Proposal Due Soon on Reserving For Risks Retained in Asset Sales

Banking regulators are close to releasing a long-delayed proposal that would lay out how much capital a bank needs when it sells an asset but retains some risk of loss.

The proposal, which the banking agencies have been grappling with for more than five years, would present a mixed bag for banks.

"There will be pluses and minuses for banks," said Susan Krause, senior deputy comptroller for bank supervision policy, during a recent interview.

She predicted that the Federal Financial Institutions Examination Council - the umbrella group for the federal bank, thrift, and credit union agencies - will issue a proposal for public comment this summer.

Under current rules, a bank must continue to hold capital against the full amount of an asset sold with recourse, even if its risk of loss is limited to 10%. The agencies want to bring capital requirements more in line with the risks involved, which would free up capital to fund more bank lending.

Determining exactly what percentage of capital a bank must hold when selling off assets has been the major cause of the proposal's delay. In some recourse arrangements, a bank will hold a certain level of capital against a pool of loans it sells. But when different pieces of that pool are securitized and sold to different buyers, figuring out the bank's loss position - and subsequently how much capital it must retain - becomes a headache, Ms. Krause said.

"The hardest issue is these multilevel securitizations, because the entity that packages the pools often carves off different tranches for buyers with different appetites for risk," Ms. Krause said.

The bad news for banks, however, is the plan will require more capital in recourse arrangements involving letters of credit, warranties, and other "direct credit substitutes." These instruments already require less than 100% capital backing.

"These are some positions ... where banks do not now have to hold as much recourse as they might have to under the new rules," Ms. Krause said.

A regulation adopted by the banking agencies early last year allowed banks to hold less capital for assets sold with "low-level" recourse. A low-level deal limits a bank's loss to something less than 8% - or the minimum risk-based capital requirement for most loans. The 1995 rule allows banks to hold capital reserves equal to the amount of the recourse.

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