Academic journal article ABA Banking Journal

Exam Council Unveils New Angles on Capital

Academic journal article ABA Banking Journal

Exam Council Unveils New Angles on Capital

Article excerpt

If capital is the cushion between a bank and its risk, the issue of recourse is one of the lumps that makes that cushion less than perfectly comfortable.

That is one way of summarizing the theme of a 49-page request for public comment released in late June by the Federal Financial Institutions Examination Council.

The basics. The interagency group's request for comment covered three broad areas: the definition of recourse; regulatory reporting of recourse arrangements; and how required capital support for such arrangements should be set. The document is an expansion of an earlier staff paper (ABA BJ, April, p. 10). It also calls for comments on the impact of recourse arrangements on calculating limits on loans to one borrower.

The comment period expires Aug. 28. The regulations that could result from the ongoing discussion would likely travel a fast track, because the regulators are considering implementing any rules they develop in conjunction with the new risk-based capital guidelines. The standards, which apply to both banks and bank holding companies, start their two-year phase-in period at the end of this year.

The agencies' stance is that any time an institution faces a risk, that risk should be balanced by capital. Yet, the paper relates, under current capital standards some types of recourse trigger capital requirements, while others do not. Under the risk-based capital guidelines, which feature techniques for capturing off-balance-sheet risks, banks must hold capital against sold assets if recourse is included in the deal. What is it? Up to this point, the three banking agencies have never had a comprehensive regulatory definition of recourse.

The announcement does not officially define the term-that's part of the point-but as a point of reference describes it as "a financial institution's acceptance, assumption or retention of some or all of the risk of loss generally associated with ownership of an asset, whether or not the institution owns or has ever owned the asset. " Traditionally, the announcement notes, the heart of the issue has been credit risk.

What worries the regulators is that the frequency and variety of recourse arrangements has been increasing.

The agencies report this has been most noticeable in connection with programs for securitizing assets. The factor that concerns the regulators is the @rowing number of private securitizations that entail neither federal guarantees nor insurance.

To satisfy investors, the regulators state, some financial institutions have provided assurances to buyers that all but remove any possible risk. At times, these assurances involve events the lenders have no control over.

These assurances go beyond the traditional type of recourse, which concerned loans that went bad. More recent recourse arrangements protect investors against such diverse factors as environmental lender liability; interest rate and prepayment risk; foreign exchange risk; liquidity and marketability risk; and the risk of poor compliance with consumer protection and other laws.

Me agencies' questions in this area are:

(1) How should "recourse arrangement" be defined? What types of risk should be construed as creating a recourse arrangement? Should the same definition be applied in the capital, reporting, and lending limit contexts?

(2) What are all the various ways in which financial institutions accept, assume, or retain recourse?

Regulatory treatment. Agency call reports treat assets transferred with recourse in a variety of ways, with the treatment depending on a number of conditions. Overall, these conditions differ from generally accepted accounting principles.

As mentioned, while current capital standards treat assets transferred with recourse in various ways, the new rules will still require capital to be held against transfers made with recourse even when they are reported as sales. …

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