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Federal Reserve Bank
OF DALLAS
ROBERT

D. M c T E E R , J R .

p re s id e n t
AND

C H IE F

E X E C U T IV E

O F F IC E R

DALLAS, TEXAS

March 20, 1996

7 5 2 65 -5 9 06

Notice 96-30
TO:

The Chief Executive Officer of each
member bank and bank holding company
in the Eleventh Federal Reserve District
SUBJECT
Request for Public Comment
on a Proposal to Amend the Risk-based
Capital Requirements
DETAILS

The Board of Governors of the Federal Reserve System, along with the
Comptroller of the Currency and the Federal Deposit Insurance Corporation, has
requested public comment on a proposal to amend an outstanding proposal to incorpo­
rate a measure for market risk into the risk-based capital guidelines for banks and bank
holding companies. The original proposal was issued in July 1995.
The Board must receive comments by April 8, 1996. Please address com­
ments to William W. Wiles, Secretary, Board of Governors of the Federal Reserve
System, 20th Street and Constitution Avenue, N.W., Washington, D.C. 20551. All
comments should refer to Docket No. R-0884.
ATTACHMENT
A copy of the Board’s notice as it appears on pages 9114-19, Vol. 61, No. 46,
of the Federal Register dated March 7, 1996, is attached.
MORE INFORMATION
For more information, please contact Dorsey Davis at (214) 922-6051. For
additional copies of this Bank’s notice, please contact the Public Affairs Department at
(214) 922-5254.
Sincerely yours,

J9
.

.

Fo r additional copies, bankers and others are encouraged to use one of the following toll-free num bers in contacting the Federal
Reserve Bank of Dallas: Dallas Office (800) 333 -4460; E l Paso Branch Intrastate (800) 592-1631, Interstate (800) 351-1012; H ouston
Branch Intrastate (800) 392-4162, Interstate (800) 221-0363; San A ntonio 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)

9114

Proposed Rules

Federal Register
Vol. 61, No. 46
T hursday, M arch 7, 1996

This section of th e FEDERAL REGISTER
contains notices to the public of the proposed
issuance of rules and regulations. The
purpose of th ese notices is to give interested
persons an opportunity to participate in the
rule making prior to the adoption of the final
rules.

DEPARTMENT OF THE TREASURY
Office of th'e Comptroller of the
Currency
12CFR Part 3
[Docket No. 96-05]
RIN 1557-AB14

FEDERAL RESERVE SYSTEM
12CFR Parts 208 and 225
[Regulations H and Y; Docket No. R-0884]

FEDERAL DEPOSIT INSURANCE
CORPORATION
12 CFR Part 325
RIN 3064—AB72

Risk-Based Capital Standards; Market
Risk; internal Models Backtesting

Office of the Comptroller of
the Currency, Treasury; Board of
Governors of the Federal Reserve
System; and Federal Deposit Insurance
Corporation.
ACTION: Joint notice of proposed
rulemaking.
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) (Agencies)
are proposing to amend their July 25,
1995, proposal to incorporate a measure
for market risk into their respective riskbased capital standards. The proposed
amendment would provide additional
guidance to an institution about how the
multiplication factor used to calculate
capital requirements for market risk
under the internal models approach
would be adjusted if comparisons of its
internal model’s previous estimates
with actual trading results indicate that
the internal model is inaccurate. The
proposed amendment would increase
the market risk capital charge for an
institution with an inaccurate model.
DATES: Comments must be received on
or before April 5,1996.
SUMMARY:

Comments should be
directed to:
OCC: Comments may be submitted to
Docket No. 96-05, Communications
Division, Third Floor, Office of the
Comptroller of the Currency, 250 E
Street, S.W., Washington, D.C., 20219.
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.COMMENTS@OCC.TREAS.GOV.
Board: Comments directed to the
Board should refer to Docket No. R 0884 and may be mailed to William W.
Wiles, Secretary, Board of Governors of
the Federal Reserve System, 20th Street
and Constitution Avenue, N.W.,
Washington, D.C., 20551. Comments
may also be delivered to Room B-2222
of the Eccles Building between 8:45 a.m.
and 5:15 p.m. weekdays, or to the guard
station 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 a.m. and 5 p.m. weekdays,
except as provided in 12 CFR 261.8 of
the Board’s rules regarding availability
of information.
FDIC: Written comments should be
sent to Jerry L. Langley, Executive
Secretary, Attention: Room F—402,
Federal Deposit Insurance Corporation,
550 17th Street N.W., Washington, D.C.
20429. Comments may be hand
delivered to Room F—402, 1776 F Street
N.W., Washington, D.C. 20429 on
business days between 8:30 a.m. and 5
p.m. (Fax number (202) 898-3838;
Internet address: comments@fdic.gov).
Comments will be available for
inspection and photocopying in Room
7118, 550 17th Street, N.W.,
Washington, D.C. 20429, between 9 a.m.
and 4:30 p.m. on business days.
ADDRESSES:

