TO THE OFFICER IN CHARGE OF SUPERVISION AT EACH FEDERAL RESERVE BANK
Questions have arisen as to the treatment of loan loss
reserves in uninsured U.S. branches and agencies1 of foreign
banking organizations ("FBOs") under the new Supervisory Program
for the U.S. Operations of FBOs ("the Program"). For U.S. banks,
the bank regulatory agencies have long recognized that an allowance
for loan and lease losses ("loan loss reserve") is only meaningful
for the bank as a whole and not on a branch by branch basis.
Accordingly, U.S. banks are not required by U.S. regulatory
authorities to establish separate loan loss reserves on the books
of either foreign or domestic branches. If foreign branches of
U.S. banks establish such reserves either voluntarily or to meet
local requirements, such "reserves" are merely reported as part of
the U.S. branch's "due to/due from" accounts in the foreign branch call
report (FFIEC 030). While the Call Report filed by U.S. branches
and agencies of FBOs (FFIEC 002) contains a line item to
accommodate reporting of any loan loss reserves maintained
voluntarily by a U.S. branch, there is no requirement in the report
to establish such reserves. Moreover, like the FFIEC 030, the
FFIEC 002 treats "reserves" as a segregation of a U.S. branch's
"due to/due from" accounts, which is consistent with their
function.
Nonetheless, in some cases, the establishment of loan
loss reserves in U.S. branches previously has been recommended in
the examination and supervision process in an attempt to address
specific concerns about particular U.S. branches of FBOs.
Generally, these situations have involved three types of problems:
(1) there are concerns about the ability of the FBO to support the
U.S. branch; (2) the U.S. branch does not have effective procedures
for identifying and resolving problem credits; and (3) the U.S.
branch may not have accurately reflected its true economic return
to the FBO as a whole and, by extension, to the FBO's supervisory
authority.
The Program, as well as the new "ROCA" rating system,
deals with these concerns explicitly and directly, rather than
indirectly through a requirement for loan loss reserves in U.S.
branches. Under the Program, each FBO will be analyzed with regard
to the degree of reliance that can be placed on the FBO's ability
to provide sufficient funds to ensure that its U.S. branches fully
honor their contractual obligations. Where there is any
significant level of uncertainty in this regard, the U.S. branches
of such an FBO either will have their net "due to/due from"
position closely monitored or will be placed under asset
maintenance. For each U.S. branch of such an FBO, all assets that
have been classified or categorized as "special mention" or "other
transfer risk problems" will be wholly or partially deducted from
third party assets in assessing the appropriate level of the
U.S. branch's net "due to/due from" position.
Under the ROCA rating system for U.S. branches and
agencies of FBOs, the "R" component specifically addresses the
extent to which a U.S. branch has an effective risk management
system. Such a system would be expected to have adequate
procedures to identify and resolve problem credits and to ensure
that problem credits are fully reported to senior management at the
head office. Where such procedures are deficient, the U.S. branch
will be subject to supervisory action to correct the deficiencies.
Similarly, the "R" component will evaluate the extent to which
management analyzes the effect of problem credits on the current
and future income of the U.S. branch and reports this information
to its head office. Any issues relating to this point will be
stated in the Report of Examination of the U.S. branch, a copy of
which will be sent to its head office.
It is stressed that U.S. branches must have adequate
procedures for identifying losses in their loan portfolio. On the
FFIEC 002 report, individual loans and similar assets must be
reported net of identified losses. To ensure proper reporting on
the FFIEC 002, a U.S. branch must have a well-defined methodology for
adjusting the original book value of such loans through either a
"charge off" or a "specific reserve." Both of these methods yield
the same result for purposes of reporting to the Federal Reserve.
Federal Reserve examination policies concerning loans that are
partially or wholly charged off2 will apply in an identical manner
to a loan that has been written down through the application of a
specific reserve on the FFIEC 002. However, the original book
value of a loan should only be reduced on the FFIEC 002 when
management has identified a specific loss amount. Where no
specific loss amount has been identified, the loan should continue
to be reported at original book value, and any general or earmarked
reserves that the U.S. branch chooses to establish should be reported as
a segregation of a portion of its due to related depository
institutions accounts. Furthermore, as with other problem assets,
the U.S. branch must have a system for reporting all identified losses
to its head office and for assessing the impact of these losses on
the overall operations of the U.S. branch. Where adjustments are made
between the FFIEC reports and reports filed with the head office,
these adjustments and their implications should be fully documented
in the U.S. branch's reporting systems with its head office.
Finally, it is recognized that accounting and regulatory
systems in different countries have developed varying mechanisms
for recognizing the effect of problem assets (including amounts
viewed as loss) on current income and capital of a bank. Where
losses or other asset quality problems identified in U.S. branches
are significant in relation to the FBO on a consolidated basis,
this fact will be taken into consideration in the evaluation and
strength-of-support assessment of the FBO.
In view of the above and consistent with the treatment of
domestic and foreign branches of U.S. banks, no allowance for loan
losses will be required to be maintained for Federal Reserve
supervisory purposes at U.S. branches and agencies of FBOs.
However, it is recognized that the licensing or insuring
authorities for U.S. branches of FBOs may require such reserves at
the U.S. branches under their respective jurisdictions to fulfill
the requirements of their individual licensing or insurance
statutes, or to satisfy other specific concerns of the authority.
All uninsured U.S. branches and agencies should be informed of
this policy statement. The following transmittal letter is
suggested for distributing the SR letter.
Please direct any questions regarding this policy
statement to Michael G. Martinson (202/452-3640), Elizabeth H.
Roberts (202/452-3846), or Patricia G. Soriano (202/728-5878).
