INTERBANK LIABILITIES 
12 CFR Part 206 
[Regulation F; Docket No. R-0769] 

AGENCY: Board of Governors of the Federal Reserve System. 
ACTION: Final rule. 

SUMMARY: The Board is publishing in final a new Regulation F, Interbank
Liabilities. The final rule implements section 308 of the Federal Deposit
Insurance Corporation Improvement Act of 1991 (FDICIA), which requires the
Board to prescribe standards to limit the risks posed by exposure of
insured depository institutions to other depository institutions. The
final rule applies to banks, savings associations, and branches of foreign
banks with deposits insured by the Federal Deposit Insurance Corporation
(FDIC).

The final rule generally requires insured banks, savings associations, and
branches of foreign banks, referred to collectively as "banks," to develop
and implement internal prudential policies and procedures to evaluate and
control exposure to the depository institutions with which they do
business, referred to as "correspondents."

The rule also establishes a general "limit" stated in terms of the exposed
bank's capital, for overnight "credit exposure" to an individual
correspondent, as defined by the rule. Under the rule, a bank ordinarily
should limit its credit exposure to an individual correspondent to an
amount equal to not more than 25 percent of the exposed bank's total
capital, unless the bank can demonstrate that its correspondent is at
least "adequately capitalized." No limit is specified by the rule for
credit exposure to correspondents that are at least "adequately
capitalized," but a bank is required to establish and follow its own
internal policies and procedures with regard to exposure to all
correspondents, regardless of capital level.

The final rule provides for a thirty-month transition period after the
effective date for full implementation of the rule. Banks must have in
place the internal policies and procedures required by the rule on June
19, 1993. The regulatory limit on credit exposure to correspondents that a
bank cannot demonstrate are at least "adequately capitalized" will be
phased in, with the limit set at 50 percent of the exposed bank's capital
for a one-year period beginning on June 19, 1994, and reduced to 25
percent as of June 19, 1995.

EFFECTIVE DATE: December 19, 1992.

FOR FURTHER INFORMATION CONTACT: Oliver Ireland, Associate General Counsel
(202/452-3625), Lawranne Stewart, Attorney (202/452-3513), or Manley
Williams-Stander, Legal Assistant (202/452-5565), Legal Division; or
Stephen Lovette, Manager (202/452-3622), or Derek L. Young, Supervisory
Financial Analyst (202/452-2960), Division of Banking Supervision and
Regulation, Board of Governors of the Federal Reserve System. For the
hearing impaired only, Telecommunications Device for the Deaf (TDD),
Dorothea Thompson (202/452-3544), Board of Governors of the Federal
Reserve System, 20th & C Streets, NW., Washington, DC 20551.
SUPPLEMENTARY INFORMATION: On July 20, 1992, the Board published for
comment a proposed Regulation F, Interbank Liabilities, to implement
section 308 of the Federal Deposit Insurance Corporation Improvement Act
of 1991 (FDICIA). 57 FR 31974, July 20, 1992. Section 308, which added a
new section 23 to the Federal Reserve Act (FRA), requires the Board to
prescribe standards, by regulation or order, that will have the effect of
limiting the risks posed by an insured depository institution's exposure
to another depository institution.  Summary of the Proposed Rule

The Board's proposed rule was designed to ensure that banks adopt prudent
limits on credit and liquidity risks in dealing with other depository
institutions. The proposed rule required banks to establish limits on both
credit and settlement exposure to each individual correspondent. The
proposed rule also established "benchmark" guidelines on the overnight
credit exposure to individual correspondents that ordinarily should not be
exceeded. The benchmark guidelines were stated as percentages of the
exposed bank's capital. The levels of overnight credit exposure considered
to be permissible under the benchmarks were tiered based on the capital of
the correspondent with which the bank is dealing, so that higher levels of
a bank's capital may be exposed to better capitalized correspondents. The
benchmark guidelines under the proposed rule were intended to establish
the maximum credit exposure that ordinarily would be considered to be
prudent with respect to a correspondent with a particular level of
capital.

The benchmark guidelines, which were based on a measure of credit exposure
that excluded certain relatively low-risk transactions, generally
permitted a bank to have credit exposure to an individual correspondent in
an amount up to 25 percent of the exposed bank's total capital. For a
correspondent that a bank could demonstrate is "adequately capitalized,"
the bank could have credit exposure under the proposed rule equal to 50
percent of the bank's total capital, but no more than 25 percent of the
bank's capital could be exposed through transactions with a term to
maturity of more than thirty days. No specific benchmark guideline was
provided under the proposed rule for credit exposure to a correspondent
that the bank could demonstrate was "well capitalized."

Summary of Final Rule

The final rule continues to require that a bank adopt internal policies
and procedures to address exposure to correspondents, and includes a
"regulatory limit" for exposure to correspondents that are less than
adequately capitalized. As with the proposed rule, "correspondent"
includes both domestically chartered depository institutions that are
federally insured and foreign banks. The Board has made several
significant modifications to the proposed rule, however, in order to
improve the effectiveness of the rule and to reduce burdens identified by
the comments.

Prudential Standards

The final rule provides greater detail concerning the prudential standards
in order to clarify the rule's requirements for internal policies and
procedures to identify and control risk. Under the final rule, a bank is
required to adopt internal policies and procedures to address the risk
arising from exposure to a correspondent, taking into account the
financial condition of the correspondent and the size, form, and maturity
of the exposure. The final rule allows banks to adopt flexible policies
and procedures to meet this requirement in order to permit banks to
allocate resources in a manner that will result in real reductions in
risk, while minimizing the burden of compliance with the rule.

The final rule requires a bank to maintain written policies and procedures
to prevent excessive exposure to any individual correspondent in relation
to the financial condition of the correspondent. Under the final rule, a
bank's board of directors must review annually the bank's policies and
procedures concerning correspondents, but need not approve individual
correspondent relationships. The policies and procedures adopted by the
board must provide for consideration of credit and liquidity risks,
including operational risks, in establishing and maintaining relationships
with correspondents. Where a bank's exposure to a correspondent is
significant, considering the size and maturity of the exposure and the
condition of the correspondent, the bank must periodically review the
financial condition of the correspondent. The final rule does not require
periodic review of the financial condition of all correspondents. For
example, the final rule does not require periodic review of the financial
condition of a correspondent to which the bank has only insignificant
levels of exposure, such as small balances maintained for clearing
purposes.
 
The final rule requires that a bank take into account any deterioration in
the condition of a correspondent in evaluating the creditworthiness of the
correspondent, and lists other factors that have a bearing on the
financial condition of the correspondent. A bank may base its review of
the financial condition of a correspondent on publicly available
information, such as call reports, Thrift Financial Reports, Uniform Bank
Performance Reports, or annual reports.1  The final rule generally does
not require a bank to obtain non-public information on which to base its
analysis of the financial condition of a correspondent.2

The final rule provides that a bank may rely on another party, such as its
bank holding company, a bank rating agency, or another correspondent, to
provide financial analysis of a correspondent, as long as the bank has
reviewed the assessment criteria used by that party. Additionally, a bank
may rely on its bank holding company to select and monitor correspondents,
or on a correspondent, such as a bankers' bank, to choose other
correspondents with which to place the bank's federal funds, as long as
the bank has reviewed and approved the selection criteria used.
 
The final rule requires that a bank establish internal limits on exposure
only where the financial condition of the correspondent and the form or
maturity of the exposure create a significant risk that payments will not
be made as contemplated. Limits must be consistent with the risk
undertaken, but may be flexible, based on factors such as the level of
monitoring of the exposure and the condition of the correspondent. The
final rule also provides that a bank need not set one overall limit on
exposure to a correspondent, but may instead set separate limits for
different forms of exposure, products, or maturities.
 
The final rule provides that, for the significant sources of exposure for
which internal limits are required, the bank either should monitor its
exposure or structure transactions with the correspondent in order to
ensure that the exposure ordinarily remains within the internal limits
established by the bank.3  Where monitoring is used, the final rule
indicates that the appropriate level of monitoring will depend on the type
and volatility of the exposure, on the extent to which the exposure
approaches the bank's internal limits, and on the condition of the
correspondent. The final rule also indicates that ex post monitoring
generally is sufficient.

The final rule continues to require that a bank's internal policies and
procedures address intraday exposure. As with other exposure of longer
maturities, however, the final rule does not necessarily require that
limits be established on intraday exposure. Such limits would be required
only if the size of the intraday exposure and the condition of the
correspondent indicated that there is a significant risk that payments
will not be made as contemplated.
 
Limit on Credit Exposure to Certain Correspondents

The final rule provides that a bank's internal policies and procedures
should limit overnight credit exposure to a correspondent to 25 percent of
the exposed bank's capital, unless the bank can demonstrate that its
correspondent is at least "adequately capitalized," as defined by the
rule. The final rule does not specify limits for credit exposure to
adequately or well-capitalized correspondents.4

The benchmark guideline included in the proposed rule for exposure to
adequately capitalized correspondents served largely as a transition from
the unrestricted exposure permitted for well-capitalized correspondents to
the 25 percent benchmark for correspondents that are less than adequately
capitalized. The final rule requires banks to take into account the
maturity of exposure and changes in the financial condition of the
correspondent in establishing internal prudential limits and monitoring,
and therefore decreases the need for formal limits on credit exposure to
adequately capitalized correspondents. Additionally, because existing
exposure above the 25 percent limit for credit exposure to a less than
adequately capitalized correspondent is not "grandfathered" under the rule
if the correspondent slips below adequately capitalized, the existence of
this limit will encourage banks to shorten the maturity of exposure to
correspondents that are at risk of dropping below the capital levels
required to be adequately capitalized.
 
This regulatory "limit" requires that a bank's internal policies and
procedures limit "credit exposure" to a correspondent to 25 percent or
less of the exposed bank's capital, unless the bank can demonstrate that
the correspondent is at least "adequately capitalized," as defined in the
rule. As in the proposed rule, this limit should be viewed as a maximum
level for credit exposure, rather than as a safe harbor. Formal limits on
credit exposure to such a correspondent would not be necessary where the
banks' policies and procedures effectively limit credit exposure to an
amount below the 25 percent limit, such as where only small balances are
maintained with the correspondent, or where the correspondent has only
been approved for a limited relationship. Although in many cases it will
be necessary for a bank to establish formal internal limits to meet the
regulatory limit, the provisions of Sec. 206.3 of the final rule
concerning excesses over internal limits also apply to limits established
for the purpose of controlling "credit exposure" under Sec. 206.4 of this
rule.
 
As in the proposed rule, the "credit exposure" that is limited under the
final rule is based on the assets and off-balance sheet transactions
against which the bank must maintain capital under the risk-based capital
guidelines, with the same exclusions of lower-risk transactions permitted.
The final rule clarifies that "credit exposure" does not include
settlement exposure, transactions in which the bank acts as agent, and
other forms of exposure that are not covered by the capital adequacy
guidelines.

Transition Provisions

To mitigate the need for a bank to reduce exposure rapidly to a
correspondent whose capital has slipped below the levels needed to be
considered adequately capitalized, the final rule increases the transition
period for application of the 25 percent limit on credit exposure to 120
days. The longer transition period will avoid undue disruptions in
correspondent relationships due to temporary declines in capital ratios by
allowing the correspondent an opportunity to bring its capital ratios back
above the relevant levels before the end of the next quarterly report. The
extended period will also provide the exposed bank more time to implement
any monitoring required to demonstrate compliance with the limit on credit
exposure and to adjust the maturities or level of its exposure to the
correspondent.

Initial Implementation Period

The proposed rule required that banks have internal policies and
procedures in place by December 19, 1992, with the benchmark guidelines to
be phased in over a two-year period. The final rule provides a transition
period of six months before the prudential standards become effective,
with the remaining limit on credit exposure phased in over a two-year
period after that date. The longer initial implementation period will
enable banks that have not made credit assessments of their correspondents
to do so, and will provide an opportunity for banks to review and, where
appropriate, improve their monitoring procedures.

Additional modifications to the proposed rule are detailed in the
discussion below.
 
