FEDERAL RESERVE SYSTEM

12 CFR Part 211

[Regulation K; Docket No. RÄ0820]

Charging for Examinations of U.S. Branches, Agencies, and Representative
Offices of Foreign Banks

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Notice of proposed rulemaking.

SUMMARY: The Board of Governors of the Federal Reserve System (Board) is
seeking public comment on a proposal to amend its regulations relating to the
activities of foreign banking organizations in the United States to implement
provisions of the Foreign Bank Supervision Enhancement Act of 1991 (FBSEA)
requiring the Board to charge foreign banks for the cost of examinations of
their branches, agencies, and representative offices in the United States
(collectively, "U.S. Offices''). Under the proposal, the amount charged for
examinations would be determined by multiplying examiner hours by an hourly
rate. For branches and agencies, the Board proposes that the number of
examiner hours would be determined by applying a formula based on the branch's
or agency's characteristics. Comment is also sought regarding the use of
actual recorded examiner hours for this purpose. For representative offices,
the Board proposes that actual recorded examiner hours would be used.

DATES: Comments should be submitted on or before April 20, 1994.

ADDRESSES: Comments, which should refer to Docket No. RÄ0820, may be mailed to
the Board of Governors of the Federal Reserve System, 20th & C Street, NW.,
Washington, DC 20551, to the attention of Mr. William W. Wiles, Secretary.
Comments addressed to the attention of Mr. Wiles may be delivered to the
Board's mail room between 8:45 a.m. and 5:15 p.m., and to the security control
room outside those hours. Both the mail room and the security control room are
accessible from the courtyard entrance on 20th Street between Constitution
Avenue and C Street, NW. Comments may be inspected in room MPÄ500 between 9
a.m. and 5 p.m. weekdays, except as provided in  261.8 of the Board's Rules
Regarding Availability of Information, 12 CFR 261.8.

FOR FURTHER INFORMATION CONTACT:

Michael G. Martinson, Assistant Director (202/452Ä3640), or Michael D.
O'Connor, Supervisory Financial Analyst (202/452Ä3808), Division of Banking
Supervision and Regulation; or Kathleen M. O'Day, Associate General Counsel
(202/452Ä3786), Sandy Richardson, Senior Attorney (202/452Ä6406), or Paul
Vogel, Attorney (202/452Ä3428), Legal Division; or Sally M. Davies, Economist
(202/452Ä2908), Division of Research and Statistics; Board of Governors of the
Federal Reserve System. For the hearing impaired only, Telecommunications
Device for the Deaf (TDD), contact Dorthea Thompson (202/452Ä3544), Board of
Governors of the Federal Reserve System, 20th & C Street, NW., Washington, DC
20551.

SUPPLEMENTARY INFORMATION: The FBSEA generally mandated a strengthened
supervisory framework and an expanded examination program for U.S. Offices of
foreign banks. Public Law 102Ä242, title II, subtitle A, Dec. 19, 1991, 105
Stat. 2286. The FBSEA also provides that the cost of examinations of U.S.
Offices shall be assessed against and collected from the foreign bank or its
parent. 12 U.S.C. 3105(c)(1)(D), 3107(c). Assessing for the cost of
examinations requires consideration of various methodologies and sources of
information for determining the appropriate costs of an examination, including
consideration of the number and experience of the examiners involved. In this
regard, in order to assure compliance with the annual examination provision of
the FBSEA, the Federal Reserve was required to hire and train large numbers of
new examiners during the implementation period. The Federal Reserve has now
reached a point where the examination program is substantially implemented and
is in a position to promulgate a methodology to assess for the cost of
examinations.

The purpose of this notice of proposed rulemaking is to seek public comment
regarding the methods developed by the Board for assessing the cost of
examinations against foreign banks. The Board also seeks comment regarding
whether implementation of the FBSEA provision requiring the assessment of
examination costs against foreign banks is consistent with the policy of
national treatment established in the International Banking Act of 1978. 12
U.S.C. 3101 et seq.

Method of Assessment

The Board considered various methods of allocating the costs of examination to
foreign banks in order to assess them for the cost of examining their U.S.
Offices. The most straightforward approach would be to refer to the time spent
by examiners in conducting examinations of these Offices ("examiner hours''),
to derive a per hour rate for their time, and to assess a given foreign bank
for its allocable share of the total cost.

Examiner Hours

The Board considers that examiner hours are the fundamental and most clearly
observable indicator of Federal Reserve System resources used in examinations.
Examiners' salaries and benefits are the largest component of the costs of
examination. Examiner hours also appear to be an appropriate and reasonable
basis upon which to allocate the other costs associated with examinations to
individual institutions. These costs include, but are not limited to, the cost
of equipment, clerical support, materials, and management review of the draft
examination report. The Board, therefore, proposes use of examiner hours both
for purposes of deriving a per hour charge and assigning examination costs to
particular banks. The Board proposes use of standard examiner hours, as
described below, for assessing branches and agencies for the cost of
examination generally and use of actual examiner hours for assessing
representative offices for such costs. The Board also seeks comment regarding
the use of actual examiner hours for purposes of assessing branches and
agencies for the cost of examination.