Associate Director
ATTACHMENTS TRANSMITTED ELECTRONICALLY BELOW
[Suggested letter to the general manager of each uninsured U.S. branch
or agency of an FBO in your district]
Subject: Allowance for Loan and Lease Losses for U.S. Branches and
Agencies of Foreign Banking Organizations
Questions have arisen as to the treatment of loan loss
reserves in uninsured U.S. branches and agencies3 of foreign
banking organizations ("FBOs") under the new Supervisory Program
for the U.S. Operations of FBOs ("the Program"). For U.S. banks,
the bank regulatory agencies have long recognized that an allowance
for loan and lease losses ("loan loss reserve") is only meaningful
for the bank as a whole and not on a branch by branch basis.
Accordingly, U.S. banks are not required by U.S. regulatory
authorities to establish separate loan loss reserves on the books
of either foreign or domestic branches. If foreign branches of
U.S. banks establish such reserves either voluntarily or to meet
local requirements, such "reserves" are reported as part of the
branch's "due to/due from" accounts in the foreign branch call
report (FFIEC 030). While the Call Report filed by U.S. branches
and agencies of FBOs (FFIEC 002) contains a line item to
accommodate reporting of any loan loss reserves maintained
voluntarily by a U.S. branch, there is no requirement in the report
to establish such reserves. Moreover, like the FFIEC 030, the
FFIEC 002 treats "reserves" as a segregation of a U.S. branch's
"due to/due from" accounts, which is consistent with their
function.
Nonetheless, in some cases, the establishment of loan
loss reserves in U.S. branches previously was recommended in the
examination and supervision process in an attempt to address
specific concerns about particular U.S. branches of FBOs.
Generally, these situations have involved three types of problems:
(1) there are concerns about the ability of the FBO to support the
U.S. branch; (2) the U.S. branch does not have effective procedures
for identifying and resolving problem credits; and (3) the U.S.
branch may not have accurately reflected its true economic return
to the FBO as a whole and, by extension, to the FBO's supervisory
authority.
The Program, as well as the new "ROCA" rating system,
will deal with these concerns explicitly and directly, rather than
indirectly through a requirement for loan loss reserves in U.S.
branches. Under the Program, each FBO will be analyzed, in part,
with regard to the degree of reliance that can be placed on the
FBO's ability to provide sufficient funds to ensure that its U.S.
branches fully honor their contractual obligations. Where there is
any significant level of uncertainty in this regard, the U.S.
branches of such an FBO either will have their net "due to/due
from" position closely monitored or will be placed under asset
maintenance. For each U.S. branch of such an FBO, all assets that
have been classified or categorized as "special mention" or "other
transfer risk problems" will be wholly or partially deducted from
third party assets in assessing the appropriate level of the
U.S. branch's net "due to/due from" position.
Under the ROCA rating system for U.S. branches and
agencies of FBOs, the "R" component specifically addresses the
extent to which a U.S. branch has an effective risk management
system. Such a system would be expected to have adequate
procedures to identify and resolve problem credits and to ensure
that problem credits are fully reported to senior management at the
head office. Where such procedures are deficient, the U.S. branch
will be subject to supervisory action to correct the deficiencies.
Similarly, the "R" component will evaluate the extent to which
management analyzes the effect of problem credits on the current
and future income of the U.S. branch and reports this information
to its head office. Any issues relating to this point will be
stated in the Report of Examination of the U.S. branch, a copy of
which will be sent to its head office.
It is stressed that U.S. branches must have adequate
procedures for identifying losses in their loan portfolio. On the
FFIEC 002 report, individual loans and similar assets must be
reported net of identified losses. To ensure proper reporting on
the FFIEC 002, a U.S. branch must have a well-defined methodology for
adjusting the original book value of such loans through either a
"charge off" or a "specific reserve." Both of these methods yield
the same result for purposes of reporting to the Federal Reserve.
Further, the Federal Reserve treats loans that have been written
down through the application of a specific reserve on the FFIEC 002
similar to loans that are partially or wholly charged off.
However, the original book value of a loan should only be reduced
on the FFIEC 002 when management has identified a specific loss
amount. Where no specific loss amount has been identified, the
loan should continue to be reported at original book value, and any
general or earmarked reserves that the U.S. branch chooses to establish
should be reported as a segregation of a portion of its due to
related depository institutions accounts. Furthermore, as with
other problem assets, the U.S. branch must have a system for reporting
all identified losses to its head office and for assessing the
impact of these losses on the overall operations of the U.S. branch.
Where adjustments are made between the FFIEC reports and reports
filed with the head office, these adjustments and their
implications should be fully documented in the U.S. branch's reporting
systems with its head office.
Finally, it is recognized that accounting and regulatory
systems in different countries have developed varying mechanisms
for recognizing the effect of problem assets (including amounts
viewed as loss) on current income and capital of a bank. Where
losses or other asset quality problems identified in U.S. branches
are significant in relation to the FBO on a consolidated basis,
this fact will be taken into consideration in the evaluation and
strength-of-support assessment of the FBO.
In view of the above and consistent with the treatment of
domestic and foreign branches of U.S. banks, no allowance for loan
losses will be required to be maintained for Federal Reserve
supervisory purposes at U.S. branches and agencies of FBOs.
However, it is recognized that the licensing or insuring
authorities for U.S. branches of FBOs may require such reserves at
the U.S. branches under their respective jurisdictions to fulfill
the requirements of their individual licensing or insurance
statutes, or to satisfy other specific concerns of the authority.
Should you or your staff have any questions regarding
this matter, please contact ______________________ at this Reserve
Bank.
Footnotes 1. Collectively referred to as "branches". Return to text 2. See SR 91-18, Classification Guidelines For An Asset When A Substantial Portion Has Been Charged Off. Return to text 3. Collectively referred to as "branches". Return to text |
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