FOR FURTHER INFORMATION CONTACT:

OCC: Margot Schwadron, Financial
Analyst, or Christina Benson, Capital
Markets Specialist (202/874-5070),
Office of the Chief National Bank
Examiner. For legal issues, Ronald
Shimabukuro, Senior Attorney, or
Andrew Gutierrez, Attorney (202/8745090), Legislative and Regulatory
Activities Division.
Board: Roger Cole, Deputy Associate
Director (202/452-2618), James Houpt,
Assistant Director (202/452-3358),

Barbara Bouchard, Supervisory
Financial Analyst (202/452-3072),
Division of Banking Supervision and
Regulation; or Stephanie Martin, Senior
Attorney (202/452-3198), Legal
Division. For the Hearing impaired only,
Telecommunication Device for the Deaf,
Dorothea Thompson (202/452-3544).
FDIC: William A. Stark, Assistant
Director, (202/898-6972), Miguel D.
Browne, Deputy Assistant Director,
(202/898—6789), or Kenton Fox, Senior
Capital Markets Specialist, (202/8987119), Division of Supervision; Jamey
Basham, Counsel, (202/898-7265) Legal
Division, FDIC, 550 17th Street N.W.,
Washington, D.C. 20429.
SUPPLEMENTARY INFORMATION:

Background
The Agencies’ risk-based capital
standards are based upon principles
contained in the agreement on
International Convergence of Capital
Measurement and Capital Standards
(Accord) issued in July 1988. The
Accord, proposed by the Basle
Committee on Banking Supervision
(Committee) and endorsed by the
central bank governors of the Group of
Ten (G-10) countries,1 assesses an
institution’s capital adequacy by
weighting its assets and off-balancesheet exposures on the basis of credit
risk. In April 1995, the Committee
issued a consultative proposal to
supplement the Accord to cover market
risk, specifically market risk in foreign
exchange and commodity activities and
in debt and equity instruments held in
trading portfolios, in addition to credit
risk.2 On July 25, 1995, the Board, the
OCC, and the FDIC issued a joint
proposal to amend their respective riskbased capital standards in accordance
1The Committee is composed of representatives
of the central banks and supervisory authorities
from the G-10 countries (Belgium, Canada, France,
Germany, Italy, Japan, Netherlands, Sweden,
Switzerland, the United Kingdom, and the United
States) and Luxembourg. The Agencies each
adopted risk-based capital standards implementing
the Accord in 1989.
2 The Committee’s document is entitled “Proposal
to issue a Supplement to the Basle Capital Accord
to cover market risk.” On December 11,1995, the
G-10 Governors endorsed a final supplement to the
Accord incorporating a measure for market risk,
subject to the completion of rulemaking procedures
in countries that require such action. The final
supplement is entitled “Amendment to the Capital
Accord to incorporate market risks.” The proposal
and the final supplement are available through the
Board’s and the OCC’s Freedom of Information
Office and the FDIC’s Reading Room.

Federal Register / Vol. 61, No. 46 / Thursday, March 7, 1996 / Proposed Rules
with the consultative proposal (60 FR
38082) (July 1995 proposal). Under the
July 1995 proposal, an institution with
relatively large trading activities would
calculate a capital charge for market risk
using either its own internal value-atrisk (VAR)3 model (internal models
approach) or, alternatively, risk
measurement techniques that were
developed by the Committee
(standardized approach). The institution
would integrate the market risk capital
charge into its risk-based capital ratios.
Under the internal models approach,
an institution would calculate a VAR
amount using its internal model, subject
to certain qualitative and quantitative
regulatory parameters. The institution’s
capital charge for market risk would
equal the greater of (1) its previous day’s
VAR amount (calculated based upon a
99 percent confidence level and a tenday holding period); or (2) an average of
the daily VAR amounts over the
preceding 60 business days multiplied
by a minimum m ultiplication factor of
three.
The July 1995 proposal also provides
that the Agencies could adjust the
multiplication factor to increase an
institution’s capital requirement based
on an assessment of the quality and
historical accuracy of the institution’s
risk management system. One of the
proposal’s qualitative criteria, which
supervisors would use to evaluate the
quality and accuracy of a risk
management system, is that an
institution would have to conduct
regular backtesting. Backtesting involves
comparing the VAR amounts generated
by the institution’s internal model
against its actual daily profits and losses
(outcomes).
Supervisory Framework for the Use of
Backtesting
Since issuing its consultative
proposal, the Committee developed a
framework that more explicitly
incorporates backtesting into the
internal models approach and directly
links backtesting results to required
capital levels.4 This framework
recognizes that backtesting can be useful
in evaluating the accuracy of an
institution’s internal model, and also
acknowledges that even accurate models
3 Generally, the VAR is an estimate of the
maximum amount that could be lost on a set of
positions due to general market movements over a
given holding period, measured with a specified
confidence level.
4The Committee sets out this framework in a
document entitled “ Supervisory framework for the
use of ‘backtesting’ in conjunction with the internal
models approach to market risk capital
requirements,” which accompanies the document
entitled “Amendment to the Capital Accord to
incorporate market risks,” supra note 2.

