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F ed er a l R es e r v e Ban k of Dallas ROBERT D. McTEER, JR. DALLAS, TEXAS PR ES ID EN T 75265-5906 AND CH IE F E X EC U TIVE O FFICER January 16, 1998 Notice 98-05 TO: The Chief Executive Officer of each financial institution and others concerned in the Eleventh Federal Reserve District SUBJECT Interim Rule and Request for Public Comment on Risk-Based Capital Standards DETAILS The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation (collectively, the Agencies) have issued an interim rule and requested public comment on their respective risk-based capital standards for market risk applicable to certain banks and bank holding companies with signifi cant trading activities. The amendment eliminates the requirement that when an institution measures specific risk using its internal model, the total capital charge for specific risk must equal at least 50 percent of the standard specific risk capital charge. The amendment implements a revision to the Basle Accord that permits such treatment for an institution whose internal model adequately measures specific risk. The rule will reduce regulatory burden for institutions with qualifying internal models because they will no longer be required to calculate a standard specific risk capital charge. The interim rule became effective December 31, 1997. The Board must receive comments by March 2, 1998. Please address comments to William W. Wiles, Secretary, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue, N.W., Wash ington, DC 20551. All comments should refer to Docket No. R-0996. ATTACHMENT A copy of the Agencies’ notice as it appears on pages 68063-69, Vol. 62, No. 249 of the Federal Register dated December 30, 1997, is attached. For additional copies, bankers and others are encouraged to use one of the following toll-free numbers in contacting the Federal Reserve Bank of Dallas: Dallas Office (800) 333-4460; El Paso Branch Intrastate (800) 592-1631, Interstate (800) 351-1012; Houston Branch Intrastate (800) 392-4162, Interstate (800) 221-0363; San Antonio Branch Intrastate (800) 292-5810. This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org) MORE INFORMATION For more information, please contact Dorsey Davis at (214) 922-6051. For addi tional copies of this Bank’s notice, contact the Public Affairs Department at (214) 922-5254. Sincerely yours, Tuesday December 30, 1997 Part V Department of the Treasury Office of the Comptroller of the Currency 12 CFR Part 3 Federal Reserve System 12 CFR Parts 208 and 225 Federal Deposit Insurance Corporation 12 CFR Part 325 Risk-Based Capital Standards: Market Risk; Interim Rule 68063 68064 Federal Register / Vol. 62, No. 249 / Tuesday, December 30, 1997 / Rules and Regulations DEPARTMENT OF THE TREASURY Office of the Comptroller of the Currency 12 CFR Part 3 [Docket No. 97-25] RIN 1557-AB14 FEDERAL RESERVE SYSTEM 12 CFR Parts 208 and 225 [Regulations H and Y; Docket No. R-0996] FEDERAL DEPOSIT INSURANCE CORPORATION 12 CFR Part 325 RIN 3064-AC14 Risk-Based Capital Standards: Market Risk Office of the Comptroller of the Currency, Treasury; Board of Governors of the Federal Reserve System; and Federal Deposit Insurance Corporation. ACTION: Joint interim rale with request for comment. AGENCIES: The Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (Board), and the Federal Deposit Insurance Corporation (FDIC) (collectively, the Agencies) are amending their respective risk-based capital standards for market risk applicable to certain banks and bank holding companies with significant trading activities. The amendment eliminates the requirement that when an institution measures specific risk using its internal model, the total capital charge for specific risk must equal at least 50 percent of the standard specific risk capital charge. The amendment implements a revision to the Basle Accord that permits such treatment for an institution whose internal model adequately measures specific risk. The rale will reduce regulatory burden for institutions with qualifying internal models because they will no longer be required to calculate a standard specific risk capital charge. DATES: This interim rule is effective December 31, 1997. Comments must be received by March 2,1998. ADDRESSES: Comments should be directed to: OCC: Comments may be submitted to Docket No. 97-25, Communications Division, Third Floor, Office of the Comptroller of the Currency, 250 E Street, S.W., Washington DC 20219. SUMMARY: Comments will be available for inspection and photocopying at that address. In addition, comments may be sent by facsimile transmission to FAX number (202) 874-5274, or by electronic mail to regs.comment@occ.treas.gov. Board: Comments directed to the Board should refer to Docket No. R 0996 and may be mailed to Mr. William W. Wiles, Secretary, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue, N.W., Washington DC 20551. Comments addressed to the attention of Mr. Wiles may also be delivered to Room B-2222 of the Eccles Building between 8:45 a.m. and 5:15 p.m. weekdays, or the security control room in the