Summary of Comments

The Board received 321 comment letters on the proposed rule. Two hundred
fourteen commenters opposed the rule. Five commenters supported the
regulation's implementation of section 308. An additional seventeen
commenters offered qualified support for the rule, urging the Board to
modify implementation to make it less burdensome, by, for example,
eliminating the guidelines based on capital. The others expressed no
opinion or offered detailed comments. The comments included seventy-three
"form letters," forty-one of which focused on the effect of the proposed
rule on bankers' banks and sixty-one of which addressed the competition
between Federal Reserve Banks and private sector correspondents. All of
the form letters were from small banks.5  The 321 commenters by category
included 233 commercial banks, 41 bank holding companies, 16 bankers'
banks, 13 trade associations, 5 clearinghouses, 6 savings associations, 1
Federal Home Loan Bank, and 6 others.
 
General Comments

Cost. One hundred fifty-one commenters expressed concern over the
additional cost burden the proposed rule would impose. The Board has
attempted to minimize costs to banks of implementing the final rule, but
some costs are inherent in any new rule that results in changes in bank
practices.

Excessive regulation. One hundred sixty-six commenters believed the
proposed rule created excessive regulation. While the Board recognizes the
regulatory burden associated with the new rule, the Board believes that
the provisions of the final rule are necessary to carry out the intent of
section 308.

Federal Reserve Bank and Federal Home Loan Bank competition. One hundred
seventy-nine commenters expressed concern that the proposed rule would
divert business from the private sector to the Federal Reserve Banks and
Federal Home Loan Banks. Two commenters suggested that the Board reduce
the competitive impact by including Federal Reserve Banks in the
definition of correspondent. Another commenter suggested the Board require
banks to conduct the same analysis of Federal Reserve Banks that would be
required for a private correspondent. Because exposure to a Federal
Reserve Bank or Federal Home Loan Bank poses minimal risk to a respondent,
the Board does not believe that Federal Reserve Banks and Federal Home
Loan Banks should be included in the definition of correspondent in the
final rule. To treat Federal Reserve Banks and Federal Home Loan Banks as
correspondents under the final rule would impose unnecessary costs and
burdens on banks, with no appreciable reduction in risk.
 
Five commenters proposed that the Board rectify the competitive effect of
the rule by changing the private-sector adjustment factor or the prices
charged for check collection.6  The Board will review the calculation of
the private-sector adjustment factor to determine if modifications are
appropriate.

Disruption of the federal funds market. Twenty-four commenters expressed
concern that the proposed rule would disrupt the federal funds market by
preventing banks from selling all of their federal funds to a single
correspondent, and stated that the need to diversify federal funds sales
among a number of purchasers could result in higher transaction costs. In
addition, commenters expressed concern that the need to evaluate the
financial condition of correspondents could lead banks that are members of
the Federal Home Loan Banks to deposit funds in those banks rather than
selling them to correspondents.
 
While the Board recognizes that there may be some initial restructuring of
the channels for federal funds sales, the Board does not believe that the
regulation will result in a material or lasting disruption of the federal
funds market or to a material reduction in the availability of federal
funds. The federal funds market is competitive, and the Board believes
that creditworthy correspondents that are buyers of federal funds will
continue to be able to fund profitable business utilizing this market. The
Board also believes that modifications incorporated in the final rule,
including elimination of the regulatory limit on credit exposure to
adequately capitalized correspondents, will reduce the effect of the rule
on the federal funds market.
 
Availability of credit. Fifty-six commenters asserted that the proposed
rule would exacerbate the "credit crunch," generally either because of
disruption in the federal funds markets or because of diversion of funds
to Federal Reserve Banks or Federal Home Loan Banks. Twenty-two of these
commenters claimed that this effect would be particularly pronounced in
small communities. As discussed above, the Board believes that the
modifications incorporated in the final rule have significantly reduced
the likelihood of any reduction in the availability of funds for lending.
Effect on the FDIC funds. Thirty-eight commenters, nine of whom submitted
a substantially similar letter, expressed concern that the proposed rule
would weaken the Federal Deposit Insurance funds. Another commenter,
however, asserted that the proposed rule would actually strengthen the
funds. To the degree that the proposed rule diverts deposits, generally in
the form of compensating balances, from depository institutions to Federal
Reserve Banks or Federal Home Loan Banks, it may reduce FDIC insurance
assessments. However, the Board believes that the overall effect of the
final rule will be to strengthen the funds by reducing losses.  Repeal.
Forty-six commenters urged the repeal of the statute and one commenter
asserted that similar limits at the state level have failed. The power to
repeal the statute, however, rests with the Congress rather than the
Board.

Miscellaneous. Thirteen commenters suggested that, as an alternative to
regulating respondents, the federal regulators supervise the correspondent
banking business by restricting which banks could engage in such business,
notifying respondents that do business with unsound correspondents,
setting limits on the amount of exposure a correspondent can accept, or
automatically transferring balances from weak correspondents to strong
ones and notifying respondents later. Seven other commenters noted that it
is inefficient for a thousand banks to monitor the same correspondent,
which is also being monitored by a regulator. The Board does not believe
that it would be appropriate to endorse specific correspondents, as such a
practice could perpetuate the "too big to fail" concept that section 308
was designed to address.

One commenter urged the Board to create a new instrument for Treasury
obligations for which the Federal Reserve Banks would be the broker and
administrator. The Board does not believe that the creation of such an
instrument is necessary, as the government securities market is broad and
deep, offering many opportunities for investment. Another commenter
suggested that the Board permit banks to sell federal funds to Federal
Reserve Banks. The Board does not believe that such a practice would be
appropriate because it would interfere with the conduct of monetary
policy.

Another commenter suggested that the Board change Regulation D and the
FDIC insurance calculation to encourage fee payment. The final rule
increases the incentives for respondents to compensate correspondents by
fees, and the Board believes that the market will make appropriate
adjustments to this change.

One commenter suggested that the Board expand legal lending limits to
include off-balance sheet items. The Board does not have the authority to
effect such a change, however, as these limits are administered by the
Comptroller of the Currency under the National Bank Act and by state
banking regulators under state law.

One commenter urged the Board to tailor the rule to the strength of the
respondent on the assumption that well-capitalized respondents would be
managed wisely. The final rule places greater emphasis on a bank's
internal policies and procedures.  Section-by-Section Comments

The section and paragraph numbers in the headings refer to the numbering
of the proposed rule. Where a provision has been renumbered or moved, the
appropriate cite in the final rule is provided in brackets.

Section 206.2 Definitions Section 206.2(a) Bank

The proposed rule defined "bank" as an insured depository institution as
defined under section 3 of the Federal Deposit Insurance Act (12 U.S.C.
1813). Banks covered by this definition must control their exposure to
correspondents under this rule. The Board received twenty-seven comments
on this section.

Exclusion of Small Banks

Fourteen commenters proposed that the Board exclude small or community
banks, defined by some commenters as banks with assets under $1 billion,
or hold such banks to a more lenient standard, especially in their
correspondents are well or adequately capitalized. Another thirteen
commenters, nine of whom submitted a substantially similar letter,
asserted that the current rule violated Congressional intent, as Congress
did not intend to harm small banks with this regulation.

Section 308 states that the Board should address the risk posed to an
insured depository institution by the failure of another depository
institution. It does not restrict that mandate to risks posed to large
institutions. Section 308 is designed to limit bank failures attributable
to losses due to the failure of a correspondent. An exemption for small
bank exposure to correspondents would be contrary to this design, as the
failure of a correspondent would continue to precipitate the failure of
small banks.

Coverage of Definition

One commenter urged that the Board clarify that a nonbank credit card
company is excluded from the definition of "bank." Nonbank credit card
companies are not considered to be banks for the purposes of this rule.
However, bank users of credit card or other payment services may,
depending upon the terms of their services, incur exposure to other banks
by virtue of use of such services.

The definition in the final rule has been redrafted for clarity.  Section
206.2(b) Correspondent [Final Rule -- Section 206.2(c)]

The proposed rule defined "correspondent" as a U.S. depository institution
or a foreign bank, as defined in the proposed rule, to which a bank had
exposure. The Board received 134 comments on this section.

Exclusion of Bankers' Banks

One hundred twenty-two commenters urged exclusion of bankers' banks from
the definition of correspondent. Forty-seven commenters, twenty-six of
whom submitted substantially similar letters, argued that bankers' banks
pose no systemic risk, either because the bankers' banks are themselves
small, or because they serve only small banks. Thirteen commenters, nine
of whom submitted a substantially similar letter, asserted that bankers'
banks reduce systemic risk by providing alternative correspondent
services. Twenty-seven commenters, eighteen of whom submitted a
substantially similar letter, argued that a bankers' bank may be less
risky because it is a local institution, it is chartered to serve only
banks, and its board includes officers of its respondent banks, who are
therefore in a position to monitor its financial condition more closely.

Forty-six commenters, twenty-nine of whom submitted a substantially
similar letter, pointed out that bankers' banks rely exclusively on
interbank liabilities and are thus uniquely vulnerable to the interbank
liability limits. Sixty-three commenters, including twenty-eight form
letters and a number of bankers' banks, argued that Congress did not
intend bankers' banks to be targeted. Many of these commenters concluded
that the rule should create special provisions for bankers' banks.
Thirty-two commenters, nine of whom submitted a substantially similar
letter, argued that Congress recognized the unique role of bankers' banks
in the Depository Institutions Deregulation and Monetary Control Act of
1980. One commenter argued that it was unfair to subject bankers' banks to
the rule when central liquidity facilities, which provide services to
credit unions, are not covered. Another commenter argued that bankers'
banks are not commercial banks and that the deserve the same treatment as
Federal Reserve Banks. Eleven commenters argued that bankers' banks should
be excluded from the scope of the rule because banks would otherwise be
forced to obtain correspondent services from their competitors.  In
contrast, two commenters argued that exclusion of bankers' banks would
unfairly restructure the market for correspondent services, and another
commenter noted that exemptions for some providers of correspondent
services would erode competition.

The Board recognizes that bankers' banks are providing important services
to respondents and are meeting a market need, and that Congress has given
special status to bankers' banks in other statutes. Nonetheless, the Board
does not believe that other legislation or the statutory language or
legislative history of section 308 demonstrate a Congressional intent to
exclude bankers' banks from the coverage of section 308. Nor does the
Board believe the Congress intended for bankers' banks to be targeted by
the rule. Accordingly, the final rule treats bankers' banks no differently
than other correspondents.

The Board does not believe that bankers' banks will be unduly harmed by
being treated as correspondents under the rule. Bankers' banks generally
are at least adequately capitalized and there is no regulatory limit on
credit exposure to an adequately capitalized correspondent under the final
rule. Although respondents will need to obtain information on
correspondents' capital ratios in order to demonstrate that correspondents
are at least adequately capitalized, bankers' banks can reduce this burden
by providing the information to their respondents directly. To the extent
that bankers' banks are concerned that the burden of meeting the
requirements of the rule's prudential standards will cause banks to
transfer business from a bankers' bank to a Federal Reserve Bank or
Federal Home Loan Bank, the Board believes that the more extensive
guidance provided in the language of the final rule will reduce this
effect.

The Board believes that including bankers' banks within the scope of the
rule is appropriate. Bankers' banks represent a concentration of interbank
risk because they rely exclusively on interbank liabilities and because
their assets subject them to the same risks as other banks. Further, an
exception for bankers' banks could alter the market for correspondent
services, possibly increasing risk as correspondent business moves to such
special purpose banks. With regard to arguments that including bankers'
banks as correspondents under the rule will force banks to obtain services
from their competitors, the Board notes that banks often do business with
competitors.

Sixteen commenters asserted that the rule would result in a reduction in
deposits at bankers' banks which, in turn, would reduce the capacity of
bankers' banks to provide "overline" loan and participation arrangements
and other correspondent services. The Board believes that the demand for
these services will provide incentives for banks to continue to do
business with bankers' banks rather than shifting to Federal Reserve Banks
or Federal Home Loan Bands, which provide only limited services.

Six commenters stated that the proposed rule would preclude a bankers'
bank from raising capital when it is most needed because banks could not
increase exposure to the bankers' bank through stock investments. Although
most bankers' banks are well or adequately capitalized, the Board
recognizes that the capital of bankers' banks generally represents
exposure of the owner-customers of the bankers' bank. The Board notes,
however, that capital ratios may be increased by other means, such as by
reducing certain assets of the bankers' bank.  Restriction of Coverage to
Large, Weak Banks

Fifty-nine commenters concerned with the regulatory burden imposed by the
proposed rule urged that the rule focus exclusively on banks that might be
considered "too big to fail." Thirty-five of these commenters,
twenty-eight of whom submitted a substantially similar letter, suggested
that the Congressional intent was to focus on the risk caused by the
failure of a large depository institution, and that small banks were not
to be affected by the regulation. In addition, thirty-five commenters,
thirty of whom submitted a substantially similar letter, urged the Board
to exempt exposure to well-capitalized correspondents from the regulation
or at least to treat exposure to them no differently than exposure to a
Federal Reserve Bank.

