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GASB Statement No. 3
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GASB-3 as it Relates to Bank Holding Companies

by Gregory Irvine, City of Corona

During the Nuts and Bolts session at the CMTA Annual Conference in Sacramento, questions were raised regarding custodial credit risk when the counterparty to a transaction and the custodian are both banks owned by the same bank holding company. This topic is addressed in the November 1997 GASB Technical Bulletin No. 97-1.

GASB Statement No. 3 establishes numerical categories of risk relating to the custody and safekeeping of deposits and investments held by third party custodians. The categories for deposits are classified as follows:

  • Category 1 - Insured or collateralized with securities held by the entity or by its agent in the entity's name.
  • Category 2 - Collateralized with securities held by the pledging financial institution's trust department or agent in the entity's name.
  • Category 3 - Uncollateralized

The Statement further categorizes investment custodial risk as follows:

  • Category 1 - Insured or registered, or securities held by the entity or its agent in the entity's name.
  • Category 2 - Uninsured and unregistered, with securities held by the counterparty's trust department or agent in the entity's name.
  • Category 3 - Uninsured and unregistered, with securities held by the counterparty, or by its trust department or agent but not in the entity's name.

The purpose of these categories is to provide a reference point for parties interested in the financial statements of the governmental agency to assess the level of custodial risk exposure associated with the agency's deposits and investments. This has nothing to do with the credit risk of the institutions issuing the securities but rather the risk that the entity holding securities on behalf of the agency may not sufficiently protect the agencies claim to those securities.

While much has been written on this subject, the question at the Nuts and Bolts session dealt primarily with understanding GASB-3 classification as it pertains to situations where the counterparty and the bank custodial agent are banks controlled by the same bank holding company. This situation is becoming more difficult to monitor in an environment of frequent bank mergers and acquisitions. In this case, true separation of the counterparty and the custodial agent become clouded. According to GASB TB 97-1, the counterparty and the custodian bank are considered as one entity if controlled by the same bank holding company. In this case, any investments or collateral held by such an entity should be classified under category 3. However, category 1 classification would be appropriate if the investments are insured or registered.

The Bulletin further provides clarification for companies under the Glass-Steagall Act when a counterparty is a "Section 20" subsidiary and the bank-custodial agent are controlled by the same bank holding company. Under a "Section 20" subsidiary, federal banking law requires a clear separation between financial institutions and trust departments. Never-the-less, a relationship still exists between the counterparty and the custodian and therefore investments held by a "Section 20" custodian may be classified in category 2 provided that the investments are held in the name of the public agency. As is the case with a non "Section 20" subsidiary, investments that are insured or registered may be classified as category 1.

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