(i.e., models whose true coverage level
is 99 percent) can perform poorly under
certain conditions.
The Agencies agree with the
Committee that backtesting can be a
useful tool in evaluating the
performance of an institution’s internal
model but recognize that backtesting
techniques are still evolving and that
they differ among institutions. The
Agencies believe that the framework for
backtesting developed by the Committee
adequately recognizes the limitations of
backtesting, while providing incentives
for institutions to improve the efficiency
of their internal models. The Agencies,
therefore, are proposing to amend their
July 1995 proposal to incorporate a
backtesting framework similar to the
one endorsed by the G-10 Governors, as
described later in the supplementary
information.
Under the supervisory framework for
backtesting, an institution must
compare its internal model’s daily VAR .
amount with the following day’s trading
outcome. The institution must use the
daily VAR amount generated for
internal risk measurement purposes, not
the daily VAR amount generated for
supervisory capital purposes. Moreover,
when making this comparison, the
institution must first adjust the VAR
amount, if necessary, to correspond to
an assumed one-day holding period and
a 99 percent confidence level.
An institution must count the number
of times that the magnitude of trading
losses on a single day, if any, exceeds
the corresponding day’s adjusted VAR
amount during the most recent 250
business days (approximately one year)
to determine the number of exceptions.
The number of exceptions, in turn, will
determine whether and how much an
institution must adjust the
multiplication factor it would use when
calculating capital requirements for
market risk. However, if the institution
demonstrates to its supervisor’s
satisfaction that an exception resulted
from an accurate model affected by
unusual events, the supervisor may
allow the institution to disregard that
exception.
The Agencies recognize that there
may be several explanations for
exceptions. For example, an exception
may result when an institution’s
internal model does not capture the risk
of certain positions or when model
volatilities or correlations are not
calculated correctly. This type of
exception reflects a problem with the
basic integrity of the model. In other
cases, the model may not measure
market risk with sufficient precision,
implying the need to refine the model.
Other types of exceptions, on the other

9115

hand, may occur occasionally even with
accurate models, such as exceptions
resulting from unexpected market
volatility or large intra-day changes in
the institution’s portfolio.
Backtesting results also could prompt
the supervisor to require improvements
in an institution’s risk measurement and
management systems or additional
capital for market risk. When
considering supervisory responses, the
Agencies would take into account the
extent to which trading losses exceed
the VAR amounts, since exceptions that
greatly exceed VAR amounts are of
greater concern than are exceptions that
exceed them only slightly. The Agencies
also could consider, for example, other
statistical test results provided by the"
institution, documented explanations
for individual exceptions, and the
institution’s compliance with applicable
qualitative and quantitative internal
model standards. The first backtesting
for regulatory capital purposes is
scheduled to begin in January 1999,
using VAR amounts and trading
outcomes beginning in January 1998.
Framework fo r Interpreting Backtesting
Results
This framework attempts to balance
the possibility that an accurate risk
model would be determined inaccurate
(Type I error) and the possibility that an
inaccurate model would be determined
accurate (Type II error). Consequently, it
divides the number of possible
exceptions into three zpnes:
(1) The green zone (four or fewer
exceptions)—Backtest results do not
themselves suggest a problem with the
quality or accuracy of the institution’s
internal model. In these cases, backtest
results are viewed as acceptable, given
the supervisors’ concerns of committing
a Type I error. Within this zone, there
is no presumed increase to an
institution’s multiplication factor.
(2) The yellow zone (five through nine
exceptions)—Backtest results raise
questions about a m odel’s accuracy, but
could be consistent with either an
adfcurate or inaccurate model. If the
number of exceptions places an
institution into the yellow zone, then it
must adjust its multiplication factor.
Because a larger number of exceptions
carries a stronger presumption that the
model is inaccurate, the adjustment to
an institution’s multiplication factor
increases with the number of
exceptions. Accordingly, the institution
would adjust its multiplication factor by
the amount corresponding to the
number of exceptions as shown in Table
1.

