Deposit Insurance Assessment System: The FDIC Issues a Final Rule Regarding Changes to the Ratios and Ratio Thresholds to Align the Deposit Insurance Assessment System With U.S. Basel III Capital Rules

Sullivan & Cromwell LLP - November 24, 2014

On November 18, 2014, the Federal Deposit Insurance Corporation (the “FDIC”) published a final rule (the “Final Rule”) modifying certain elements of its deposit insurance assessment system for insured depository institutions (“IDIs”).  The Final Rule amends the FDIC’s 2011 revised methodology for determining insurance assessment rates both for large institutions and for highly complex institutions (the “2011 Assessments Rule”)—the so-called “scorecard” method that is currently used to calculate assessment rates for these institutions.  The Final Rule indicates that it is intended to align the deposit insurance assessment system for all IDIs—including advanced approaches banking organizations—with the standardized approach (the “Standardized Approach”) under the new U.S. Basel III-based revised capital rules (the “U.S. Basel III Capital Rules”), which were adopted by the Federal banking agencies in 2013.

The scorecards for both large and highly complex institutions introduced in the 2011 Assessments Rule use quantitative measures in attempting to predict a large institution’s long-term performance.  The scorecard for highly complex institutions, however, includes additional measures, such as (i) the ratio of top 20 counterparty exposures to Tier 1 capital and reserves and (ii) the ratio of the largest counterparty exposure to Tier 1 capital and reserves.  The methodology used to calculate exposure is the sum of exposure at default associated with derivatives trading and securities financing transactions (“SFTs”) and the gross lending exposure for each counterparty or borrower.
Although the Final Rule largely adopts the FDIC’s rule as originally proposed (the “Proposed Rule”), the Final Rule includes the following modifications in response to comments received by the FDIC:

  • Allows highly complex institutions to reduce their scorecard counterparty exposure amount associated with derivative transactions by the amount of cash collateral that is all or part of variation margin that satisfies the same conditions that would allow such collateral to be excluded from the institution’s total leverage exposure for purposes of the U.S. supplementary leverage ratio.  This calculation, however, differs from the applicable methodology in the Standardized Approach, which permits other types of collateral to reduce an institution’s derivative counterparty exposure.
  • Provides that any changes to the conversion of the counterparty exposure measures to scores (that is, recalibration of the minimum and maximum cut-off values) will be done through a future notice-and-comment rulemaking. The minimum and maximum cut-off values are used to scale the exposure measures across highly complex institutions so that an institution’s score is determined relative to other highly complex institutions.  The FDIC adjusts the minimum and maximum cut-off values as it collects additional data that affect what the cut-off values should be.  For example, as exposures to central counterparties (“CCPs”) increase, the existing cut-off values, which were established before clearing mandates came into effect, may need to be adjusted.  The FDIC continues to reserve the general right to update the minimum and maximum cut-off values for all other measures in the scorecards without additional notice-and-comment rulemaking.
  • Allows custodial banks to continue to deduct from their assessment base certain securitization exposures that have a risk weight of 20% under the Standardized Approach. The Proposed Rule would not have permitted custodial banks to deduct any assets that qualify as securitization exposures from the assessment base. 
The Final Rule largely rejects the comments received, in particular with respect to better aligning the proposal with actual economic risk, and thereby continues to shift the burden of deposit premium assessments to the largest banks.  In particular, the Final Rule continues to require exposures to non-U.S. sovereigns, affiliates and CCPs, including default fund contributions to CCPs, to be included as counterparty exposures.  In addition, the Final Rule, consistent with the Proposed Rule, eliminates the internal model method (“IMM”) option for measuring counterparty exposure.  The rejection of the previously adopted more risk sensitive IMM for these purposes, even when the models involved would require regulatory approvals, underscores the growing skepticism of some in the regulatory community of models-based approaches.

Except as noted above, the Final Rule is consistent with the Proposed Rule.  Specifically, the Final Rule revises the ratios and ratio thresholds for “well-capitalized,” “adequately capitalized,” and “undercapitalized” evaluation categories used in the FDIC’s risk-based deposit insurance assessment system to conform to the prompt corrective action (“PCA”) capital ratio thresholds adopted by the Federal banking agencies as part of the U.S. Basel III Capital Rules.  Additionally, the Final Rule expands the category of liquid assets that a custodial bank may deduct from its total average consolidated assets at 50% to include those assets with a Standardized Approach risk weight greater than 0% and up to and including 20%, in order to include cleared transactions with Qualified Central Counterparties, which carry 2% or 4% risk weights.  Custodial banks may continue to deduct 100% of liquid assets with a Standardized Approach risk weight of 0%.
The Final Rules will be effective on January 1, 2015, except with respect to the supplementary leverage ratio equivalent PCA requirement, which does not become effective until January 1, 2018, the effective date under the U.S. Basel III Capital Rules.