Although the introductory language in section 308 refers to the failure of
a large depository institution, the text of the statute directs the Board
to limit risks posed by exposure to "any other depository institution."
Further, excluding exposure to small correspondents from the rule could
cause correspondent business to shift to small correspondents, regardless
of their financial condition, thereby increasing the risk that the failure
of a small correspondent would cause the failure of other banks. Finally,
entirely excluding exposure to well-capitalized correspondents could
encourage banks to take exposure to a well-capitalized correspondent that
may be excessive in relation to the overall financial condition of the
correspondent. Thus, the Board believes that the definition of
"correspondent" should not exclude depository institutions on the basis of
size or capitalization.

Expansion of the Definition of Correspondent

Nine commenters expressed concern about competition in the correspondent
business from nonbanks and credit unions. Three of these commenters
proposed that the definition of correspondent encompass all providers of
correspondent services, including nonbanks. One commenter pointed out that
Edge Act companies are not defined as correspondents but are included as
subsidiaries.

The Board notes that the interbank liability provisions of section 308
concern exposure to depository institutions, not to financial service
providers generally. The definition of "correspondent" in the proposed
rule was limited to institutions that receive special treatment under the
capital adequacy guidelines, which provide that claims against certain
foreign banks and federally insured domestic depository institutions
generally are given a 20 percent risk weight.7  Furthermore, the Board
does not believe that nonbank providers of correspondent services,
including credit unions, provide a full range of correspondent services in
competition with traditional correspondents or that risk to banks will
increase materially through migration to providers of services that are
not covered by the rule. Finally, the failure of financial institutions
that are not insured by the Federal Deposit Insurance Corporation would
not pose a threat to the Federal Deposit Insurance funds through
invocation of "too big to fail."

Final Rule

The definition of correspondent has been amended to exclude commonly
controlled correspondents that are subject to cross-guarantees under the
Federal Deposit Insurance Act. The proposed rule excluded commonly
controlled correspondents from the limits on credit exposure, but not from
the prudential standards. In the final rule this exclusion has been
extended to the prudential standards for consistency. This exclusion does
not affect the applicability of other statutory provisions governing
transactions with affiliated institutions, such as section 23A of the
Federal Reserve Act (12 U.S.C. 371c).

Section 206.2(c) Exposure [Final Rule -- Section 206.2(d)]

The proposed rule defined "exposure" as the risk that payment to complete
a transaction will not be made in a timely manner or that an obligation
will not be paid in full. The definition further provided that "exposure"
includes the operational and liquidity risks related to the settlement of
transactions and risk related to the creditworthiness of a correspondent.
Both overnight and intraday exposure were covered by the definition. The
proposed rule required exposure to be monitored under the prudential
standards. The Board received twenty comments on this section.

Scope of the Definition

Ten commenters urged that the scope of the definition be restricted. Nine
commenters suggested that the definition of exposure include only
significant exposure measured by the amount at risk and the product line
at issue to a particular correspondent. Four of these commenters suggested
that the Board provide guidance, such as that in the payments system risk
policy, as to what constitutes significant exposure. One commenter urged
that the definition exclude items covered by FDIC insurance. Another
commenter suggested that the purchase and sale of Treasury securities be
excluded. One commenter suggested that the Board exclude settlement risk
from the definition of exposure. Another commenter suggested that the
settlement risk in delivery-versus-payment systems be excluded. Two
commenters, clearinghouses, suggested that the settlement risk attendant
to a clearing and settlement system that includes settlement finality
should be excluded from the definition of exposure because it is
insignificant. One commenter asked the Board to exclude collateralized
interest rate swaps from the definition of exposure. Another commenter
questioned whether other exposures like payroll, pending ATM, and coin and
currency settlements should be included in exposure. One commenter
suggested that the definition of exposure distinguish exposure due to
capital market transactions from exposure due to correspondent banking
activity. In addition, four commenters urged the exclusion of short-term
exposure. One commenter suggested that the rule exclude all exposure with
a maturity of less than 14 days, two others urged the exclusion of demand
deposits, and the fourth called for the exclusion of federal funds
transactions. Three commenters expressed concern that regulators would
unreasonably expand the definition.

The final rule excludes certain lower-risk transactions from the
definition of "credit exposure," which is the measure of exposure subject
to a specific regulatory limit under the rule. The general definition of
"exposure" used in the final rule, however, covers all types of
transactions that create a risk of nonpayment or delayed payment. The
Board believes that banks should consider all types of financial exposure
in establishing prudential policies and procedures. As discussed in the
summary of the final rule, however, the prudential standards in the final
rule have been amended to clarify that a bank is not required to treat all
types of exposure in the same manner, and that a bank's internal policies
and procedures may provide for differential treatment of exposure based on
the form, maturity, and size of the exposure, as well as on the condition
of the correspondent.

Clarification of the Definition

Seven commenters found the definition of exposure too vague. Two
commenters sought clarification of the definition of settlement risk. One
commenter asked for clarification of how settlement risk relates to
automated clearinghouse (ACH) transactions. One commenter urged that
exposure arising out of credit card transactions should be excluded from
the definition of exposure because a bank cannot control the banks to
which it has this exposure. In this regard, the Board notes that exposure
arising from the following transactions generally is insignificant because
the exposed bank usually has prompt recourse to other parties or because
the amounts involved are not significant: (1) A collecting bank's risk
that a check will be returned, (2) an originating bank's risk that an ACH
debit transfer will be returned or its settlement reversed, (3) a
receiving bank's risk that settlement for an ACH credit transfer will be
reversed, or (4) a credit card transaction. Under the final rule, a bank
is not required to conduct periodic reviews of the financial condition of
a correspondent where the amount of the exposure is insignificant and
would not be required to limit exposure unless there is a significant risk
that payment will not be made as contemplated.

Another commenter requested clarification of the terms "liquidity risk"
and "operational risk" used in the definition of exposure. Liquidity risk
is the risk that payment will be delayed for some period of time. For
example, a bank is subject to the liquidity risk that a payment due from a
failed correspondent will not be made on time; the bank's credit risk may
be a lesser amount due to later distributions from the correspondent's
receiver. Liquidity risk is included in the definition of exposure in the
final rule. Operational risk if the risk that operational problems at a
correspondent, such as computer failure, may prevent it from making
payments, thereby creating liquidity risks for other banks, and is also
included in the definition of exposure in the final rule.  One commenter
asked if correspondent obligations that a bank holds in a fiduciary
capacity are excluded. Because obligations held in a fiduciary capacity do
not expose the bank itself to loss due to credit, liquidity, or
operational problems, such obligations are not included in the definition
of exposure.

One commenter argued that depository institution equity securities taken
as collateral or in satisfaction of a debt should be excluded from the
definition of "exposure" because they are not payment obligations. Such
transactions are covered by the definition of "exposure," in the final
rule, as they create a credit risk to the bank should the depository
institution fail. The definition in the final rule has been redrafted for
clarity.  Section 206.2(d) Foreign Banks [Final Rule -- Section 206.2(e)]

The proposed rule defined a "foreign bank" as an institution that is
organized under the laws of a country other than the United States,
engages in the business of banking, is recognized as a bank by the bank
supervisory or monetary authorities of the country of the bank's
organization, receives deposits to a substantial extent in the regular
course of business, and has the power to accept demand deposits. Foreign
banks were included in the definition of correspondent in the proposed
rule. The Board received seven comments on this section.

Exclusion of Foreign banks

Two commenters urged that the rule exclude foreign banks because of the
cost and difficulty in obtaining necessary information, such as capital
information, and because the proposed rule would harm the competitiveness
of U.S. banks in foreign correspondent markets. These commenters also
argued that foreign banks do not pose a risk to the deposit insurance
fund, or to the U.S. banking system as a whole. An additional two
commenters, focusing on the lack of current risk-based capital ratio
information and on the decreased risk posed by foreign banks, suggested
that exposure to foreign banks be excluded from application of the
benchmark guidelines and subjected only to the prudential standards. Two
other commenters, however, strongly supported the coverage of foreign
banks in the rule, arguing that exclusion would grant such banks a
competitive advantage over domestic banks. One commenter, a clearinghouse,
noted that its members were divided on this issue.

Foreign banks were included as correspondents under the proposed rule
because failure to cover foreign banks could encourage a migration of
correspondent and interbank business to foreign banks irrespective of
their condition, thereby potentially increasing risk to insured depository
institutions. Consequently, the Board does not believe that foreign banks
should be excluded from coverage of the limits on credit exposure or the
prudential standards. To address problems with obtaining adequate
information concerning foreign banks, however, the final rule provides
greater flexibility as to the timing and frequency with which a bank must
obtain information on the capital levels of its foreign bank
correspondents.

Clarification of the Definition

Two commenters called for recognition of the decreased risk posed by a
foreign central bank or a bank guaranteed by a foreign government, and
perhaps even exclusion of these institutions from coverage as
"correspondents" under this rule. The definition of "foreign bank" is
based on the criteria used in the risk-based capital guidelines. As those
guidelines exclude the central bank of a foreign country, such
institutions would be excluded for the purposes of this rule as well. The
Board believes, however, that banks guaranteed by foreign central
governments may pose risks and should be included as correspondents for
the purposes of this rule.  The definition remains unchanged in the final
rule.

Section 206.2(e) Primary Federal Supervisor [Final Rule -- Section
206.2(f)]

No comments were received on this section, and the definition remains
unchanged in the final rule.

Section 206.2(f) Quality Asset [Final Rule -- Section 206.4(f)(3)]

The proposed rule defined a "quality asset" as an asset that is not in a
nonaccrual status, on which principal or interest is not more than thirty
days past due, and whose terms have not been renegotiated or compromised
due to the deteriorating financial condition of the primary obligor.
Furthermore, under the proposed rule an asset would not be considered to
be a "quality asset" if any other loans to the primary obligor on the
asset have been classified as "substandard," "doubtful," or "loss" or
treated as "other loans specially mentioned" in the most recent report of
examination or inspection of the bank or an affiliate prepared by either a
federal or a state supervisory agency. Under the proposed rule, a
transaction for which a correspondent is only secondarily liable could be
excluded from a bank's "credit exposure" to the correspondent as long as
the transaction could be considered a "quality asset."

The Board received one comment, which criticized this definition as too
restrictive. The commenter urged that the definition include assets on
which principal or interest is not more that 90 days past due, as is the
standard in SEC Guide 3 Section III C.1. This SEC standard is used for
reporting and disclosure purposes and does not appear to be appropriate
for the purposes of this rule. The Board believes that the proposed
definition, which was derived from section 23A of the Federal Reserve Act
(12 U.S.C. 371c), permits a more accurate measure of actual credit
exposure. In the final rule the definition of "quality asset" has been
incorporated into the section concerning "credit exposure" (Sec. 206.4).

Section 206.2(g) Subsidiary [Final Rule -- Section 206.4(e)]

Under the proposed rule, the term "subsidiary" was given the same meaning
as that term under section 23A of the Federal Reserve Act, and therefore
included any company in which a bank owns or control 25 percent or more of
any class of voting securities. This definition in the final rule has been
modified and incorporated into Sec. 206.4, and is discussed below in the
description of comments on that section.

Section 206.2(i) Total Capital [Final Rule -- Section 206.2(g)]

The proposed rule defined total capital as the total of a bank's Tier 1
and Tier 2 capital under the risk-based capital guidelines provided by the
bank's primary federal supervisor. For an insured branch of a foreign bank
organized under the laws of a country that subscribes to the principles of
the Basle Capital Accord, "total capital" means total Tier 1 and Tier 2
capital as calculated under the standards of that country. For an insured
branch of a foreign bank organized under the laws of a country that does
not subscribe to the principles of the Basle Capital Accord, "total
capital" means total Tier 1 and Tier 2 capital as calculated under the
provisions of the Accord. The Board received two comments on this section.

Two commenters requested clarification that the benchmark guidelines would
be based on the total capital of a foreign bank, rather than only on the
capital of the branch. The limit on credit exposure of the insured branch
of a foreign bank is based on the foreign bank's total capital, as defined
in this section, not on the imputed capital of the branch.

