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OCC BULLETIN 2006-9
To: Chief Executive Officers of National Banks, Department and Division Heads, Examining Personnel and Other Interested Parties

Description: Final Rule

Purpose

This bulletin transmits a final rule on the risk-based capital treatment of securities borrowing transactions in which the borrower of the security posts cash collateral. This rule applies only to banks that have implemented the market risk amendment to the risk-based capital rules (12 CFR 3, appendix B). The final rule was published in the Federal Register on February 22, 2006.

Summary

The interagency final rule makes permanent and expands the scope of an interim rule issued in 2000. Specifically, the final rule permits banks subject to the market risk amendment to include in risk-weighted assets an amount that is based on the difference between the amount of cash collateral posted and the market value of the borrowed security, subject to certain conditions. The final rule modifies one of the conditions of the interim rule to permit securities borrowing transactions with counterparties that are not eligible for certain exemptions from U.S. federal bankruptcy treatment or receivership law to qualify for this capital treatment.

Under the final rule, a securities borrowing transaction must meet all the following requirements to qualify for recognition of the net exposure in risk-weighted assets:

  • The transaction must be based on securities includable in the trading book that are liquid and readily marketable;
  • The transaction must be marked to market daily;
  • The transaction must be subject to daily margin maintenance requirements; and
  • The transaction must meet one of the two following criteria:

A. The transaction must be a securities contract for the purposes of section 555 of the Bankruptcy Code (11 USC 555), a qualified financial contract for the purpose of section 11(e)(8) of the Federal Deposit Insurance Act (12 USC 1821(e)(8)), or a netting contract between or among financial institutions for the purposes of sections 401-407 of the Federal Deposit Insurance Corporation Improvement Act of 1991 (12 USC 4401-4407), or the Federal Reserve Board's Regulation EE (12 CFR 231), or

B. If the transaction does not meet the criteria of (A), then either:

i) The banking organization has conducted sufficient legal review to reach a well-founded conclusion that (1) the securities borrowing agreement executed in connection with the transaction provides the banking organization the right to accelerate, terminate, and close-out, on a net basis, all transactions under the agreement and to liquidate or set off collateral promptly upon an event of counterparty default, including in a bankruptcy, insolvency, or other similar proceeding of the counterparty and (2) under applicable law of the relevant jurisdiction, its rights under the agreement are legal, valid, binding, and enforceable and any exercise of rights under the agreement will not be stayed or avoided; or

ii) The transaction is either overnight or unconditionally cancelable at any time by the banking organization, and the banking organization has conducted sufficient legal review to reach a well-founded conclusion that (1) the securities borrowing agreement executed in connection with the transaction provides the banking organization the right to accelerate, terminate, and close-out, on a net basis, all transactions under the agreement and to liquidate or set off collateral promptly upon an event of counterparty default and (2) under the law governing the agreement, its rights under the agreement are legal, valid, binding, and enforceable.

The final rule revises the fourth condition to expand the ways in which a securities borrowing transaction can qualify for the capital treatment of the rule. As in the interim rule, the final rule allows for netting of transactions with counterparties that meet the bankruptcy requirements. The final rule also allows for netting of transactions with counterparties that are not covered by U.S federal bankruptcy or receivership law, provided the bank has conducted a legal review and concluded that it has similar protections in the event of counterparty bankruptcy. Additionally, if the securities borrowing transaction is overnight or unconditionally cancelable, it can qualify for netting as long as the bank has conducted a legal review and concluded that it has the ability to close out or net its position promptly upon the event of a counterparty default.

If these conditions are met, only the net exposure (i.e., cash collateral less the value of the borrowed security) rather than the gross exposure, must be incorporated into the risk-based capital calculation. The capital treatment of this final rule is effective upon its publication in the Federal Register.

FOR FURTHER INFORMATION, CONTACT:

For further information about this bulletin, contact the Office of the Chief National Bank Examiner (202) 649-6370.

Emory W. Rushton
Senior Deputy Comptroller and
Chief National Bank Examiner

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