U.S. Federal Banking Agencies Release Final Rule on the Effect of FAS 166 and 167 on Risk-Based Capital Rules
U.S. Federal Banking Agencies Release Final
Rule on the Effect of FAS 166 and 167 on Risk-
Based Capital Rules.
Risk Based Capital Rules . 2
On January 21, 2010, four U.S. federal banking agencies: the Board of
Governors of the Federal Reserve System, the Office of the Comptroller of the Transition Period: Delay
Currency, the Federal Deposit Insurance Corporation (“FDIC”) and the Office of and Phase-In .................... 2
Thrift Supervision (collectively, the “Federal Banking Agencies”) jointly issued
Transition for ALLL ........... 3
a final rule (the “Final Rule”) amending their risk-based capital rules in
connection with changes to U.S. generally accepted accounting principles ABCP Programs ............... 3
(“GAAP”) introduced by the Financial Accounting Standard Board’s (“FASB”)
Statements of Financial Accounting Standards Nos. 166 and 167 (“FAS 166 and Reservation of Authority ... 3
FAS 166 and 167 are expected to result in the consolidation of many existing
and future securitization vehicles onto the balance sheets of banks. As a result,
the Federal Banking Agencies have acknowledged that the implementation of
FAS 166 and 167 by banks will likely adversely affect the banks’ risk-based
capital and leverage ratios.
In brief, FAS 166 and 167 amend U.S. GAAP by (i) eliminating the “qualifying
special purpose entity” (“QSPE”) status used by sponsors of securitization
structures to deconsolidate securitization vehicles from their balance sheets and
(ii) changing the way that securitization structures are analyzed for purposes of
determining whether they should be consolidated and by who. The types of
securitization structures particularly at risk for consolidation under FAS 166 and
167 include asset-backed commercial paper (“ABCP”) programs, revolving
securitizations, some mortgage-backed securitizations and some term loan
securitizations. Banks are required to comply with FAS 166 and 167 at the
beginning of their first annual reporting period that begins after November 15,
The Federal Banking Agencies previously issued a Proposed Notice of
Rulemaking on September 15, 2009 that requested public comment on several
questions and proposals. In response they subsequently received
approximately forty-one comment letters.
In crafting the Final Rule, the Federal Banking Agencies appear to have largely
rejected comments requesting a substantial delay in the effectiveness of FAS
166 and 167 on banks’ risk-based capital and leverage ratios as well as calls for
1 U.S. Federal Banking Agencies Release Final Rule on the Effect of FAS 166 and 167 on
Risk-Based Capital Rules
permanent modifications to the risk-based capital rules that would minimize the
increase in capital requirements as a result of these accounting changes.
The Final Rule’s effective date will be sixty days after it is published in the
Federal Register (which is expected shortly).
Risk Based Capital Rules
The Federal Banking Agencies decided against granting permanent relief to
banks from the increased capital requirements resulting from FAS 166 and 167,
despite numerous comment letters requesting such changes. The decision was
in part grounded in concerns that the existing rules were already insufficient to
account for non-contractual risks inherent in certain securitized assets and thus
their effectiveness should not be further diluted. The Federal Banking Agencies
also rejected requests to modify their leverage ratios to provide similar relief.
However, the Federal Banking Agencies have agreed to create a transition
period during which banks may obtain some temporary relief from the increased
risk-based capital requirements.
Transition Period: Delay and Phase-In
The Final Rule provides for (i) an optional two-quarter delay of recognition of
FAS 166 and 167’s effect on risk-weighted assets and allowance for loan and
lease losses (“ALLL”) includable in Tier 2 capital (the “Delay Period”) and (ii) an
optional phase-in of increased capital requirements for the next two quarters
(the “Phase-In Period”). Any bank that elects to take advantage of the
transition mechanism must apply this treatment to all relevant entities that it
would be required to consolidate under FAS 166 and 167. Banks will also be
required to maintain two sets of records (one for GAAP reporting and one for
regulatory capital purposes) during the transition period.
