December 2004 update to the Bank Holding Company Supervision Manual

Federal Reserve Bulletin, Spring, 2005

The December 2004 update to the Bank Holding Company Supervision Manual has been published (supplement no. 27). The new supplement includes supervisory and BHC inspection guidance on the following subjects:

1. Revised Uniform Agreement on the Classification of Assets and Appraisal of Securities Held by Banks and Thrift Institutions. The section on the inspection reporting of consolidated classified and special-mention assets and other transfer-risk problems has been revised to incorporate this June 15, 2004, revised Uniform Agreement (the uniform agreement) that was jointly issued by the federal banking and thrift institution agencies. The uniform agreement sets forth the definitions of the classification categories and the specific examination procedures and information for classifying bank assets, including securities. The June 2004 revision did not change the classification of loans in the uniform agreement. The uniform agreement addresses, among other items, the treatment of rating differences, multiple security ratings, and split or partially rated securities. It also eliminates the automatic classification for sub-investment-grade debt securities. The uniform agreement's classification categories also apply to the classification of assets held by the subsidiaries of banks and bank holding companies. See SR letter 04-9.

2. Tying Arrangements. The section on "Tie-In Considerations of the BHC Act" has been revised to incorporate an August 18, 2003, Board interpretation and a February 2, 2004, Board staff interpretation on tying arrangements pertaining to section 106 of the Bank Holding Company Act Amendments of 1970 (section 106). These two interpretations state that bank customers that receive securities-based credit can be required to hold their pledged securities as collateral at an account of a bank holding company's or bank's broker-dealer affiliate. Section 106 generally prohibits a bank from conditioning the availability or price of one product or service (the tying product, or the desired product) on a requirement that a customer obtain another product or service (the tied product) from the bank or an affiliate of the bank.

3. "Guidance on Accepting Accounts from Foreign Governments, Foreign Embassies, and Foreign Political Figures." A new section "Establishing Accounts for Foreign Governments, Embassies, and Political Futures" conveys the June 15, 2004, interagency advisory that was issued by the federal bank and thrift institution agencies (agencies) and the U.S. Department of the Treasury's Financial Crimes Enforcement Network (FinCEN). The advisory responds to inquiries the agencies and FinCEN received on whether financial institutions should do business and establish account relationships with those foreign customers cited in the advisory. Banking organizations are advised that the decision to accept or reject such a foreign-account is a decision they should make after considering the factors outlined in the advisory, including the institution's business objectives and its ability to manage the risk.

Financial institutions should be aware that there are varying degrees of risk associated with these accounts, depending on the customer and the nature of the services provided. Institutions should take appropriate steps to manage these risks, consistent with sound practices and applicable anti-money-laundering laws and regulations. This advisory is primarily directed to financial institutions located in the United States. The boards of directors of bank holding companies, however, should consider whether the advisory should be applied to their other U.S. subsidiaries' financial and other services. See SR letter 04-10.

4. Risk-Based Capital Requirements for Asset-Backed Commercial Paper Programs. The sections "Examiners' Guidelines for Assessing the Adequacy of Capital of BHCs" and "Credit-Supported and Asset-Backed Commercial Paper" have been updated to include the Board's July 17, 2004, approval (effective September 30, 2004) of its revisions to the risk-based capital requirements for asset-backed commercial paper (ABCP) programs sponsored by state member banks and bank holding companies (collectively, banking organizations). See appendix A of the Board's Regulation Y (12 CFR 225, appendix A).

Under the Board's revised risk-based capital rule, a banking organization that qualifies as a primary beneficiary and must consolidate an ABCP program that is defined as a variable interest entity under generally accepted accounting principles (see the Financial Accounting Standards Board's Interpretation FIN 46-R) may exclude the consolidated ABCP program's assets from risk-weighted assets, provided that it is the sponsor of the ABCP program. Such banking organizations must hold risk-based capital against any credit enhancement or liquidity facility that they provide to the ABCP program. In particular, a banking organization must hold risk-based capital against eligible ABCP liquidity facilities with an original maturity of one year or less that provide liquidity support to ABCP by applying a new 10 percent credit-conversion factor to such facilities. When calculating the banking organization's tier 1 and total capital, any associated minority interests must also be excluded from tier 1 and total capital. Certain inspection objectives and inspection procedures were also revised to incorporate this revised rule for ABCP programs.