(3) The red zone (ten or more
exceptions)—Backtest results indicate a

9116

Federal Register / Vol. 61, No. 46 / Thursday, March 7, 1996 / Proposed Rules

problem with the institution’s internal
model, and the probability that the
model is accurate is remote. Unless the
high number of exceptions is attributed
to a regime shift involving dramatic
T a b le 1— A d j u s t m e n t

in

changes in financial market conditions
that result in a number of exceptions for
the same reason in a short period of
time, the institution must increase its
multiplication factor from three to four,

M u l t ip l ic a t io n F a c t o r F r o m R e s u l t s

of

and improve its risk measurement and
management system,
The presumed adjustments to an
institution’s multiplication factor based
on the number of exceptions follow:

B a c k t e s t in g B a s e d

on

2 5 0 T r a d in g O u t c o m e s 1

Zone

No. of excep­
tions

Adjust­
ment to
mul­
tiplica­
tion fac­
tor

Cumu­
lative
prob­
ability
(in per­
cent)

G reen Zone .......................................................................................................................................................................................

4 or fewer ..
5 ..................
6 ..................
7 ..................
8 ..................
9 ..................
10 or more

0.00
0.40
0.50
0.65
0.75
0.85
1.00

89.22
95.88
98.63
99.60
99.89
99.97
99.99

Yellow Zone ......................................................................................................................................................................................

1The zones are defined according to the cumulative probability of obtaining up to a given number of exceptions in a sample of 250 independent observations
when the true level of coverage is 99 percent. The yellow zone begins where the cumulative probability equals or exceeds 95 percent, and the red zone begins
where the cumulative probability equals or exceeds 99.99 percent.

The Agencies urge institutions to
continue working on improving the
accuracy of backtests that use actual
trading outcomes and to develop the
capability to perform backtests based on
the hypothetical changes in portfolio
value that would occur if there were no
intra-holding period changes (e.g., from
fee income or intra-holding period
changes in portfolio composition).
Questions on Which the Agencies
Specifically Request Comment
1. Some industry participants have
argued that VAR measures cannot be
compared against actual trading
outcomes because the actual outcomes
will be contaminated by intra-day
trading and the inclusion of fee income
booked in connection with the sale of
new products. The results of intra-day
trading, they believe, will tend to
increase the volatility of trading
outcomes while the inclusion of fee
income may mask problems with the
internal model. Others have argued that
the actual trading outcomes experienced
by the bank are the most important and
relevant figures for risk management
and backtesting purposes.
*
What are the merits and problems
associated with performing backtesting
on the basis of hypothetical outcomes
(e.g., the changes in portfolio values that
would occur if end-of-day positions
remained unchanged with no intra-day
trading or fee income)?
What are the merits and problems
associated with performing backtesting
on the basis of actual trading profits and
losses?
2. What, if any, operational problems
may institutions encounter in
implementing the proposed backtesting
framework? What changes, if any,

should the Agencies consider to
alleviate those problems?
3. What type of events or regime shifts
might generate exceptions that the
Agencies should view as not warranting
an increase in an institution’s
multiplication factor? How should the
Agencies factor in or exclude the effects
of regime shifts from subsequent
backtesting exercises?
4. The adjustments to the
multiplication factor set forth in Table
1 of the proposal are based on the
number of exceptions in a sample of 250
independent observations. Should the
Agencies permit institutions to use
other sample sizes and, if so, what
degree of flexibility should be provided?
5. The Agencies recognize that an
institution may utilize different
parameters (e.g., historical observation
period) for the VAR model that it
employs for its own risk management
purposes than for the VAR model that
determines its market risk capital
requirements (as specified in the July
1995 proposal). Should the adjustment
to an institution’s multiplication factor
be determined using trading outcomes
backtested against the institution’s VAR
amounts generated for internal risk
management purposes or against the
VAR amounts generated for market risk
capital requirements? Should the
Agencies permit an institution to
choose? Should backtesting be required
against both sets of VAR amounts?
Regulatory Flexibility Act Analysis
OCC Regulatory Flexibility A ct Analysis
Pursuant to section 605(b) of the
Regulatory Flexibility Act, the
Comptroller of the Currency certifies
that this proposal would not have a
significant impact on a substantial