Branches and Agencies

The Board seeks comment on two alternative methods of assigning costs of
examination to individual branches and agencies: (1) Developing a formula
based upon experience to derive the standard number of examiner hours
necessary to examine U.S. branches and agencies of foreign banks of given
profiles and with given characteristics ("standard hours''); or (2) using the
actual number of hours that examiners spend in conducting examinations
("actual hours''). Both of these approaches would relate a bank's examination
charges to the amount of Federal Reserve resources expended on examination of
its U.S. Offices. As discussed below, the Board recognizes that there may be
advantages associated with each method. For the reasons discussed below,
however, the Board proposes to use the standard hours method to calculate the
examination charges to be assessed against U.S. branches and agencies of
foreign banks. The Board also encourages commenters to provide their views
regarding use of actual hours to calculate the examination charges. Each of
these methods is described below, together with the Board's assessment of the
relative merits of each.

Actual Hours

The Federal Reserve maintains records regarding the actual hours examiners
spend on particular examinations. Actual hours, therefore, could be used to
determine foreign banks' examination charges.

The Board is concerned with the use of actual hours for this purpose, however,
because there are numerous factors that can cause variability in the amount of
time spent examining U.S. Offices of foreign banks, even among offices having
similar profiles. Such variability may result from supervisory judgments
regarding matters requiring further enquiry. Decisions to make an intensive
investigation of certain areas or activities, for example, will increase the
number of examiner hours, even though the further enquiry may often serve to
alleviate rather than to confirm supervisory concerns. Administrative
decisions regarding the composition of the examination team also may affect
examiner hours. For example, the number of examiner hours may increase or
decrease depending upon the overall level of experience of examiners assigned
to the team. Decisions to provide new examiners with on-the-job training also
can increase significantly the total number of hours spent on an examination.

For these reasons, the Board is concerned that charges based on actual hours
might create an atmosphere in which disagreements over the composition of
examiner teams or the amount of time spent on the examination would divert
attention from critical supervisory issues raised in the course of the
examination. The Board also does not wish to compromise the examination
process by adding to pressures from the examined entities on examiners not to
take the time necessary to conduct a thorough examination of a particular
institution.

The Board, therefore, does not propose use of actual hours generally to
calculate charges for examinations of branches and agencies. The Board,
however, is interested in receiving comment on the use of actual examiner
hours for this purpose, including whether actual costs per hour (based upon
actual salaries, benefits and other expenses), rather than the standard rate
per hour proposed below, should be used in conjunction with actual hours to
derive the examination charge. In this regard, the Board is concerned that a
system of cost assessment based upon actual hours and actual costs per hour
may be inefficient, given the added costs that would be associated with
establishing, maintaining and administering such a system. Comment is sought
regarding these matters.

Standard Hours

The Board's preferred method of determining the examination charge to be
assessed against a foreign bank for its U.S. branches and agencies is to
develop a formula, based upon experience, that would calculate a standard
number of examiner hours required to examine these offices of given profiles
and with given characteristics. Use of the standard hours method would offer
the advantage of decreasing the variability of examination charges levied
against offices with similar profiles, while increasing the predictability of
examination costs for an individual office. In particular, random variations
in charges that arise from differences in examiner experience or the other
factors discussed above would not be reflected in the charges assessed against
foreign banks for their individual branches and agencies in a given year. The
Board believes that assessments based on standard hours would be less costly
to administer and less likely to lead to billing disputes than would charges
based on actual hours.

A number of other U.S. bank regulators use standardized assessments to charge
banking institutions for examination and supervisory costs. Generally, such
assessments are related to the size of the banking institution. It has been
the Federal Reserve's experience, however, that the cost of examining any
given institution will be influenced significantly by characteristics other
than its asset size. In view of the relevant language of the FBSEA, the Board
considers that, to the extent possible, such characteristics should be taken
into account in determining the charges to be assessed against institutions
for their examinations. The Board nevertheless would be interested in
receiving comment regarding whether standardized assessments for the cost of
examination based solely on asset size would be preferable to the
multi-variable methodology described below.

Proposed Methodology

For the reasons discussed above, in proposed  211.26(d), the Board proposes
developing a formula to derive standard hours by using standard statistical
techniques to estimate the number of hours generally required to examine
branches and agencies with similar characteristics. The basic approach would
be to estimate a linear regression of Federal Reserve examiner hours devoted
over a past period to examining various branches and agencies on the
characteristics thought likely to have affected the amount of time necessary
to examine such offices. All characteristics ("variables'') that are thought
potentially to have a material effect on examiner hours would be considered
for this purpose, including total assets, total loans, assets and loans in
offshore "shell'' branches, measures of off-balance sheet activities, problem
loans, the composite rating of assets, internal controls and management ("AIM
rating''), and the individual components of the AIM rating. These types of
variables are key factors that influence the amount of time required to
examine a banking entity.

The data used in the regression analysis would be collected from three sources
examination reports and two types of quarterly reports of condition, the FFIEC
002 and 002s reports. The examination reports would supply
examination-specific data, such as the examination rating and its components
and classified assets. The FFIEC 002 reports provide information regarding the
U.S. operations of foreign banks, such as the dollar amount and composition of
assets and liabilities and information on certain off-balance-sheet
activities. The FFIEC 002s reports contain information on the balance sheets
of off-shore offices of foreign banks that are "managed or controlled'' (as
that phrase is defined in the instructions to the 002s report) by their U.S.
Offices. Data would be collected for the year prior to the year in which the
standard hours, as derived under this methodology, would be applied to
determine a bank's charge. Earlier years' data, if available, may also be used
in the regressions, provided that examiners' practices have not changed
significantly since that time.