The risk-weighted assets that may be excluded are those that (i) the bank did
not previously consolidate and (ii) the bank is required to consolidate as a result
of FAS 166 and 167. In addition, the related variable interest entity (“VIE”) must
have existed prior to the bank’s implementation date for FAS 166 and 167.
During the transition period, banks may also exclude assets held by ABCP
program VIEs as long as the bank is the sponsor of the ABCP program, the
bank consolidated the ABCP program VIE onto its balance sheet under GAAP
and the bank excluded the VIE’s assets from its risk-weighted assets prior to its
implementation of FAS 166 and 167.
One important caveat is that banks may not exclude any VIE assets to which
they have provided “implicit support” – that is, support that extends beyond the
bank’s contractual obligations to a VIE. Such practices were common during the
recent credit crisis and were particularly troubling to the Federal Banking
Agencies because they were not sufficiently accounted for by the existing risk-
based capital rules.
During the third and fourth quarters of the transition period, fifty percent of the
amount excluded during the two-quarter delay period may continue to be
excluded, subject to a floor of an amount equal to the aggregate risk-weighted
2 U.S. Federal Banking Agencies Release Final Rule on the Effect of FAS 166 and 167 on
Risk-Based Capital Rules
assets stemming from the bank’s contractual exposures to the related VIEs as of
the date of the bank’s implementation of FAS 166 and 167.
The Federal Banking Agencies specifically rejected requests for a longer
transition period despite acknowledging that “affected banking organizations’
risk-based and leverage capital ratios likely will decrease with their
implementation of FAS 166 and 167.” In choosing a year-long transition period,
however, the Federal Banking Agencies did acknowledge the uncertainty facing
banks during 2010 from “securitization reform” proposals under consideration by
Congress and some regulators (including the FDIC).
Transition for ALLL
A bank electing to utilize the transition period may also include without limit in
Tier 2 capital the full amount of the ALLL calculated as of the date of the bank’s
implementation of FAS 166 and 167 that is attributable to excluded assets (the
“Inclusion Amount”). This overrides the limits on ALLL that may be included in
Tier 2 capital found in the Federal Banking Agencies’ general and advanced
risk-based capital rules (the “Existing Limits”).
During the Phase-in Period, a bank that has elected to utilize the transition
period may then include fifty percent of the Inclusion Amount in Tier 2 capital
without regard to the Existing Limits. Any ALLL in excess of this amount may
still be included in Tier 2 capital subject to the 1.25 percent limit found in the
Federal Banking Agencies’ general risk-based capital rules.
Once again, these rules do not apply to VIEs to which a bank has provided
Prior to the effectiveness of the Final Rule, banks are and have been permitted
to exclude the assets of an ABCP program VIE which was consolidated under
GAAP and sponsored by the bank and assess its risk-capital capital
requirements based solely on the bank’s contractual exposure to such ABCP
Noting that “recent events have raised serious questions about the original
rationale for” such exclusion, the Federal Banking Agencies have decided to
eliminate it. Concluding that no viable alternative proposals exist, the Final Rule
eliminates the ABCP exclusion, subject to the transition period described above.
Reservation of Authority
In an effort to combat regulatory arbitrage, the Final Rule also contains a new
reservation of authority for the Federal Banking Agencies which states that a
bank may be required to hold regulatory capital against an off balance sheet
exposure as if it were consolidated “if the primary federal supervisor
determine[s] that the banking organization’s exposure or other relationship to the
entity [is] not commensurate with the actual risk relationship of the banking
organization to the entity.” The new language is an extension of an existing
concept found in the risk-based capital rules that allow the Federal Banking
Agencies to override the regulatory capital treatment of an asset whenever they
3 U.S. Federal Banking Agencies Release Final Rule on the Effect of FAS 166 and 167 on
Risk-Based Capital Rules
determine that the capital levels required by the rules are not sufficient given the
4 U.S. Federal Banking Agencies Release Final Rule on the Effect of FAS 166 and 167 on
Risk-Based Capital Rules