Eccles Building courtyard on 20th Street, N.W. (between Constitution Avenue and C Street) at any time. Comments may be inspected in Room MP-500 of the Martin Building between 9:00 a.m. and 5:00 p.m. weekdays, except as provided in 12 CFR 261.8 of the Board’s Rules Regarding Availability of Information. FDIC: Send written comments to Robert E. Feldman, Executive Secretary, Attention: Comments/OES, Federal Deposit Insurance Corporation, 550 17th Street, N.W., Washington, DC 20429. Comments may be hand-delivered to the guard station at the rear of the 17th Street Building (located on F Street), on business days between 7:00 a.m. and 5:00 p.m. (FAX number (202) 898-3838; Internet address: comments@fdic.gov). Comments may be inspected and photocopied in the FDIC Public Information Center, Room 100, 801 17th Street, N.W., Washington, DC 20429, between 9:00 a.m. and 4:30 p.m. on business days. FOR FURTHER INFORMATION CONTACT: OCC: Roger Tufts, Senior Economic Advisor (202/874-5070), Capital Policy Division; Margot Schwadron, Financial Analyst (202/874-5670), Treasury and Market Risk; or Ronald Shimabukuro, Senior Attorney (202/874-5090), Legislative and Regulatory Activities Division. Board: Roger Cole, Associate Director (202/452-2618), James Houpt, Deputy Associate Director (202/452-3358), Barbara Bouchard, Senior Supervisory Financial Analyst (202/452-3072), Division of Banking Supervision; or Stephanie Martin, Senior Attorney (202/ 452-3198), Legal Division. For the hearing impaired only, Telecommunication Device for the Deaf (TDD), Diane Jenkins (202/452-3544). FDIC: William A. Stark, Assistant Director (202/898-6972), Miguel Browne, Manager (202/898-6789), John J. Feid, Chief (202/898-8649), Division of Supervision; Jamey Basham, Counsel (202/898-7265), Legal Division, Federal Deposit Insurance Corporation, 550 17th Street, N.W., Washington DC 20429. SUPPLEMENTARY INFORMATION: Background The Agencies’ risk-based capital standards are based upon principles contained in the July 1988 agreement entitled “International Convergence of Capital Measurement and Capital Standards” (Accord). The Accord, developed by the Basle Committee on Banking Supervision (Committee) and endorsed by the central bank governors of the Group of Ten (G— countries 10) (G-10 Governors), provides a framework for assessing an institution’s capital adequacy by weighting its assets and off-balance-sheet exposures on the basis of counterparty credit risk.1 In December 1995, the G-10 Governors endorsed the Committee’s amendment to the Accord (effective by year-end 1997) to incorporate a measure for exposure to market risk into the capital adequacy assessment. On September 6, 1996, the Agencies issued revisions to their risk-based capital standards implementing the Committee’s market risk amendment (61 FR 47358). Under the Agencies’ market risk rales, banks and bank holding companies (institutions) with significant trading activities must measure and hold capital for exposure to general market risk arising from fluctuations in interest rates, equity prices, foreign exchange rates, and commodity prices and exposure to specific risk associated with debt and equity positions in the trading portfolio. General market risk refers to changes in the market value of onbalance-sheet assets and off-balancesheet items resulting from broad market movements. Specific risk refers to changes in the market value of individual positions due to factors other than broad market movements and includes such risks as the credit risk of an instrument’s issuer. Under the Agencies’ current rules, an institution must measure its general market risk using its internal risk measurement model, subject to certain qualitative and quantitative criteria, to calculate a value-at-risk (VAR) based capital charge.2 An institution may 1The G -10 countries are Belgium, Canada, France, Germany, Italy, Japan, Netherlands, Sweden, Switzerland, the U nited Kingdom, and the U nited States. The Committee is com prised of representatives of th e central banks and supervisory authorities from th e G— countries and 10 Luxembourg. 2 The VAR-based capital charge is the higher of (i) the previous day’s VAR measure, or (ii) the average of the daily VAR measures for each of the preceding 60 business days m ultiplied by a factor Federal Register / Vol. 62, No. 249 / Tuesday, December 30, 1997 / Rules and Regulations measure its specific risk through a valid internal model or by the so-called standardized approach. The standardized approach uses a riskweighting process developed by the Committee that is applied to individual instruments and through which debt and equity positions in the institution’s trading account are assessed a categorybased fixed capital charge. However, the Agencies’ current rules provide that an institution using an internal model to measure specific risk must hold capital for specific risk at least equal to 50 percent of the specific risk charge calculated using the standardized approach (referred to as the minimum specific risk charge). If the portion of the institution’s VAR which is attributable to