Following the specification of various regression models, the variables that
produce the best fit (that is, the characteristics of the branch or agency
that best explain the amount of time necessary to examine the office, which
subsequently will be referred to as the "explanatory variables'') will be
determined. When examiner hours are regressed on these explanatory variables,
a coefficient will be estimated for each of these variables. Each coefficient
when multiplied by its corresponding variable will produce a number of
examiner hours typically attributable to that variable, which then will be
totaled in order to derive the number of standard examiner hours for a
particular branch or agency.

The Board proposes that the model be evaluated annually in light of the data
for the previous year. In order to improve the predictive ability of the
regression, additional variables may be identified and included and variables
previously included may be deleted or modified. Such changes to the variables
may be necessary to allow for interactions between variables or to account for
possible nonlinear relationships between examiner hours and the
characteristics of branches or agencies. In addition, if appropriate, lagged
values of some of the variables may also be included, such as ratings from the
previous examination (in addition to ratings from the current examination). In
determining which variables to include in the model, three criteria will be
considered: (1) How likely it seems that a variable would influence examiner
hours significantly or would be indicative of unmeasured variables that
significantly influence examiner hours; (2) the variable's contribution to the
predictive ability of the model; and (3) how reasonable the estimated
coefficients seem when evaluated against examiner experience.

Application of Proposed Methodology

Using data that were available from the sources described above for 1993,
Board staff specified a number of regression models containing all of the
variables listed above.®1¯  The variables that produced the best fit for these
data were: The dollar amounts of each of total loans, loans administered by
the branch or agency but booked in off-shore branches, off-balance sheet
derivative activities, loans in non-accrual status, and loans past due 90 days
or more; whether the composite AIM rating for the current exam was 3 or worse;
whether the internal controls component ("I rating'') was 3 or worse for that
examination; and whether the I rating for the previous examination was 4 or
worse. Each of the latter two variables were scaled by the amount of total
loans.®2¯ 

®1¯ The data used in the analysis were obtained from the five Federal Reserve
Banks that conduct the vast majority of examinations of branches and agencies
Atlanta, Chicago, Dallas, New York and San Francisco. These data were then
matched with data reported by the branches and agencies in the FFIEC 002 and
FFIEC 002s reports.

®2¯ Variables that were examined but that did not improve the predictive
ability of the regression were total assets, previous composite AIM rating,
individual components of the AIM rating other than internal controls, the
dollar amount of total assets booked in off-shore branches, and off-balance
sheet credit activities.

The regression results for the model that includes these variables are
discussed in further detail in a separate section below. However, statistical
analysis indicates that the relationship between examiner hours and the
explanatory variables is highly significant. The adjusted R-squared statistic
measures the percentage of the total variation of examiner hours explained by
the variables included in the regression, thereby measuring the goodness of
fit of the model. A high adjusted R-squared (close to 1) indicates a good fit.
If all of the explanatory variables listed above are included in the
regression analysis, the adjusted R-squared is 0.85, which indicates that this
method of calculating predicted examiner hours explains 85 percent of the
total variation of examiner hours for examinations of branches and agencies
included in the sample. An adjusted R-squared of 0.85 generally would be
regarded as very good for cross-section data, which these data are (having
been drawn from actual examinations of branches and agencies during the last
year). The remaining 15 percent of the variation in examiner hours that is
unexplained by this model is attributable to characteristics other than the
explanatory variables.

Although the total costs recovered by the Federal Reserve using standard hours
should equal the total costs recovered using actual hours, for some branches
and agencies there may be considerable variation between the standard hours
predicted by the model and the actual hours recorded for examinations.®3¯  The
Board considers that a substantial portion of the unexplained variation
between standard and actual hours is due to omitted supervisory and
administrative factors, such as decisions to explore certain aspects of a
bank's operations in greater detail, the level of experience of various
examination teams, and unavoidable interruptions in the examination process.
In investigating differences between standard and actual hours, the Board
found that use of examinations to train new examiners increased actual
examiner hours significantly. The Board considers that this is a transitory
development resulting from the substantial build-up of staff during the past
year to meet the new FBSEA requirements and expects this factor to be much
less significant in the future. Other exceptional events, such as the bombing
of the World Trade Center, which houses a number of branches and agencies,
also were found to disrupt or prolong the examination process.

®3¯ In 76 percent of the total observations in the model, the predicted cost,
which is calculated based upon standard hours, is within a range of plus or
minus $10,000 of cost calculated based upon actual hours. Ninety-two percent
of the observations are within a range of plus or minus $20,000 and 99 percent
are within a range of plus or minus $30,000. The average predicted examination
cost was $28,000. Fifty percent of the observations had predicted costs based
on standard hours of less than $17,000; 75 percent had predicted costs less
than $32,000; and 90 percent had predicted costs less than $65,000.

The Board also has identified two additional bank-specific factors not taken
into account in the current model that might have an effect on actual examiner
hours. These factors are: (1) The presence in the branch's or agency's
portfolio of participations in large loans that are examined under the Shared
National Credit Program ("shared national credits''); and (2) the number of
loans in a branch's or agency's portfolio. All shared national credits are
reviewed centrally at the offices of the lead banks, which obviates the need
for examiners to analyze these loans during on-site examinations and
consequently reduces the number of actual examiner hours. The number of loans
in a branch's or agency's portfolio (not just the dollar amount of loans) also
may influence the actual number of hours necessary to examine the branch or
agency: The greater the overall number of loans, the more examiner time that
may be required.

