WASHINGTON -- The Federal Reserve Board on Friday adopted rules for limiting interbank credit risk that were substantially more flexible than originally proposed.

The new rules, which will be phased in over a two-year period starting next May, requires banks to develop written policies for controlling credit exposure to other banks. They also set caps on banks' exposure to financially troubled institutions.

|A Concerted Effort'

But the Fed adopted a much narrower definition of banks that are weak enough to require credit caps than what was initially proposed in a draft released in July. In so doing, the Fed Basically followed advice contained in many of the more than 300 comment letters filed on the proposal.

"It appears that the Fed made a concerted effort to limit some of the more onerous pieces of the proposal in order to make it more palatable" to banks, said Diane Casey, executive director of the Independent Bankers Association of America, Washington.

The new Regulation F was developed to comply with Section 203 of the FDIC Improvement Act of 1991, in which Congress asked the Fed to "limit the risk that the failure of a large depository institution would pose" to other federally insured institutions.

The rules aim to prevent problems at a troubled bank from infecting other banks and destabilizing the entire banking system.

Documentation Required

Under the new rules, starting on June 19, 1993, banks must document internal policies and procedures for monitoring credit exposure to other banks.

When exposure is exceptionally large or volatile, or when a correspondent bank is particularly weak, banks are required to follow more stringent monitoring.

The following year, banks will be required to limit to 50% of total capital their exposure to institutions that are deemed to be undercapitalized. Starting on June 19, 1995, banks will be required to decrease this exposure to no more than 25% of total capital.

Undercapitalized banks are defined as those that fall below a total risk-based capital ratio of 8%, a Tier 1 risk-based capital ratio of 4%, and a leverage ratio of 4%.

Monkey Wrench Feared

The original proposal required banks to limit their exposure to both adequately capitalized institutions and undercapitalized institutions, with only well-capitalized banks being exempted.

Critics argued that this requirement would have thrown a monkey wrench into the correspondent banking business. Small institutions often keep a large portion of their capital in correspondent banks that handle check collection and payment services for them.

Since many correspondent banks are close to, or fall within, the definition of "adequately capitalized," many observers said small banks would have simply moved their check clearing operations to the Fed to avoid the regulatory hassle of monitoring the correspondent bank's financial health, and their own credit exposure.

But now, since the credit limits apply only to undercapitalized institutions, the disruption to the correspondent banking business is expected to be nominal.

Bankers Split on Rule

"I think it will only affect the margins," said Philip Corwin, director of operations and retail banking for the American Bankers Association.

Bankers were split on the wisdom of the adopted rule. Some observers said the Fed did the best it could, given the Congressional mandate to act. Others complained that the new rules aren't needed since the industry is doing a good job of policing itself.

"I think that the whole regulation is unwarranted, unnecessary, and a perfect example of how banks are being micromanaged by the government," said Gayle M. Earls, president and chief executive of the Texas Independent Bank in Dallas.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.