NOVEMBER 2005
Proposed Rules Changing Risk-Based Capital Requirements
Recently, the Office of the Comptroller of the
Currency, the Board of Governors of the Federal
Reserve System, the Federal Deposit Insurance
Corporation, and the Office of Thrift Supervision
published an Advanced Notice of Proposed
Rulemaking in the Federal Register1 that seeks comments on a number of potential revisions to the existing financial institution risk-based capital structure
designed to enhance its risk sensitivity. While these
modifications would address similar risk-based capital standards that are being considered under the proposed Basel II framework, these regulatory changes
(which have been referred to by some as “Basel IA”)
would apply to all banks, bank holding companies
and savings associations.2
The proposed changes to the risk-based capital
requirements would impact a wide variety of financial products, and could affect the pricing, availability, structure and terms of loans, securitizations, letters of credit and other similar bank products. One
proposal of note would establish a credit conversion
factor for certain commitments with a duration of less
than one year, which currently have none, that would
require banks to maintain 10 percent of the commitment in risk-based capital. Another would assign
certain commercial real estate acquisition, development and construction loans (“ADC Loans”) a risk
weight greater than 100 percent, unless the related
project meets specified regulatory guidelines and is
supported by a substantial amount of borrower equity.
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Permitting greater use of external credit agency
ratings to assign risk weights to certain rated
obligations, similar to the present system for
risk-weighting mortgage-backed securities; i.e.,
those with higher external ratings will be placed
in lower risk-weight categories. The proposed
rule would not generally apply to U.S. government and municipal securities.
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Expanding the criteria for recognized financial
collateral and guarantors that may qualify an
exposure for a lower risk classification.
■
Revising risk-weight methodology for certain
first lien one-to-four family residential mortgages; i.e., those with lower loan-to-value ratios
could be placed in lower risk-weight categories.
Other relevant measures of credit quality in
addition to loan-to-value ratios for determining
risk-weight categories such as credit score and
debt-to-income ratios are also being considered.
■
Using credit assessments (credit score or ability
to service debt) to increase credit risk sensitivity
for retail exposures such as consumer loans,
credit cards and automobile loans.
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Assigning a higher risk weighting to loans that
are 90 days or more past due or in nonaccrual
status. The amount of the exposure assigned to
the higher risk weight may be reduced by any
reserve directly allocated to the potential loss.
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Revising the capital requirements for ADC
Loans to higher than a 100% risk weight, except
for ADC Loans that meet the Interagency Real
Estate Lending Standards and have at least 15%
borrower equity.
Changes proposed for consideration include the following:
■
Increasing the number of risk-weight categories
from 5 to 9 to better associate credit risks with
underlying exposures. The new risk-weights
would be 35, 75, 150 and 350 percent.
1
70 Fed. Reg. 61,068 (October 20, 2005).
2
The Basel II framework would only apply to certain large US banking organizations and those who choose to voluntarily assume it.
Kirkpatrick & Lockhart Nicholson Graham
LLP
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Revising risk weighting for small business loans.
For example, certain fully amortizing, fully collateralized, performing small business loans with
a maturity of seven years or less could qualify
for less than a 100% risk-weighting.
Assessing the risks imposed by early amortization of asset-backed securities.
Comments in respect of the proposed rules are requested by the agencies no later than January 18, 2006.
Steven H. Epstein
sepstein@klng.com
212.536.4830
Rebecca H. Laird
rlaird@klng.com
202.778.9038
Ira L. Tannenbaum
itannenbaum@klng.com
202.778.9350
Special thanks to Aaron W. Menzi for his help in
preparing this Alert.
If you have any questions regarding the proposed rules or the comment process, please don’t hesitate to contact any
of the attorneys listed on this Alert for further information.
Boston
Stephen Moore
Stanley V. Ragalevsky
617.951.9191
617.951.9203
smoore@klng.com
sragalevsky@klng.com
Los Angeles
Ronald W. Stevens
William P. Wade
310.552.5521
310.552.5071
rstevens@klng.com
wwade@klng.com
New York
Elwood F. Collins
Steven H. Epstein
Lorraine Massaro
Thomas C. Russler
212.536.4005
212.536.4830
212.536.4043
212.536.4068
ecollins@klng.com
sepstein@klng.com
lmassaro@klng.com
trussler@klng.com
Pittsburgh
Steve J. Adelkoff
Kristen Larkin Stewart
412.355.6325
412.355.8975
sadelkoff@klng.com
kstewart@klng.com
San Francisco
Jonathan D. Joseph
415.249.1012
jjoseph@klng.com
Washington
Phillip J. Kardis II
Rebecca H. Laird
John Steele
Ira L. Tannenbaum
Robert A. Wittie
202.778.9401
202.778.9038
202.778.9489
202.778.9350
202.778.9066
pkardis@klng.com
rlaird@klng.com
jsteele@klng.com
itannenbaum@klng.com
rwittie@klng.com
www.klng.com
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