Although it is possible that the effects of shared national credits and the
number of loans are indirectly accounted for in the model because the model
allows for economies of scale in examining loans, the Board considers that
these factors merit further consideration with a view to possibly
incorporating them as additional explanatory variables in the model if
sufficient data are available. The Board would appreciate comment on whether
these factors expressly should be incorporated in the model or simply taken
into account indirectly through variables that allow for economies of scale.

Finally, as noted above, the standard hours methodology assigns similar hours
to institutions with similar measured characteristics. However, as also
discussed above, actual hours can vary substantially across institutions with
similar profiles. Thus, the difference between actual and standard hours also
may be due to differences in actual examiner hours for institutions with
similar profiles. When these differences in actual hours are substantial, one
would expect that the variation between actual and standard hours also would
be substantial. Some of these differences in actual hours likely result from
the administrative and supervisory factors discussed above and are smoothed
out by the standard hours methodology, as are any differences resulting from
unmeasured bank characteristics. Any such differences would be examined to
determine possible reasons and adjustments to the model would be as
appropriate.

The Board specifically seeks comment from foreign banks that would be subject
to these examination charges regarding whether they consider the standard
hours approach preferable to establishing the charge based upon the actual
number of hours taken to complete the examination. The Board recognizes that
the standard hours method is based upon complex statistical analysis, but
considers that, once the methodology is implemented, it may be more
straightforward to apply, more cost-effective in nature because new
record-keeping systems would not be required by the Reserve Banks, and more
predictable in its end result. In establishing a system for recovery of
examination costs, the Board is particularly mindful of the additional costs
potentially associated with the implementation, maintenance and administration
of such a cost-assessment system; in the Board's view, such costs should be
kept to a minimum and certainly in proportion to the amounts eligible for
recovery. Comments on these matters are requested.

Specialized Examinations

The Board is mindful that the standard hours methodology described above may
prove to be less appropriate for certain types of examinations conducted by
the Federal Reserve, either because the examinations are of a specialized
nature or because they may be conducted less than annually. Among these types
of specialized examinations are electronic data processing (EDP) examinations,
consumer compliance examinations, and trust examinations. The Board seeks
comment on whether, if feasible, the costs associated with specialized
examinations should be included in the total cost of examination and recovered
on the basis of the standard hours methodology described above or some
variation thereof, or whether these costs should be recovered on the basis of
actual examiner hours.

Representative Offices

While the Board generally favors the standard hours method described above,
the model discussed above is based upon data relating to the examinations of
branches and agencies and would not be appropriate for calculating charges for
examinations of representative offices. Examinations of representative offices
by the Federal Reserve commenced in late 1992. These initial examinations by
Federal Reserve examiners have been, in large part, exploratory, and further
experience with examinations of these offices is necessary before examination
procedures for these offices can be standardized. In these circumstances, the
Board considers that development of a model for representative offices similar
to that described above is not feasible at this time. The Board proposes that,
until further experience with examinations of these offices is gained, actual
examiner hours will be used to assess representative offices for examination
costs.

Identifying the Costs To Be Recovered

Another question considered by the Board in developing this proposal is which
costs constitute the cost of examinations, given that such costs are the costs
to be recovered by the Federal Reserve pursuant to the FBSEA. The Board
considers that only those costs reasonably related to the conduct of
examinations should be considered to be the cost of examinations and assessed
against foreign banks.

The official cost accounting system of the Federal Reserve System is known as
the Planning and Control System (PACS). PACS is used for purposes of
developing budgets for Reserve Banks, accounting for Federal Reserve System
expenses, and determining the cost of its various output services, including
prices for check collection, Fedwire, and automated clearinghouse services.
PACS data, which are available to the public, constitute the sole source of
information on examination costs other than examiners' salaries, benefits, and
travel expenses. Such costs include, e.g., costs related to materials and
supplies, computer equipment and software, data processing, and printing and
duplication.

The Board considers that the fundamental role of PACS in accounting for
Federal Reserve System expenses and its use in setting the prices of the
Federal Reserve's services sold in the market argue for its use as the basis
for determining the appropriate amounts to assess foreign banks for
examinations of their U.S. Offices. As currently structured, however, PACS
does not provide information sufficient to segregate the costs incurred in
conducting examinations of U.S. Offices of foreign banks from other
examination and supervisory costs.

Instead, these costs presently are aggregated in PACS with the cost of
examining the U.S. subsidiaries of foreign banks (e.g., commercial banks, bank
holding companies and their nonbank subsidiaries, and Edge Act corporations)
and with other examination and supervisory costs. It is necessary, therefore,
to revise PACS in order to provide information sufficient to segregate the
costs of examining U.S. Offices from other examination and supervisory costs.