The definition remains unchanged in the final rule.

Section 206.2(j) U.S. depository Institution [Final Rule -- Section
206.2(h)]

The proposed rule defined "U.S. depository institution" as a federally
insured depository institution chartered in the United States under
federal or state law, and included an insured national bank, state bank,
District bank, or savings association, as those terms are defined under
section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813), but did
not include an insured branch of a foreign bank. U.S. depository
institutions were included in the definition of "correspondent" in the
proposed rule. The Board received eight comments on this section, two of
which supported the definition as written.

Scope of the Definition

Three commenters urged the inclusion of credit unions, asserting that they
poses risks to the financial system through the large inter-institution
liabilities of credit union corporate centrals. Credit unions do not offer
a full range of correspondent services to FDIC-insured banks and are not
insured by the FDIC. Therefore, the Board does not believe that exposure
to credit unions poses risks to insured banks and to the FDIC insurance
funds of the type that section 308 was designed to address.

Clarification of the Definition

Three commenters suggested that the final rule include specific language
excluding Federal Home Loan Banks. The Board believes that the definition
excludes Federal Home Loan Banks and that a specific exclusion for Federal
Home Loan Banks is unnecessary. The definition in the final rule has been
redrafted for clarity.

Section 206.3 Prudential Standards

Section 206.3(a) Internal limits. [Final Rule -- Section 206.3(c)]

The proposed rule required that a bank establish and maintain policies and
procedures to limit exposure to the correspondents with which it does
business. The rule further required that banks establish and periodically
review and revise, as necessary, limits on exposure to individual
correspondents based on an evaluation of the overall financial condition
and other factors being on the creditworthiness of each correspondent.
Finally, it required that a bank structure these limits to avoid undue
concentration of settlement or credit risk with respect to any individual
correspondent. Most of the comments received addressed the prudential
standards, and 110 of those comments addressed Sec. 206.3(a) on internal
limits.
 
Appropriateness of Internal Prudential Standards

Twenty-four commenters agreed that the prudential standards reflect
prudent banking and general industry practice, and twenty-eight commenters
indicated that they had already established prudential standards for
interbank exposure. Moreover, twenty-four commenters suggested that this
provision, supplemented by examination, be the heart of the regulation. On
the other hand, forty-two commenters, including five who indicated that
they already conduct similar prudential analyses, disagreed with the
Board's approach to the problem of interbank liabilities. These commenters
argued that the examination process can adequately address the problem,
both because adequate controls already exist in the safety and soundness
criteria and because the examination and consultative process is superior
to regulation. These commenters concluded, therefore, that the rule would
impose increased costs without achieving a commensurate reduction in risk.
Three of these commenters suggested that the Board conduct an empirical
study of the risks associated with interbank liabilities and the cost of
controlling those risks.

Thirty-two commenters offered alternatives to the prudential standards.
Three suggested approval of correspondent relationships by vote of the
bank's board of directors. Eighteen commenters, submitting an identical
letter, suggested that the prudential standards require only that a bank
obtain information from its correspondents once a year to demonstrate that
the correspondents meet appropriate capital standards. One commenter
suggested that banks be permitted to tier their prudential standards in a
similar fashion as the capital guidelines. Six commenters favored a simple
statement that the risks must be addressed, while another suggested that
the standard be the same due diligence standard applied to any loan. One
commenter urged the Board to require specific, detailed lending policies,
similar to those for highly leveraged transactions, while another
commenter asserted that only on-site examinations offer a true measure of
risk. One commenter suggested that the rule require an annual review of
capital, management experience, and income trends.

Implementation of the Requirement

Twelve commenters expressed a desire for greater specificity regarding the
preparation and review of the internal limits. Six requested specificity
as to the factors that a bank should evaluate or argued that the factors
be limited. One commenter sought clarification of whether internal
standards could ever be breached. Four commenters indicated that
respondents may lack the expertise to analyze the financial condition and
risk of larger correspondent banks, particularly where the correspondent
has significant off-balance sheet activities. Six commenters expressed
concern about the availability of the information. One of these commenters
stated that correspondents that compete on other fronts may be unwilling
to divulge non-public information. One commenter asked whether banks could
rely on information from correspondents. Two commenters expressed concern
that call and audit reports do not address overall conditions and
operations, although both are mentioned as factors in the proposed rule.
Five commenters expressed concern that the proposed rule failed to
encourage banks to improve continuously their risk management programs and
may encourage banks to abandon a more sophisticated system for one which
tracks the guidelines. One of those commenters urged that the Board adopt
uniform examination guidelines that reflect to the greatest degree
possible existing risk monitoring and control practices.

Final Rule

The primary focus of the final rule is on a bank's analysis of the
creditworthiness of its correspondents. Many of the concerns raised by
these commenters are addressed by the more extensive guidance in the final
rule as to the standards that a bank's internal policies and procedures
would be expected to meet. The final rule states that internal procedures
should be directed at preventing excessive exposure to a correspondent in
relation to the financial condition of the correspondent, and allows banks
to adopt flexible policies and procedures to meet this standard. The final
rule does not require the same procedures to be used for all
correspondents or all types of exposure.

Under the final rule, a bank's internal policies and procedures must
provide for periodic reviews of a correspondent's financial condition only
where exposure to the correspondents is significant. Periodic review of
the financial condition of correspondents to which the bank has only
insignificant levels of exposure, such as small balances maintained for
clearing purposes, would not be required under the final rule. While the
bank's board of directors would be required to review the bank's policies
and procedures concerning correspondents on an annual basis, the board
would not be required to approve individual correspondent relationships.
The final rule also does not require the bank to obtain non-public
information on which to base its analysis of the financial condition of a
correspondent, but permits use of publicly available information, such as
call reports, Uniform Bank Performance Reports, and annual reports.8

Additionally, the final rule requires the establishment of internal limits
only where the financial condition of the correspondent and the form or
maturity of the exposure create a significant risk that payments will not
be made as contemplated. The rule does not require a particular structure
or method of maintaining such limits, but permits the bank flexibility to
structure limits in a manner that will meet the needs of the bank. For
example, in appropriate circumstances a bank may establish limits for
longer term exposure to a correspondent, while not setting limits for
overnight or intraday exposure.

Clarification of the Requirement

Eight commenters inquired whether the Board would permit a lead bank or
bank holding company to conduct the prudential analysis for affiliated
banks. The final rule clarifies that a bank may rely on its bank holding
company, a bank rating agency, or another party to provide financial
analysis of correspondents or to select correspondents, as long as the
board of directors of the bank has reviewed the assessment or selection
criteria used by that party.

Section 206.3(b) Monitoring. [Final Rule -- Sec. 206.3(c)]

The proposed rule required that a bank structure transactions with a
correspondent or monitor exposure to a correspondent to ensure that its
exposure does not exceed its internal limits established under Sec.
206.3(a) and that its credit exposure ordinarily not exceed any applicable
guidelines on credit exposure specified in Sec. 206.4. The Board received
160 comments on this section.

One hundred fourteen commenters, thirty of whom submitted a substantially
similar letter, protested the cost burden implicit in the monitoring
requirements. Sixteen commenters argued that the costs of the monitoring
provisions of the proposed rule outweigh the benefits. Fifty-nine
commenters argued that these costs will be exacerbated if banks must
spread their correspondent business among a number of banks. Two
commenters complained that the cost burden would fall disproportionately.
One asserted that small community banks would bear the brunt of it and
another asserted it would fall inequitably on the adequately and
well-capitalized banks of the Midwest. Seven commenters pointed out that
even well-capitalized private correspondents and respondents will have to
bear these costs.

Clarification of the Requirement

Six commenters requested clarification as to whether the requirement of
the rule would be satisfied by structuring relations so that the limits
are not exceeded, such as through agency sales policies. Five commenters
urged the Board to consider permitting a lead or parent bank in a bank
holding company to monitor exposure for its affiliated banks. Two
commenters urged that the monitoring requirements distinguish between
significant and insignificant exposure. Another urged that the final rule
permit systems consistent with the institution's business, internal
systems operations, and personnel. Seven commenters expressed concern that
examiners might unduly restrict the regulatory flexibility that was
designed to permit the use of diverse existing monitoring and risk control
practices. They urged the Board to adopt uniform examination guidelines
that would accommodate existing systems. Two commenters suggested as a
model the guidelines for self-assessments on payment system risk.

Frequency of Monitoring

Twelve commenters argued that daily monitoring is excessive if not
impossible. One commenter asserted that a banker cannot know the balance
on a pass-through account. Two other commenters stated that global
monitoring of outstanding exposures on a daily basis in products such as
interest rate swaps, letters of credit, and other transactions would be
extremely difficult, and that banks should be permitted to use their
prudential limits as proxies for actual exposure where these limits are
below the benchmarks. One commenter urged that the final rule match the
frequency of review with the risk, while another urged the Board to permit
banks to monitor exposure in arrears and take corrective action should
exposure exceed prearranged levels. One commenter urged the Board to
permit banks to monitor weekly or monthly averages. Two commenters
expressed approval of the proposed rule's acceptance of ex post
monitoring.

Monitoring Overnight Exposure

Fourteen commenters urged the Board to clarify the requirements for
monitoring overnight interbank transactions and to consider eliminating
monitoring of these transactions. Four of these commenters stated that the
likelihood of a bank failing solely on the basis of its overnight exposure
is very remote, and two argued that market factors weed out weak
correspondent banks. Five other commenters argued that the regulatory
burden on small banks in monitoring and controlling overnight interbank
transactions is unreasonable and costly, and could force small banks to
transfer their business to Reserve Banks. Another commenter urged the
exclusion of overnight federal funds sales from the exposure that must be
monitored as long as the sales were made under a preauthorized line to an
approved list of correspondents, on the grounds that it may be difficult
to determine other exposure to a correspondent at the time of a federal
funds transaction.

Monitoring Credit Exposure

Fifteen commenters addressed the issue of monitoring credit exposure. Five
of these commenters urged that the proposed rule's acceptance of
occasional or inadvertent excesses be maintained and broadened
sufficiently that small banks with unexpected large deposits or late
incoming wire transfers be permitted to adjust their balances within a day
or two. Six commenters expressed concern that the guidelines would be
viewed as rigid limits. Another commenter asserted that the proposed
rule's acceptance of occasional excesses would be where the trouble spots
would arise. Three other commenters requested clarification as to how
often and under what circumstances a bank may exceed the guidelines. One
commenter suggested that the final rule grant banks time to bring combined
credit exposures due to mergers or other acquisitions into compliance with
the benchmark guidelines.9

Monitoring Intraday Exposure

Eleven commenters urged the Board to eliminate any requirement for
intraday monitoring. Three of these commenters stated that most banks, and
especially smaller banks, would find it difficult or impossible to monitor
and manage intraday exposure. Another commenter expressed concern that
banks' attempts to limit intraday exposure by delaying settlements pending
receipt of offsetting funds could lead to system gridlock. Two commenters
argued that intraday exposure was similar to cash items in the process of
collection and should be excluded from the rule. Four additional
commenters sought clarification as to whether daylight overdrafts would be
violations of the rule.

The Final Rule

The final rule allows a bank to adopt monitoring policies and procedures
that are appropriate for the bank's particular situation. The final rule
does not require the establishment of limits or monitoring for all sources
of exposure to all correspondents. The final rule provides that, for the
significant sources of exposure for which internal limits are required, a
bank may either monitor exposure or structure transactions to ensure that
internal limits generally are not exceeded. A bank could accomplish this
either by monitoring actual overall exposure, or by establishing
individual lines for significant sources of exposure, such as federal
funds sales, and establishing procedures to ensure that exposure generally
remained within the established lines. A bank could also maintain limits
on exposure by establishing limits with correspondents, such as for
federal funds sold on an agency basis.  Under the final rule, banks are
not expected to monitor exposure to correspondents on a real-time basis.
Monitoring generally may be done retrospectively, and the required
frequency depends on the extent to which exposure approaches the bank's
internal limits, on the volatility of the exposure, and on the condition
of the correspondent.