number of small business entities in
accord with the spirit and purposes of
the Regulatory Flexibility Act (5 U.S.C.
601 et seq.). Accordingly, a regulatory
flexibility analysis is not required. The
impact of this proposal on banks
regardless of size is expected to be
minimal. Further, this proposal
generally would apply to larger banks
with significant trading activities and
would cover only trading activities and
foreign exchange and commodity
positions throughout the bank.
Board Regulatory Flexibility A ct
Analysis
Pursuant to section 605(b) of the
Regulatory Flexibility Act, the Board
does not believe this proposal would
have a significant impact on a
substantial number of small business
entities in accord with the spirit and
purposes of the Regulatory Flexibility
Act (5 U.S.C. 601 et seq.). Accordingly,
a regulatory flexibility analysis is not
required. In addition, because the riskbased capital standards generally do not
apply to bank holding companies with
consolidated assets of less than $150
million, this proposal would not affect
such companies.
FDIC Regulatory Flexibility A ct Analysis
Pursuant to section 605(b) of the
Regulatory Flexibility Act (Pub. L. 96354, 5 U.S.C. 601 et seq.), it is certified
that the proposal would not have a
significant impact on a substantial
number of small entities.
Paperwork Reduction Act
The Agencies have determined that
this proposal would not increase the
regulatory paperwork burden of banking
organizations pursuant to the provisions

Federal Register / Vol. 61, No. 46 / Thursday, March 7, 1996 / Proposed Rules
of the Paperwork Reduction Act (44
U.S.C. 3501 etseq.).
OCC Executive Order 12866
Determination
The OCC has determined that this
proposal is not a significant regulatory
action under Executive Order 12866.
OCC Unfunded Mandates Reform Act of
1995 Determination
The OCC has determined that this
proposal would not result in
expenditures by state, local, and tribal
governments, or by the private sector, of
$100 million or more in any one year.
Accordingly, a budgetary impact
statement is not required under section
202 of the Unfunded Mandates Reform
Act of 1995.
List of Subjects
12 CFR Part 3
Administrative practice and
procedure, Capital, National banks,
Reporting and recordkeeping
requirements, Risk.
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
Administrative practice and
procedure, Banks, banking, Capital
adequacy, Reporting and recordkeeping
requirements, Savings associations,
State non-member banks.
Authority and Issuance

2. Appendix B to part 3 as proposed
to be added at 60 FR 38095 would be
amended by revising paragraph (a)(2) of
section 4 and by adding a new
paragraph (d) to section 5 to read as
follows:
Appendix B to Part 3—Market Risk
*
*
*
*
*
S ection 4. M arket R isk E xposure

*

*

*

*

*

*

*

*

*

*

*

*

S e c t io n

5(d )(4 )
T a b l e .— A d ju s t ­
M u l t ip l ic a t io n F a c t o r
F r o m R e s u l t s o f B a c k t e s t in g
B a s e d o n 2 5 0 T r a d in g O u t c o m e s

ment

For the reasons set out in the
preamble, part 3 of title 12 of chapter I
of the Code of Federal Regulations, as
proposed to be amended at 60 FR 38082,
is further proposed to be amended as
follows:

Authority: 12 U.S.C. 93a, 161, 1818,
1828(n), 1828 note, 1831n note, 3907, and
3909.

*

(d) B acktesting. A bank u sin g an internal
m arket risk m odel shall co n d u ct backtesting
as follows:
(1) T h e ban k shall co n d u ct backtesting
quarterly;
(2) For each backtesting, th e b ank shall
com pare the prev iou s 250 busin ess days’
trading outcom es w ith th e corresponding
daily value-at-risk m easurem en ts generated
for its in tern al risk m easu rem en t purposes,
calibrated to a one-day h old in g period and a
99 p ercen t confidence level;
(3) T he bank shall co nsid er each business
day for w h ich the trading loss, if any,
exceeds th e daily value-at-risk m easurem ent
as a n exception; how ever, the OCC m ay
allow th e ban k to disregard an exception if
it determ ines th at the exceptio n does not
reflect an inaccurate m odel; and
(4) D epending o n th e n u m ber of
exceptions, a bank shall ad ju st the
m u ltip licatio n factor of three described in
section 4(a)(2) o f this a p p en d ix B by the
corresponding am ou n t in d icated in Section
5(d)(4) Table, and shall use the adjusted
m u ltip licatio n factor w h en d eterm in ing its
m arket risk capital requirem ents u n til it
obtains the next quarter’s backtesting results,
u nless the OCC determ ines th at a different
adjustm ent or oth er action is appropriate:

12 CFR CHAPTER I

1. The authority citation for part 3
continues to read as follows:

*

Sectio n 5. Q ualifying In terna l M arket R isk
M odel

Office of the Comptroller of the
Currency

PART 3— MINIMUM CAPITAL RATIOS;
ISSUANCE OF DIRECTIVES

*

(a) * * *
(2) T he average of the daily value-at-risk
am ounts for each of the precedin g 60
bu siness days tim es a m u ltip lic atio n factor of
three, ex cep t as pro vid ed in section 5(d).

to

No. of exceptions

4 or fewer ...............................................
5 ................................................................
6 ................................................................
7 ................................................................
8 ................................................................
9 ................................................................
10 or m o r e ..............................................
*

*

*

*

*

Adjust­
ment
to mul­
tiplica­
tion
factor
0.00
0.40
0.50
0.65
0.75
0.85
1.00

9117

Dated: February 26,1996.
Eugene A. Ludwig,
C om ptroller o f th e Currency.

Federal Reserve Board
12 CFR CHAPTER H

For the reasons set forth in the
preamble, parts 208 and 225 of title 12
of chapter II of the Code of Federal
Regulations, as proposed to be amended
at 60 FR 38082 (July 25,1995) are
further proposed to be 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. 36, 248(a), 248(c),
321-338a, 371d, 461, 481-486, 601, 611,
1814, 1823(j), 1828(o), 18310, 1 8 3 1 p -l, 3105,
3310, 3331-3351, and 3906-3909; 15 U.S.C.
78b, 781(b), 781(g), 78l(i), 78o-4(c)(5), 78q,
78q—1, an d 78w; 31 U.S.C. 5318; 42 U.S.C.
4012a, 4104a, 4104b, 4106, and 4128.

2. In appendix E to part 208 as
proposed to be added at 60 FR 38103,
section III.B. would be amended by
revising paragraph 2.a. and adding a
new paragraph 3 to read as follows:
Appendix E to Part 208—Capital
Adequacy Guidelines for State Member
Banks: Market Risk Measure
*

*

*

*

*

m . The Internal M odels Approach
*

*

*

*

*

'

B. * * *
2. * * *

a. A bank m ust have a risk control u n it that
is in d ep en d en t from its business trading
un its an d reports directly to senior
m anagem ent of the bank. The u n it m ust be
responsible for designing an d im plem enting
the b an k ’s risk m anagem ent system and
analyzing daily reports on the o u tp u t of the
b an k ’s risk m easurem ent m odel in the
context of trading limits. The u n it m ust
co n d u ct regular b ack testin g 13 an d adjust its
m ultip licatio n factor, if appropriate, in
accordance w ith section III.B.3. of this
ap p en d ix E.

*
£

*
*
* * *

*

*

3. In addition to any backtesting the bank
m ay co n d u ct as part of its internal risk
m anagem ent system , the bank m ust conduct,
for regulatory capital purposes, backtesting
that m eets the following criteria:
a. The backtesting m ust be conducted
quarterly, using the m ost recent 250 trading
days’ outcom es and VAR m easures, w hich
encom pass approxim ately tw elve months.
The VAR m easures m u st be calibrated to a
one-day holding period and a 99 percent
confidence level.
b. The b an k should identify the num ber of
exceptions (that is, cases w here the

9118

Federal Register / Vol. 61, No. 46 / Thursday, March 7, 1996 / Proposed Rules

m agnitude of th e d aily trading loss, if any,
exceeds the p rev iou s d a y ’s VAR m easure) to
determ ine its ap pro priate zone and level

w ithin a zone, as set forth in Table A of
section III.B.3.c. of th is ap p en d ix E.
c- A bank sh ou ld adjust its m u ltip licatio n
factor by the a m o u n t in d icated in Table A of

th is paragraph c., un less the Federal Reserve
determ ines that a different adjustm ent or
other action is appropriate:

T a b le A — A d ju s t m e n t t o M u l t ip l ic a t io n F a c t o r f r o m R e s u l t s o f B a c k t e s t in g B a s e d o n 2 5 0 T r a d in g
O utcomes

Level (No.
of e x cep ­
tions)

Zone

G reen Zone .......................................................................................................................................................................................

Yellow Zone ......................................................................................................................................................................................