For this reason, the Board has provisionally created for 1993 sub-categories
referred to as "sub-activities'' in order to isolate examination costs
pertaining to U.S. Offices from these other costs. Each Reserve Bank has
reviewed the information reported in PACS for the first quarter of 1993 and
has provided provisional data for the new sub-activities for that quarter, as
well as cost estimates for these sub-activities for the entire year. The
Reserve Banks also have reported total examiner hours spent thus far in 1993
in the examination of U.S. Offices and estimated total examiner hours in this
sub-activity for the year as a whole. Commencing with the first quarter of
1994, the Board proposes to revise the relevant PACS activities in order to
provide information sufficient to isolate the costs of examination of U.S.
Offices of foreign banks from other examination and supervisory costs.

The Board believes that the information provided in the revised PACS
activities will constitute a reliable and appropriate measure of the cost of
examination to be recovered by the Board pursuant to the cost-assessment
provision of the FBSEA. These activities will include both direct and support
costs as these components are defined in PACS.®4¯ 

®4¯ Direct costs are those expenses charged directly to a PACS activity based
on actual resource usage. Examples of direct costs include salaries and
benefits, travel, materials and supplies, equipment, software, shipping and
communications. Support costs are charged to a PACS activity based on that
activity's usage of the support function. Examples of support costs include
data processing, office space, housekeeping and printing and duplication.

The Board considers that certain of the Federal Reserve System's expenses that
under PACS presently are categorized as overhead®5¯  also should be recovered
as additional direct examination costs. Specialist staff, such as lawyers,
accountants or systems experts, that are assigned to examinations because of a
need for their particular expertise would charge their time directly to the
examination activity. The Board also considered whether certain other of the
Reserve Banks' general overhead expenses should be recovered from foreign
banks. The Board concluded that such costs are too remotely related to the
conduct of examinations to include such costs in examination charges assessed
against foreign banks.

®5¯ PACS overhead expenses consist largely of administrative, bank services,
accounting and legal costs.

Table 1 summarizes the direct and support costs of examination for the Federal
Reserve System as a whole for 1993, which have been estimated based upon PACS
data. Table 1 also includes an estimate of the additional specialist costs
associated with examination, which under PACS presently are included in
overhead. This estimate was derived by taking the total PACS cost allocated to
such staff and multiplying it by .0743, which is the approximate proportion of
examination costs for U.S. Offices of foreign banks to the total costs for the
PACS category or "service'' to which examination costs presently are
attributed. Commencing with the first quarter of 1994, PACS will be revised
such that specialist staff used during the course of an examination will
charge their time directly to the examination function rather than generally
to overhead.

c2,L2,i1,s50,11

Table 1. Projected System Costs of Examination of U.S. Offices of Foreign
Banks for 1993

I96[In dollars]

 [col head 1]   [col head 1] Per year

Total PACS Direct Costs	11,023,302

Personnel	10,128,406

Travel	554,621

Other Direct	340,275

Total PACS Support Costs	493,806

Total PACS Direct and Support Costs	11,517,108

Allocated Specialist Costs (derived from PACS overhead data)	202,369
=====

Total Costs	11,719,477

Calculating the Examination Charge

The Board proposes that a particular bank's examination charge would be
calculated as the product of examiner hours (either actual or standard) times
a rate per hour.®6¯  An hourly rate would be derived by dividing the projected
total examination costs for a given period, e.g., a year, by the projected
total hours spent by examiners in conducting such examinations during that
period.

®6¯ The total of all charges for the examination of branches, agencies, and
representative offices collected during a given period should be roughly
equivalent to the Board's aggregate examination costs relating to those
offices for the same period.

Hourly rates based upon projected 1993 total costs and examiner hours are set
out in Table 2.

c2,L2,i1,s50,7

Table 2. Projected System Costs of Examination of U.S. Offices Per Examiner
Hour Estimated 1993 Annual Dollars

 [col head 1]   [col head 1] Hourly rate

Total Direct Costs®1¯ 	45.12

Personnel	40.53

Travel	2.23

Other Direct	1.37

Total Support Costs 	1.98

Total Direct and Support Costs	47.10rd

Total Examiner Hours	248.773

®1¯ For purposes of this Table, the specialist costs separately listed in
Table 1 have been included as additional direct personnel costs, which will be
the approach taken by PACS commencing first quarter 1994 as noted above.

Federal Reserve examination costs vary by Federal Reserve District. The Board
considers, however, that a single national hourly rate, representing average
Federal Reserve System costs, is appropriate for determining banks'
assessments. This is the approach taken by the OCC, the other Federal banking
regulator that assesses banks for its supervisory costs including the cost of
examination. A single national rate would be much simpler and less costly to
administer than would a system of local rates. It also would be consistent
generally with the Board's policy of assuring uniformity of examination
standards and procedures throughout the Federal Reserve System.

Regression Results

The standard hours methodology described above has been applied to data for
143 full-scope U.S. Office examinations that were completed in 1993. Table 3
sets out the definitions of the variables used in the regression. All
variables specified in terms of a dollar amount are expressed in millions of
dollars.

c2,L2,i1,xs72,r200

Table 3. Variable Definitions

 [col head 1] Name  [col head 1] Definition

TOTLOANS 	Total loans of the branch or agency.

TOTXLE1B 	The amount of total loans that is less than or equal to $1 billion.

TOTXGT1B 	The amount of total loans that is greater than $1 billion.

IPOOR 	Indicator variable equal to 1 if the current I rating is 3 or worse,
otherwise equal to zero.

IPOORx TOTXLE1B 	The product of IPOOR and TOTXLE1B; for branches or
agencies with current I of 3 or worse, equal to the amount of total loans that
is less than or equal to $1 billion, otherwise equal to zero.