Although the purpose of requiring monitoring or structuring of
transactions is to ensure that exposure generally remains within
established limits, the final rule recognizes that occasional excesses may
occur. The final rule provides that a bank should structure transactions
or monitor exposure to a correspondent to ensure that exposure ordinarily
does not exceed internal limits, except for occasional excesses resulting
from factors such as unusual market disturbances, market movements
favorable to the bank, operational problems, or increases in activity.
Unusual late incoming wires or unusually large cash letters would be
considered examples of the types of activities that could lead to excesses
over internal limits that would not be considered impermissible under the
final rule. The final rule requires the bank to establish appropriate
procedures to address excesses over internal limits.

With respect to intraday monitoring, the Board recognizes that intraday
exposure may be difficult for a bank to actively monitor and limit. Under
the final rule, intraday exposure, like interday exposure, may be
monitored retrospectively. Further, where the risk resulting from intraday
exposure is low, taking into account the condition of the correspondent
and the size of the exposure, specific limits and monitoring to those
limits would not be required under the final rule.

Additionally, to ease monitoring in the case of mergers or acquisitions,
the final rule excludes exposure resulting from the merger or acquisition
of a bank from the calculation of "credit exposure," for the purposes of
the limit on credit exposure for one year after the merger or acquisition.

Under the final rule, a bank's internal policies and procedures are
required to limit credit exposure to a less than adequately capitalized
correspondent to not more than 25 percent of the exposed bank's capital.
Therefore, these monitoring requirements for exposure would also apply to
monitoring credit exposure limits.

Section 206.4 Guidelines for Credit Exposure

The proposed rule provided that, in addition to the prudential limits on
exposure established by a bank under Sec. 206.3, a bank ordinarily would
be expected to maintain credit exposure to an individual correspondent, as
calculated under Sec. 206.5, within certain guidelines or limits unless
the exposure is to a commonly controlled insured depository institution,
as provided in paragraph (b) of that section. The proposed guidelines or
limits were structured as "benchmarks" that would be considered prudent
outside limits on credit exposure and were not intended to endorse levels
of credit exposure that otherwise would not be considered prudent based on
the condition and operations of the correspondent. The Board received 112
comments addressing this section specifically.

Elimination of the Guidelines

Forty-three commenters, primarily large banks, opposed the requirement
that banks adhere to these limits. Forty commenters argued that the Board
should eliminate the guidelines, and three commenters urged that the
guidelines be merged into the prudential standards to retain
responsibility in management for the safe and sound management of
exposure. One commenter proposed that where banks have appropriate
internal prudential policies, they need not demonstrate that they are
within the guidelines. Seven commenters argued that the proposed rule
would require the creation of a comprehensive system to monitor credit
exposure, as measured by the rule, simply to demonstrate that credit
exposure is substantially within the guidelines. Ten other commenters
argued that the benchmarks are crudely calibrated and that compliance with
them would divert resources within banks away from activities designed to
achieve real reductions in risks. Eight other commenters stated that the
guidelines would create costly inefficiencies and reduce interbank
liquidity, as banks would reduce exposure to an individual correspondent
solely to avoid monitoring costs. One commenter contended that the
guidelines would, in effect, penalize banks with existing internal
controls. One commenter asserted that many banks lack the information
technology that would permit on-line access to information on credit
exposure to a specific correspondent, and that purchasing such a system
would cost $1 million. Two commenters argued that it is impossible to
monitor and therefor to limit global exposure daily.

The Level of the Guidelines

The board received fifty-seven comments concerning the amount of
permissible exposure under the guidelines, two of which specifically
endorsed the guidelines. Two commenters urged that banks in a bank holding
company be permitted to aggregate their credit exposure to individual
correspondents in measuring compliance with the guidelines. One commenter
argued that the limits were too high and suggested that they not exceed
the legal lending limits, which are themselves too high in the opinion of
the commenter. The remainder of the commenters argued that the guidelines
were too restrictive.

The commenters presented a number of arguments for relaxing the
guidelines. Seventeen commenters noted that the benchmarks could force a
bank to reduce its exposure to a well-managed, adequately capitalized
correspondent while taking more exposure to other correspondents that the
bank may not believe are as creditworthy. Eight commenters stated that
small banks' federal funds sales can fluctuate dramatically, making
continuous compliance costly and difficult. Six commenters expressed
concern that cash letter fluctuations would make compliance with the
guidelines difficult. Two commenters expressed concern that the guidelines
would make it difficult to fund their correspondent to cover payments
system transactions. One commenter argued that the guidelines would force
inexperienced banks to engage in securities trading in order to avoid
federal funds sales.

Sixty-two commenters emphasized the difficulty of diversifying
correspondent business in order to comply with the guidelines. Fifty-nine
of these commenters focused on the costs of establishing and maintaining
additional correspondent relationships, and many argued that the expense
of diversification exceeds the reduction in risk. Four commenters asserted
that mergers and acquisitions have reduced the number of suitable
correspondents. One commenter argued that larger correspondents were not
interested in providing services to smaller banks. Five correspondents
argued that concentrating correspondent business is beneficial because a
close relationship covering multiple services is important and brings such
benefits as preferred customer status. One commenter argued that only by
concentrating its correspondent business can a small bank engage in a
broad range of transactions, such as settling trades in Treasury bills in
an amount large enough to obtain the maximum yield. Six other commenters
argued that concentrating correspondent business may reduce systemic risk
by facilitating closer monitoring.  Eight commenters contended that
reducing exposure by selling federal funds through an agent is more
expensive. Four commenters asserted that reducing exposure by shifting
from compensating balances to fees reduces profitability because
compensating balances often provide a higher return than short-term
investments. Another commenter argued that fees created a risk to the
correspondent of nonpayment.

Three commenters proposed modifications to the guidelines. One urged an
exemption for well-managed banks and two others suggested that the tiers
be altered to permit a minimum percentage or dollar amount of acceptable
exposure without regard to capitalization.

The Final Rule

The final rule places greater emphasis on analysis of the creditworthiness
of correspondents and decreases the emphasis on across-the-board limits.
The limit on credit exposure to adequately capitalized correspondents has
been eliminated. The limit on credit exposure to correspondents that a
bank cannot demonstrate are at least adequately capitalized remains,
however. The Board believes that the elimination of the limit for
adequately capitalized correspondents will significantly reduce the
problems associated with the limits. Because fewer correspondents would be
subject to the limits, monitoring to ensure compliance should be less
costly.  Additionally, because the remaining limit on credit exposure
would be implemented as part of the bank's normal policies and procedures,
the final rule permits a bank to choose to implement the limit through
structuring of relationships or monitoring.

Section 206.4(a)(1) Well-Capitalized Correspondents [Final Rule --
Included With Adequately Capitalized Correspondents Under Section
206.4(a)(1)]

The proposed rule stated that, except as otherwise provided in Sec. 206.3,
a bank need not limit its credit exposure to a correspondent that the bank
can demonstrate is well capitalized, as defined in Sec. 206.6 of the
proposed rule. The Board received three comments on this section, two of
which strongly endorsed the rule as written.

One commenter expressed concern that regulators will restrict respondent's
discretion in creating exposure to well-capitalized banks and that
respondents, fearing that, will themselves restrict their exposure,
reducing liquidity and fragmenting correspondent relationships. The final
rule continues to provide that, while prudential limits to
well-capitalized correspondents may be appropriate, these limits are not
bounded by an express limit in the rule.

Section 206.4(a)(2) Adequately Capitalized Correspondents [Final Rule --
Included in Section 206.4(a)(1)] The proposed rule provided that a bank
ordinarily should limit its daily interday credit exposure to a
correspondent that the bank can demonstrate is adequately capitalized, as
defined in Sec. 206.6 of the proposed rule, to an amount equal to not more
than 50 percent of the bank's total capital. The proposed rule also
provided that, for such a correspondent, the bank ordinarily should limit
its daily inter-day credit exposure with a remaining term to maturity of
more than thirty days to an amount equal to not more than 25 percent of
the bank's total capital. Twenty-three commenters specifically addressed
this section.

Elimination of Limit

Eighteen commenters suggested that the final rule eliminate the
distinction between adequately and well-capitalized correspondents
altogether.

A number of banks argued that this provision would have an adverse effect
on adequately capitalized banks or that the difference between adequately
and well-capitalized banks was not meaningful. One commenter argued that
the rule would interfere with an adequately capitalized bank's ability to
compete in international funding markets. Three commenters pointed out
that, although the difference between a well-capitalized bank and an
adequately capitalized bank is insignificant at the margin, the rule
imposes a significant monitoring burden on respondents dealing with an
adequately capitalized correspondent. Two other commenters asserted that
the burden of complying with the rule would lead respondents to cease to
do business with adequately capitalized banks. Three commenters argued
that it would be very difficult for banks to regain market share if they
drop, even temporarily, from well to adequately capitalized. Two
commenters suggested that the rule may exacerbate systemic risk by
restricting credit to a bank when that bank's capital declines by an
arbitrary amount.

Two commenters complained that, in effect, the rule would force banks to
restrict their exposure to transactions with maturities shorter than 30
days, leading banks to concentrate bank funding in shorter maturities,
rather than balancing short- and long-term exposure. These commenters also
argued that the rule would force banks to buy securities, reducing
liquidity and exacerbating the credit crunch. In addition, two commenters
expressed concern that misunderstanding of the purpose of the capital
classifications could lead to a retreat from institutions that do not pose
a risk to the banking system or to their customers, but that do not meet
the standards to be considered "well capitalized."

Proposed Changes

Six commenters proposed changes to the guidelines concerning adequately
capitalized banks. Two commenters suggested that the 25 percent limit only
apply to exposures with a maturity of over 90 days. One suggested that the
only restriction on banks dealing with adequately capitalized
correspondents be a limit of 50 percent of capital on exposure with
maturities of 90 days or more. Two other commenters suggested that the
exposure limit be increased to 100 percent of capital with a 50 percent
limit for 30 day maturities. Conversely, one commenter suggested that the
Board eliminate limits on credit exposure with maturities longer than 30
days, asserting that tracking exposure by maturity is expensive,
especially for small banks, and that as a result banks will eliminate
exposure to adequately capitalized banks.  The Final Rule

The final rule does not include a regulatory limit on credit exposure to
adequately capitalized institutions. The Board believes that this change
will reduce monitoring costs and avoid unwarranted reductions in the
business of adequately capitalized banks due to the implementation of
section 308. Elimination of this limit also reflects the difficulty in
setting an appropriate exposure limit that reflects the actual credit and
liquidity effects of a correspondent's failure in light of prompt partial
payment by the FDIC.

Further, the proposed limit on credit exposure for adequately capitalized
correspondents served largely as a transition from the unrestricted credit
exposure permitted for well-capitalized correspondents to the 25 percent
limit for less than adequately capitalized correspondents. The prudential
standards of the proposed final rule have been modified to address this
issue more directly by emphasizing analysis of the creditworthiness of a
correspondent and requiring a bank to take into account any deterioration
in the financial condition of its correspondent.  Finally, credit exposure
in excess of 25 percent of the bank's total capital would not be
"grandfathered" under the proposed final rule, thus encouraging a bank
with significant credit exposure to a correspondent that is in danger of
slipping below adequately capitalized to limit the maturity of any credit
exposure in excess of the 25 percent guideline.

The final rule also reduces the need for a rapid reduction in exposure to
a correspondent that has slipped below adequately capitalized by extending
the transition provision to 120 days, allowing the bank more time to
evaluate exposure and restructure activities.

Section 206.4(a)(3)  Other Correspondents [Final Rule -- Incorporated in
Section 206.4(a)(1)]

The proposed rule provided that a bank ordinarily should limit its daily
interday credit exposure to a correspondent that the bank cannot
demonstrate is well or adequately capitalized to an amount equal to not
more than 25 percent of the bank's total capital. The Board received nine
comments on this section, one of which supported the regulation as
written.

Three commenters proposed that the rule increase permissible exposure to
50 percent of capital. One of these commenters suggested that this
increase be contingent upon the respondent conducting due diligence
quarterly. Another commenter argued that restricting exposure to less than
adequately capitalized banks would increase the likelihood of their
failure. Three commenters suggested that the final rule be more stringent.
Two suggested that the rule prohibit any uninsured exposure to a
significantly or critically undercapitalized correspondent, and the other
suggested that the rule prevent significantly undercapitalized banks from
purchasing federal funds or certificates of deposit with maturities over
seven days. Finally, one commenter questioned why the proposed rule did
not distinguish between undercapitalized, significantly undercapitalized,
and critically undercapitalized banks.

