Proposed Risk-Based Capital Rules' Treatment of Recourse and Direct Credit Substitutes
March 9, 2000
Circular No. 11232

Comments Invited by June 7, 2000

To All State Member Banks and Bank Holding Companies in the Second Federal Reserve District:

The four federal banking agencies -- the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision -- have proposed revisions to their risk-based capital requirements for certain obligations related to securitized transactions. The following is from the announcement of the proposal:

The proposal is intended to produce more consistent capital treatment for credit risks associated with exposures arising from securitization transactions. It would amend the risk-based capital requirements for asset-backed securities as well as recourse obligations and direct credit substitutes.

Public comment is requested by June 7, 2000.

In securitizations, assets such as residential and commercial mortgages, credit-card receivables and automobile loans are pooled and reconstituted into securities. Securitizations typically carve up the credit risks from underlying assets and redistribute them to different parties. Sellers of assets into a securitization may retain part of the risk of credit loss through recourse arrangements. Sellers also may arrange for a third party, such as a banking organization, to accept some of the credit risk through guarantees, referred to as direct credit substitutes.

The proposed revisions would:

Assign a risk-based charge to positions in securitized transactions according to the relative credit risk of those positions, as measured by credit ratings received from nationally recognized rating agencies.

Treat recourse obligations and direct credit substitutes more consistently under risk-based capital rules.

Define "recourse" and revise the definition of "direct credit substitute."

Permit the limited use of an institution's internal risk-rating system and other alternative approaches in determining the risk-based capital requirement for unrated direct credit substitutes associated with asset-backed commercial paper programs and other structured finance programs.

Require banking organizations to hold additional risk-based capital against risks presented by the early amortization feature of revolving asset securitizations.

The current interagency proposal incorporates many of the industry comments received in response to an earlier version published in November 1997. A consultative paper issued in June 1999 by the Basel Committee on Banking Supervision considers a similar approach to that contained in the current proposal.

The interagency proposal, published as Part II of the March 8 Federal Register, is available as a PDF file (pdf - 353kb). Your comments should be sent directly to the Board, as indicated in the proposal, by June 7, 2000. The relevant portions of the proposal, together with the contacts to whom questions may be directed, are indicated below:

Interagency preamble - pages 12320 to 12332;

Office of Comptroller of Currency - pages 12332 to 12335 - contact Roger Tufts (202-874-5070);

Federal Reserve Board - pages 12335 to 12339 (Regulation H), pages 12339 to 12343 (Regulation Y) - Board contact Thomas R. Boemio (202-452-2982); contact at this Bank Kim Olson (212-720-1635);

Federal Deposit Insurance Corporation - pages 12343 to 12347 - contact Robert F. Storch (202-898-8906);

Office of Thrift Supervision - pages 12347 to 12352 - contact Michael D. Solomon (202-906-5654).