Release of minutes of discount rate meetings - Announcements

Federal Reserve Bulletin, Feb, 2003

The Federal Reserve Board on December 23, 2002, released the minutes of its discount rate meetings from October 7 to November 6, 2002.

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.