IPOORx TOTXGT1B 	The product of IPOOR and TOTXGT1B; for branches or
agencies with current I of 3 or worse, equal to the amount of total loans that
is greater than $1 billion, otherwise equal to zero.

PIBAD 	Indicator variable equal to 1 if the previous I rating is 4 or
worse, otherwise equal to zero.

PIBADx TOTLOANS 	The product of PIBAD and TOTLOANS; for branches or
agencies with previous I of 4 or worse, equal to the amount of total loans,
otherwise equal to zero.

AIMPOOR 	Indicator variable equal to 1 if the current AIM rating is 3 or
worse, otherwise equal to zero.

OFFXLE1B 	The amount of loans administered by the branch or agency but booked
off-shore ("off-shore loans'') that is less than or equal to $1 billion.

OFFXGT1B 	The amount of off-shore loans that is greater than $1 billion.

OBSXLE1B 	The amount of the sum of commitments to purchase foreign currency
and U.S. dollar exchange and the notional value of outstanding interest rate
swaps ("off-balance-sheet derivatives'') that is less than or equal to $1
billion.

OBSXGT1B 	The amount of off-balance-sheet derivatives that is greater than $1
billion.

NONACCR 	The amount of loans in non-accrual status.

PASTDUE 	The amount of loans past-due 90 days or more.

The regression results reported in Table 4 can be used to devise a schedule of
standard examiner days based on the characteristics of U.S. branches and
agencies.®7¯  This schedule can be represented by a formula, which is derived
by multiplying each variable by its corresponding coefficient:

®7¯ For ease of interpretation, the regression results are presented in terms
of days, as opposed to examiner hours. To convert standard examiner days to
examiner hours, simply multiply standard days by eight.

Standards days=27.3 + 0.0315 x  TOTXLE1B + 0.0118 x  TOTXGT1B + 0.0098 x 
IPOOR x  TOTXLE1B + 0.12 x  IPOOR x  TOTXGT1B + 0.25 x  PIBAD x  TOTXLOANS +
15.3 x  AIMPOOR + 0.039 x  OFFXLE1B + 0.0167 x  OFFXGT1B + 0.0377 x  OBSXLE1B
+ 0.0004 x  OBSXGT1B + 0.0981 x  NONACCR + 0.228 x  PASTDUE.

c2,L2,i1,s50,6.6

Table 4. Regression Results: Examiner-Days Regressed on Branch and Agency
Characteristics

 [col head 1] Variable  [col head 1] Coefficient estimate (t-statistics are
listed in parentheses)

INTERCEPT 	27.3** 	(6.6)

TOTXLE1B 	0.0315** 	(3.2)

TOTXGT1B 	0.0118* 	(2.6)

IPOOR x TOTXLE1B 	0.0098 	(0.6)

IPOOR x TOTXGT1B 	0.120** 	(6.9)

PIBAD x TOTLOANS 	0.250** 	(7.4)

AIMPOOR 	15.3* 	(2.5)

OFFXLE1B 	0.0390** 	(2.9)

OFFXGT1B 	0.0167** 	(3.5)

OBSXLE1B 	0.0377** 	(3.6)

OBSXGT1B 	0.0004* 	(2.5)

NONACCR 	0.0981 	(1.1)

PASTDUE 	0.228 	(0.6)rs,n

Adjusted R®2¯  	0.85

Regression F-statistic significance level (in percents) 	67.7 	0.01

*Significant at the 5 percent confidence level.

**Significant at the 1 percent confidence level.

The coefficient on the INTERCEPT indicates that the minimum standard days for
an examination is 27.3 days. The next two coefficients, on TOTXXLE1B and
TOTXXGT1B, measure the number of additional examiner days typically needed to
examine a given amount of total loans. If the branch or agency has less than
$1 billion in total loans, then the increment to standard days is 0.0315 days
per million dollars of loans. If the branch or agency has more than $1 billion
in total loans, then the increment to standard days attributable to total
loans is 31.5 days ($1,000 million times 0.0315) plus 0.0118 days for each
million dollars of loans in excess of $1 billion.®8¯  The next two
coefficients, on IPOORx TOTXXLE1B and IPOORx TOTXXGT1B, measure the increment
to standard days (over and above that already added by TOTXXLE1B and
TOTXXGT1B) required to examine loans if the branch's or agency's I rating is 3
or worse.®9¯  For branches or agencies with total loans less than $1 billion
and an I rating no better than 3, the increment to standard days attributable
to total loans increases by an additional 0.0098 days per million dollars of
loans (the coefficient on IPOORx TOTXXGT1B), for a total of 0.0413 days per
million dollars of loans. For branches or agencies with total loans above $1
billion and an I rating no better than 3, standard days increases by an
additional 0.120 days per million dollars of loans in excess of $1 billion
(the coefficient on IPOORx TOTXXLE1B), for a 0.1318, plus an additional 9.8
days for the first $1 billion, for a total of 41.3 days for the first billion.
The coefficient on PIBADx TOTXXLOANS, 0.25, is the increment to standard days
per million dollars of loans for branches or agencies that have an I rating of
4 or worse in the previous exam. The coefficient on AIMPOOR indicates that the
increase in the minimum standard days for a branch or an agency with a current
AIM rating of 3 or worse is 15.3 days.

