Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the act) requires each federal agency to review its regulations and identify (1) any regulation that requires the use of an assessment of the creditworthiness of a security or money market instrument and (2) any references to or requirements in such regulations regarding credit ratings. Each agency must carry out the review no later than one year after the date of the enactment of the act. 1 The act further requires each federal agency to transmit a report to Congress upon the conclusion of the review. 2 Finally, section 939A directs each federal agency to modify the regulations identified in the review by removing all references to or requirements of reliance on credit ratings and substituting alternative standards of creditworthiness. In establishing such alternative standards, an agency must, to the extent feasible, establish uniform standards, taking into account the entities it regulates and the purposes for which such entities would rely on the alternative standards of creditworthiness. 3
Pursuant to section 939A of the act, the Board has completed the review of its regulations and has identified 46 references to or requirements regarding credit ratings. The majority of references to credit ratings in the Board’s rules appear in its capital adequacy guidelines for state member banks and bank holding companies (capital requirements). 4 Certain Board regulations for state member banks, foreign banking organizations, and bank holding companies also rely on or reference ratings, including Regulation W (transactions between member banks and their affiliates) 5 and Regulation K (international banking operations). 6
Since the act was signed into law, in addition to reviewing the Board’s regulations as required by section 939A, the Board has been working in cooperation with the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC, and together with the Board and OCC, the banking agencies) to develop alternative standards of creditworthiness. In furtherance of this effort, in August 2010, the Board and the banking agencies issued an advance notice of proposed rulemaking requesting public comment on alternative standards of creditworthiness to be used in the risk-based capital rules. In addition, in November 2010, the Board hosted a roundtable discussion with industry experts to generate ideas for complying with section 939A.
The Board anticipates that it will propose amendments to remove references to credit ratings from its capital requirements in conjunction with other expected changes to those requirements, including the implementation of recent international agreements on capital through the Basel Committee on Banking Supervision.
Review of Board Regulations
The Board’s regulations that reference credit ratings are summarized below. A complete list and description of the regulations identified as part of the review is included in the appendix .
The majority of references to credit ratings issued by nationally recognized statistical ratings organizations (NRSROs) that appear in the Board’s regulations are in its capital requirements. 7 For example, the Board’s Risk-Based Measure for state member banks and bank holding companies (general risk-based capital rules) 8 and the Board’s Internal-Ratings-Based and Advanced Measurement Approaches (Basel II advanced approaches capital rules) 9 capital requirements for larger banks generally assign risk weights to securitization exposures based on the external credit ratings of such exposures. Under the general risk-based capital rules, asset-backed securities that are rated by an NRSRO are risk-weighted according to the level of the external ratings. 10 For instance, an asset-backed security that has a long-term rating in the highest or second-highest investment grade, such as AAA or AA, receives a 20-percent risk weight; an asset-backed security that has a long-term rating one category below investment grade, such as BB, receives a 200-percent risk weight.
Other uses of NRSRO credit ratings in the Board’s capital requirements include: (1) assignment of risk weights under the general risk-based capital rules for claims on certain securities firms; 11 (2) assignment of standardized capital charges for certain exposures under the market risk rule; 12 and (3) special methodologies for determining risk weights for guarantees and collateral under the Basel II advanced approaches capital rules. 13
Other References to Credit Ratings in Board Regulations
The Board’s Regulation H, 14 which establishes various supervisory requirements for state member banks, references credit ratings in several contexts. For example, Regulation H imposes certain limits on ownership by state member banks of financial subsidiaries based on the bank’s long-term unsecured debt rating by an NRSRO. 15 This reference is based on provisions of the Gramm-Leach-Bliley Act, which were modified by the act to remove references to ratings. 16 In addition, Regulation H references credit ratings in specifying the disclosures a member bank must make when conducting securities transactions for its customers. Regulation H requires a member bank that effects a debt securities transaction for a customer to notify the customer in writing that the security is unrated by an NRSRO, if that is the case. 17