specific risk does not equal the minimum specific risk charge, the institution’s VAR-based capital charge is subject to an add-on charge for the difference. The sum of these capital charges is factored into an institution’s risk-based capital ratio. When the Agencies included the minimum specific risk charge as part of the market risk rules, the Agencies recognized that dual calculations of specific risk—that is, calculating specific risk in the internal model as well as using the standardized approach to establish the minimum specific risk charge—would be burdensome. However, the Agencies’ decision to include the minimum specific risk charge was consistent with the Committee’s conviction, at the time the Committee adopted its market risk amendment, that a floor was necessary to ensure that modeling techniques for specific risk adequately measured that risk. Since the Committee adopted the market risk amendment, many institutions have significantly improved their modeling techniques and, in particular, their modeling of specific risk. In September 1997 the Committee determined that sufficient progress had been made to eliminate the use of the minimum specific risk charge and the burden of a separate calculation. Accordingly, the Committee revised the market risk amendment to the Accord so that an institution using a valid internal model to measure specific risk may use the VAR measures generated by the model without being required to compare the model-generated results to the minimum specific risk charge as calculated under the standardized An institution whose internal model does not adequately measure specific risk must continue to calculate the standard specific risk capital charge and add that charge to its VAR-based capital charge to produce its total regulatory capital requirement for market risk. An institution whose internal model adequately captures specific risk may base its specific risk capital charge on the model’s estimates. The Agencies will review an institution’s internal model to ensure that the model adequately measures specific risk. In order to clarify the risks that must be assessed in this regard, the rule contains a new definition that states that specific risk means the changes in market value of specific positions due to factors other than broad market movements, including such risks as idiosyncratic variation as well as event and default risk. In order to adequately capture specific risk, an institution’s internal model must explain the historical price variation in the portfolio and be sensitive to changes in portfolio concentrations (both magnitude and changes in composition), requiring additional capital for greater concentrations. The Agencies will also take into account whether an internal model is robust to an adverse of three. Beginning no later than one year after adopting the m arket risk rules, an institution is required to backtest its internal model. An institution m ay be required to apply a higher m ultiplication factor, u p to a factor of four, based on backtesting results. 3 The revisions are described in the Com m ittee’s docum ent entitled “Explanatory Note: M odification of the Basle Capital Accord of July 1988, as A m ended January 1996” and is available through the Board’s and the OCC’s Freedom of Information Office and the FDIC’s Public Inform ation Center. approach.3 The revisions specify that the specific risk elements of internal models will be assessed consistently with the assessment of the general market risk elements of such models through review by the relevant supervisor and backtesting. To implement this revision to the market risk amendment, the Agencies are issuing an interim rule with a request for comment. As discussed in the section entitled “Interim Effectiveness of the Rule,” the Agencies have found that good cause necessitates making the amendments herein effective immediately, without opportunity for public comment or a delayed effective date. Effectiveness of the amendments herein is on an interim basis, until the Agencies issue a final rule, following public comment on this interim rule, in accordance with the procedures specified in section 553 of the Administrative Procedure Act, 5 U.S.C. 553. The interim rule applies only to the calculation of specific risk under the market risk rules. All other aspects of the market risk rules remain unchanged. Description of the Interim Rule 68065 environment. The model’s ability to capture specific risk must be validated through backtesting aimed at assessing whether specific risk is adequately captured. In addition, the institution must be able to demonstrate that its methodologies adequately capture event and default risk. An institution that has been able to demonstrate to its supervisor that its internal model adequately captures specific risk consistent with the preceding discussion may use its VAR-based capital charge as its measure for market risk. Such an institution will have no specific risk add-on. An institution whose model addresses idiosyncratic risk but does not adequately capture event and default risk will