As discussed above, the limit on credit exposure to correspondents that a
bank cannot demonstrate are at least adequately capitalized has been
retained in the final rule. Greater credit exposure to such correspondents
would generally create undue risk to banks. However, the Board does not
believe that additional guidelines to address more significantly impaired
correspondents are warranted. Banks' prudential policies and procedures
should address exposure to particularly troubled correspondents.

Section 206.4(b)  Commonly Controlled Insured Depository Institutions
[Final Rule -- Section 206.2(b) and (c)]

The proposed rule provided that, except for the general prudential
standards in Sec. 206.3, a bank need not limit its credit exposure to a
correspondent that is commonly controlled with the bank and for which the
bank is subject to liability under section 5(e) of the Federal Deposit
Insurance Act.

The proposed rule defined a correspondent as commonly controlled with the
bank if 25 percent or more of any class of voting securities of the bank
and the correspondent were owned, directly or indirectly, by the same
depository institution or company; or, either the bank or the
correspondent owns 25 percent or more of any class of voting securities of
the other. Exposure to a commonly controlled depository institution was
excluded from the limits on credit exposure because there is no effective
way for an insured bank to limit its credit exposure to an FDIC-insured
depository institution that is commonly controlled with the bank. The
cross-guarantee provisions of the Federal Deposit Insurance Act make an
insured depository institution potentially liable to the FDIC for losses
resulting from the failure of a commonly controlled insured depository
institution. The Board received fourteen comments on this section, three
of which supported the section as written.
 
Substantive Comments
 
Eleven commenters criticized the exemption for commonly controlled
institutions. Eight of them, submitting a substantially similar letter,
argued that this provision would permit big banks to evade the purpose of
the statute by shifting funds among commonly controlled institutions.
Another commenter argued that depositor risk is measured by institutions
and that risk to the deposit insurance system is not reduced because of
bank consolidation. The commenter questioned whether the rule reflects a
regulatory bias towards consolidation. In contrast, two other commenters
argued that the Board should exclude inter-affiliate transactions from the
rule entirely.

The provisions of the proposed rule reflected the authority of the FDIC to
invoke cross-guarantees and thereby override any efforts of a bank to
limit exposure to a commonly controlled correspondent, as well as current
inter-affiliate funding arrangements within bank holding companies.
Because of the cross-guarantees, disruption of these arrangements would
not yield a commensurate reduction in risk to the FDIC insurance funds or
to the banking system. The Board believes that exposure to commonly
controlled correspondents should not be covered by either the limits on
credit exposure or the prudential standards provisions of the final rule,
as a bank cannot effectively limit its exposure to such correspondents
under either provision. However, the Board notes that section 23A(a)(4) of
the Federal Reserve Act would continue to apply to transactions with
affiliates, including commonly controlled insured depository institutions.

One commenter suggested that the exclusion apply to banks that own shares
in bankers' banks. The Board does not believe that it is appropriate to
apply the exclusion to owners of a bankers' bank because the failure of
the bankers' bank would not subject the owners to the cross-guarantee
provisions of section 5(e) of the Federal Deposit Insurance Act.

Drafting

Two commenters suggested that the exception include banks subject to the
provisions of section 23A of the Holding Company Act. This portion of the
rule reflects those banks subject to the cross-guarantee provisions, which
will cover virtually all those covered by section 23A.  This provision has
been retained in the final rule but has been moved to the definitions
section with conforming drafting changes.

Section 206.4(c) Exposure of Subsidiaries [Final Rule -- Section 206.4(e)]

The proposed rule provided that, in calculating credit exposure to a
correspondent under this part, a bank must include the credit exposure of
the bank's subsidiaries to the correspondent. If the bank did not own 100
percent of the shares of the subsidiary, the proposed rule required the
bank's credit exposure to include a pro rata portion of the subsidiary's
exposure, based on the percentage ownership of the bank in the subsidiary.
The purpose of this section was to capture the full exposure of a bank to
a correspondent. The Board received five comments on this section.

Four commenters argued for restricting the scope of the regulation to
subsidiaries of which the bank owns a majority of the voting stock. Two
commenters argued that where a bank owns only a minority position, it may
be unable to obtain daily exposure figures. Three commenters stated that
the parent bank is unlikely to have consolidated systems for calculating
exposure for minority-owned subsidiaries, and one noted that the
percentage ownership may not justify the expense to the subsidiary of
establishing an information reporting system for the shareholder bank. One
of the commenters argued a bank cannot cause a subsidiary that the bank
does not control to reduce its exposure, and the bank therefore could
ensure compliance with the limits only by selling its interest in the
subsidiary or by reducing its own exposure to the counterparty. Finally,
three commenters argued that where the subsidiary is not included in the
bank's consolidated financial statements, but is only reported as an
investment, the parent's exposure is not the subsidiary's exposure but is
limited to the bank's investment.

One commenter queried how the pro rata portion should be determined if a
bank holds different classes of stock in the subsidiary. This commenter
suggested that the provision only apply to banks holding common stock
because the same credit exposure does not exist if the bank holds
preferred stock, and proposed that where a bank holds a different class of
stock, it should be permitted to use any reasonable method to calculate
exposure.

In formulating the proposed rule, the Board noted that banks may assume
obligations to support a subsidiary beyond their actual investment.
However, the Board has modified the final rule to require a bank to
include with the bank's own credit exposure 100 percent of the credit
exposure of any subsidiary that the bank is required to consolidate on its
Report of Condition and Income or Thrift Financial Report. This provision
generally captures the credit exposure of any majority-owned subsidiary of
the bank. Under the final rule, therefore, none of a minority-owned
subsidiary's exposure and all of a majority-owned subsidiary's exposure
would be included in the parent bank's exposure calculation.
 
Section 206.4(d) Transition Provisions [Final Rule -- Section 206.4(a)(2)]

The proposed rule required that, where a bank is no longer able to
demonstrate that a correspondent is adequately capitalized or well
capitalized for the purposes of Sec. 206.4(a)(1) or (2), including where
the bank cannot obtain adequate information concerning the capital ratios
of the correspondent, the bank should reduce its credit exposure to the
appropriate level under Sec. 206.4(a) within 30 days after the date when
current call report or other relevant financial data normally would be
available. The Board received forty-seven comments on this section.

Extension of the Transition Period

Forty-five commenters expressed concern about the increase in monitoring
requirements when a correspondent drops from well to adequately
capitalized, the competitive impact on the correspondent, and compliance
burdens. These commenters urged the Board to avoid overreaction to
temporary dips in capital and to extend the transition period. Thirty of
these commenters, submitting a substantially similar letter, proposed that
banks be given one year to resume well-capitalized status. Eight
commenters recommended transition periods ranging from 90 to 120 days.
Four commenters noted that a variety of factors, such as regulatory
changes, increases in reserves, asset revaluation, or acquisitions, could
cause a bank's capitalization ratio to change abruptly without necessarily
signifying significantly increased risk. Another commenter argued that the
proposed rule, as written, would require a swift, abrupt adjustment to
temporary swings in capital, resulting in a market bias for banks with
capital less subject to fluctuations. Five commenters argued that where
the credit exposure consists of off-balance sheet items or instruments
with maturities of longer than 30 days, judicious reductions in credit
exposure may not be possible within the rule's time frame. Three others
stated that delays in financial reporting, especially where the respondent
relies on a reporting service, may make compliance with the transition
provisions extremely difficult.

One commenter inquired whether a respondent must adjust its exposure if
the correspondent provides assurances that it will reacquire its former
status within the next reporting period.  The Board believes that a longer
transition period of at least a calendar quarter will avoid undue
disruptions in correspondent relationship for temporary declines in
capital ratios by allowing the correspondent an opportunity to bring its
capital ratios back the relevant levels before the next quarterly report.
The extended period will also provide the exposed bank more time to
implement any monitoring required to demonstrate compliance with the
regulatory limit and to adjust the maturities or level of exposure to the
correspondent. Accordingly, the final rule would permit a bank 120 days to
reduce its credit exposure to a correspondent.

If a bank has been relying on information from call reports or from a bank
rating service for a correspondent's capital ratios, the 120-day period
would run from the date when the call report or bank rating reflecting the
correspondent's reduced capital ratios was received, or from the date that
the information normally would be received. If a bank has been relying on
information received from the correspondent to demonstrate that the
correspondent is at least adequately capitalized, and the correspondent is
no longer providing such information, the 120-day period would run from
the date when the bank ordinarily would have received the information from
the correspondent.

Section 206.5 Credit Exposure [Final Rule Consolidated in Section 206.4]
Section 206.5(a) Scope of Credit Exposure [Final Rule -- Section 206.4(b)]

The proposed rule defined the credit exposure of a bank to a correspondent
as the bank's assets and off-balance sheet items that are subject to
capital requirements under the capital adequacy guidelines of the bank's
primary federal supervisor and that involve claims on the correspondent.
The proposed rule excluded certain relatively lower-risk items. In
addition, for the purposes of this section, the rule provided that
off-balance sheet items were to be valued on the basis of current
exposure. Under the proposed rule, "credit exposure" was subject to the
numerical benchmark guidelines or limits. In addition to the comments
concerning the definition of exposure, addressed in Sec. 206.2(c) above,
the Board received ten comments on the definition of credit exposure.

One commenter noted that credit exposure is difficult to measure and
criticized the proposed rule's emphasis on it. The proposed final rule
deemphasizes credit exposure by eliminating the regulatory limit on credit
exposure to adequately capitalized correspondents. While most of the
commenters addressed the specific exclusions from the calculation of
credit exposure, one commenter expressed concern about the inclusion of
derivative instruments, such as swaps, in the calculation of interbank
exposures, especially in light of the fact that non-bank correspondents or
parties to derivative instruments are excluded. This commenter argued that
the rule would drive the derivative business to non-bank counter-parties,
weakening the safety protocols introduced into the swaps and other
derivative markets as a result of bank participation in the markets. The
Board believes that banks should have similar controls on credit exposure
to nonbanks as on credit exposure to banks. However, exposure to nonbanks
was not addressed by the statute. Further, the Board believes that it is
not appropriate to exclude credit exposure from derivative instruments
from the rule, as it represents a significant source of interbank exposure
in many cases.

One commenter argued that depository institution equity securities taken
as collateral or in satisfaction of a debt should be excluded from the
definition of "credit exposure" because these instruments are not payment
obligations. Such transactions give rise to a risk of loss if the
correspondent fails, and therefore are covered by the definition of
"credit exposure." In some circumstances, however, obligations
collateralized by bank stock may qualify for exclusion under 206.4(d)(3)
of the final rule. The definition in the final rule has been redrafted to
clarify that capital instruments issued by the correspondent are included
in the definition of "credit exposure."

Another commenter asked if the calculation of "current replacement value"
for interest rate and foreign exchange contracts means that banks must
make daily mark-to-market calculations on a counterparty by counterparty
basis. The rule provides that monitoring must be on a mark-to-market
basis. However, the marking need only be done at the appropriate
monitoring intervals, which depend on the factors listed in the revised
monitoring provision discussed above, not daily. One commenter stated that
it has a sophisticated system which measures fractional rather than
mark-to-market exposure, and inquired whether it may use its own system
rather than the proposed rules. As noted above in the discussion of
monitoring, alternative systems may be used where they will effectively
maintain exposure within the prescribed limits.

Six commenters urged that settlement exposure be specifically excluded for
the sake of clarity. Two commenters urged that intraday exposure be
specifically excluded. One commenter suggested that intraday exposure be
defined as exposure of less than 24 hours.  The proposed final rule has
been redrafted for greater clarity, specifying that intraday or settlement
exposure and agented funds are not included in "credit exposure."

Section 206.5(b) Netting [Final Rule -- Section 206.4(c)]

The proposed rule provided that transactions covered by netting agreements
that are valid and enforceable under all applicable laws may be netted in
calculating exposure. The Board received two comments on this section.

One commenter urged the Board to permit mutual correspondents to deduct
the reciprocal "due from" balances from exposure limits because they
reduce exposure risk. Another commenter requested that the Board clarify
the requirements that a bank "must have reasoned legal opinions" that
netting contracts are valid and enforceable.

Under the final rule, the netting provision remains unchanged. Reciprocal
"due from" balances that do not result in legally binding netting do not
reduce credit risk to the same extent as legally binding netting. Reasoned
legal opinions that netting contracts are valid would include opinions of
counsel describing the legal reasoning that led to the conclusions
expressed in the opinions.