Adjust­
ment
to mul­
tiplica­
tion
factor

Cumu­
lative 1
prob­
ability
(in per­
cent)

0.00
0.40
0.50
0.65
0.75
0.85
1.00

89.22
95.88
98.63
99.60
99.89
99.97
99.99

4 or fewer ..
5 ..................
6 ..................
7 ..................
8 ..................
9 ..................
10 or more

1 The zo nes a re defined according to the cumulative probability of obtaining up to a given num ber of exceptions in a sam ple of 250 independ­
ent observations w hen the true coverage level is 99 percent. The yellow zone begins w here cumulative probability equals or exceed s 95 percent,
and the red zone begins w here the cumulative probability equals or ex ceeds 99.99 percent.

*

*

*

*

*

PART 225— BANK HOLDING
COMPANIES AND CHANGE IN BANK
CONTROL (REGULATION Y)

Appendix E to Part 225—Capital
Adequacy Guidelines for Bank Holding
Companies: Market Risk Measure
*
*
*
*
*
III. The Internal M odels Approach

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—1, 1843(c)(8), 1844(b),
1972(1), 3106, 3108, 3310, 3331-3351, 3907,
a nd 3909.

2. In appendix E to part 225 as
proposed to be added at 60 FR 38116,
section III.B. would be amended by
revising paragraph 2.a. and adding a
new paragraph 3 to read as follows:

*

*

*

B

*

*

*

2

*

*

*

*

*

a. A institu tion m u st have a risk control
u n it that is in d e p e n d e n t from its business
trading un its a n d reports directly to senior
m anagem ent o f th e bank h old ing com pany.
The u n it m u st be respo n sible for designing
and im plem enting the in stitu tio n ’s risk
m anagem ent system a n d analyzing daily
reports on th e o u tp u t of the in stitu tio n ’s risk
m easurem ent m odel in the context of trading
lim its. T he u n it m u st co n d u ct regular
b a ck te stin g 13 a n d ad just its m u ltip lication
factor, if ap p ro priate, in accordance w ith
section III.B.3. of th is ap p en d ix E.

*

*
£

*

*
*

*

*

*

3. In ad d itio n to any backtesting the bank
h olding com pan y m ay co n d u ct as part of its
internal risk m anagem ent system , the bank
h olding com pan y m u st conduct, for
regulatory capital purpo ses, backtesting that
m eets th e follow ing criteria:
a. The backtesting m ust be co n du cted
quarterly, u sing th e m ost recent 250 trading
d ay s’ outcom es a n d VAR m easures, w hich
encom pass ap proxim ately tw elve m onths.
T he VAR m easures m u st be calibrated to a
one-day holding perio d a n d a 99 percent
confidence level.
b. T he ban k ho ld in g com pany sho u ld
identify the num ber of exceptions (that is,
cases w here the m ag nitud e of the daily
trading loss, if any, exceeds the previous
d a y ’s VAR m easure) to determ ine its
app ropriate zone a n d level w ith in a zone, as
set forth in Table A o f section III.B.3.C. of th is
app en dix E.
c. An institu tion sh o u ld ad just its
m u ltip licatio n factor by the am o u nt in dicated
in Table A of th is paragraph c., unless the
Federal Reserve determ ines th at a different
adjustm ent or o th er action is appropriate:

T a b le A.— A d j u s t m e n t t o M u l t i p l i c a t i o n F a c t o r F r o m R e s u l t s o f B a c k t e s t i n g B a s e d o n 2 5 0 T r a d i n g O u t c o m e s
Zone
Green Zone ....................................................................................................................................................................
Yellow Zone ...................................................................................................................................................................
Red Zone ........................................................................................................................................................................

Level
(No. of ex­
ceptions)
4 or fewer ..
5 ..................
6 ..................
7 ..................
8 ..................
9 ..................
10 or more

Adjustment to
multiplication
factor
0.00
0.40
0.50
0.65
0.75
0.85
1.00

Cumulative'
probability
(in percent)
89.22
95.88
98.63
99.60
99.89
99.97
99.99

1The zones are defined according to the cumulative probability of obtaining up to a given number of exceptions in a sample of 250 independent observations
when the true coverage level is 99 percent. The yellow zone begins where cumulative probability equals or exceeds 95 percent, and the red zone begins where
the cumulative probability equals or exceeds 99.99 percent.

Federal Register / Vol. 61, No. 46 / Thursday, March 7, 1996 / Proposed Rules
2. In appendix C to part 325 as
proposed to be added at 60 FR 38129,
section III.B.2. introductory text and
section III.B.2.a. would be revised and
section III.B.3. would be added to read
as follows:

By o rder of th e B oard of Governors of the
Federal Reserve System , February 9,1 9 9 6 .
W illiam W. W iles,
S ecetary o f th e Board.