®8¯ This result suggests that there may be economies of scale in examining
total loans. As discussed above, examiner hours likely increase with the
number of loans, but decrease with the number of loans that are shared
national credits. At larger values of total loans, the number of loans likely
increases at a slower rate because both loan size and the number of shared
national credits likely increase. This would create the observed relationship
between total loans and examiner hours examiner hours increase as total loans
increase, but they increase more slowly at higher values of total loans.

®9¯ Poor internal controls in a banking office generally lengthen the amount
of time it takes to examine an office of any particular size. Regression
results indicate that scaling this variable against total loans provides a
reasonable basis for assessing a charge taking into account this variable.

The marginal cost in examiner days of examining off-shore loans and
off-balance-sheet derivatives also declines as total off-shore loans and the
notional value of derivatives, respectively, exceed $1 billion. The
coefficient on OFFXXLE1B indicates that up to the first billion dollars of
off-shore loans, standards days increase by 0.039 per million. Above the first
billion dollars of off-shore loans, standard days increase by 0.0167 days per
million of these loans (the coefficient on OFFXXGT1B). The coefficient on
OBSXXLE1B suggests that up to the first billion dollars of off-balance-sheet
derivatives, standard days increase by 0.0377 per million. Above the first
billion dollars of off-balance-sheet derivatives, standard days increase by
0.0004 days per million of the notional value of these instruments (the
coefficient on OBSXXGT1B).

The coefficients on NONACCR and PASTDUE indicate that standard days increase
0.0981 and 0.228, respectively, per million dollars of loans in non-accrual
status and past-due loans. Note that the coefficients on NONACCR and PASTDUE
are not statistically significantly different from zero. However, one would
expect that these variables should have an influence on the amount of time
required to perform an examination. Since it may be the case that these
variables are insignificant because of the small sample size, these variables
are included for consideration. If the coefficients remain insignificant when
estimated using a larger sample, they may be removed from the model.

Paperwork Reduction Act

No collections of information pursuant to section 3504(h) of the Paperwork
Reduction Act (44 U.S.C. 3501 et seq.) are contained in the proposed rule.

Regulatory Flexibility Act

The Regulatory Flexibility Act (5 U.S.C. 601Ä612) does not apply to a rule of
particular applicability relating to rates, wages, corporate or financial
structures or reorganizations thereof. Id. at 601(2). Accordingly the Act's
requirements regarding an initial and final regulatory flexibility analysis
(id. at 603 and 604) are not applicable here.

In any event, two of the requirements of an initial regulatory flexibility
analysis a description of the reasons why the action of the agency is being
considered and a statement of the objectives of, and the legal basis for, the
proposed rule are contained in the supplementary information above. The
Board's proposed rule would require no additional reporting or recordkeeping
requirements by the public; nor are there relevant Federal rules that
duplicate, overlap, or conflict with the proposed rule, other than as required
by law.

Another requirement of the initial regulatory flexibility analysis is a
description of and, where feasible, an estimate of the number of small
entities to which the rule shall apply. The Board's proposed rule would apply
to all U.S. Offices of foreign banks, and would charge each foreign bank for
the costs of examination attributable to that bank's U.S. Offices, as required
by Congress. Thus, the proposed rule fulfills the primary purpose of the
Regulatory Flexibility Act, which is to make sure that agencies' rules do not
impose disproportionate burdens on small businesses.

Accordingly, the Board hereby certifies that the proposed rule, if adopted in
final form, will not have a significant economic impact on a substantial
number of small entities within the meaning of the Regulatory Flexibility Act.

For the reasons set out in the preamble, 12 CFR part 211 is proposed to be
amended as follows:

PART 211 INTERNATIONAL BANKING OPERATIONS (REGULATION K)

1. The authority citation for part 211 is revised to read as follows:

Authority: 12 U.S.C. 221 et seq., 1841 et seq., 3101 et seq., 3901 et seq.,
title II, Pub. L. 97Ä290, 96 Stat. 1235; and title III, Pub. L. 100Ä418, 102
Stat. 1384.

2. Section 211.26 is amended by adding paragraphs (d) through (g) to read as
follows:

 211.26 Examination of offices and affiliates of foreign banks.

                                  * * * * *

(d) Cost of examinations of branches and agencies

(1) Assessment and payment of costs. The Board shall assess against the
foreign bank or its parent the cost of any examination of its U.S. branches or
agencies conducted by the Federal Reserve pursuant to paragraphs (a)(1) or (c)
of this section. The foreign bank or its parent shall pay to the appropriate
Reserve Bank or, if so directed, to the Board the amount assessed for the cost
of such examination.

(2) Determination of cost. The cost assessed by the Board, pursuant to
paragraph (d)(1) of this section, shall be determined by multiplying the
standard hours, determined pursuant to paragraph (d)(3) of this section, by
the hourly rate, determined pursuant to paragraph (f) of this section.

(3) Linear Regression; standard hours formula. (i) The standard hours for a
branch or agency of a foreign bank shall be calculated by using a formula
derived from a linear regression that relates examiner hours to
characteristics of U.S. branches or agencies of foreign banks.

(ii) The linear regression shall be used to estimate coefficients for each
characteristic included in the regression.