Section 206.5(c) Exclusions [Final Rule -- Section 206.4(d)]

The proposed rule established four exclusions to the scope of credit
exposure.

Section 206.5(c)(1) Secured Transactions [Final Rule -- Section
206.4(d)(1)]

The first exclusion involved transations, including reverse repurchase
agreements, that are fully secured by government securities or readily
marketable collateral having a current market value equal to 100 percent
of the credit exposure under the transaction. For the purpose of this
exclusion, "government securities" were defined as obligations of, or
obligations fully guaranteed as to principal and interest by, the United
States government or any department, agency, bureau, board, commission, or
establishment of the United States, or any corporation wholly owned
directly or indirectly by the United States. "Readily marketable
collateral" means financial instruments or bullion that may be sold in
ordinary circumstances with reasonable promptness at a fair market value
determined by quotations based on actual transactions on an auction or a
similarly available daily bid- and ask-price market. Both of these
definitions were taken from the Office of the Comptroller of the
Currency's lending limits on national banks. The Board received six
comments on this section.

Two commenters suggested that this exception cover transactions to the
extent that they are secured. The final rule has been redrafted to exclude
transactions to the extent that they are secured.

Two other commenters suggested that the definition of government
securities include those backed by the full faith and credit of a state
government as well. The definition of government securities has not been
changed, but the Board believes that most state securities would be
covered by the definition of "readily marketable collateral." Transactions
secured by these securities, therefore, would be excluded from credit
exposure.

One commenter asked if letters of credit guaranteed by the Export-Import
Bank of the United States would be considered government securities. The
Board notes that, regardless of whether guaranteed letters of credit would
be considered to be government securities, such transactions generally
would qualify for exclusion from the calculation of credit exposure
provided under Sec. 206.4(d)(3) of the final rule (see discussion under
"Quality assets").

Another commenter expressed concern that the exclusion for transactions
secured by government-backed securities would lead to increased investment
in government securities and decreased loans. The Board recognizes that
the rule could encourage investment in government securities, but
investment in government securities reflects lower credit risk than many
other transactions and is consistent with the capital guidelines.

Section 206.5(c)(2) Cash Items in the Process of Collection (CIPC) [Final
Rule -- Section 206.4(d)(2)]

The second exclusion from the calculation of credit exposure covered the
proceeds of checks and other cash items deposited in an account at a
correspondent that are not yet available for withdrawal. The Board
received nine comments on this section, three of which supported the
section as written.

Three commenters expressed concern about the rule's treatment of when a
cash item becomes exposure. One asked if "due from" balances should be
measured by the actual available balance as reported by the bank on its
internal ledger balance. The final rule requires that such balances be
measured by the actual available balance. Two trade associations
commenting on the rule stated that current correspondent practice is to
make funds available as early in the day as possible, causing respondents
under the proposed rule to incur a measurable exposure for a longer period
of time and perhaps before collection of the underlying item has actually
taken place. The Board notes that the valuation of cash items in the
process of collection that would not be considered to be deposits by the
FDIC, acting as receiver of a failed bank, can only be made after the
fact. The Board believes, however, that the proposed standard best
approximates this value and has retained it in the final rule.

Clarification

Six commenters asked what comparable items are included in "checks and
other cash items." One commenter specifically suggested that credit card
and debit card transaction be covered by the exclusion. Two commenters
urged that it exclude all cash items, since the associated risk tends to
be relatively short in duration. While cash items that are not treated as
"agency" transactions by the FDIC clearly result in credit risk and should
be included in credit exposure, the Board believes that it is appropriate
to exclude from credit exposure any item that the FDIC treats as being
collected in an agency capacity rather than as a deposit or claim. The
Board does not believe, however, that the FDIC has addressed whether the
credit and debit card transactions are collected in an agency capacity.

Miscellaneous

One commenter asked if the Board would provide systems support in
accounting for settlement exposure and cash items in the process of
collection. The Board believes that this support is better provided by the
market, and that correspondents may provide such support.  This exclusion
remains unchanged in the final rule.

Section 206.5(c)(3) Quality Assets [Final Rule -- Section 206.4(d)(3)]

The third exclusion covered "quality assets" on which the correspondent is
secondarily liable or that result in secondary exposure to the
correspondent, including loans to third parties secured by stock or debt
obligations of the correspondent, loans to third parties purchased from
the correspondent with recourse, and loans or obligations of third parties
backed by stand-by letters of credit issued by the correspondent. The
Board received three comments on this section.  One commenter expressed
concern that the definition of "quality asset" raises the possibility that
a loan secured by the stock of a correspondent may lose its status and be
counted as exposure, discouraging such loans. Another commenter suggested
that the rule give an exposed bank at least 30 days to adjust to a decline
in the quality of a quality asset. The third commenter argued that credit
exposure backed by a quality asset, such as a letter of credit, should be
excluded from the definition of credit exposure.

In the final rule the exclusion for quality assets has been broadened to
include direct exposure to a correspondent that is backed by a
creditworthy obligor as well as a correspondent's secondary exposure on a
quality asset. Additionally, under the final rule, the potential for
excesses in exposure is recognized and a bank is required to have
appropriate procedures to deal with such excesses.

Section 206.5(c)(4) FDIC-Insured Amounts [Final Rule -- Section
206.4(d)(5)]

No comments were received on this section and it remains unchanged in the
final rule.

Mergers and Acquisitions [Final Rule -- Section 206.4(d)(4)]

As noted above, one commenter suggested that banks be given time after a
merger to bring exposure within the guidelines for credit exposure. The
final rule excludes exposure that results from a merger or acquisition of
a bank from the definition of "credit exposure" for one year after the
merger or acquisition. This exclusion gives banks one year to merge their
systems for monitoring credit exposure.

Section 206.6  Capital Levels of Correspondents [Final Rule -- Section
206.5]

The proposed rule provided that, for the purpose of compliance with the
credit exposure guidelines, a correspondent would be considered "well
capitalized" if the correspondent has a total risk-based capital ratio of
10.0 percent or greater, a Tier 1 risk-based capital ratio of 6.0 percent
or greater, and a leverage ratio of 5.0 percent or greater. A
correspondent would be considered "adequately capitalized" if the
correspondent has a total risk-based capital ratio of 8.0 percent or
greater, a Tier 1 risk-based capital ratio of 4.0 percent or greater, and
a leverage ratio of 4.0 percent or greater. As used in the proposed rule,
the terms "well capitalized" and "adequately capitalized" were similar but
not identical to the definition of those terms as used for the purposes of
the prompt corrective action standards under section 38 of the Federal
Deposit Insurance Act (12 U.S.C. 1831o) ("prompt corrective action
standards"). The proposed rule further provided that a correspondent that
is a foreign bank may be considered "well capitalized" or "adequately
capitalized" under this section without regard to the minimum leverage
ratios required under subparagraphs (a)(1)(iii) and (a)(2)(iii) of this
section of the proposed rule. The Board received 137 comments on this
section.

Criticism of the Emphasis on Capital

Sixteen commenters disagreed with the Board's approach to structuring the
limits on credit exposure. Ten commenters argued that the proposed rule
overemphasized capital relative to other creditworthiness indicators such
as liquidity, asset quality, earnings strength, regional and product line
portfolio diversity, and operating environment. These commenters expressed
concern that the proposed rule could encourage banks to focus on
capitalization rather than on their own, broader based, prudential systems
for analyzing correspondent credit or on the efficiency or competitiveness
of the correspondent's payments and processing systems. In addition, seven
commenters questioned the value of capital as an indicator of strength.
One commenter pointed out that risk-based capital provides a numerical
assessment of subjective risks. Another commenter asserted that capital
levels measured on a daily or quarterly basis are notoriously inaccurate.
A third commenter argued that the limits on credit exposure should be
based on the book value rather than on the market value of a
correspondent's assets. A bank holding company argued that inadequate loan
loss provisions can lead to a misrepresentation of a bank's actual
strength. Two commenters suggested that if the proposed rule is seeking an
objective measure it should select one which is easy to measure and not
subject to frequent fluctuations. One commenter suggested that, as an
alternative, the guidelines be based on the financial markets. In
contrast, two commenters pointed out that the advantage of using capital
is that it will encourage large banks that are not well capitalized to
strengthen their capital position in order to maintain their interbank
business. The final rule has been amended to de-emphasize the capital of
correspondents by removing the limit on credit exposure to adequately
capitalized correspondents.

Monitoring Capital of Domestic Banks

Sixteen commenters argued that gathering and analyzing data to the extent
required by the rule is extremely difficult and unfairly burdensome, and
that small banks lack the technical capacity and resources to conduct this
analysis. Eight commenters objected to the cost of monitoring capital.
Another commenter claimed that large banks may resist giving
capitalization information to smaller banks seeking to initiate a
correspondent relationship. Moreover, this commenter pointed out that
prompt corrective action rules forbid advertizing capital levels. One
commenter argued that without access to its correspondent's examination
report, it would be unable to determine if the correspondent was
adequately capitalized. Four commenters noted that CAMEL ratings are
confidential.

Nineteen commenters suggested that regulatory agencies publish
capitalization ratings, lists of well and adequately capitalized
correspondents, or exposure limits for particular correspondents, domestic
and foreign. These commenters justified the request by arguing that
regulatory agencies have access to the information and have the capacity
to make a more complete evaluation of safety and soundness. One commenter
urged that the regulatory authorities release the data they have
available. Five others urged that call reports or financial reports be
altered to require banks to disclose capital adequacy.

Four commenters expressed concern that small banks will be unable to
analyze capitalization information from a call report due to the length
and complexity of the document. Four commenters urged that where federal
funds are sold on an agency basis, the respondent should be able to rely
on the capitalization information supplied by the agent. One commenter
expressed concern that although the regulation only required a ratio
analysis, respondents will ask for quarterly call reports. Moreover, seven
commenters complained of the cost of disseminating this information. One
of these commenters, for example, noted that it has 110 respondents to
distribute the report to. Two other commenters expressed concern that the
compliance burden would increase the advantage enjoyed by other financial
service providers. One commenter proposed that the Board draft a model
form with only the essential information necessary to comply with the
rule.

Eight commenters urged the Board to shift the burden from respondents to
correspondents. Two commenters proposed that the rule require
correspondents to prepare uniform disclosure reports and to disclose
promptly any deterioration in capitalization. Two other commenters urged
that the rule permit respondents to base their credit assessment on a
correspondent's self-assessment of its capital adequacy classification
together with any supporting information it may provide. Twenty
commenters, nineteen of whom submitted a substantially similar letter,
urged the Board to permit respondents to rely on a correspondent's annual
documentation of its capital levels. Thirty-four commenters suggested that
quarterly submissions satisfy the requirement. One commenter urged the
Board to inform correspondents that the financial information provided to
other banks is subject to review by examiners and should be consistent
with the information provided to regulators.

The Board recognizes that it is currently difficult to obtain information
on the risk-based capital levels of a correspondent. Under the final rule,
this task is somewhat simplified, as a bank will be required to
demonstrate only that its correspondent's capital ratios qualify it as at
least adequately capitalized. While the call report for correspondents
that are not required to file a complete Schedule RC-R currently does not
provide sufficient information to calculate a correspondent's precise
capital ratios, it can be relied on to demonstrate that a correspondent is
at least adequately capitalized. /10 Further, the Board anticipates that
most banks will receive information on their correspondent's capital
ratios either directly from the correspondents or from a bank rating
agency. Finally, the Board notes that the standard used in the rule is
based solely on capital ratios and does not require disclosure of CAMEL
ratings.

/10 Banks with assets of $1 billion or less generally are required to
complete only Part I of the Schedule, which provides a rough estimate of
risk-based capital. A bank may assume that its correspondent is at least
adequately capitalized if the correspondent has completed only Part I of
Schedule RC-R. For correspondents that file a complete Schedule RC-R, the
call report does include sufficient information to calculate a
correspondent's risk-based capital. The Board expects that further
information to facilitate this calculation will be made available prior to
the implementation of the regulatory limit on credit exposure to less than
adequately capitalized correspondents.
 
