IV. Minimum Supervisory Ratios and Standards

The interim and final supervisory standards set forth below specify minimum supervisory ratios based primarily on broad credit-risk considerations. As noted above, the risk-based ratio does not take explicit account of the quality of individual asset portfolios or the range of other types of risks to which banking organizations may be exposed, such as interest-rate, liquidity, market, or operational risks. For this reason, banking organizations are generally expected to operate with capital positions well above the minimum ratios.

Institutions with high or inordinate levels of risk are expected to operate well above minimum capital standards. Banking organizations experiencing or anticipating significant growth are also expected to maintain capital, including tangible capital positions, well above the minimum levels. For example, most such organizations generally have operated at capital levels ranging from 100 to 200 basis points above the stated minimums. Higher capital ratios could be required if warranted by the particular circumstances or risk profiles of individual banking organizations. In all cases, organizations should hold capital commensurate with the level and nature of all of the risks, including the volume and severity of problem loans, to which they are exposed.

Upon adoption of the risk-based framework, any organization that does not meet the interim or final supervisory ratios, or whose capital is otherwise considered inadequate, is expected to develop and implement a plan acceptable to the Federal Reserve for achieving an adequate level of capital consistent with the provisions of these guidelines or with the special circumstances affecting the individual organization. In addition, such organizations should avoid any actions, including increased risk-taking or unwarranted expansion, that would lower or further erode their capital positions.

As reflected in attachment VI, by year-end 1992, all bank holding companies⁶⁴ should meet a minimum ratio of qualifying total capital to weighted-risk assets of 8 percent, of which at least 4.0 percentage points should be in the form of tier 1 capital. For purposes of section IV.A., tier 1 capital is defined as the sum of core capital elements less goodwill and other intangible assets required to be deducted in accordance with section II.B.1.b. of this appendix. The maximum amount of supplementary capital elements that qualifies as tier 2 capital is limited to 100 percent of tier 1 capital. In addition, the combined maxi-mum amount of subordinated debt and intermediate-term preferred stock that qualifies as tier 2 capital is limited to 50 percent of tier 1 capital. The maximum amount of the allowance for loan and lease losses that qualifies as tier 2 capital is limited to 1.25 percent of gross weighted-risk assets. Allowances for loan and lease losses in excess of this limit may, of course, be maintained, but would not be included in an organization’s total capital. The Federal Reserve will continue to require bank holding companies to maintain reserves at levels fully sufficient to cover losses inherent in their loan portfolios.

Qualifying total capital is calculated by adding tier 1 capital and tier 2 capital (limited to 100 percent of tier 1 capital) and then deducting from this sum certain investments in banking or finance subsidiaries that are not consolidated for accounting or supervisory purposes, reciprocal holdings of banking organizations’ capital securities, or other items at the direction of the Federal Reserve. The conditions under which these deductions are to be made and the procedures for making the deductions are discussed above in section II(B).

The transition period for implementing the risk-based capital standard ends on December 31, 1992. Initially, the risk-based capital guidelines do not establish a minimum level of capital. However, by year-end 1990, banking organizations are expected to meet a minimum interim target ratio for qualifying total capital to weighted-risk assets of 7.25 percent, at least one-half of which should be in the form of tier 1 capital. For purposes of meeting the 1990 interim target, the amount of loan-loss reserves that may be included in capital is limited to 1.5 percent of weighted-risk assets and up to 10 percent of an organization’s tier 1 capital may consist of supplementary capital elements. Thus, the 7.25 percent interim target ratio implies a minimum ratio of tier 1 capital to weighted-risk assets of 3.6 percent (one-half of 7.25) and a minimum ratio of core capital elements to weighted-risk assets ratio of 3.25 percent (nine-tenths of the tier 1 capital ratio).

Through year-end 1990, banking organizations have the option of complying with the minimum 7.25 percent year-end 1990 risk-based capital standard, in lieu of the minimum 5.5 percent primary and 6 percent total capital to total assets ratios set forth in appendix B of this part. In addition, as more fully set forth in appendix D to this part, banking organizations are expected to maintain a minimum ratio or tier 1 capital to total assets during this transition period.