(iii) The formula shall be used to calculate standard hours for each branch or
agency of a foreign bank examined by the Federal Reserve by multiplying each
regression coefficient by the value of the corresponding characteristic of the
branch or agency and adding the products to the intercept, which is the
minimum number of standard hours for an examination.

(iv) The value of each of the characteristics used in the calculation
described in paragraph (d)(3)(iii) of this section shall come from the same
sources as the regression data described in paragraph (d)(4) of this section,
but shall be the most recent data that are available upon completion of the
examination for which the charge is being assessed.

(4) Regression data. (i) The data used in the regression shall be collected
from one or more of the following sources: examination reports and Federal
Financial Institutions Examination Council Forms 002 and 002s.

(ii) The data used in the regression shall include data for the year in which
the "Notice of Standard Hours Formula and Hourly Rate for Examinations of U.S.
Offices of Foreign Banks'' (hereafter referred to as "Notice''), provided for
in paragraph (g) of this section, is published in the Federal Register.

(iii) The data used in the regression may, in the discretion of the Board,
also include data relating to previous years, if including such data improves
the predictive ability of the regression and examiners' practices have not
changed significantly since that time.

(5) Regression variables. Characteristics that, in the discretion of the
Board, may be specified as variables in the regression include:

(i) The dollar amounts of each of total assets, total loans, loans
administered by a U.S. branch or agency but booked in off-shore branches,
off-balance sheet derivative and credit activities, loans in non-accrual
status, loans past due 90 days or more, and classified assets; and

(ii) The composite AIM rating and the individual components of the AIM rating
(asset quality, internal controls, and management).

(6) Other considerations regarding variables. In order to improve the
predictive ability of the regression, in the light of developments regarding
characteristics of branches or agencies of foreign banks or the Federal
Reserve's examination practices, the Board may:

(i) Include additional variables other than those specified in paragraph
(d)(5) of this section;

(ii) Drop variables or amend their specification, if appropriate, to allow for
possible interactions between variables or non-linear relationships; or

(iii) Include lagged values of some variables.

(7) Factors considered in determining regression variables. In determining
which variables to include in the regression, the Board shall consider:

(i) The likelihood that a variable would influence examiner hours
significantly or would serve as a proxy for unmeasured variables that would
influence examiner hours significantly;

(ii) The variable's contribution to the predictive ability of the regression;
and

(iii) The reasonableness of the signs and magnitudes of the estimated
coefficients.

(8) Publication of standard hours formula and hourly rate. The formula for
calculating standard hours pursuant to paragraph (d)(3) of this section shall
be published in the Notice provided for in paragraph (g) of this section.

(e) Cost of examination of representative offices

(1) Assessment and payment of costs. The Board shall assess against the
foreign bank the cost of any examination of its representative offices
conducted by the Federal Reserve, pursuant to paragraph (a)(2) of this
section. The foreign bank shall pay to the appropriate Reserve Bank or, if so
directed, to the Board the cost of such examination.

(2) Determination of cost. The cost assessed by the Board, pursuant to
paragraph (e)(1) of this section, shall be determined by multiplying the
actual number of hours taken to examine the representative office by Federal
Reserve examiners by the hourly rate, determined pursuant to paragraph (f) of
this section.

(f) Calculation of hourly rate (1) Formula. The hourly rate charged by the
Board, pursuant to paragraphs (d)(2) and (e)(2) of this section, shall be
calculated as follows:

E:\FR\FM\EP15DE93.000

where:

DC: Direct costs

SC: Support costs

EH: Examiner hours

HR: Hourly rate

(2) Components of formula. The component parts of the hourly rate formula set
out in paragraph (f)(1) of this section are defined as follows:

(i) Direct costs: Those expenses budgeted for the coming year to be charged
directly to the Federal Reserve's Planning and Control System (PACS) for the
examination of U.S. branches, agencies and representative offices of foreign
banks, including, but not limited to, expenses relating to salary and
benefits, travel, materials and supplies, equipment, software, shipping, and
communications.

(ii) Support costs: Those expenses budgeted for the coming year to be charged
to PACS for the usage of support functions during the course of examinations
of U.S. branches, agencies and representative offices of foreign banks,
including, but not limited to, expenses relating to data processing, office
space, housekeeping, and printing and duplication.

(iii) Examiner hours: The number of hours budgeted for on-site examinations of
U.S. branches, agencies, and representative offices of foreign banks by
examiners for the coming year.

(3) Publication of hourly rate. The hourly rate determined pursuant to
paragraph (f) of this section shall be published in the Notice provided for in
paragraph (g) of this section.

(g) Notice of standard hours formula and hourly rate for examinations of U.S.
offices of foreign banks (1) December Notice. A Notice shall be published in
the Federal Register by the Board no later than the first business day in
December of each year. The Notice shall specify the standard hours formula and
the hourly rate to be used by the Federal Reserve to charge for the
examination of U.S. branches, agencies, and representative offices of foreign
banks and shall be effective on January 1 of the calendar year following
publication.

(2) Interim or amended notice. The Board may publish in the Federal Register
an interim or amended Notice from time to time throughout the year. Unless
otherwise specified, an interim or amended Notice will be effective 30 days
after the date of publication in the Federal Register.

Board of Governors of the Federal Reserve System, December 9, 1993.

William W. Wiles,

Secretary of the Board.

[FR Doc. 93Ä30537 Filed 12Ä14Ä93; 8:45 am]

BILLING CODE 6210Ä01ÄM