continue to have a specific risk add-on. The specific risk add-on for such an institution may be calculated using either one of two approaches, both of which have the effect of subjecting the modeled specific risk elements of the institution’s internal risk model to a multiplier of four.4 Under the first approach, an institution’s internal model must be able to separate its VAR measure into general market risk and specific risk components. The institution’s measure for market risk would equal the sum of the total VAR-based capital charge (typically three times the internal model’s general and specific risk measure), plus an add-on consisting of the isolated specific risk component of the VAR measure. Alternatively, an institution whose internal model does not separately identify the specific and general market risk of its VAR measure, may use as its measure for market risk the sum of the total VAR-based capital charge, plus an add-on consisting of the VAR measure(s) of the subportfolios of debt and equity positions that contain specific risk. An institution using this approach normally would identify its sub-portfolio structures prior to calculating market risk capital charges and may not alter those sub-portfolio structures without supervisory consultation. An institution using its internal model for specific risk capital purposes must backtest its internal model to assess whether observed price variation arising from both general market risk and specific risk are accurately 4 The m ultiplier applicable to the m odeled general m arket risk elem ents w ill not be affected. Thus, the m ultiplier for general m arket risk will continue to be three, unless a higher m ultiplier is indicated by virtue of the institu tio n ’s backtesting results for general m arket risk, or unless no m ultiplier is applied because the previous day’s VAR for general m arket risk is higher than the 60day average tim es the m ultiplier. 68066 Federal Register / Vol. 62, No. 249 / Tuesday, December 30, 1997 / Rules and Regulations explained by the model. To assist in model validation, the institution should perform backtests on subportfolios containing specific risk, i.e., traded debt and equity positions. The institution should conduct these backtests with the understanding that subportfolio backtesting is a productive mechanism for assuring that instruments with higher levels of specific risk, especially event or default risk, are being accurately modeled. If backtests of subportfolios reflect an unacceptable internal model, especially for unexplained price variation that may be arising from specific risk, the institution should take immediate action to improve the internal model and ensure that it has sufficient capital to protect against associated risks. The Agencies, based on information available to them, presently feel that the industry is making significant progress in developing methodologies for modeling specific risk, although progress relating to measurement of event and default risk lags somewhat. The Agencies’ consultation over the past two years with other national supervisors on the Committee has supported this view. The Agencies expect institutions to continue improving their internal models and particularly to make substantial progress in measuring event and default risk for traded debt and equity instruments. The Agencies intend to work with the industry in these efforts and believe that, over time, market standards for measuring event and default risk will emerge. As individual modeling methodologies are improved and become accepted within the industry as effective measurement techniques for event and default risk, the Agencies will consider permitting all internal models based on that methodology to be applied without any add-on charge. The Basle Supervisors Committee may issue general guidance for capturing event and default risk for trading book instruments. Until such time as standards for measuring event and default risk are established within the industry, the Agencies intend to cooperate with each other and communicate extensively with other international supervisors to ensure that the market risk capital requirements are implemented in an appropriate and consistent manner. The Agencies request comment on all aspects of these amendments to their market risk rules. Interim Effectiveness of the Rule The Agencies’ amendments to their market risk rules are effective on December 31, 1997, but only on an Regulatory Flexibility Act Analysis interim basis during the Agencies’ full notice and comment rulemaking Pursuant to section 605(b) of the process. Section 553 of the Regulatory Flexibility Act, the Agencies Administrative Procedure Act permits have determined that this interim final the Agencies to issue a rule without rule would not have a significant public notice and comment when the economic impact on a substantial agency, for good cause, finds (and number of small entities within the incorporates the finding and a brief meaning of the Regulatory Flexibility statement of reasons therefore in the Act (5 U.S.C. 601 et seq.). The Agencies’ rules issued) that notice and public comparison of the applicability section procedure thereon are impracticable, of the rule to which these amendments unnecessary, or contrary to the public pertain to Consolidated Reports of interest. 