Seal of the Board of Governors of the Federal Reserve System
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM

WASHINGTON, D. C.  20551

DIVISION OF BANKING
SUPERVISION AND REGULATION


SR 92-37 (FIS)
October 15, 1992

TO THE OFFICER IN CHARGE OF SUPERVISION
          AT EACH FEDERAL RESERVE BANK


SUBJECT: Clarification of August 28, 1992 Interpretation on Subordinated Debt

                        This SR letter is being issued to clarify three points raised by several banking organizations and others with respect to the August 28, 1992 interpretation concerning criteria subordinated debt must meet to be included in risk-based capital.  The interpretation was effective as of September 4, 1992.  A technical amendment to the interpretation will be issued shortly.

Extent of subordination

                        In order to be included in capital, subordinated debt of a bank must be subordinated in right of payment to the claims of all the issuer's general creditors and depositors.  For bank holding companies, such debt must be subordinated to senior indebtedness.  To meet this requirement, bank holding company debt must be subordinated at a minimum to:  (1) all borrowed and purchased money, (2) similar obligations arising from off-balance sheet guarantees and direct credit substitutes, (3) and obligations associated with derivative products such as interest and foreign exchange rate contracts, commodity contracts, and similar arrangements.

Acceleration clauses

                        The interpretation makes clear that subordinated debt included in capital may not contain provisions permitting debtholders to accelerate payment of principal upon the occurrence of any event other than bankruptcy (in the case of a bank holding company) or receivership (in the case of a bank).

                        A provision in bank holding company subordinated debt that permits acceleration in the event a major bank subsidiary enters into receivership would not jeopardize the issue's Tier 2 capital status.  A provision permitting acceleration in the event that any other type of affiliate of the issuer entered into bankruptcy or receivership would not be acceptable in a subordinated debt issue included in capital.

Provisions inconsistent with safe and sound banking practices

                        The interpretation reiterated the principle that in order to qualify as capital, instruments, including subordinated debt, may not contain provisions that are inconsistent with safe and sound banking practice.  As noted in the interpretation, certain terms found in subordinated debt may provide protection to investors without adversely affecting the overall benefits of the instrument to the organization and thus, would be acceptable for subordinated debt included in capital.  Among such acceptable terms would be a provision that prohibits a bank holding company from merging, consolidating, or selling substantially all of its assets unless the new entity assumes the subordinated debt.  Another acceptable provision would be the inclusion as an event of default the failure to pay principal or interest on a timely basis or to make mandatory sinking fund deposits, so long as such event of default does not allow the debtholders to accelerate the repayment of principal.  

                        Should you have any questions, please contact Norah Barger (ext. 2402) or Robert Motyka (ext. 3621).

Stephen C. Schemering
Deputy Director


SR letters | 1992