process, focusing supervisory resources on areas of greatest potential risk. The Federal Reserve's examination-frequency mandates for trust and transfer-agency examinations have been integrated with the safety-and-soundness examinations. (See SR letter 01-5.) Supervisory risk profiles, risk assessments, and supervisory plans are to reflect fiduciary activities. (See SR letter 96-10.) The composite Uniform Interagency Trust Rating System (UITRS) (see SR letter 98-37) and transfer-agent ratings are discussed that reflect the overall condition of each bank's fiduciary function. The Federal Reserve's concerns about direct or indirect financial incentives for banks and trust institutions that place trust assets with particular mutual funds are also discussed. See SR letter 99-7.
8. Formal and Informal Corrective Actions. This revised section discusses various statutory provisions regarding such actions, including actions that must be taken by the Federal Reserve. The discussion on prompt-corrective-action directives, including the potential assessment of civil money penalties against a bank or company, or any of its institution-affiliated parties, for noncompliance is also revised. Included are the Federal Reserve's supervisory concerns and guidance on the FDIC's regulations on indemnification agreements and payments. See SR letter 02-17.
9. International--Country Risk and Transfer Risk. The former international-transfer-risk section is revised to include the February 22, 2002, interagency supervisory and examination guidance on an effective country-risk management process. Country risk is the risk that economic, social, or political conditions in a foreign country might adversely affect an organization's financial condition, primarily through impaired credit quality or transfer risk. (Transfer risk is a subset of country risk.) The new guidance supplements and strengthens the existing guidance. Examiners' responsibilities are discussed for ensuring that a bank's management of its country risks are appropriately addressed during the bank examination process. Revised examination objectives, procedures, and an internal-control questionnaire are included. See SR letter 02-5.
A more detailed summary of changes is included with the update package. The Manual and updates, including pricing information, are available from Publications Fulfillment, Mail Stop 127, Board of Governors of the Federal Reserve System, Washington, DC 20551 (or charge by facsimile: 202-728-5886). The Manual is also available on the Board's public web site at www.federalreserve.gov/ boarddocs/supmanual/.
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|Publication:||Federal Reserve Bulletin|
|Date:||Feb 1, 2003|
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