5 U.S.C. 553(b)(B). Section 553 Condition and Income (Call Report) data also permits the Agencies to issue a rule on all existing institutions shows that without delaying its effectiveness for the rule will rarely, if ever, apply to thirty days from the publication if the small entities. Accordingly, a regulatory agency finds good cause and publishes flexibility analysis is not required. it with the rule. 5 U.S.C. 553(d)(3). In Paperwork Reduction Act addition, section 302 of the Riegle Community Development and The Agencies have determined that Regulatory Improvement Act of 1994, 12 the interim final rule does not involve U.S.C. 4802(b), permits the Agencies to a collection of information pursuant to issue a regulation which takes effect the provisions of the Paperwork before the first day of a calendar quarter Reduction Act of 1995 (44 U.S.C. 3501 beginning on or after the date on which et seq.). the regulations are published in final OCC Executive Order 12866 form when the agency determines for Determination good cause published with the The OCC has determined that the regulation that the regulation should interim final rule does not constitute a become effective before such time. The “significant regulatory action” for the Agencies have found that good cause purpose of Executive Order 12866. exists, for several reasons. First, the amendments are extremely OCC Unfunded Mandates Reform Act of limited in scope. The number of 1995 Determination institutions subject to the Agencies’ Section 202 of the Unfunded market risk rules, and consequently to Mandates Reform Act of 1995, Public the amendments, is very small, in both Law 104-4 (Unfunded Mandates Act) absolute and relative terms. The requires that an agency prepare a amendments will serve only to reduce budgetary impact statement before regulatory burden, by eliminating the need for institutions that model specific promulgating a rule that includes a risk to make dual calculations under the Federal mandate that may result in expenditure by State, local, and tribal standardized approach in order to governments, in the aggregate, or by the determine their minimum specific risk private sector, of $100 million or more charge. Such calculations, while not in any one year. If a budgetary impact necessarily difficult from an analytical statement is required, section 205 of the standpoint, are a voluminous and Unfunded Mandates Act also requires detailed operation to execute. an agency to identify and consider a Second, immediate effectiveness of reasonable number of regulatory the amendments is necessary. The market risk rules become mandatory for alternatives before promulgating a rule. As discussed in the preamble, this certain institutions in January of 1998, interim rule eliminates the minimum and the Agencies will not be able to complete the full rulemaking process by specific risk charge for institutions that use internal models that adequately that time. Institutions covered by the market risk rule that model specific risk capture specific risk. The effect of this rule is to reduce regulatory burden by would be needlessly forced to commit no longer requiring institutions to make significant internal resources to dual calculations under both the implement the dual calculation institution’s internal model and the approach potentially on a temporary standardized specific risk model. The basis. Contrary to the public interest, OCC therefore has determined that the they could also be placed at a effect of the interim rule on national competitive disadvantage vis a vis their banks as a whole will not result in competitors (intemationally-active expenditures by State, local, or tribal banks in other G-10 countries) who, governments or by the private sector of because of the recent G-10 Governors’ $100 million or more. Accordingly, the endorsement of the Committee’s new OCC has not prepared a budgetary approach, will not be subject to any impact statement or specifically dual calculation requirement. Federal Register / Vol. 62, No. 249 / Tuesday, December 30, 1997 / Rules and Regulations addressed the regulatory alternatives considered. List of Subjects 3. Section 5 of appendix B to part 3 is amended by revising paragraphs (a) and (b) to read as follows: * * * * * Dated: December 19, 1997. Eugene A. Ludwig, Comptroller o f the Currency. Section 5. Specific R isk 12 CFR Chapter II 12 CFR Part 3 Administrative practice and procedure, Capital, National banks, Reporting and recordkeeping requirements, Risk. (b) * * * (2) Specific risk means changes in the m arket value of specific positions due to factors other than broad market movements and includes default and event risk as well as idiosyncratic variations. (a) Specific risk surcharge. For purposes of section 3(a)(2)(ii) of this appendix, a bank shall calculate its specific risk surcharge as follows: (1) Internal