Federal Deposit Insurance Corporation
For the reasons set forth in the
preamble, part 325 of title 12 of chapter
III of the Code of Federal Regulations, as
proposed to be amended at 60 FR 38082
(July 25,1995), is further proposed to be
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),
1 8 1 6 ,1818(a), 1818(b), 1818(c), 1818(t),
1819(Tenth), 1828(c), 1828(d), 1828(i),
1828(n), 1828(o), 1831o, 3907, 3909, 4808;
Pub. L. 1 0 2 -2 3 3 ,1 0 5 Stat. 1 7 6 1 ,1 7 8 9 ,1 7 9 0
(12 U.S.C. 1831n note); Pub. L. 1 0 2 -2 4 2 ,1 0 5
Stat. 2236, 2355, 2386 (12 U.S.C. 1828 note).
to

context o f trading lim its. The u n it m u st
co n d u ct regular back testin g 14 and adjust its
m u ltip licatio n factor, if appropriate, in
accordance w ith section III.B. 3. of this
ap pen d ix C.

*

*

*

*

*

3. In ad d itio n to any backtesting the bank
m ay co n d u ct as p art of its internal risk
Appendix C to Part 325—Risk-Based
m anagem ent system , the bank m ust conduct,
Capital for State Non-Member Banks:
for regulatory capital purposes, backtesting
Market Risk
that m eets the follow ing criteria:
a. The backtesting m u st be conducted
quarterly, using th e m ost recent 250 trading
HI. The Internal M odels Approach
days’ outcom es a n d VAR m easures, w hich
*
*
*
*
*
encom pass approxim ately tw elve m onths.
B. * * *
T he VAR m easures m ust be calibrated to a
| * * *
one-day h o ldin g period and a 99 percent
2.
A bank m u st m eet th e follow ing
confidence level.
m in im um qualitative criteria before using its
b. The bank sho u ld identify the nu m b er of
internal m odel to m easure its exposure to
exceptions (that is, cases w here the
m arket risk.13
m agnitude of th e daily trading loss, if any,
a.
A bank m u st have a risk control u n it that exceeds th e previous d a y ’s VAR m easure) to
is in d ep e n d e n t from its business trading
determ ine its ap p ro p riate zone and level
un its an d reports directly to senior
w ith in a zone, as set forth in Table A of
m anagem ent of the bank. T he u n it m ust be
section III.B.3.C. of this app en dix C.
responsible for designing and im plem entin g
c. A b an k sh ou ld adjust its m ultiplication
the b a n k ’s risk m anagem ent system and
factor by the am o u n t ind icated in Table A,
analyzing d aily reports on the o u tp u t of the
u nless th e FDIC determ ines th at a different
b an k ’s risk m easurem ent m odel in the
adjustm ent or o th er action is appropriate.

12 CFR CHAPTER ID

T a b le A .— A d j u s t m e n t

9119

M u l t ip l ic a t io n F a c t o r F r o m R e s u l t s

Zone

of

B a c k t e s t in g B a s e d

on

2 5 0 T r a d in g O u t c o m e s

Level
No. of excep­
tions)

Adjustment to
multiplication
factor

Cumulative1
probability (in
percent)

5 ..................
6 ..................
7
8 ..................
9 ..................
10 or more

0 00
0.40
0.50
0 65
0.75
0.85
1.00

89 22
95.88
98.63
99 60
99.89
99.97
99.99

G reen Zone ..................................................................
Yellow Zone ............................................................................................
Red Zone ............................................................................

' The zones are defined according to the cumulative probability of obtaining up to a given number of exceptions in a sample of 250 independent observations
when the true coverage level is 99 percent. The yellow zone begins where cumulative probability equals or exceeds 95 percent, and the red zone begins where
the cumulative probability equals or exceeds 99.99 percent.
*

*

*

*

*

By o rder of the Board of Directors.
Dated at W ashington, D.C., this 27th day of
February 1996.
Jerry L. Langley,
E xecutive Secretary.
[FR Doc. 96-5235 Filed 3 -6 -9 6 ; 8:45 am)
BILLING CODE 4810-33—P (Vi), 6210-01-P (Vs), 671401 -P (V4)

13 Back-testing includes ex post comparisons of
the risk measures generated by the model against
the actual daily changes in portfolio value.

FEDERAL RESERVE BANK OF DALLAS
P.O . BOX 6 5 5 9 0 6
DALLAS, TX 7 5 2 6 5 - 5 9 0 6