CAPITAL Section 2.1
Capital (8/22) 2.1-4 Risk Management Manual of Examination Policies
Federal Deposit Insurance Corporation
Finally, non-advanced approaches institution management
must consider threshold deductions for three specific types
of assets: investments in the capital of unconsolidated
financial institutions, MSAs, and temporary difference
DTAs. Generally, management must deduct the amount of
exposure to these types of assets, by category that exceeds
25 percent of a base common equity tier 1 capital
calculation. The amounts of MSAs and temporary
difference DTA threshold items not deducted are assigned a
250 percent risk-weight, while investments in the capital of
unconsolidated financial institutions that are not deducted
get assigned a risk-weight determined by the type of asset
exposure (e.g., common stock, preferred stock, sub-debt).
Additional Tier 1 Capital
Additional tier 1 capital includes qualifying noncumulative
perpetual preferred stock, bank-issued Small Business
Lending Fund (SBLF) and Troubled Asset Relief Program
(TARP) instruments that previously qualified for tier 1
capital,
2
and qualifying tier 1 minority interests, less certain
investments in other unconsolidated financial institutions’
instruments that would otherwise qualify as additional tier
1 capital.
Tier 2 Capital
Under the generally applicable rule, tier 2 capital includes
the allowance for loan and lease losses (ALLL)
3
up to 1.25
percent of risk-weighted assets, qualifying preferred stock,
subordinated debt, and qualifying tier 2 minority interests,
less any deductions in the tier 2 instruments of an
unconsolidated financial institution. Effective April 1,
2019, the agencies revised the regulatory capital rules
to include a new term, adjusted allowances for credit
losses (AACL), which replaces the term ALLL in the
capital rules upon an institution’s adoption of
Accounting Standards Codification (ASC) Topic
326, Financial Instruments – Credit Losses, which
includes the Current Expected Credit Losses or
CECL allowance methodology. The term
allowance for credit losses (ACL) as used in ASC
Topic 326 applies to most financial assets, including
available-for-sale (AFS) debt securities. In contrast,
the term AACL, as used in the regulatory capital rules,
excludes credit loss allowances on purchased credit
deteriorated assets and AFS debt securities.
4
The
AACL also excludes an institution’s allocated transfer
risk reserves, if any.
2
SBLF and TARP were federal financial stability programs that
provided capital support to financial institutions in response to the
2008 financial crisis.
3
Adjusted allowances for credit losses replaces the term ALLL for
institutions that have adopted ASC Topic 326. Such institutions
may also elect to apply a Current Expected Credit Losses (CECL)
Part 324 eliminates previous limits on term subordinated
debt, limited-life preferred stock, and the amount of tier 2
capital includable in total capital.
Deductions and Limits
The 2013
capital rule introduced a number of limitations
and deductions that were generally in response to issues
recognized during the financial crisis of 2008 and were
adopted to enhance the quality of capital. Investments in
the capital instruments of another financial institution, such
as common stock, preferred stock, subordinated debt, and
trust preferred securities might need to be deducted from
each tier of capital.
For advanced
approaches institutions only, investments in
the capital of unconsolidated financial institutions must be
analyzed to determine whether they are significant or non-
significant, which depends on the percentage of common
stock that an institution owns in the other financial
institution. If the institution owns 10 percent or less of the
other institution’s common shares, then all of that
investment is non-significant. If an institution owns more
than 10 percent, then all of the investment in that company
is significant. Part 324 contains separate deduction
requirements for significant and non-significant
investments.
In most cases,
threshold-based deductions for all institutions
will be made from the tier of capital for which an investment
would otherwise be eligible. To illustrate, if an institution’s
investment is an instrument that qualifies as tier 2 capital, it
is deducted from tier 2 capital. If it qualifies as an additional
tier 1 capital instrument, it is deducted from additional tier
1 capital. If it qualifies as a common equity tier 1 capital
instrument, it is deducted from common equity tier 1 capital.
If the institution does not have sufficient tier 2 capital to
absorb a deduction, then the excess amount is deducted
from additional tier 1 capital or from common equity tier 1
capital if there is insufficient additional tier 1 capital.
Part 324 limits the amount of minority interest in a
subsidiary that may be included in each tier of capital. To
be included in capital, the instrument that gives rise to
minority interest must qualify for a particular tier of capital.
Non-advanced approaches institutions are allowed to
include common equity tier 1, tier 1, and total capital
minority interest up to 10 percent of the banking
organization’s total capital (before the inclusion of any
transition provision over three or five years, if applicable. See the
section below titled CECL Transition Period.
4
Purchased credit deteriorated assets and AFS debt securities are
risk-weighted net of credit loss allowances as measured under
ASC Topic 326.