m odels that incorporate specific risk, (i) No specific risk surcharge required fo r qualifying internal m odels. A bank that incorporates specific risk in its internal m odel has no specific risk surcharge for purposes of section 3(a)(2)(ii) of this appendix if the bank dem onstrates to the OCC that its internal m odel adequately measures all aspects of specific risk, including default and event risk, of covered debt and equity positions. In evaluating a bank’s internal m odel the OCC w ill take into account the extent to w hich the internal model: (A) Explains the historical price variation in the trading portfolio; and (B) Captures concentrations. (ii) Specific risk surcharge fo r m odeled specific risk that fa ils to adequately m easure default or event risk. A bank that incorporates specific risk in its internal m odel but fails to dem onstrate that its internal m odel adequately m easures all aspects of specific risk, including default and event risk, as provided by this section 5(a)(1), m ust calculate its specific risk surcharge in accordance w ith one of the following methods: (A) If the bank’s internal m odel separates the VAR m easure into a specific risk portion and a general m arket risk portion, th en the specific risk surcharge equals the previous day’s specific risk portion. (B) If the b ank’s internal m odel does not separate the VAR m easure into a specific risk portion and a general market risk portion, then the specific risk surcharge equals the sum of the previous day’s VAR measure for subportfolios of covered debt and equity positions. (2) Specific risk surcharge fo r specific risk n o t m odeled. If a bank does no t model specific risk in accordance w ith section 5(a)(1) of this appendix, then the bank shall calculate its specific risk surcharge using the standard specific risk capital charge in accordance w ith section 5(c) of this appendix. (b) Covered debt and equity positions. If a m odel includes the specific risk of covered debt positions b u t not covered equity positions (or vice versa), then the bank may reduce its specific risk charge for the included positions u nd er section 5(a)(l)(ii) of this appendix. The specific risk charge for the positions not included equals the standard specific risk capital charge under paragraph (c) of this section. * * 12 CFR Part 208 Accounting, Agriculture, Banks, banking, Confidential business information, Crime, Currency, Federal Reserve System, Mortgages, Reporting and recordkeeping requirements, Securities. 12 CFR Part 225 Administrative practice and procedure, Banks, banking, Federal Reserve System, Holding companies, Reporting and recordkeeping requirements, Securities. 12 CFR Part 325 Bank deposit insurance, Banks, banking, Capital adequacy, Reporting and recordkeeping requirements, Savings associations, State non-member banks. Authority and Issuance Office of the Comptroller of the Currency 12 CFR Chapter I For the reasons set out in the joint preamble, part 3 of chapter I of title 12 of the Code of Federal Regulations is amended as set forth below: PART 3— MINIMUM CAPITAL RATIOS; ISSUANCE OF DIRECTIVES 1. The authority citation for part 3 continues to read as follows: Authority: 12 U.S.C. 93a, 161, 1818, 1828(n), 1828 note, 1831n note, 1835, 3907, and 3909. 2. Section 2 of Appendix B to part 3 is amended by revising paragraph (b)(2) to read as follows: Appendix B To Part 3—Risk-Based Capital Guidelines; Market Risk Adjustment * * * * * Section 2. Definitions * * * * * * * * * 68067 * * * * Federal Reserve System For the reasons set forth in the joint preamble, parts 208 and 225 of chapter II of title 12 of the Code of Federal Regulations are amended as follows: PART 208— MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL RESERVE SYSTEM (REGULATION H) 1. The authority citation for part 208 continues to read as follows: Authority: 12 U.S.C. 24, 36, 92(a), 93(a) 248(a), 248(c), 321-338a, 371d, 461, 481-486, 601, 611, 1814, 1816, 1 8 1 8 ,1820(d)(9), 1823(j), 1828(o), 1831, 18310, 1 83 1 p -l, 1831r— , 1835(a), 1882, 2901-2907, 3105, 1 3310, 3331-3351, and 3906-3909; 15 U.S.C. 78b, 781(b), 781(g), 781(i), 78o-4(c)(5), 78q, 7 8 q -l, and 78w; 31 U.S.C. 5318; 42 U.S.C. 4012a, 4104a, 4104b, 4106, and 4128. 2. In appendix E to part 208, section 1., paragraph (a), footnote 1 is revised to read as follows: Appendix E to Part 208—Capital Adequacy Guidelines for State Member Banks; Market Risk Measure Section 1. Purpose, Applicability, Scope, and Effective Date * * * * * * 1 * * * * * 3. In appendix E to part 208, section 2., paragraph (b)(2) is revised to read as follows: * * * * * Section 2. D efinitions * * * * * (b) * * * (2) Specific risk means changes in the market value of specific positions due to factors other than broad market movements. Specific risk includes such risk as idiosyncratic variation, as well as event and default risk. * * * * * 4. In appendix E to part 208, section 5., paragraphs (a), (b), and (c) introductory text are revised to read as follows: * * * * * 1This appendix is based on a framework developed jointly by supervisory authorities from the countries represented on the Basle Committee on Banking Supervision and endorsed by the Group of Ten Central Bank Governors. The framework is described in a Basle Committee paper entitled “A m endm ent to the Capital A ccord to Incorporate Market Risks,” January 1996. Also see m odifications issued in Septem ber 1997. 