Five commenters asked for clarification of permissible sources for
capitalization information. One claimed that the most accurate information
is informal information and sought acknowledgement of the validity of it
as a source. Another suggested that the rule explicitly permit banks to
rely on call reports in determining capitalization. Two commenters
requested that banks be permitted to rely on call reports alone. Three
commenters asked the Board to describe a publicly available information
base. The final rule does not limit a bank to a single source of
information for capital ratios, but indicates that a bank may rely on
capital information obtained from a correspondent, bank rating agency, or
other reliable source of information. The bank may also rely on
information contained in the call report for this purpose. While the Board
recognizes that informal information may be useful in evaluating the
overall condition of a correspondent, such information is not sufficient
to justify the higher levels of credit exposure permitted to adequately or
well-capitalized correspondents under the rule. As stated in the summary
of the final rule, the rule does not limit a bank to the use of publicly
available information, but merely provides that a bank generally is not
required to obtain non-public information.

Application of the Provision to Foreign Banks

Thirteen commenters expressed concern about the difficulty and cost of
monitoring capital levels of foreign banks. One commenter noted that
disclosure of capital information varies widely among foreign banks and
another noted that information is difficult to obtain from the institution
or from secondary sources. One requested that G-10 banks be required to
provide uniform information. Two other commenters suggested that
additional flexibility be granted to U.S. banks which deal with non-Basle
banks because of the added difficulty in obtaining capital information.
Two commenters requested that the Board develop a method to determine the
capital levels of foreign correspondents.

One commenter proposed that the rule permit respondents to rely on annual
data if that is the best available. Another commenter argued that it is
inequitable to require quarterly analysis of the capital of U.S. banks
while permitting banks to analyze the capitalization of foreign banks
semi-annually because information on foreign banks is unavailable on a
more frequent basis. A third commenter proposed that if information is not
available at least semi-annually, exposure to foreign banks should be
restricted to 25 percent.

As in the proposed rule, the final rule permits a foreign correspondent to
be considered "adequately capitalized" without regard to the level of the
foreign bank's leverage ratio. As indicated in the supplementary
information to the proposed rule, the Board believes that this treatment
of foreign banks is consistent with the findings of the Capital
Equivalency Report submitted by the Board and the Department of Treasury
to Congress earlier this year.  The Board recognizes that public sources
of information on risk-based capital ratios may not be available for many
foreign bank correspondents. As with domestic correspondents, however, the
Board anticipates that in most instances the correspondent will provide
the information to the banks with which it does business. As foreign banks
do not necessarily prepare financial statements on a quarterly basis, as
domestic banks do, the final rule would permit a bank to rely on the
foreign bank correspondent's most recent financial statements.

Clarification of the Provision

Eight commenters quoted the supplementary information to the proposed
rule, which stated that banks should not rely on capitalization alone and
that weakness in a correspondent's management, operations, or loan
portfolio might lead a bank to restrict its exposure below the permissible
limits on credit exposure. These commenters pointed out that these terms
are subjective and that their interpretation by the various federal bank
regulators may lead to substantial and unevenly enforced compliance
burdens. Two of these commenters added that it may be prohibitively
expensive to judge any potential "weakness" in a correspondent and, as a
result, respondents may shift their correspondent activities to the public
sector. One commenter suggested that to facilitate compliance, the final
rule eliminate references which cut back on what is permissible under the
guidelines and leave other considerations for the prudential analysis
section.

The Board continues to believe that the remaining limit on credit exposure
should be viewed as a maximum level for credit exposure rather than a safe
harbor. To the extent that a bank's prudential policies and procedures
suggest a lower level of credit exposure to a correspondent, the bank
should adhere to the lower level.

Frequency of Monitoring

Twenty-six commenters sought clarification of the frequency with which
capital must be monitored and the way it must be measured. Two commenters
suggested that quarterly monitoring is too frequent and another proposed
that capital be monitored annually. Twenty-three commenters, nineteen of
whom submitted a substantially similar letter, urged that capital be
measured over a period of time, rather than at a point in time. Three
commenters urged that the capitalization of a correspondent in a multibank
holding company be based on the capital of the bank holding company.

Under the final rule for domestic correspondents, capital should be
monitored quarterly to pick up information based on the correspondent's
most recent call report, financial statement, or bank rating report. For
foreign bank correspondents, monitoring frequency should be related to the
frequency with which financial statements or other regular reports are
available. Although such information is available quarterly for some
foreign banks, for many foreign banks financial statements generally will
be available only on a semi-annual basis. Further, quarterly monitoring of
capital is only required for correspondents to which a bank's potential
credit exposure is more than 25 percent of its own capital. If the
internal systems of a bank ordinarily limit credit exposure to a
correspondent to less than 25 percent of the exposed bank's capital, no
monitoring of the correspondent's capital would be necessary, although
periodic reviews of the correspondent's financial condition may be
required under Sec. 206.3(a)(2) if exposure to the correspondent is
significant.

Six commenters expressed concerns about the timeliness of the required
information. Three noted substantial delays before generally published
reports become available and another noted that this information is more
expensive if it is obtained before it is commercially available. Two
commenters requested guidelines on the requisite freshness of this data.
Because information in risk-based capital ratios is generally based on the
call report, a bank would be justified in relying on the most recently
available reports based on call report data. While there may be a
significant lag in such data, the Board believes that where the
information in such reports is followed by the bank on a continuing basis,
the reports remain a useful monitor of trends in the conditions of the
correspondent.

Definition of "Adequately Capitalized"

Several commenters criticized the definition of "adequately capitalized."
One suggested that the definition include all banks with a leverage ratio
of 4 percent or greater and a total risk based capital ratio in excess of
8 percent. One suggested it include all banks with a tier 1 ratio of at
least 5 percent. Another argued that the definition of adequately
capitalized is unjustifiably more restrictive than the definition in the
prompt corrective action standards and suggested that the definition
include correspondents with a capital ratio of 3 percent and a 1 CAMEL
rating. While acknowledging that a bank cannot disclose its CAMEL rating,
the commenter suggested that it could disclose if it is adequately
capitalized under this standard. Another bank suggested that the leverage
ratio be excluded because it is not applied to foreign banks. Commenters
also addressed the definition of "well capitalized," which has been
deleted. One commenter suggested that the rule be written to state clearly
the capital requirements imposed upon correspondents. Another commenter
supported the capital definitions.

The definition of adequately capitalized in the proposed rule was based
on, but not identical to, the definition used for prompt corrective
action. The difference between the definitions is to enable banks to
determine, from publicly available information, a correspondent's capital
for the purpose of this rule. The Board believes that it would be
confusing to make further changes in this rule's definition of "adequately
capitalized" and the definition in the final rule remains unchanged.

Section 206.7 Waiver [Final Rule -- Section 206.6]

The proposed rule provided that the Board may waive the application of
Sec. 206.4(a) to a bank if the primary federal supervisor of the bank
advises the Board that the bank is not reasonably able to obtain necessary
services, including payment-related services and placement of funds,
without incurring exposure to a correspondent in excess of otherwise
applicable limits. The Board received three comments on this section.

Two commenters suggested that if the guidelines are not relaxed, small
rural banks with seasonal cash flows should receive waivers. As noted
above, the proposed final rule would eliminate the regulatory limit on
credit exposure for adequately capitalized banks, substantially easing
this constraint. To the extent that seasonal cash flows require rural
banks to sell federal funds or engage in other transactions in excess of
25 percent of their capital, the Board believes that they should deal with
banks that are adequately capitalized or better or diversify their credit
exposure.  Another commenter suggested that the Board use its waiver
authority liberally when the exposure is of a length or a type that
extrication within 30 days is quite difficult. The Board does not believe
that this use of the waiver authority is appropriate. The waiver is
designed for low capital banks that need payment services and would not be
able to obtain them otherwise. Rather than liberalize the waiver
provisions, the Board has extended to 120 days the transition period for
compliance with the limit on credit exposure to a correspondent that is
less than adequately capitalized. This extension should permit banks to
reduce exposure judiciously to a bank whose capital has been reduced.
Under the final rule, the waiver provision remains unchanged.

Section 206.8 Record Retention [Deleted in Final Rule]

The proposed rule required that banks establish recordkeeping reasonably
designed to demonstrate compliance with the provisions of Secs. 206.3 and
206.4. The Board received forty-seven letters that commented on this
section specifically and one hundred eight letters that complained of
excessive paperwork generally.

Concerns With Cost Burdens

All of the forty-seven comments on this section complained of the cost and
burden of these requirements. A trade association pointed out that banks
already confront substantial compliance and recordkeeping requirements and
that the requirements in the proposed rule may exceed banks' compliance
capacity and ability. Two commenters asserted that requiring documentation
of every closed transaction would substantially increase compliance costs.
These commenters stated that records of closed transactions generally are
not retained. Rather, limits are set for specific products and maturities,
and internal limits are monitored to ensure they are not exceeded without
specific credit approval. The commenters proposed that rather than
requiring that records of closed transactions be available for review, the
final rule should focus on the adequacy of a bank's establishment and
monitoring of limits, including any reported overages.

Clarification of the Requirement

Three commenters requested that the final rule articulate what
documentation must be maintained on file, in what format, and for how
long, both to assist banks in maintaining reasonable records and to
provide examiners with guidelines to effect uniform enforcement.

Proposals of Modification

Thirty-eight commenters offered specific suggestions for reducing the
burden. Two commenters suggested that the requirements should not apply to
exposure covered by FDIC insurance and that the requirements should be
reduced for smaller amounts of exposure regardless of the correspondent's
capitalization. Another commenter suggested an exception when exposure is
less than 25% of capital.

Thirty-two commenters urged a reduction in recordkeeping requirements for
respondents dealing with well-capitalized banks. Thirty of them sent an
identical letter urging that the recordkeeping requirement be the same for
a well-capitalized bank as it is for a Federal Reserve Bank. One commenter
suggested that if a respondent selects a well-capitalized correspondent
the recordkeeping burden should be restricted to maintaining on file the
correspondent's quarterly disclosure and certification of its
capitalization.

Other commenters urged a generalized reduction in the burden. One
commenter suggested that the prudential standards requirement be limited
to documenting an annual review. Two commenters suggested that the capital
monitoring requirement be satisfied by documentation of an annual review
of capital.

One commenter urged that the requirement be eliminated altogether,
proposing that examiners rely on the adequacy of the prudential policies
and that the burden be on the examiners to prove a violation of the
regulation rather than on banks to prove compliance.

Final Rule

The specific record retention requirement has been deleted from the final
rule. Examiners will use examiner guidance to determine compliance with
the rule.

Section 206.9 Transition Provisions [Final Rule -- Section 206.7]

The proposed rule provided that for a period of one year beginning on
December 19, 1992, a bank would be required to comply with the prudential
standards required under Sec. 206.3(a), and under Sec. 206.3(b) would be
required to structure transactions with a correspondent or monitor
exposure to a correspondent to ensure that its exposure did not exceed its
internal limits established under Sec. 206.3(a). During this period, the
proposed rule did not require the bank to meet the guidelines for credit
exposure established under Sec. 206.4 or monitor credit exposure under
Sec. 206.3(b).

The proposed rule further provided that for a period of one year beginning
on December 19, 1993, the overall guideline for credit exposure to an
adequately capitalized correspondent contained in Sec. 206.4(b)(ii) would
be 100 percent of the bank's total capital, with the guideline for credit
exposure having a remaining term to maturity of more than 30 days at 50
percent of the bank's capital. The proposed rule set the interim guideline
on credit exposure to an individual correspondent contained in Sec.
206.4(a)(iii) at 50 percent of the exposed institution's total capital.
This section was designed to allow banks adequate time to rearrange their
correspondent banking relationship to meet the new requirements. The Board
received twelve comments on this section, one of which supported the
provision as written and another of which supported the idea of a
transition period.

Proposed Extension of the Transition Period.

Nine commenters urged the Board to extent the initial transition period,
i.e. the period before the prudential guidelines become effective, to
permit banks to prepare new policies or review and revise existing
policies, to establish procedures to monitor and control interbank
exposures, and to restructure correspondent relationships. Two commenters
suggested that the proposed implementation date would not allow bank
regulatory agencies sufficient time to train examiners.  The Board
believes that a longer initial transition period will enable banks that
have not made credit assessments of their correspondents to do so and for
banks to review and, where appropriate, improve their monitoring
procedures. An extended initial transition period also will enable the
Board to develop examination guidelines related to the rule. Therefore,
the final rule provides for a six-month transition period before the
prudential standards become effective, with the regulatory limit on credit
exposure phased in over a two year period after that date.

Competitive Analysis

The proposed rule included a competitive impact analysis discussing the
effects of the proposed rule on the ability of private sector
correspondent banks to compete effectively with the Federal Reserve