WASHINGTON -- The Federal Reserve Board on Wednesday released a long-awaited proposal that would require banks to hold additional capital if they have unusually high exposure to swings in interest rates.
Under the complex plan, nearly 20% of banks could have higher core-capital requirements, the Fed said.
The proposal, which was put out for public comment and is expected to take effect next June, is aimed at incorporating interest-rate risk in the determination of capital levels.
"There has been a concern that organizations don't know how to manage interest-rate risk," said Robert Mannion, a partner in the law firm of Arnold & Porter. "This is an attempt to set up a standard for doing that in the future."
First Agency with Proposal
International regulators have adopted capital standards that measure the credit risk assumed by banks. But the Fed and other agencies are required by U.S. law to go to a step further and include interest-rate risk. The Fed is the first agency to issue a proposal.
The Office of Thrift Supervision is expected to release its proposed formula for determining interest-rate risk next month.
Under the Fed's proposal, interest rate risk exposure is measured in terms of the interest-rate sensitivity of the net present value of a bank's assets and liabilities, both on and off the balance sheet.
The regulators would determine whether a bank needs to boost its capital by looking at how heavily it is involved in riskier activities, such as collateralized mortgage obligations, long-term bonds, and interest-only and principal-only stripped mortgage-backed securities.
The proposal requires banks with interest-rate exposure above "normal" levels to add capital.
"Normal" levels are based on supervisory considerations and the industry practices. The plan assumes that current capital standards that measure the riskiness of assets cover normal levels of interest-rate risk.
The agency said on-site reviews could lead to higher assessments for interest-rate risk than the quantitative measure.
A bank's interest rate exposure would be determined by applying a simplified duration-based measure of risk to a standard maturity gap report. It would approximate the change in net economic value of the institution arising from a one-percentage-point change in interest rates.
Modified duration measures the sensitivity of the present value of a financial instrument to changes in market rates. The greater the duration of the instrument, the more sensitive is its value to changes in market rates.
Six Levels of Maturity
Banks would report their assets, liabilities, and off-balance positions to the Fed on a form that showed six maturity levels, ranging from three months or less to 15 years or greater.
The positions reported in each maturity range would be multiplied by an interest-rate risk weight that represents the interest-rate sensitivity of the positions.
The weights would be established by the banking agencies and would be based on the modified duration of instruments with maturities, cash flows, coupons, and yields that are assumed to be representative of the positions being weighted.
"This is a very complicated issue," said Paul Smith, administrative counsel with the American Bankers Association. "There are some real judgments that have to be made."
Mr. Smith said that one of the challenges facing the Fed is to measure the rate sensitivity of core deposits.
"The question is, Is there a hell of a lot of difference of giving it [a deposit] a two years or a value of seven years?" he said.