68068 Federal Register / Vol. 62, No. 249 / Tuesday, December 30, 1997 / Rules and Regulations Section 5. Specific R isk * (a) M odeled specific risk A bank m ay use its internal m odel to m easure specific risk. If the bank has dem onstrated to the Federal Reserve that its internal m odel measures the specific risk, including event and default risk as w ell as idiosyncratic variation, of covered debt and equity positions and includes the specific risk m easures in the VAR-based capital charge in section 3(a)(2)(i) of this appendix, then the bank has no specific risk add-on for purposes of section 3(a)(2)(ii) of this appendix. The m odel should explain the historical price variation in the trading portfolio and capture concentration, both m agnitude and changes in com position. The m odel should also be robust to an adverse environm ent and have been validated through backtesting w hich assesses w hether specific risk is being accurately captured. (b) A dd-on charge fo r m odeled specific risk. If a bank’s m odel measures specific risk, b u t the bank has not been able to dem onstrate to the Federal Reserve that the m odel adequately m easures event and default risk for covered debt a n d equity positions, the n the bank’s specific risk add-on is determ ined as follows: (1) If the m odel is susceptible to valid separation of the VAR measure into a specific risk portion and a general market risk portion, then the specific risk add-on is equal to the previous day’s specific risk portion. (2) If the m odel does not separate the VAR m easure into a specific risk portion and a general m arket risk portion, th en the specific risk add-on is the sum of the previous day’s VAR measures for subportfolios of covered debt and covered equity positions. (c) A dd-on charge i f specific risk is n ot m odeled. If a bank does not m odel specific risk in accordance w ith paragraph (a) or (b) of this section, then the b ank’s specific risk add-on charge equals the com ponents for covered debt and equity positions as appropriate: 3. In appendix E to part 225, section 2., paragraph (b)(2) is revised to read as follows: * * * * * * * * * * PART 225— BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL (REGULATION Y) 1. The authority citation for part 225 continues to read as follows: Authority: 12 U.S.C. 1817(j)(13), 1818, 1828(o), 1831i, 1831p-l, 1843(c)(8), 1844(b), 1972(1), 3106, 3108, 3310, 3331-3351, 3907, and 3909. 2. In appendix E to part 225, the appendix heading is revised and in section 1., paragraph (a), footnote 1 is revised to read as follows: Appendix E To Part 225—Capital Adequacy Guidelines For Bank Holding Companies:'Market Risk Measure Section 1. Purpose, Applicability, Scope, and Effective Date (cl.) * * * 1 * * * 1 This appendix is based on a framework developed jointly by supervisory authorities from the countries represented on the Basle Committee * * * * Section 2. Definitions * * * * * (b) * * * (2) Specific risk, m eans changes in the market value of specific positions due to factors other th an broad market movements. Specific risk includes such risk as idiosyncratic variation, as w ell as event and default risk. * * * * * 4. In appendix E to part 225, section 5., paragraphs (a), (b), and (c) introductory text are revised to read as follows: * * * * * Section 5. Specific R isk (a) M odeled specific risk. A bank holding com pany may use its internal m odel to m easure specific risk. If the institution has dem onstrated to the Federal Reserve that its internal m odel measures the specific risk, including event and default risk as well as idiosyncratic variation, of covered debt and equity positions and includes the specific risk m easures in the VAR-based capital charge in section 3(a)(2)(i) of this appendix, then the institution has no specific risk add on for purposes of section 3(a)(2)(ii) of this appendix. The m odel should explain the historical price variation in the trading portfolio and capture concentration, both magnitude and changes in composition. The m odel should also be robust to an adverse environm ent and have been validated through backtesting w hich assesses w hether specific risk is being accurately captured. (b) A dd-on charge fo r m odeled specific risk. If a bank holding com pany’s m odel measures specific risk, but the institution has not been able to dem onstrate to the Federal Reserve that the m odel adequately m easures event and default risk for covered debt and equity positions, then the institu tio n’s specific risk add-on is determ ined as follows: (1) If the m odel is susceptible to valid separation of the VAR measure into a specific risk portion and a general m arket risk portion, th en the specific risk add-on is equal to the previous day’s specific risk portion. (2) If the m odel does not separate the VAR m easure into a specific risk portion and a general m arket risk portion, then the specific risk add-on is the sum of the previous day’s VAR measures for subportfolios of covered debt and covered equity positions. (c) Add-on charge i f specific risk is not m odeled. If a bank holding com pany does not m odel specific risk in accordance w ith paragraph (a) or (b) of this section, then the in stitution’s specific risk add-on charge on Banking Supervision and endorsed by the Group of Ten Central Bank Governors. The framework is described in a Basle Committee paper entitled “A m endm ent to the Capital Accord to Incorporate Market Risks,” January 1996. Also see m odifications issued in Septem ber 1997. equals the com ponents for covered debt and equity positions as appropriate: * * * * * By order of the Board of Governors of the Federal Reserve System, December 19,1997. W illiam W. Wiles, Secretary o f the Board. Federal Deposit Insurance Corporation 12 CFR Chapter III For the reasons set forth in the joint preamble, part 325 of chapter III of title 12 of the Code of Federal Regulations is amended as follows: PART 325— CAPITAL MAINTENANCE 1. The authority citation for part 325 continues to read as follows: Authority: 12 U.S.C. 1815(a), 1815(b), 1816, 1818(a), 1818(b), 1818(c), 1818(t), 1819(Tenth), 1828(c), 1828(d), 1828(i), 1828(n), 1828(o), 1831o, 1835, 3907, 3909, 4808; Pub. L. 102-233, 105 Stat. 1761,1789, 1790 (12 U.S.C. 1831n note); Pub. L. 1 02242, 105 Stat. 2236, 2355, 2386 (12 U.S.C. 1828 note). 2. In appendix C to part 325, section 1(a), footnote 1 is revised to read as follows: Appendix C to Part 325—Risk-Based Capital For State Non-Member Banks; Market Risk Section 1. Purpose, Applicability, Scope, and Effective Date (a) * * * i * * * * * * * * 3. In appendix C to part 325, section 2., paragraph (b)(2) is revised to read as follows: * * * * * Section 2. Definitions * * * * * (b) * * * (2) Specific risk means changes in the market value of specific positions due to factors other than broad market movements. Specific risk includes such risk as idiosyncratic variation, as w ell as event and default risk. * * * * * 4. In appendix C to part 325, section 5., paragraphs (a), (b), and (c) introductory text are revised to read as follows: * * * * * Section 5. Specific R isk (a) M odeled specific risk. A bank may use its internal m odel to m easure specific risk. If 1This appendix is based on a framework developed jointly by supervisory authorities from the countries represented on the Basle Committee on Banking Supervision and endorsed by the Group of Ten Central Bank Governors. The framework is described in a Basle Committee paper entitled “A m endm ent to the Capital Accord to Incorporate Market Risks,” January 1996. Also see modifications issued in Septem ber 1997. Federal Register / Vol. 62, No. 249 / Tuesday, December 30, 1997 / Rules and Regulations the bank has dem onstrated to the FDIC that its internal m odel measures the specific risk, including event and default risk as well as idiosyncratic variation, of covered debt and equity positions and includes the specific risk m easure in the VAR-based capital charge in section 3(a)(2)(i) of this appendix, then the bank has no specific risk add-on for purposes of section 3(a)(2)(ii) of this appendix. The m odel should explain the historical price variation in the trading portfolio and capture concentration, both m agnitude and changes in composition. The m odel should also be robust to an adverse environm ent and have been validated through backtesting w hich assesses w hether specific risk is being accurately captured. (b) A dd-on charge for m odeled specific risk. If a bank’s m odel measures specific risk, but the bank has not been able to dem onstrate to the FDIC that the model adequately m easures event and default risk for covered debt and equity positions, then the bank’s specific risk add-on for purposes of section 3(a)(2)(li) of this appendix is as follows: (1) If the m odel is susceptible to valid separation of the VAR m easure into a specific risk portion and a general m arket risk portion, then the specific risk add-on is equal to the previous day’s specific risk portion. (2) If the m odel does not separate the VAR m easure into a specific risk portion and a general m arket risk portion, then the specific risk add-on is the sum of the previous day’s VAR measures for subportfolios of covered debt and covered equity positions. 68069 (c) A dd-on charge i f specific risk is n ot m odeled. If a bank does not m odel specific risk in accordance w ith paragraph (a) or (b) of this section, the bank’s specific risk add on charge for purposes of section 3(a)(2)(ii) of this appendix equals the com ponents for covered debt and equity positions as appropriate: * * * * * Dated at W ashington, D.C. this 9th day of December, 1997. By order of the Board of Directors. Federal Deposit Insurance Corporation. Robert E. Feldm an, Executive Secretary. [FR Doc. 97-33653 Filed 12-29-97; 8:45 am] BILLING CODE 4810 -33 -P , 6 210 -01 -P , 6 7 14 -01 -P
@FedFRASER